India: Recent Economic Developments
Author: International Monetary Fund
Publication Date:
01 Nov 2000
eISBN:
9781451818543
Language:
English
Keywords:
ISCR; CR; India; bank; tariff; government; GDP; government securities; state outlay; excise tax; plan fund; state risk; Budget planning and preparation; Government debt management; State sales taxes
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The Indian economy has recovered strongly. The government's poverty alleviation programs have focused on generation of employment in rural areas. The overall deficit of the consolidated public sector has risen sharply in recent years, erasing most of the consolidation that was achieved during the first half of the 1990s. The paper discusses the monetary and financial market developments, reforms and performance, external sector, trade policy, and structural policy developments in India. The new government has taken a number of initiatives committed to structural reform.

Abstract

The Indian economy has recovered strongly. The government's poverty alleviation programs have focused on generation of employment in rural areas. The overall deficit of the consolidated public sector has risen sharply in recent years, erasing most of the consolidation that was achieved during the first half of the 1990s. The paper discusses the monetary and financial market developments, reforms and performance, external sector, trade policy, and structural policy developments in India. The new government has taken a number of initiatives committed to structural reform.

III. Recent Fiscal Developments1

A. Fiscal Trends Over the Last Decade

1. The overall deficit of the consolidated public sector has risen sharply in recent years, erasing most of the consolidation that was achieved during the first half of the 1990s (Chart III.1, upper panel).2 Major fiscal adjustment by the central and state governments and the public sector undertakings (PSUs) in the wake of the 1991 balance of payments crisis helped reduce the deficit of the consolidated public sector by 3 percentage points to 8¼ percent of GDP by 1995/96.3 Since then, however, balances of both the central and state governments have deteriorated, and the public sector deficit is estimated to have reached 11 percent of GDP in 1999/00.

CHART III.1
CHART III.1

INDIA: Government Deficits and Debt, 1990/91 - 1999/2000

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A003

Source: Union budget documents, Reserve Bank of India, Public Enterprise Survey, and staff estimates.1/ Consolidated public sector comprises central and state governments, central public sector undertakings (PSUs), and the Oil Coordinating Committee (OCC). Figures are staff estimates.2/ 1999/00 figure is a staff estimate.

2. Moreover, high deficits and public sector debt levels have adversely affected the composition of expenditure at both the central and state government levels. The debt-service bill has increased steadily, reflecting the reduced share of external concessional financing and pressures on interest rates exerted by the high public sector debt stock—which has averaged in excess of 80 percent of GDP during the decade (Chart III.1, lower panel). In addition, financial sector liberalization has reduced the scope for government pre-emption of domestic saving at nonmarket rates.4 Higher debt-service payments combined with significant increases in salaries and wages in recent years have crowded out spending on infrastructure, health, and education (Chart III.2, top panel).

CHART III.2
CHART III.2

INDIA: Fiscal Indicators - Central and State Governments

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A003

Source: Union budget documents, Reserve Bank of India, Government Subsidies in India (1997).1/ General government comprises central and state governments.2/ 1999/00 figures are revised estimates (central government) or budget estimates (state governments).3/ Expenditures on education, family welfare, medical & public health, and water supply & sanitation. 1997/98 figures are revised estimates; 1998/99 figures are budget estimates.

3. At the central government level, the deficit has increased by more than 2 percentage points since 1996/97, to reach an estimated 7 percent of GDP in 1999/00. This erosion reflects a lack of tax buoyancy and weak expenditure discipline. Tax reforms enacted during the decade—including significant cuts in customs duties—were not accompanied by sufficient base-broadening measures, and the tax revenue ratio (net of tax transfers to the states) fell steadily from 7.7 percent of GDP in 1991/92 to 6.5 percent of GDP in 1999/00 (Chart III.2, middle panel). On the expenditure side, cuts in subsidies and defense expenditures made in the early 1990s were not sustained. Also, as discussed above, the debt-service bill increased steadily throughout the decade, and civil service salaries and pensions rose sharply beginning in 1997/98, following implementation of wage increases recommended by the Fifth Pay Commission.5

4. Deficits at the state government level have also deteriorated significantly, from an aggregate of 2.7 percent of GDP in 1995/96 to around 4.5 percent of GDP in 1999/00 (staff estimate), reflecting weakness in both revenues and expenditures. Tax and grant transfers from the central government have been negatively affected by structural weaknesses in central tax collections and fiscal federal relations (see Box III.1), as well as the center’s consolidation efforts. States’ own tax receipts have been undermined by a narrow base and the competitive provision of tax concessions (see Box III.2), while nontax revenues have been affected by poor cost recovery rates for public services and utilities (Chart III.2, bottom panel). On the expenditure side, although state outlays were reduced by 1.6 percent of GDP in the five years following the 1991 crisis, they subsequently increased strongly with rising interest payments and the upward revision of civil service pay scales beginning in 1998/99.6

