Current Situation

3. The Tamil Nadu Fiscal Responsibility Act (TNFRA 2003, amended in 2017) serves as a fiscal anchor. Fiscal management principles described in Section 4 of the TNFRA provide for a debt-to-GSDP ceiling of 25 percent and a deficit⁵ ceiling of 3 percent.⁶ These two fiscal rules have been generally adhered to in recent years (Figure 3 and Figure 4), with the exception of 2016/2017, when the deficit reached 4.4 percent of GSDP due to the impact of a bailout of the public power company, Tamil Nadu Generation and Distribution Corporation (TANGEDCO), which was authorized by the central government and known as “Ujwal DISCOM Assurance Yojana” (UDAY).

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Fiscal Deficit

(Percent of GSDP)

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

Sources: Comptroller and Auditor General (CAG) until 2017/18; MTFP appended to the 2019/20 budget (revised estimates for 2018/19)

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Debt Stock

(Percent of GSDP)

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

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4. TNFRA also provides for a Medium-Term Fiscal Plan (MTFP). Section 4 of TNFRA states that the MTFP shall set a multiyear rolling target for the main fiscal indicators and shall include the specification of underlying assumptions. It shall also contain (1) elements on fiscal performance in the previous year and in the current year vis-à-vis the past MTFP, (2) a statement on recent economic trends and future prospects for growth, and (3) elements on main fiscal policies both on the revenue and the expenditure side.

5. In practice, the MTFP suffers from several shortcomings. It provides projections two years beyond the next year’s budget; these are known as “advanced estimates” (AE) for main revenue and expenditure items. However, the most recent MTFP appended to the 2019–20 budget does not provide much detail, notably, on the assumptions underpinning the macroeconomic and macrofiscal scenario until 2021/22. In particular, growth assumptions (nominal growth increasing from 8 percent in 2019/20 to 10 percent in 2020/21 and 2021/22 are not presented and defended explicitly. Policy assumptions and choices on the expenditure and the revenue side are not detailed, either. Overall, the MTFP preparation and submission seem to aim more at complying with a legal requirement rather than at providing a strategic framework for the overall budget formulation process. This is apparent in the very significant discrepancy both on the revenue and the expenditure sides between AE and actual outturns, as shown in Figure 5. Moreover, the track record has worsened in the most recent years, with revenue collection typically 15–20 percent lower than advanced estimates.⁷

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Deviations between Advanced Estimates in Year t-2 and Outturns for Revenue and Expenditure

(Advanced Estimates, percent)

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

Source: Mission, based on FD data for Revenue Receipts and Revenue Expenditures.Note: Positive numbers indicate that actuals exceeded advanced estimates from t-2.

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6. These shortcomings are partly due to limited capability to undertake macroeconomic and fiscal forecasts. Although the Directorate for Economics and Statistics in the Planning Department produces estimates of GSDP twice a year in July and January, no entity within the State is tasked with producing a macroeconomic framework for the State and assessing its fiscal implications.⁸ The GSDP and fiscal projections currently derive from an iterative process whereby the Finance Department (FD), after taking into account expenditure requests, adjusts revenue forecasts to a level consistent with broad fiscal targets. This process may lead to inconsistencies, such as for the State Own Tax Revenue (SOTR) scenario contained in the MTFP 2019–22, which provides for a nominal growth of 13 percent per year, even though nominal GSDP growth is consistently much lower over the whole period (Figure 6). In the absence of detailed explanations for the high tax buoyancy, this scenario lacks credibility, especially considering the downward pressures on liquor taxes that make up 20 percent of the SOTR.⁹

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State Own Tax Revenue and GSDP Growth in the 2019/–22 MTFP

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

Source: MTFP attached to 2019/20 budget.Note: BE = Budget Estimates; RE = Revised Estimates; 2018/19 figures = Base 100.

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Challenges

7. Tamil Nadu should introduce a Medium-Term Fiscal Framework (MTFF) to enhance its fiscal planning capacity. A MTFF is an institutional framework for setting aggregate multiyear fiscal targets or objectives within a projected macrofiscal environment, which can then be used as a reference during the budget formulation process. Key components of a MTFF include (1) a set of realistic and consistent medium-term macrofiscal projections, (2) a medium-term fiscal strategy to be described in a specific document (see I.B), and (3) a comprehensive assessment of the potential impacts of fiscal risks (see II). Taken together, all of these elements would enable Tamil Nadu to appropriately steer fiscal policy, assess the need for further expenditure or revenue reforms, and communicate effectively to investors,¹⁰ businesses, and citizens. They would provide a solid foundation on which to build a strategic budget formulation process with a strong top-down and multiannual dimension (see I.B).

8. Prerequisites for the implementation of an MTFF include sound methods for macrofiscal analysis and forecasting, as well as adequate and transparent procedures. Priority should be given to (1) developing stronger methodologies and analyses, and (2) setting formal processes for the preparation of the MTFF projections and underlying fiscal strategy.

9. Simple macrofiscal methodologies can be used to estimate the resource envelope and available fiscal space in time for budget preparation. Excel-based templates could be sufficient in the initial stages, because Excel includes basic regression tools that allow simple correlations and assessment of buoyancy. These templates can grow into more advanced forecasting models, making use of statistical software. SARTTAC’s course on developing a macrofiscal forecasting tool for State governments would be useful in this respect.

10. Several analyses should be undertaken on a regular basis to set the stage for a fully-fledged MTFF.

• Understanding macrofiscal linkages: These are economic interactions between the macroeconomic and the fiscal dimensions. Assessing these linkages is critical to ensure consistency in the macrofiscal framework and to support the policies underpinning the fiscal strategy. In practice, this means analyzing historical fiscal data series—neutralized from major discretionary changes,—identifying long-term correlations with relevant macroeconomic indicators and assessing buoyancy and fiscal multipliers.

• Explaining forecast revisions and deviations: Instead of having to start from scratch, detailing the reasons behind forecast revisions highlights all of the changes since the last forecast vintage of historical data and shapes the narrative on the causes of deviation between historical vintages. Analyzing the gap between forecasts and actuals helps to improve forecasting methods and reinforces the credibility of forecasts. This analysis is especially relevant in Tamil Nadu, given the track record of past MTFPs when compared to actuals.

• Addressing macroeconomic uncertainty: The preparation and publication of sustainability analyses and alternative scenarios would help to illustrate the inherent volatility of macroeconomic indicators and its fiscal consequences.

11. In terms of process, macrofiscal planning requires strong coordination. It draws on numerous data sources, for example, historical macrofiscal data, in-year disbursement/collection data, macroeconomic projections, and information on current and future policy decisions. This process represents a large amount of data produced by different agencies (for example, various parts of the FD, Directorate for Economics and Statistics, Directorate for Evaluation and Applied Research in the Planning Department, and Commercial Tax Department), which can only be gathered and utilized in a timely manner if there is strong coordination.

12. The FD should assume this coordination role within the framework of a cross-departmental committee that is to be established and that requires clear deadlines, shared assumptions, and sound data management practices.

• A calendar for the macrofiscal planning process that is shared well in advance of the forecast preparation helps to clarify what is expected of each stakeholder. The calendar should (1) leave sufficient time for the whole process to allow for detailed analysis and consistency checks; (2) provide for a number of updates leading up to the presentation of the budget proposal; (3) offer a sequencing of data exchanges—both to and from the FD—consistent with the calendar of important data releases. This internal calendar could ultimately become part of a wider-ranging budget circular, covering both the preparation of the MTFF and of the annual budget.

• Key assumptions underlying the planning exercise should be shared by the FD with all stakeholders from the start to avoid inconsistencies. A standard format for these key assumptions would facilitate communication when new information has to be shared. Final assumptions should then ideally be disclosed to the public to support the credibility of the forecasts.

• Data management arrangements should be set by the FD to preserve the integrity of the forecasting process, notably, with a repository of all assumptions and forecasts attached to a specific vintage of historical data to facilitate subsequent comparisons or references.

13. Sensitization of the whole administration to the usefulness of the planning process is critical. Raising awareness at senior levels is required to make the MTFF a solid anchor of the budget preparation process. Regular memorandums on the space for new policies or on forecast revisions could help to demonstrate the power of the framework in terms of policy framing and storytelling. Finally, technical-level staff should receive training on the benefits of a macrofiscal planning process to sound budget preparation, as well as on tools to develop forecasting capacity.

Recommendations

a. Short term

• FD should identify staff for a macrofiscal unit.

• BD should develop the capacity, supported by SARTTAC, to create a macrofiscal capability within the FD.

b. Medium term

• FD should implement a medium-term fiscal framework to anchor the overall budget formulation process.

Budget formulation process

Current situation

14. Budget formulation in Tamil Nadu benefits from some underlying strengths. Fiscal management has been relatively conservative, and the fiscal rules set by TNFRA have broadly been complied with. The FD is equipped with experienced and skilled staff, with career paths enabling a well-developed system of mentorships. The FD also enjoys a strong institutional standing vis-à-vis line departments, and the annual budget circular that sets the stage for the annual budget formulation process is clearly written.

15. Tamil Nadu follows a traditional budget formulation process, characterized by annual, bottom-up, and incremental budgeting. Budget rules in Tamil Nadu are largely captured in a budget manual dating back to 1992 that emphasizes a control function for FD rather than a strategic prioritization role.¹¹ The scope of the budget preparation process is limited to the upcoming fiscal year.¹² No ex ante ceilings, whether indicative or binding, are set by FD to provide a framework for the budget requests of other departments. Moreover, the budget process is incremental, based on line item budgeting; it does not evaluate existing performance but rather focuses on new schemes and measures. Some documents known as “performance budgets” are published by line departments, but these are unrelated to budget estimates and are not reviewed by FD.

16. This budget formulation process has served the State reasonably well so far, but its limitations are being felt. The traditional budget formulation process was appropriate in a period of high growth and inflation, but it is less so now. The inadequacies of the current budget preparation process have become more pressing in recent years. The increase in the share of nondiscretionary expenditure and the uncertainties on revenue growth limit fiscal space. Adequate prioritization and thorough evidence-based discussion of expenditure priorities are required to address this trend. Doing so is not possible in the current, purely incremental budget formulation process, which is largely disconnected from actual budget outturn and performance against policy objectives.

17. A compressed calendar leaves inadequate time to prepare a robust budget. The Tamil Nadu budget calendar essentially spans five months from September–January from the publication of the budget circular to the preparation of the budget speech. Departments have only three weeks in September to prepare their budget requests for transmission to the FD. This timeframe is hardly sufficient to provide credible estimates and costing of new measures.¹³

18. The budget framework is undermined by frequent supplementary budgets and reappropriations. The challenge of annual budgeting is compounded by the absence of strategic planning; departments routinely launch new schemes through announcements after the budget preparation process.¹⁴ The State of Tamil Nadu routinely prepares two to three supplementary budgets every year; work on a first supplementary budget often starts within the first quarter of the new fiscal year, which reinforces the lack of credible estimates. This practice contradicts international good practice—which recommends one supplementary budget in a given fiscal year, tabled in the Legislature. after the midyear point. Further revisions should only be considered for unforeseen and unavoidable circumstances.

19. Budget discussions do not focus on strategic priorities and fail to examine performance or quality of spending. The Decentralized Budget Meetings (DCBs) between sectoral units of the budget wing and line departments usually occur in October. They are mainly used to discuss spending estimates for the current and next financial years for existing schemes, as well as the cost of new policy initiatives (Tamil Nadu Innovation Initiatives, or “Part II schemes”). Performance information is not used in this discussion, nor is there any assessment of the “value for money” of existing and proposed schemes. The discussion centers on the accuracy of the technical assumptions underpinning the budget requests, focusing on inputs in terms of staff and other operating or capital expenditures. This approach is insufficient to form a strategic judgment of the quality of spending.

20. The poor quality of budget discussions is largely due to the absence of spending ceilings, resulting in a time-consuming process to reduce budget requests within the available resource envelope. An iterative process is required to reduce the gap between requests from spending departments and realistic budget estimates. Spending departments are best equipped to identify projects within their mandate, while the FD’s role is best confined to evaluating the quality of the spending proposals and checking the consistency of the estimates.

21. Under these circumstances, only makeshift measures, such as expenditure control, accumulation of arrears, and off-budget borrowing, can be used to meet fiscal targets. The lack of accuracy in the budget formulation process is evident both on the revenue and the expenditure sides. Over the past four years, revenues are lower than budget estimates by 4 to 10 percent (Figure 7). Expenditures are also—with the exception of 2014–15—significantly lower than authorized appropriations. Nevertheless, Tamil Nadu managed—with the exception of the impact of the UDAY scheme in 2016–17—to achieve its headline fiscal balance targets (Figure 8). Rather than indicating sound financial management, this practice demonstrates the ability of the FD to control in-year budget execution by combining various expenditure control practices, such as shortfalls in contributions to various funds, or by accumulation of arrears to Public Sector Undertakings (PSUs), such as the electricity generation company (see II.A). As regards the debt stock indicator, however, off-budget financing is captured in the evolution of the debt stock, owing to the broader definition of the debt stock that is not limited to liabilities accruing to the Consolidated Fund.

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Deviations between Budget Estimates and Outturns for Revenue and Expenditure

(in percent of budget estimates)

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

Source: Based on MTFP database of FD from 2013/14 – 2017/18 .Note: Positive numbers indicate that actuals exceeded budget estimates.