5. In contrast, the PSU sector has achieved a relatively durable adjustment, with its consolidated deficit declining from 2.7 percent of GDP at the start of the decade to an estimated 1.8 percent of GDP in 1999/00. This reduction primarily reflects restructuring and downsizing efforts, accompanied by a steady decline in central government budgetary support for PSUs (loans and support for losses), and stricter requirements for enterprises to finance investments either through internal resources or market borrowings (Chart III.3). Tighter budget constraints, in turn, have caused PSU plan expenditures to fall sharply relative to GDP.7 PSUs involved in the petroleum and telecom industries have been among the more profitable enterprises—due partly to regulatory advantage, and partly to improved efficiency in the wake of deregulation—and now account for almost half of PSU plan expenditures.8

CHART III.3
CHART III.3

INDIA: Fiscal Indicators - PSUs, 1990/91 - 1999/2000

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A003

Source: Union budget documents.

India: Fiscal Federal Issues

India’s fiscal federal system involves a fairly complex system of expenditure responsibilities and transfers.

Tax-sharing arrangements

  • Tax sharing-arrangements between the center and states are reviewed by a Finance Commission convened every five years, and have typically involved fixing the percentages of centrally-collected excise and personal income taxes that will be shared with the states. This arrangement has created incentives for the central government to focus most heavily on developing nonshared taxes, especially customs duties.

  • The Tenth Finance Commission (1995-2000) recommended that 77½ percent of personal income taxes and 47½ percent of excise taxes collected by the center be shared with the states, while also suggesting an alternative scheme to devolve 29 percent of almost all central government tax receipts to the states. In February 2000, the new government approved this alternative scheme in large part, and a new bill was passed by Parliament in May.

  • The Eleventh Finance Commission (2000-2005), which is expected to submit its final report by end-June 2000, is reviewing inter alia the revenue-sharing arrangement and the principles governing grants to states for the next five years. As an interim measure for the 2000/01 budget, the Commission assigned 80 percent of centrally-collected income taxes and 52 percent of excise taxes to the states.

  • However, the horizontal distribution of tax revenues across states for 2000/01 and beyond will not be announced until the Commission publishes its final report. Currently, the distribution is based on population, but also provides compensation to states with weak tax bases, poor infrastructure development, and low levels of per capita income. Many analysts have suggested that the system provides inadequate incentives for states to implement fiscal and structural reforms.

Other tax issues

  • Although states have been given constitutional responsibility for taxing the agricultural sector, they have been ineffective in expanding the tax base in this area. In fact, the agricultural sector—which accounts for one-third of national income—is a major beneficiary of direct and indirect subsidies.

  • States also have made extensive use of entry taxes—termed “octroi”—to boost revenues at other states’ expense, distorting trade and production decisions.

  • Sales tax competition among the states—in particular through the provision of tax holidays to businesses—has been severe. A November 1999 agreement among the states was struck to establish floors on sales tax rates and eliminate this incentive (Box III.2).

  • Efforts to develop a nationwide VAT have been complicated by the fact that the center only has constitutional jurisdiction over excises at the manufacturing level. Recent efforts by states to develop a common VAT will require significant improvements in tax administration and will be complicated by the fact that jurisdiction over services has not been constitutionally granted to either the center or the states.

Expenditure assignment and financing

  • Plan assistance is provided to the states to fund both central and state projects, with the total amount of this assistance largely at the discretion of the central government. Allocation across states of support for central and centrally-sponsored plan schemes is also largely discretionary. Assistance for state plans is typically distributed as 30 percent grants and 70 percent loans (for low-income states, the split is 90 percent and 10 percent, respectively), and state plan funds are allocated across states according to a formula based on population (60 percent weight), per capita income (25 percent weight), and fiscal performance (7½ percent weight).

  • Some observers have suggested that the system does not allocate resources toward states that have demonstrated effective project implementation. Moreover, funding often goes to projects without consideration of the states’ ability to finance the recurrent spending requirements that arise once the project is completed.

Financing issues

  • States can access the domestic market directly to mobilize up to 35 percent of their gross borrowing program, which according to the Constitution is subject to central government approval. A number of states (Punjab, Andhra Pradesh, Tamil Nadu, and Kamataka) exercised this option in 1998/99 and 1999/00. Nevertheless, the bulk of market borrowing by the states is still effected through “package” issues of state government securities with a uniform maturity (typically 10 years), and at pre-determined coupon rates which set a small premium to yields on central government securities of similar maturity. A few financially stronger states have been able to borrow directly from the market at more favorable rates.