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Deviations between Budget Estimates and Outturns for Fiscal Balance

(in percent of GSDP)

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

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22. The current process does not contribute to a sustainable fiscal path, given the looming fiscal risks from revenue reductions and spending pressures. Tamil Nadu faces increasing fiscal risks, both in the short-term and long-term (see II.A). Slower revenue and expenditure growth will limit the State’s ability to satisfy citizens’ service delivery demands. Sustainability risks are apparent from the limited safety margin vis-à-vis debt and deficit ceilings (see Figure 1 in I.A) and in the deterioration of the coverage ratio of revenue receipts to revenue expenditures. Whereas the State is not allowed to run a revenue deficit¹⁵ under the Tamil Nadu Fiscal Responsibility Act, the State now covers only around 85 percent of its expenditure with revenue receipts, down from 98 percent as recently as 2013–14 (Table 2).

^{Table 2.}

Evolution of the Revenue Deficit

Sources: Mission calculations; data from Finance Department.

^{Table 2.}

Evolution of the Revenue Deficit

(bn INR)	2013/14	2014/15	2015/16	2016/17	2017/18
Total revenue receipts	1,080	1,224	1,290	1,402	1,463
Total revenue deficit	-18	-64	-120	-130	-216
Revenue deficit (% of total receipts)	-1.7	-5.2	-9.3	-9.3	-14.8

Sources: Mission calculations; data from Finance Department.

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^{Table 2.}

Evolution of the Revenue Deficit

(bn INR)	2013/14	2014/15	2015/16	2016/17	2017/18
Total revenue receipts	1,080	1,224	1,290	1,402	1,463
Total revenue deficit	-18	-64	-120	-130	-216
Revenue deficit (% of total receipts)	-1.7	-5.2	-9.3	-9.3	-14.8

Sources: Mission calculations; data from Finance Department.

23. Committed revenue expenditure is increasingly limiting the fiscal space for infrastructure spending. The weight of “committed expenditure” (nondiscretionary expenditure, such as wages, pensions, and debt interest) has strongly increased over the past few years and now represents more than 63 percent of total revenue expenditure (Table 3). This composition of spending reduces margins for new schemes and for capital expenditure and calls for a renewed approach to budgeting to actually cut spending or curb expenditure growth.

^{Table 3.}

Evolution of the Share of Committed Expenditure in Total Revenue Expenditure

Source: Comptroller and Accountant General Report 2017/18 reviewed by Finance Department

^{Table 3.}

Evolution of the Share of Committed Expenditure in Total Revenue Expenditure

(bn INR)	2013/14	2014/15	2015/16	2016/17	2017/18
Committed Revenue Expenditure	665	753	833	948	1,063
Total Revenue Expenditure	1,098	1,288	1,410	1,532	1,679
Committed Expenditure to Total (%)	60.6	58.5	59.07	61.9	63.3

Source: Comptroller and Accountant General Report 2017/18 reviewed by Finance Department

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^{Table 3.}

Evolution of the Share of Committed Expenditure in Total Revenue Expenditure

(bn INR)	2013/14	2014/15	2015/16	2016/17	2017/18
Committed Revenue Expenditure	665	753	833	948	1,063
Total Revenue Expenditure	1,098	1,288	1,410	1,532	1,679
Committed Expenditure to Total (%)	60.6	58.5	59.07	61.9	63.3

Source: Comptroller and Accountant General Report 2017/18 reviewed by Finance Department

24. The introduction of a new information technology (IT) system presents an opportunity to modernize budget formulation. Efforts already mentioned in the 1992 budget manual to supplement incremental budgeting by applying zero-based budgeting to various policy areas seem to have had little traction. However, a new Integrated Financial and Human Resource Management System (IFHRMS) is being developed and will provide a platform for real-time data collection both on payroll and non-payroll expenditures. IFHRMS will enable automated budget submissions—minimizing errors from manual estimates and facilitating increased scrutiny.

Challenges

25. Restoring the credibility of the annual budget should be the first priority. Doing so means ending the practice whereby the FD focuses so much energy on budget execution and control that it has little time for a well-run budget preparation process. The current process leads to unnecessarily complex budget execution. Credible budget preparation is a prerequisite for the success of other reforms, such as the introduction of top-down budgeting and (later) medium-term budgeting.

26. A longer budget calendar would allow more time to prepare and discuss realistic budget estimates. An earlier start, giving more than a few weeks to line departments to prepare their spending estimates and budget requests, would help to increase the quality of budgeting, especially if the process is anchored in a strong top-down dimension.

27. Policy planning should be properly articulated with the budget formulation process. The budget has to fully play its role as a vehicle to accurately determine and authorize the fiscal consequences of the government’s policies. Doing this requires a strong capacity for policy planning¹⁶ and support at the highest political levels to ensure that initiatives with significant financial impact are presented through the normal budget formulation process. Consulting with the Cabinet on priorities through a Fiscal Strategy Statement very early in the budget process could help to ensure a level of discipline among line departments.

28. A contingency reserve or planning margin could be established for new initiatives to provide flexibility. A Tamil Nadu Contingency Fund of INR 1.5 billion, or less than 0.1 percent of total expenditure, already exists in the budget. Although this fund may handle some limited unforeseen expenditure, it is not appropriate for substantial policy priorities that emerge during the fiscal year. An adequate contingency reserve would amount to 2 or 3 percent of total expenditure.¹⁷ Its rules of engagement should be carefully designed so that allocating the contingency reserves does not turn into an alternative budget preparation exercise (See Box 1 for more details on the role and size of contingency reserves.).

^{Box 1.}

International Experience with Contingency Reserves

A Contingency Reserve is a mechanism to address uncertainties during in-year budget execution, notably, linked with fiscal risks. It may take several forms. In many countries, it is an unallocated appropriation in the annual budget law. In other countries, it is a fund with an appropriate amount of financing authorized under the legal framework and replenished at the beginning of each fiscal year, depending on the drawdown during the previous year. The benefit of such an appropriation is that urgent but unforeseen needs can be met without seeking additional appropriations or having to cut spending elsewhere, which may lead to the accumulation of arrears.

Issues of attention in the design of a Contingency Reserve include the following:

• Access criteria: There should be transparent criteria in place governing the circumstances under which a given department may access appropriations from the Contingency Reserve; eligibility should only be considered for unforeseen expenditure and not for expenditure needs resulting from lack of adequate planning.

• Role of the FD: The FD should have a role as gatekeeper and ensure that the Contingency Reserve is not used to circumvent decisions on expanding or creating new schemes not funded during the earlier budget formulation process.

• Reporting: Transparent reporting will ensure accountability to the legislature and to the wider public, and it will help the FD to uphold the access criteria as defined in legal regulations.

• Size: The size of the contingency reserve should not be so large as to undermine budget discipline or so small as to be consistently exhausted part way through the year. In most countries, this size implies a contingency appropriation of between 1 percent and 3 percent of total budgeted expenditure (Figure 1.1).