  • States automatically obtain 75 percent (now 80 percent) of deposits received by the postal saving system (Box III.3). These deposits are onlent to the states at high rates of interest, but in long maturities, and have been actively encouraged by the states since such funds do not fall under centrally-imposed borrowing limits.

  • Borrowing limits also are not adjusted for borrowing against provident funds of state employees, or for guarantees of the debt of off-budget entities.

  • Moreover, borrowing limits are sometimes relaxed by additional central government transfers at year-end to cover accrued financing requirements.

India: Harmonization of State Sales Taxes

The structure of domestic trade taxes in India is very complex and, until recently, there were wide differences between the states with regard to tax rates and coverage. Domestic taxes are also inefficient with a strong cascading element in intra-and inter-state transactions. These complexities and disparities have been exacerbated over the years as the states sought to attract investment by offering incentives in the form of tax exemptions, waivers, deferrals, and refunds. The efficiency of the system and state revenues has been further undermined by weak tax administration and enforcement.

A number of states had attempted to introduce input credit mechanisms in their sales taxes to reduce cascading. These VAT-type taxes were levied either on the basis of turnover or on a select group of commodities. However, implementation difficulties have compelled most states to abandon this approach.

In a landmark decision reached in November 1999, the state governments agreed to harmonize their sales tax structures. As a part of this agreement, which became effective in January 2000:

  • Uniform floor rates (0, 4, 8 and 12 percent) apply to a uniform set of commodities. The states have the option of taxing commodities in each slab up to the rate of the higher slab. In addition, two uniform special floor rates of 1 and 20 percent apply, respectively, to petroleum products and to gold, silver, and precious stones.

  • No new tax incentives are to be granted by the states, and existing incentives are to be gradually phased out.

  • Preparations are to be made to introduce a uniform VAT at the state level by April 1, 2001 with technical assistance from the central government.

6. Throughout the decade, the balance on the accounts of the Oil Coordinating Committee (OCC) has fluctuated inversely with respect to world oil prices, reflecting lags in adjustments to domestic prices (chart).9 However, the deficits have trended downward in recent years (and even turned to significant surplus) as a result of the 1997 petroleum sector reforms, which included a phased withdrawal of the administered pricing mechanism.10 Implementation of the reforms was facilitated by the drop in world oil prices in 1998, and the need to repay debts associated with previous years’ deficits. 1999/00 was an exception to this recent trend, and an OCC deficit re-emerged as a result of delays in adhering to scheduled price adjustments in the face of the significant rise in world petroleum prices.

uA03fig01

OCC Balance and World Oil Prices

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A003

Source: Ministry of Petroleum, IFS.OCC deficit figure for 1999/00 is a revised estimate.

B. Central Government Fiscal Performance in 1998/1999

7. Against a background of sluggish economic activity, the 1998/99 central government budget sought to achieve modest deficit reduction while boosting growth through increased public investment spending, especially in infrastructure (Table III.1). The deficit was targeted at 5.5 percent of GDP—a 0.4 percentage point reduction relative to the 1997/98 outturn—to be accomplished primarily through increased tax collections.11 Tax revenues were projected to rise by 0.4 percent of GDP in response to a rationalization of excise tax rates, a 4 percent surcharge on import duties, and measures to improve tax compliance and widen the tax base—including the expansion of a mandatory tax filing scheme, new filings by VDIS respondents, and the inclusion of additional services under the service tax net.12 13 On the expenditure side, a reduction in net lending to state governments was expected to free modest resources for higher plan spending.

Table III.1.

India: Central Government Operations, 1996/97-2000/01

article image
Sources: Data provided by the Indian authorities; and staff estimates and projections.

Includes onlending to the states from Small Savings Schemes.

Total revenues and grants less current expenditures.

Authorities’ definition excludes onlending to states of small savings collections from capital expenditure and net lending beginning in 1999/00; divestment receipts are included in nontax revenue, rather than in domestic financing.

Figure for 2000/01 is a staff projection.

8. In the event, the central government deficit rose to 6.8 percent of GDP in 1998/99, due to both revenue shortfalls and expenditure overruns.14 Total revenues and grants fell almost 1 percentage point short of target, owing largely to lower excise and customs collections. Excise tax revenues were adversely impacted by slowing industrial growth, while customs revenues were affected by lower trade volumes and a decline in import unit values (particularly for petroleum products). However, corporate and personal income tax collections were only slightly below target, as improved income tax collection and lower depreciation provisions made by PSUs (mainly oil refineries) offset the impact of slower growth.