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Size of Contingency Reserves in Selected Countries

(Percentage of Total Expenditure)

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

Sources: IMF Fiscal Transparency Handbook, with data from Fiscal Transparency Evaluations; OECD Budget Practices; and country budget documentation.

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29. Determining ceilings at the beginning of the budget formulation process would put the onus on spending departments to prioritize their expenditure. In such a top-down process, expenditure ceilings would be derived from the first year of the MTFF (see I.A), with the ex-ante breakdown of the aggregate MTFF expenditure ceiling across departments determined by an internal FD exercise, taking into account expenditure pressures and policy priorities endorsed by the Cabinet. Although strict adherence to ceilings is unlikely to be immediate, experience shows that compliance normally increases year after year once departments become used to the new system. It is important to make sure that departments trying to “game the system” and get more than their allocated ceiling are not rewarded; otherwise, this practice could introduce moral hazard in the top-down budgeting process. Figure 9 shows the impact of a well-functioning top-down budgeting mechanism, as opposed to a comparable bottom-up method; the discrepancy between budget bids and available resources is much lower, if not absent, as departments do their own prioritization to respect their ceilings.

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Top-Down versus Bottom-Up Budgeting

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

Source: IMF Mission.

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30. A shift to top-down budgeting would help to change the nature of budget discussions and refocus the FD on its budget challenge function. The FD should investigate and scrutinize the policy and expenditure choices of other public entities, with the aim of aligning these with wider government objectives and ensuring “value for money,” not only compliance with financial management rules. Successful examples of exercising the budget challenge function in Tamil Nadu already exist, such as the role of the FD in encouraging the outsourcing of maintenance in public hospitals. Further diffusion, however, requires expansion of the skill set of FD officials and improvement in the tools available to them for costing and measuring the impact of public policies. Annex II explains in more detail how the budget challenge function can be developed.

31. A clear political mandate is required to implement top-down budgeting. A Cabinet-level discussion of the basis of a concept paper explaining the implications of top-down budgeting for policymaking and policy implementation is necessary to ensure that the transition to top-down budgeting is fully “owned” by the full Cabinet, as well as by the FD and the Minister of Finance.

32. These reforms could be piloted to the local context before full-scale implementation. One or two departments could be identified to pilot the new approach: a trade-off in terms of budget flexibility (more freedom to redeploy and manage appropriations) and resource predictability, on the one hand, against a strong commitment to respect the allocated budget and to meet some performance targets, on the other hand. Experience shows that relatively mature service delivery administrations are usually well-suited for a piloting role. In discussions with the mission, the Department of Industry indicated its readiness to participate in such a pilot.

33. The introduction of medium-term budgeting would further improve the budget formulation process. The main advantages of a Medium-Term Budget Framework (MTBF) with ceilings per policy area or administrative department are threefold: (1) ensure the predictability of resources to line departments over a longer time horizon; (2) show more clearly the shifts in the allocation of resources that reflect changes in political priorities; (3) allow for better decision-making by making more visible the medium-term impact of savings measures or new projects. A MTBF also facilitates the work of the FD and its dialogue with line departments, with outer year budget figures serving as a starting point for the construction of the budget in the following year.

34. However, the prerequisites of medium-term budgeting are not yet in place. In this context, continuing to ask line ministries to systematically provide AE for their spending while not using them makes little sense. The FD could usefully restrict this request to the most important spending schemes and start an internal exercise to develop its own vision of how resources should be allocated for line ministries over the medium term. This process would emulate the practice in most countries, where the budget department often had extensive experience with internal medium-term projections of expenditure before transitioning to a full MTBF.

35. The evolution to a new model of budgeting needs to be captured in the FD’s tools. This would require a thorough overhaul of the 1992 budget manual. Adjustments to the IFHRMS may also be needed to ensure consistency with a top-down approach and with the increased managerial freedom granted to line departments. Annex II suggests a new budget calendar in line with the requirements of this reformed budget formulation process.

Budget Documents

Recommendations

a. Short term

• Publish a brief citizens’ budget alongside the budget 2020–21.

b. Medium term

• Develop a fiscal strategy report based on the macrofiscal forecast with budget 2021–22. Gradually improve the quality and content of the report.

^{Box 3.}

A Citizens’ Budget

A citizens’ budget is a nontechnical presentation that can take many forms; it is designed to reach and be understood by as large a segment of the population as possible. It is essential that governments be proactive in helping the general public make sense of the budget. Broadening understanding of the country’s public finances can help frame more realistic citizens’ expectations and build support for difficult choices. It can also help to offset the influence of narrow special interest groups and avoid public debates being conducted in jargon by technocrats.

The relevant principle under the IMF Fiscal Transparency Code¹⁸ states that a citizens’ guide to the budget would enable all interested citizens to conveniently obtain key information on fiscal policies. Basic practice requires governments to publish accessible information summarizing the economic and fiscal projections, as well as the main policy initiatives, with a discussion of their impact on the average citizen.

An annual budget is typically the key instrument by which a government translates its policies into action. Accordingly, budgets should not only be available to the public; they should also be accessible to the public.

However, the annual budget is normally long and complex and accompanied by a number of detailed supporting documents. Even for technical experts, understanding the budget can be a difficult and time-consuming task. A government’s citizen budget should focus on the objectives and contents of the budget rather than its process. It should meet a range of quality standards, including comprehensiveness, objectivity, relevance, reliability, ease of understanding, and timeliness.¹⁹ It should also be disseminated at the same time that the government presents the annual budget to the legislature so that the public is engaged in the discussion in time to have an impact on the legislature’s deliberations on the budget.

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Example of the Philippines:

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

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Source: https://www.internationalbudget.org/open-budget-survey/resources-for-governments/citizens-budgets/examples/ In addition: https://www.dbm.gov.ph/index.php/budget-documents/2018/2018-people-s-budget/ Source: Murray Petrie and Jon Shields. 2010. “Producing a Citizens’ Guide to the Budget: Why, What and How?” OECD Journal on Budgeting

Current Situation

45. Based on current trajectories, the finances of some large PSUs²¹ are on an unsustainable path, despite receiving significant fiscal support from the Tamil Nadu government. PSUs in the electricity and transport sectors have been experiencing large losses for a number of years, despite receiving significant annual and exceptional fiscal support (Figure 10). In 2016–17, under the Government of India (GOI) UDAY scheme, the Government of Tamil Nadu loaned INR 228 billion to TANGEDCO as an interest-free loan, to be converted to a grant over five years. This action added 1.8 percent of GSDP that year to the fiscal deficit. The expectation is that these losses will continue unless there are significant policy changes. As noted in IA, the fiscal space within the statutory deficit and debt ceilings has shrunk progressively since 2013–14, and there is limited ability to accommodate further deficits or another exceptional assumption of PSU debt.²²

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PSU Profits and Losses 2013–14 to 2016–17 (INR, in billions) 20–14 to 26)

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

Sources: Review of Performance of State Public Sector Undertakings and Statutory Bodies for the year 2016–17; Bureau of Public Enterprises, Finance Department, undated (most recent report).