9. Total expenditures and net lending in 1998/99 were 0.4 percent of GDP higher than budgeted. Significant shortfalls in plan and capital expenditures were more than offset by larger outlays for interest payments, pensions and subsidies, and higher grants and onlending against small savings collections to state governments (see Box III.3). Larger interest payments resulted from higher-than budgeted borrowing, and the replacement of maturing domestic debt at higher interest rates. Cost-of-living adjustments and higher-than-expected backpayments associated with the Fifth Pay Commission awards raised pension outlays, and a hike in payments to manufacturers and importers of fertilizer in late 1998 increased subsidy payments. Higher onlending to state governments resulted from strong growth of small savings collections, which were actively encouraged by the states in order to finance their growing deficits (discussed below).

10. The central government’s deficit in 1998/99 was financed almost entirely from domestic sources, as has historically been the case (Chart III.4, top panel). The increase in the deficit over 1997/98 was met largely by higher market borrowing, although the increase in small saving collections was also an important source of funding. On March 31, 1999, total liabilities of the central government—including small saving deposits, provident funds, and other accounts—stood at Rs 8.8 trillion, or 50 percent of GDP. Of this, only about 3 percentage points were external liabilities, while 26 percentage points were in the form of domestic securities and loans, largely held by domestic banks and other financial institutions (Chart III.4, bottom panel).

CHART III.4
CHART III.4

INDIA: Central Government Financing and Debt, 1990/91 - 2000/01

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A003

Sources: Union budget documents, Reserve Bank of India, and staff estimates.

India: Small Savings Schemes

Background

An extensive system of small savings schemes are administered by the central government in India, principally in the form of deposits made with post offices. Through March 1999, three-fourths of the amount collected under these schemes were on-lent to the governments of the states where the deposits were made. Interest rates on the loans during 1998/99 were 13.5-14 percent, while most deposit rates ranged between 9 percent and 13.5 percent. However, tax incentives also applied to these deposits, implying that effective deposit rates were even higher. Given the tax incentives and administration costs born by the central government, the loans to the states implied a significant interest rate subsidy, compounded by the maturity mismatch between deposits and loans—loan maturities are typically 25 years with a 5-year grace period, while deposit maturities range only up to five years.

This arrangement has had the effect of softening the states’ budget constraints. Although states are subject to annual borrowing limits set by the central government, these limits are not adjusted for the on-lending from small savings schemes. As a result, state governments have made vigorous efforts to increase small savings deposits, including by offering incentives to depositors.

Accounting treatment

From 1991, the inflow from small savings schemes was treated as below-the-line financing in the central government’s main fiscal account, while the 75 percent of collections that were on-lent to state governments were recorded under capital expenditures and net lending. In the states’ fiscal accounts, on-lending of small savings deposits by the center was treated as a financing item. In consolidating the general government and public sector accounts, loans between the center and the states net out, and total inflows from small savings schemes were recorded as financing, while no adjustment was made to general government expenditures.

Given strong growth of small savings deposits, and since on-lending against these deposits was treated as an explicit expenditure item, the old accounting treatment inflated the central government deficit in recent years—by 1.3 percent of GDP in fiscal year 1998/99, in particular. This prompted the authorities to announce in the 1999/2000 budget a change in accounting treatment effective April 1, 1999.

Small savings collections and associated withdrawals have subsequently been shown as credits to and debits from, respectively, a new “National Small Savings Fund,” recorded in a separate central government account. One quarter of the accumulated net balance of this fund is invested in central government securities, while the remaining three quarters is invested in state government securities.1 Only the central (state) government securities sold to the new fund are shown as financing on the central (state) governments’ main fiscal account. However, since funds borrowed by the states against small savings collections are no longer treated as an explicit expenditure item of the center, the new system substantially lowers the central government’s measured deficit—although the consolidated states’ and general government deficits have been unaffected.

Small Savings Schemes and Fiscal Accounting

(In percent of GDP)

article image
Source: Data provided by the Indian authorities.

Excludes divestment proceeds.

1 From 2000/01, 20 percent of the accumulated net balance are to be invested in central government securities, and 80 percent in state government securities.

C. Central Government Fiscal Performance in 1999/2000

11. The 1999/2000 central government budget targeted a deficit of 5.8 percent of GDP— 1 percentage point lower than the outturn for 1998/99.15 About one-third of this improvement was to be achieved through expenditure reductions, while tax reforms and a pickup in industrial activity were expected to generate 0.7 percent of GDP in additional revenues.

12. On the revenue side:

  • New tax measures were expected to increase revenues by a total of Rs 93 billion (0.5 percent of GDP). These included a temporary 10 percent income tax surcharge imposed on corporations and higher-income individual taxpayers, a Rs 1 per liter diesel fuel tax, and the replacement of 5 percent in special duties on imports (imposed between 1996 and 1998) with a new 10 percent surcharge.16

  • Measures to streamline the tax system included a reduction in the number of ad valorem excise rates from 11 to 3 (although a number of special excise surcharges were also imposed), and a reduction in the number of tariff bands from 7 to 5.