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46. A major driver of these PSU losses is the undercompensated requirements that government imposes on the companies to conduct noncommercial activities. These noncommercial obligations assume a range of types, as described in Box 4. The Government of Tamil Nadu pays subsidies toward the cost of these activities, and it provides guarantees, loans, and other fiscal support. However, the substantial and chronic PSU losses and the negative net worth of these PSUs illustrate that a significant part of the cost of PSU noncommercial obligations is not being borne by the State budget. For instance, the Passenger Transport Group had negative net worth of INR 90.47 billion in 2013–14 and INR 164.79 billion in 2016–17.

47. A fundamental driver of the cost of PSU noncommercial obligations is the failure to regularly adjust tariffs, particularly in the electricity sector. The Tamil Nadu Electricity Regulatory Commission (TNERC) determines tariffs for generation, supply, transmission, and distribution of electricity in terms of S.86 of the Electricity Act of 2003. The tariff policy applies to the level of distribution charges and surcharges under the open access policy that allows private companies to purchase electricity from private suppliers. TANGEDCO has not filed for a tariff increase since 2012, although TNERC granted a tariff increase in 2014 in the absence of a filing. In the absence of a tariff increase since 2014, electricity prices have declined in real terms, and the gap between TANGEDCO’s costs and revenues has increased.

48. The effects of PSU noncommercial obligations are complex and have considerably weakened the financial position and service delivery performance of the companies. They also create the potential need for a cycle of periodic large injections of fiscal support to keep the companies operating—with major impacts on the State budget and level of public debt. The cross-subsidy between business and household users of electricity reduces the competitiveness of the private sector, harming economic growth, tax revenue growth, and the development of Tamil Nadu. It may also lead to pressure for other potentially distortionary policies to compensate businesses, such as tax incentive schemes for new investment.²⁴ Ultimately, these policies may be unsustainable.

49. Business customers are already switching to private electricity suppliers, despite the existence of a cross-subsidy surcharge, so that the tax base from which to subsidize households may erode further or even collapse at some point under pressure from the private sector.²⁵ To the extent that the PSUs find it difficult to finance new investment, public perception of chronic poor service quality may entrench consumer resistance to paying for the services—a vicious downward spiral.²⁶

50. PSUs are overseen by Boards of Directors, officials from the relevant line department, and the FD. Officials from line departments and from FD sit on PSU Boards, and this practice is viewed as an important means of overseeing the operations of PSUs. PSUs are also required to seek approval from the relevant line department and FD for capital expenditures above INR 100 million and for land acquisition. The Bureau of Public Enterprises (BPE) in FD also monitors the performance of PSUs. It would be desirable to review the respective responsibilities of the line department and the different units in FD in monitoring PSU performance and overseeing the fiscal risks to government. The BPE—a separate unit reporting to the PS—publishes an Annual Report on the financial results of PSUs, but its oversight is backward looking and passive. It usually publishes the Annual Report, which is submitted to the legislature for information about 15 months after the end of the financial year.²⁷ The report contains details of the balance sheet and profit and loss performance for each PSU and Statutory Board. An overview section presents summary results across different portfolios of PSUs, but it does not contain any forward-looking information, any assessment of areas of strong or weak performance, or any discussion of the government’s plans to improve performance. Nor does the BPE report internally to government on these issues.

51. The absence of information available on the costs of noncommercial activities undertaken by PSUs limits the ability to assess if they are meeting public policy objectives. No quantitative information is published on the cost of these noncommercial activities in the annual budget documents, and no information is included in PSU Annual Reports or in the Policy Notes produced by departments.²⁸ It is unclear whether the PSU or the government produces any additional information on the financial impacts on PSUs of their noncommercial activities.

Current Situation

59. Revenue performance has lagged behind expenditure growth, and tax buoyancy is low, pointing to a structural problem. The revenue deficit increased from INR 18 billion in 2013–14 (0.18 per cent of GSDP) INR 216 billion (1.51 per cent of GSDP) in 2017–18.²⁹ Revenue expenditure grew 2.22 times faster than revenue receipts in 2017–18, while total revenue receipts grew by only 4.3 percent, considerably less than the growth rate of revenue receipts in comparable States in India.’ The State’s own tax buoyancy with respect to GSDP has ranged from 0.26 to 0.84 over the past five years and stood at 0.74 in 2017–18.

60. Receipts from one of the main revenue sources—taxes on alcohol—are expected to continue to decline. Taxes on alcohol comprise sales taxes and excise taxes; in 2017–18, they comprised 28 percent of the SOTR, which in Tamil Nadu made up 89 percent of the State’s total revenues in 2017–18, higher than for most States. There is some risk around the future path of these revenues.³⁰ In addition, the compensation from GOI for GST revenue shortfalls is expected to end by 2021–22.

61. There may be opportunities to increase revenue collections by improving performance on revenue arrears and by reviewing tax exemptions. Revenue arrears as of March 31, 2018, were INR 301 billion, equivalent to 32 percent of SOTR and 75 percent of the fiscal deficit. Of this amount, 53 percent was under recovery process, 33 percent was under litigation, and action was yet to be initiated on the remaining 14 percent.³¹ There may be opportunities to increase the rate and speed of collections and to reduce the flows of new arrears. There are also a number of tax exemptions under the jurisdiction of the Tamil Nadu government. The actual cost of the exemptions that are quantified was reported as INR 200 million in 2017–18, which is less than 1 percent of the fiscal deficit.³² However, other unquantified exemptions may be more significant.

62. The rate of return on government financial assets is low. The average rate of return on government financial assets increased from 0.2 percent in 2013–14 to 0.62 percent in 2016–17, before declining to 0.45 percent in 2017–18.³³ This amount represents a fraction of the government’s average rate of borrowing of 8.53 percent in 2017–18. The low return on investment was mainly due to the poor financial results of PSUs—although, as Figure 10 shows, some PSUs are profit making and may present an opportunity for divestment, for example, Tamil Nadu News Print and Paper Ltd, which is a listed company. Another important cause of the low returns is poor management of government loans; for example, the poor record keeping of government loans to various borrowers, including TANGEDCO contributed to write-downs in the value of loans or government grants to reduce the value of loans.³⁴ Finally, the CAG noted that the State invests the employee and employer contributions to the defined contribution pension scheme for civil servants in 90 day T-Bills, which earned interest ranging from 6.03 percent to 7.85 percent between 2015–2018; the interest paid to individual pension account holders ranged from 7.60 percent to 8.70 percent in this same period. The CAG observed that by not joining the Government of India’s National Pension Scheme, the Government of Tamil Nadu incurred an avoidable additional expenditure on pensions for 2015–18 of INR 7.97 billion due to low returns on T-Bills.³⁵

Challenges

63. Given the structural issues facing the revenue performance of the Government of Tamil Nadu, there is a pressing need for a medium-term revenue strategy. The practice in recent years of nominal tax or rates that have not been adjusted for some time to increase revenues is neither sufficient nor sustainable. The secular weak trend in revenues, combined with a limited space within the fiscal rules and a tightening fiscal outlook, points to the need for a more fundamental approach to assess whether there are feasible underexploited or untapped revenue sources. This approach requires a medium-term perspective rather than a series of more limited annual exercises, underpinned by adequate revenue forecasting capabilities developed as part of an overall macrofiscal function (see I.A).