  • Also, new tax incentives were introduced to stimulate the capital markets, corporate restructuring, bank provisioning, research and development, the housing sector, and the entertainment industry.

13. On the expenditure side:

  • Food subsidies were budgeted to fall by 0.1 percent of GDP, due to increases in the prices of foodgrains sold through the Public Distribution System (PDS) announced in February.17

  • After substantial increases in 1998/99, due to higher-than-anticipated inflation and associated cost-of-living adjustments, pension payments were expected to remain roughly constant in rupee terms, implying a decline of 0.1 percentage points relative to GDP. Central government wages and salaries were also budgeted to fall slightly as a result of downsizing efforts—in particular, the abolition of four Secretary-level posts and the associated merger and rationalization of central government departments.

  • Higher-budgeted spending on central government plan programs and other capital expenditures was roughly offset by lower budgeted loans and grants to state governments and PSUs.

14. Other policy initiatives announced in the 1999/00 budget included the initiation of a system of zero-based budgeting, and continued emphasis on divestment as a source of financing. In addition, Finance Minister Sinha projected that the central government deficit would decline to under 2 percent of GDP over the next four years (under revised accounting standards), that a full-fledged VAT would be introduced over the medium term, and that customs duties would be lowered to “Asian levels” in five years.

15. The estimated outturn for 1999/00 indicates a central government deficit in excess of 7 percent of GDP—1¼ percent of GDP in excess of the budget target.18 Most of the slippage was on the expenditure side, with tax revenues only 0.1 percent of GDP under target. In particular:

  • Interest payments were 0.3 percent of GDP higher, due to higher-than-budgeted borrowing.

  • Military expenditures exceeded the budget allocation by 0.2 percent of GDP, as a result of the border conflict with Pakistan in 1999.

  • Higher pension outlays (0.2 percent of GDP) resulted from larger-than-expected backpayments associated with the Fifth Pay Commission awards, especially for military retirees.

  • Given the dire financial situation of many states, Rs 30 billion (0.2 percent of GDP) in tax advances to state governments were converted into medium-term loans. In addition, increased grant support for state plans boosted central government plan expenditures by 0.2 percent of GDP.

  • Central government emergency assistance to the state Orissa, which was devastated by a cyclone in November, totaled almost 0.1 percent of GDP.

  • Outlays on subsidies were slightly higher than targeted (0.1 percent of GDP) owing to post-budget increases in fertilizer subsidies and the high costs of maintaining large grain stockpiles—as lower world prices of wheat increased farmers’ incentives to sell wheat to the government at fixed minimum support prices.

16. Financing of the deficit in 1999/00—totaling an estimated Rs 1.4 trillion19—again came mostly from domestic sources. Most of the Rs 771 billion in market borrowing was provided by the banking sector, with net commercial bank credit to government of about Rs 588 billion. Given the net repayment by the central government to the RBI of Rs 39 billion, the remaining Rs 222 billion or so in debt was bought by insurance companies and mutual funds. Rs 517 billion was borrowed against small savings, provident funds, and special deposits. Political uncertainties slowed the pace of divestment, and privatization receipts—at Rs 26 billion—fell far short of the Rs 100 billion target.

D. 2000/01 Central Government Budget

17. The 2000/01 central government budget targeted a deficit of 7.1 percent of GDP, implying little consolidation relative to the expected outturn for 1999/00.20 Although new tax measures were expected to increase revenues and significant cuts had been targeted for food and fertilizer subsidies, these had been offset by pressures to increase military expenditures and mandated increases in transfers to the states.

18. New tax measures were expected to yield Rs 48.9 billion (0.2 percent of GDP), while improved buoyancy of excise and customs collections was budgeted to increase gross tax collections by a further 0.3 percent of GDP. However, more than half of the total increase would be transferred to state and union territory governments, according to the interim recommendations of the Eleventh Finance Commission.21 Key measures included:

  • The three-rate MOD VAT excise tax was replaced by a single-rate (16 percent) CENVAT excise tax, although many items would still be exempt or subject to special rates. This restructuring was expected to yield around 0.1 percent of GDP in additional revenues.

  • The special additional duty (SAD) on manufacturing imports was extended to cover imports by traders, for an expected revenue gain of about 0.1 percent of GDP.

  • The tax exemption on export earnings was to be phased out in equal increments over the next five years.22

  • The tax rate on dividends and income distributed by domestic companies and debt-oriented mutual funds was increased from 10 percent to 20 percent, reducing the disparity between the tax treatment of dividends and interest income.23

  • Offsetting some of these expected revenue gains were anticipated revenue losses of 0.2 percent of GDP, owing to a reduction in the peak rate of customs duty from 40 percent to 35 percent, and cuts in duties on crude oil and selected petroleum products.24

  • In addition, new tax concessions and exemptions were introduced, including for Small Scale Industrial units (SSIs), new ventures in backward areas, and the film industry.