Recommendation

Current Situation

64. Tamil Nadu is exposed to a range of other specific fiscal risks, including debt management, expenditure arrears, contingent liabilities, legal claims, PPPs, disasters, and climate change. Each of these risks has the potential to impact significantly on the public finances and is discussed in turn.

65. Risks in debt management include rollover risk³⁶, indirect exchange rate risk, and operational risks. During the four-year period from 2021–22 to 2024–25, 31.81 percent of the current outstanding debt—totaling INR 918.5 billion—will become due for repayment.³⁷ This amount represents a substantial fiscal burden and funding risk. The exchange rate risk is indirect through GOI borrowing internationally and on-lending to the Government of Tamil Nadu, although the level of foreign exchange exposure may be small.

66. Public debt is managed by staff in FD who are also responsible for other functions. Market operations are conducted by the Reserve Bank of India on behalf of the Government of Tamil Nadu, while the CAG performs record keeping for debt. Debt management operates in the absence of a medium-term debt management strategy and of a formal debt sustainability analysis.³⁸ A Consolidated Sinking Fund (CSF) for debt amortization, established in 2006–07, has a required annual contribution of 0.5 percent of the outstanding liabilities at the end of the previous financial year. The CSF balance as of March 31, 2018, was INR 58.66 billion—approximately 2 percent of total debt— invested mainly in GOI securities.

67. There are systematic expenditure arrears and an established practice of shortfalls in the government’s annual contributions to various reserve funds. The government’s financial statements do not present arrears as a liability, but it is understood that there are systematic expenditure arrears to external entities. In addition, the CAG notes that there are shortfalls in required contributions to Public Account Funds (for example, the Debt Sinking Fund, Pension Scheme Fund, and Guarantee Redemption Fund). Expenditure arrears create a control risk and, if not recorded as they arise, can accumulate unexpectedly and increase cost. They are liabilities of government (not contingent liabilities) and should be systematically recorded. The shortfalls in contributions to reserve funds also reflect that the desired level of provisioning is not being achieved due to fiscal pressures.

68. The management of risks from government guarantees exhibits a number of good practices, although exposures increased by 52 percent in 2018–19. These good practices include the following: (1) Guarantee fees are charged, and there is provision for them to be risk-based within a band; (2) a Guarantee Redemption Fund (GRF) was established in 2003; and (3) the TNFRA 2003 (as amended) caps outstanding risk-weighted guarantees at 75 percent of revenue receipts of the previous year or 7.5 per cent of GSDP, whichever is lower. These are all elements of good international practice. In practice, however, guarantee fees are set at a flat rate, and the fees are not always paid. Although there had been a declining trend of guarantee exposures between 2013–14 and 2017–18, and few guarantees have been called in the past 20 years, guarantees jumped by 52 percent in 2018–19 due to new guarantees issued to TANGEDCO. The balance of the GRF was only 0.7 percent of total guarantees outstanding as of March 31, 2018.

Table 4.

Guarantees and the Guarantee Redemption Fund 2018–19

Sources: IMF Staff calculations drawn from the Appendices to the Budget Memorandum; Appendix-IV Statement of Guarantees given by the Government of Tamil Nadu; and Outstanding Guarantees as of March 31, 2018.

Table 4.

Guarantees and the Guarantee Redemption Fund 2018–19

	2018/19, INR billion
Total Outstanding Guarantees as of March 31, 2018	361.3
As a share of revenue receipts	24.7%
As a share of GSDP	2.5%
Ratio of GRF to outstanding guarantees	0.7%
New Guarantees issued in 2018–19	188.2
Share of new guarantees to existing stock	52.0%
Share of new guarantees issued to TANGEDCO	97.0%

Sources: IMF Staff calculations drawn from the Appendices to the Budget Memorandum; Appendix-IV Statement of Guarantees given by the Government of Tamil Nadu; and Outstanding Guarantees as of March 31, 2018.

View Table

Table 4.

Guarantees and the Guarantee Redemption Fund 2018–19

	2018/19, INR billion
Total Outstanding Guarantees as of March 31, 2018	361.3
As a share of revenue receipts	24.7%
As a share of GSDP	2.5%
Ratio of GRF to outstanding guarantees	0.7%
New Guarantees issued in 2018–19	188.2
Share of new guarantees to existing stock	52.0%
Share of new guarantees issued to TANGEDCO	97.0%

Sources: IMF Staff calculations drawn from the Appendices to the Budget Memorandum; Appendix-IV Statement of Guarantees given by the Government of Tamil Nadu; and Outstanding Guarantees as of March 31, 2018.

69. Other explicit contingent liabilities include legal action against the State government. The State is a respondent party to a range of legal claims, including claims against tax and duty assessments. At times, court decisions have had sizeable fiscal impacts, for example, with respect to taxes on alcohol. Departments are not required to record the existence or details of claims; no data are available on the stock of claims, the amounts claimed, or the stage at which the legal proceedings are. It is understood that the FD centrally monitors all of the significant legal claims to which FD itself is a respondent. Legal claims are explicit contingent liabilities similar to guarantees, and good practice is to maintain formal records at the departmental level and to aggregate the information for centralized oversight.³⁹ The State also initiates legal claims, particularly with respect to taxation (the Commercial Tax Department); these claims are in the nature of contingent assets.

70. A small number of PPPs is under implementation, but the government intends to significantly expand the number of PPPs. Existing projects include five road and water supply projects, partly financed through viability gap funding from the State budget. Available data are sketchy, but total annual payment commitments for two of the projects amount to INR 2.93 billion for up to 25 years. The government established the Tamil Nadu Infrastructure Development Board (TNIDB) through the Tamil Nadu Infrastructure Development Act 2012. TNIDB is chaired by the Chief Minister; the Minister of Finance is the Vice-Chair. The TNIDB’s roles include developing and prioritizing public infrastructure through all modalities, conducting appraisals of all major public investment projects, evaluating proposed PPPs against a public sector comparator project, and recommending financial support for projects from the Government under the Tamil Nadu Infrastructure Development Fund or from the Central Government. Although the TNIDB has a pipeline of 169 PPP projects, the status and stage of each remain unclear.