19. On the expenditure side:

  • The defense budget was stated to increase to Rs 586 billion, representing an increase of 0.2 percent of GDP relative to the 1999/00 outturn (which was already inflated by Kargil-related defense expenditures), and an increase of almost 0.5 percent of GDP relative to the 1998/99 outturn.

  • Food subsidies were budgeted to decline by 0.1 percent of GDP, through increases in prices charged by the Public Distribution System. Above-poverty-line (APL) customers would pay “economic cost”—the price paid to producers—for foodgrains, while the price paid by below-poverty-line (BPL) consumers would increase to 50 percent of economic cost. However, since the monthly allocation to BPL consumers would be doubled, the government estimated that total monthly expenditures by a typical BPL family of four would decline.

  • Fertilizer subsidies were also budgeted to decline by 0.1 percent of GDP, following 7–15 percent increases in fertilizer prices. Moreover, it was announced that the retention pricing scheme for fertilizers would be phased out over the medium term.25

  • Grants to states and UTs were budgeted to increase by 0.4 percent of GDP, as per the interim recommendations of the Eleventh Finance Commission.

  • A number of programs were introduced to promote rural housing, the provision of basic services, and credit flow to SSIs and the agricultural sector.

20. Other initiatives announced in the budget included the further gradual extension of the zero-based budgeting system to all remaining departments; and the constitution of the Expenditure Reforms Commission—first announced in the 1999/00 budget—to make recommendations on rationalization of government activities, civil service reform, and reduction of explicit and implicit subsidies.

21. Prior to its passage by Parliament in May 2000, the Finance Minister introduced several amendments to the budget’s tax proposals. These included 10-year tax holidays to some exporters and research and development companies; more favorable tax treatment of employee stock options and venture capital funds; higher tax exemption limits for housing loans and infrastructure bonds; increases in customs duties on tea, coffee, poultry meat, and other items, in order to protect domestic industries; and exemption of several items from the new 16 percent CENVAT. It was estimated that these measures would reduce revenues by about Rs 10 billion, or 0.05 percent of GDP.

E. State Government Finances 1998/99–1999/00

22. State finances deteriorated sharply in 1998/99, with the combined deficits of the states and union territories26 widening to 4.3 percent of GDP from 2.9 percent of GDP in the previous year. All states recorded deficits, with six states accounting for 55 percent of the total (Chart III.5). The structural weaknesses in state finances were exacerbated in 1998/99 by a 1.1 percent of GDP increase in the states’ wage bill and pension payments, following the upward revision of the central government’s pay scale.27 At the same time, state tax revenues and transfers of central tax revenues were adversely affected by the sluggish economy, and grant transfers were reduced by fiscal difficulties at the central level (Chart III.6 and Table III.2).

CHART III.5
CHART III.5

INDIA: State Governments’ Fiscal Deficits

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A003

Source: Reserve Bank of India
CHART III.6
CHART III.6

INDIA: State Governments’ Fiscal Developments, 1994/95-1999-00

Citation: IMF Staff Country Reports 2000, 155; 10.5089/9781451818543.002.A003

Source: Reserve Bank of India.
Table III.2.

India: Consolidated State Government Operations, 1994/95-1999/00

article image
Source: RBI Bulletin; RBI Reports on Currency and Finance; Union budget documents; and staff estimates.

Data on central government tax and grant transfers are taken from Union budget documents, rather than from state sources.

Includes other expenditure, and discrepancies between central government and state sources on (i) share of central government revenue and (ii) grants from central government.

Includes other financing, and discrepancy between central government and state sources on loans from central government.

Total revenues and grants less current expenditures.

23. Owing to the severe deterioration in fiscal positions, eleven states signed memoranda of understanding (MOUs) with the central government in 1999/00. These involved the provision of short-term loans (totaling an estimated Rs 30 billion) by the central government and relaxation of states’ borrowing limits, in exchange for commitments to reform.28 Although the overall reform parameters were agreed jointly, policy design was left primarily to individual states, and included enhanced user charges and fees, improved targeting of subsidies, divestment, and reforms to tax systems, civil services, and power sectors

24. While details of these commitments were not made public, the states’ aggregate deficit in 1999/00 was budgeted to fall to 3.9 percent of GDP. Total revenue and grants were expected to increase to 10.8 percent of GDP, 0.4 percent of GDP higher than the preliminary 1998/99 outturn. The state budgets anticipated higher grants from the center (particularly for plan schemes) as well as significantly larger tax collections due to the expected recovery in industrial production. Own tax receipts were also expected to be boosted by 0.3 percent of GDP due to additional revenue mobilization by a number of states under the MOU reforms.29 Total state expenditure was expected to remain broadly unchanged at 14.8 percent of GDP, although an increase in nondevelopment expenditure (due to the Lingering effects of the wage adjustment and higher interest payments) was expected to be offset by lower development expenditure, relative to GDP.

25. Although comprehensive data on state finances in 1999/00 are not yet available, states’ performance under the MOUs appears to have been mixed, as the election climate from April to October made it difficult for the states to implement many politically-sensitive measures.30 On the basis of available information on transfers from the center, the states’ borrowing during the year, and fragmentary data available on expenditure, their combined deficit is estimated at about 4.5 percent of GDP.

26. The states’ fiscal deficits have been financed predominately by loans and advances from the center and by market borrowing. Divestment proceeds have been insignificant. In 1998/99, resources mobilized through government-sponsored saving schemes, provident funds, and postal deposits increased by almost 60 percent and comprised over 70 percent of net loans from the center (Box III.3). Market borrowing by the states through issues of long-term securities also increased in 1998/99. Recently, the states have been encouraged to access the market directly, within the approved borrowing program, thus giving them greater flexibility with regard to the timing, maturity and the cost of borrowing. This has also prompted the states to seek credit ratings and has enabled the market to assess state risks independently.

27. The combined outstanding liabilities of the states is estimated to have exceeded 20 percent of GDP by end-March 2000, with loans and advances from the center accounting for an increasing share of the total (60 percent in March 1999). In addition, the state governments have accumulated large contingent liabilities (totaling 4.7 percent of GDP at end-March 1999) arising from explicit guarantees extended against borrowing by state enterprises and institutions, mostly for infrastructure projects. There have already been a few cases where such guarantees have been invoked by lenders. As a part of their fiscal reform efforts, a number of states have initiated legislation to place statutory limits on guarantees and establish sinking funds, and some have begun issuing guarantees more selectively. Moreover, with effect from 2000/01, the RBI has requested banks and financial institutions to assign a risk weight of 20 percent to state government securities outside of market borrowing, and a risk weight of 100 percent on guaranteed bonds of defaulting entities.

1

Prepared by Patricia Reynolds and Cyrus Sassanpour.

2

The consolidated public sector is comprised of the central government, state governments, public sector undertakings (PSUs) of the central government, and the accounts of the Oil Coordinating Committee (OCC).

3

All ratios to GDP are calculated using the revised series (1993-94 base year); GDP figures prior to 1993-94 are constructed using the growth rates of the old series (1980-81 base year).

4

Interest rate trends are discussed in greater detail in Chapter III of the accompanying Selected Issues volume.

5

Pay scales for central government civil servants are determined by the awards of the Pay Commission, a constitutionally-mandated body set up to make recommendations about every ten years. Recommendations of the Fifth Pay Commission, which submitted its report in January 1997, included a three-fold increase in basic pay scales, downsizing of 30 percent in each government department and agency over a 10-year period, and an overhaul of the organizational structure of the central government. Although the wage awards were incorporated beginning with the 1997/98 budget—resulting in a permanent increase in central government wages and salaries of roughly 0.5 percent of GDP—the recommended reorganization and staffing cuts were not implemented.

6

State governments are not obliged to adopt the Pay Commission recommendations, but in practice have tended to follow central government pay revisions with a year or so lag.

7

Plan expenditures are jointly determined by the Planning Commission, Ministry of Finance, central government spending ministries, and—where relevant—state governments. These consist mainly of outlays for development projects, and have both capital and current expenditure components.

8

World Bank, India—Policies to Reduce Poverty and Accelerate Sustainable Development, Report No. 19471-IN, January 2000.

9

The OCC facilitates the provision of subsidies on key consumer petroleum products (diesel, kerosene, and liquid petroleum gas (LPG)) by operating a series of accounts which track the payments to and receipts from producers and importers of crude oil, refineries, marketing companies, and distributors. The operation of the OCC is discussed in greater detail in Chapter II of India Selected Issues (IMF Staff Country Report No. 97/74, September 1997).

10

Petroleum sector reforms are discussed in Box III.2 of India—Recent Economic Developments (IMF Staff Country Report No. 98/120, November 1998).

11

Excluding divestment receipts from revenues, and utilizing the revised national accounts figures. Official deficit figures include divestment receipts in revenues; on this basis, the budgeted deficit for 1998/99 was 5.2 percent of GDP, relative to 5.9 percent of GDP in 1997/98.

12

The Ministry of Finance has launched several tax amnesty schemes in India in recent years, in order to bring more of the large underground economy under the tax net. The Voluntary Disclosure of Income Scheme (VDIS) was introduced in 1997. While some tax payers were estimated to have reduced their effective tax rate to below 10 percent in 1997/98, these respondents were henceforth required to file taxes on an annual basis, thereby permanently increasing the tax base.