71. It is important that the Ministry of Finance has a formal budget gatekeeper role at the project appraisal stage. This role is intended to advise the government on the affordability of each individual project and of the accumulated obligations and risks in the portfolio of approved and proposed projects. Because of the long-term debt-like obligations in some PPPs, as well as contingent liabilities, the government will need to maintain a complete central register of all projects and to ensure that the fiscal commitments in approved projects are incorporated in fiscal policy analysis. The IMF and the World Bank have developed the PPP Fiscal Risk Assessment Model (PFRAM) for this purpose.⁴⁰

72. Disasters are a significant source of fiscal risks. Over the past 10 years, Tamil Nadu has experienced substantial fiscal costs from cyclones, floods, and droughts. Annual expenditure incurred on natural calamities since 2010–/11 ranged from a low of INR 3.75 billion in 2014/15 to INR 29.84 billion in 2015–/16. These costs are shared between the State Disaster Relief Fund and the GOI National Disaster Relief Fund; the National Fund pays 75 percent of the costs. Fiscal impacts include the provision of disaster relief to victims; expenditure on water shortage emergencies; reconstruction of damaged infrastructure; the need for new capital investment to increase the resilience of public infrastructure (for example, a cyclone-resilient electrical network project); and other investments in coastal disaster risk reduction.

73. Tamil Nadu may be exposed to a range of fiscal impacts from climate change. Climate change is associated with an increased likelihood of the incidence and severity of natural disasters, such as cyclones. Annual expenditures on calamities vary from year to year in Tamil Nadu, but the three most costly years over the past decade occurred in the past four years, indicating a potential increasing exposure.⁴¹ Cyclone Gaja in November 2018 damaged the electricity network to a much greater extent than previous cyclones; total damages are estimated at INR 23.8 billion.⁴² In addition to reconstruction, other climate-related spending pressures include the need for the increased investment in renewable energy sources and public infrastructure resilience.⁴³ Tamil Nadu may also be exposed to slow-onset disasters, such as water scarcity. Fiscal exposures resulting from this situation include spending on emergency drinking water deliveries and the current planning for three significant water desalination plants as PPP projects. It is important that FD takes a broad view of the potential shocks to the public finances from climate change, considering a range of sources.⁴⁴ FD also needs to be alert to the possibility that some fiscal policies may be raising the level of environmental risks, such as the possibility that free or subsidized electricity result in the unnecessary and inefficient usage of scarce fresh-water resources.

74. Although the risks from local governments have not been apparent, the FD should monitor their finances. Fiscal shocks to higher levels of government from lower levels of governments are a common source of fiscal risk globally. Local governments are required to obtain State government approval before borrowing; however, it is still important for the FD to routinely monitor the evolution of local government deficits, expenditure arrears, and their risk exposures as an early warning of potential problems that could rebound on the state.

Challenges

75. Oversight of fiscal risks is currently only one year ahead, at best. Government revenues are projected at an aggregate level over the medium term, but bottom-up forecasts of government revenues are currently produced only for the next budget year. On paper, there are three-year expenditure forecasts; in practice, however, these have little credibility and are not relevant to fiscal management. Debt management operates in the absence of a medium-term debt management strategy or the ability to conduct formal debt sustainability analysis. The focus of spending on civil service pensions is one year ahead, and there is no actuarial calculation of the government’s pension liability. Even large PSUs only produce one year ahead financial forecasts, while, as discussed in II.D, the oversight of PSUs is largely backward-looking and passive. Accordingly, there is no medium-term orientation to fiscal policy or to the identification of fiscal risks.

76. Fiscal risk identification and monitoring should be extended to other important sources. Information is not recorded or aggregated on expenditure arrears (liabilities) or on legal action against the State (contingent liabilities), although a PPP register and pipeline are being populated.

77. The FD needs to progressively move to proactive and forward-looking management of fiscal risks from the current generally passive and reactive approach. Improved awareness of the need for fiscal risk management and of the capacity for it in FD is needed. The new IFHRMS piloted in January 2020 has the potential to help improve record keeping in FD, reduce operational risks (for example, in loans management), and improve forecasting capacity (for example, of multiyear pension expenditures).

Recommendations

Current Situation

78. Elements of good practice fiscal risk reporting exist in Tamil Nadu. Information on some sources of fiscal risk are transparently published within various government documents. For example, with respect to guarantees, information is published on the value of outstanding guarantees by sector, by entity, and by risk weighting. Details on mechanisms designed to manage guarantee risks, such as guarantee fees owed and received and available contingencies funds, are also disclosed. Similarly, extensive information on loans from the State government that are outstanding are disclosed by entity, rate of interest, concessional terms, and lists of loans issued to entities in arrears are identified.⁴⁵ With respect to PSUs and corporations, schedules of transfers between entities and the State are published. The financial situation of individual PSUs can be found in their respective annual financial reports and also in a consolidated report produced by the FD (BPE) that looks at the aggregate performance of the PSU sector. This report identifies loss-making entities in a table, although is produced with some time lag.⁴⁶

79. However, reporting practices across sources of fiscal risks are uneven, with some risks yet to be fully identified, analyzed, and disclosed. Publicly available information does not exist or is limited for some sources of fiscal risks. For example, the Government of Tamil Nadu does not assess or publish the impact of macroeconomic risks. Similarly, potential obligations arising from contingent liabilities for legal claims or outstanding arrears are not disclosed. Limited disclosures exist around the performance of local governments; expenditure arrears; future pension obligations like pensions, debt repayments, or PPPs. Further, although disclosure of PSU performance is generally very good, elements are absent, including identifying, analyzing, and reporting on the financial impacts of noncommercial obligations.

80. Where elements of good practice disclosures do exist, there is limited analysis to help readers connect the dots. The good practice disclosures referred to are very detailed, normally in tabular form. These disclosures most often include quantification; however, there is limited analysis supporting the disclosure and no narrative or assessment of the risks. This is important as it helps the reader better understand each of these risks, alongside the likelihood of these risks occurring and actions to help mitigate their impact.

81. Moreover, given that fiscal risk reporting is fragmented, it is difficult, even for the government, to build a comprehensive picture of overall fiscal risks to government finances and their interconnectedness. As discussed, while fiscal risk reporting practices exists across a number of elements, reporting practices for some sources of fiscal risks is more limited. Where disclosures exist, they are dispersed across different reports, making it difficult to visualize the full extent of fiscal risk exposure. A summary report of fiscal risks could assist the State to better understand and manage vulnerabilities by providing a sense of the totality of potential threats to the fiscal position; a summary could also, over time, help to inform an integrated understanding of the conditions under which they are likely to materialize, including an understanding of the interconnectedness among different risks types. This summary is important because IMF research has proven that fiscal risks are highly correlated.⁴⁷

82. Fiscal risk reporting in Tamil Nadu primarily focuses on historical outcomes and has yet to inform future decision-making. Current disclosures, even in the budget documents, are largely historical, or at most are one year ahead. Disclosures do not generally feature any analysis of the nature of future risks, potential future impacts, likelihood of the risks materializing, and strategies to monitor and manage risks going forward. For example, while information currently disclosed in relation to PSUs is very detailed, identifying loss-making PSUs and the size of the loss, reporting, and analysis, the information is not yet forward-looking (see II.A for details).