13

The Indian constitution does not explicitly assign rights of taxation on service transactions, and there is some controversy as to whether it should fall under the jurisdiction of the central or state governments. The central government has imposed taxes on a limited number of services in recent years, although associated revenues have averaged only around 1 percent of total tax revenues.

14

On the authorities’ definition, the deficit was 6.4 percent of GDP, compared to the budget target of 5.2 percent of GDP (see footnote 10).

15

This measure of the deficit includes on-lending from small savings collections in central government net lending. From 1999/00, official deficit figures exclude on-lending from the central government’s accounts. Excluding on-lending from expenditures and net lending, and including divestment receipts from revenues (see footnote 10 and Box III.3), the official deficit target for 1999/00 was 4.0 percent of GDP, compared to 5.0 percent of GDP in 1998/99 measured on the same basis.

16

However, the proceeds from the Rs 1 per liter levy were to be earmarked for the Central Road Fund (50 percent) and initiatives in rural development and social sectors.

17

Key food items (mainly wheat, rice, and sugar) are sold to the public through the PDS, at central issue prices fixed by the government, using an extensive network of Fair Price Shops. Food subsidies and the role of the PDS are discussed in greater detail in Chapter IV of India Selected Issues, (IMF Staff Country Report No. 96/132, January 1997).

18

The authorities’ definition of the deficit puts the 1999/00 estimated outturn at 5.6 percent of GDP, compared to the budget target of 4.0 percent of GDP (see footnotes 10 and 14, and Box III.3).

19

This amount includes the states’ share of small saving collections, as under the old accounting treatment.

20

On the authorities’ accounting basis, the deficit was budgeted to decline by 0.5 percentage points, to 5.1 percent of GDP, owing to the anticipated increase in divestment receipts (see footnote 17 and Box III.3).

21

Tax-sharing arrangements between the central and state governments are reviewed by a Finance Commission convened every five years. See Box III.1.

22

Corporate tax collections were budgeted to rise by Rs 50 billion (¼ percent of GDP) in 2000/01 in response to new measures, which would include the phase out of the tax exemption on export earnings, the continuation of the 10 percent surcharge on corporate incomes, as well as the impact of new tax concessions and exemptions.

23

Income distributed under the US-64 and other open-ended equity-oriented schemes of the UTI and other mutual funds would continue to be exempt from taxation. All new personal income tax measures combined—including the increase in the dividend tax rate and the 15 percent surcharge on higher-income taxpayers—were expected to yield Rs 11 billion (0.05 percent of GDP) in 2000/01.

24

Given the special surcharge of 10 percent, the effective peak rate is now 38.5 percent. Although the tariffication of 714 items previously subject to quantitative restrictions, announced at end-March, was effected at the new peak rate, the budget did not make a provision for increased customs revenues from this source.

25

The retention pricing scheme guarantees a cost-plus-rate-of-return margin to fertilizer manufacturers. Fertilizer subsidies are discussed in greater detail in Chapter IV of India—Selected Issues, (IMF Staff Country Report No. 96/132, January 1997).

26

Includes 25 states and the National Capital Territory of Delhi.

27

See footnotes 4 and 5. State government wage and salary payments are included under both developmental expenditures (e.g., for teachers) and nondevelopmental expenditures (e.g., for state government administrators).

28

The central government initially accelerated transfer of budgeted central tax and plan grants; in December 1999, Rs 30 billion in transfers were converted to three-year loans under a newly-created Extended Ways and Means Advances Facility. In addition, some states were allowed to borrow Rs 20 billion in excess of borrowing limits set by the central government at the beginning of 1999/00.

29

The states are also expected to benefit from the recent harmonization of sales tax rates and the gradual elimination of tax exemptions (Box III.2), although the revenue impact in 1999/00 would be small.

30

Consolidated data on state finances are compiled and published by the RBI, typically nine to ten months after the end of the fiscal year.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
India: Recent Economic Developments
Author: International Monetary Fund
Volume/Issue:
Volume 2000: Issue 155
Publisher:
International Monetary Fund
ISBN:
9781451818543
ISSN:
1934-7685
Pages:
113
DOI:
https://doi.org/10.5089/9781451818543.002

INDIA: Government Deficits and Debt, 1990/91 - 1999/2000

INDIA: Fiscal Indicators - Central and State Governments

INDIA: Fiscal Indicators - PSUs, 1990/91 - 1999/2000

OCC Balance and World Oil Prices

INDIA: Central Government Financing and Debt, 1990/91 - 2000/01

INDIA: State Governments’ Fiscal Deficits

INDIA: State Governments’ Fiscal Developments, 1994/95-1999-00