Challenges

83. As fiscal constraints begin to bind, improvements in fiscal risk reporting are more important than ever to help manage the sustainability of State finances. Macroeconomic shocks are typically the most common and one of the largest sources of fiscal risk.⁴⁸ Sudden changes in fiscally relevant macroeconomic variables can result in sharp changes in government deficits and debts. FD and ministers have limited information on the potential impact that macroeconomic risks could have on the State’s finances. The capacity to identify, analyze, and report on the impact of macroeconomic risks on the fiscal forecasts also appears limited (see I.A for details).

84. Without further efforts to identify, monitor, manage, and report on fiscal risks, the State will be left unprepared to deal with looming fiscal costs in the context of narrowing fiscal space. As the State starts to reach the debt limits imposed by the fiscal rules against a potentially declining and narrow revenue base, the ability of the State to respond to fiscal risks as they emerge will become more challenging.

85. A comprehensive approach to fiscal risk reporting is necessary to enhance the State’s understanding, analysis, and management of risk exposures. Comprehensive disclosure and analysis of fiscal risks can help to ensure that fiscal policy settings can respond to a range of potential future economic and fiscal shocks and that abrupt and disruptive changes in policy are avoided when risks materialize.

86. Sound institutional arrangements are needed to support an effective and integrated approach to risk management. Establishing a central function responsible for overseeing fiscal risk management (Box 6) is one way to help Achieve a comprehensive approach. The centralized function would facilitate coordination across the government and be responsible for putting together the overall picture on fiscal risk management. Individual departments and line ministries would be responsible and accountable for identifying, estimating, analyzing, and monitoring specific fiscal risks that fall within their functions.

87. Opportunities exist to leverage, build, and improve on fiscal risk disclosure practices in Tamil Nadu, bringing together an integrated and comprehensive picture of fiscal risks. Further efforts to strength fiscal risk reporting practices will be needed if the State is to continue to maintain its attractiveness to investors and keep pace with fiscal risk reporting reforms commencing in other parts of the country. Some Indian States, like Odisha, are already working to strengthen and modernize their fiscal risk reporting practices. Odisha has recognized the value of taking an integrated, comprehensive, and forward-looking approach to fiscal risk reporting following a recent IMF Technical Assistance mission.

88. Publishing summary information on fiscal risks reinforces the credibility of the government’s forecasts among creditors and across markets and, in some cases, can reduce borrowing costs. It enables decision-makers, the public, and the legislature to have a better grasp of risks and their potential impacts on the budget (Box 7).

^{Box 7.}

Why Is Fiscal Risk Disclosure Important?

Disclosing fiscal risks is a critical part of fiscal transparency. The IMF Fiscal Transparency Code,⁴⁹ the most widely recognized international standard for disclosure of information about public finances, devotes one-third of its principles to fiscal risk analysis and management. The Code requires that risks to the public finances be disclosed, analyzed, and managed and that fiscal decision-making across the public sector be effectively coordinated.

To enhance the credibility of its fiscal policy and forecasts, the Government of Tamil Nadu should provide summary information on fiscal risks to the public. When information is highly fragmented and dispersed across different reports, or when it is lacking, it becomes difficult to visualize the full extent of exposure to fiscal risks. It helps to boost support for mitigation policies, and it reinforces the credibility of the government’s macrofiscal forecasts among creditors and across markets.

Fiscal transparency is essential to effective fiscal management and accountability. It fosters good governance and helps to reduce corruption. It ensures:

• Governments have an accurate picture of their fiscal position and prospects and the costs and benefits of any policy changes to support a better-informed debate about the design and results of fiscal policy.

• Policymakers have a sound understanding of the potential risks to public finances and can better manage these, allowing for earlier and smoother fiscal policy adjustments where required.

• Legislatures, citizens, and markets have the information they need to hold governments accountable.

Greater fiscal transparency can also help strengthen the credibility of a country’s fiscal plans and can help foster market confidence and market perceptions of fiscal solvency (Figure 7.1). The loss of market confidence in governments with underestimated or hidden deficits in the wake of the global financial crisis underscored the importance of fiscal transparency to global financial and economic stability.

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Fiscal Transparency and Market Perceptions of Solvency

Citation: IMF Staff Country Reports 2020, 208; 10.5089/9781513548586.002.A001

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Source: IMF. 2018. Fiscal Transparency Handbook. Washington, DC: IMF.

89. A forward-looking approach to fiscal risk reporting would allow for more informed decision-making, as internal risk reports could feed into the budget process and increase the preparedness of the State to respond to adverse shocks. Improved disclosure not only helps investors and citizens; it can also help the State to better understand, monitor. and manage fiscal risks, as these actions are mutually reinforcing activities. At a minimum, the State could work to improve the internal reporting of fiscal risks. Progressively comprehensive reporting on fiscal risks within government to ministers at the time of budget development should be a priority. Annex VI provides an example fiscal risk register template that could be a useful tool for furthering internal fiscal risk reporting and external disclosure practices. Efforts should be prioritized toward fiscal risks that have the potential to be significant or where current practices need additional attention. Box 8 provides country examples of fiscal risk statements.

90. An increasing number of countries has opted for the publication of a summary chapter or standalone report on fiscal risks, supported in many cases by domestic legislation. In the South and Southeast Asia region, Pakistan, the Philippines, and Indonesia have been trailblazers in relation to the publication of comprehensive fiscal risk statements. In its first occurrence, a Fiscal Risk Statement for Tamil Nadu could contain a simple, qualitative assessment of the most prevalent risks (a fiscal risk register), and, as available, quantitative information. It should at first cover macroeconomic risks, as well as the most significant sources of specific fiscal risks. Over the years, as the fiscal risk register becomes more exhaustive and internal reporting processes are strengthened, the report could be extended to other types of fiscal risks, become more detailed and more quantitative, and comprise more complex analyses. Following the presentation of each type of risk, a short paragraph should help the reader to understand by explaining the nature of the risk, its key features, the likelihood of occurring risks, and any mitigation measures taken. As the practice evolves, the presentation of fiscal risks could become a standalone document, published alongside the budget document. Annex VII proposes an outline for the fiscal risk statement, which becomes more elaborate over the years.

91. Requirements to publish comprehensive fiscal risk statements are supported by evolving international standards, reinforced by domestic legislation. These standards include the Government Finance Statistics Manual 2014, the International Public Sector Accounting Standards, and the IMF’s Fiscal Transparency Code 2014. In addition, an increasing trend is to support fiscal risk disclosure practices with amendments to domestic legislation. Hence, consideration could be given to strengthening fiscal risk reporting requirements by amending the Tamil Nadu Fiscal Responsibility Act.

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