Subnational Public Finance in Times of Recession

The Reserve Bank of India’s study State Finances: A Study of Budgets of 2009-10 (published in February 2010) was drafted against the background of the unforeseen effect of the global fi nancial crisis on the Indian economy. It is well known that the Indian economy went through an uncertain macroeconomic environment in the fiscal year 2008-09. In order to tackle the economic downturn, the central and state governments were forced to increase their expenditures. Demand-raising measures in the form of various stimulus packages indeed contributed to the increase in fiscal deficits of the central government, while the states were allowed to borrow over and above the rule-based limit of deficits, specified under the state-level Fiscal Responsibility Act (FRA). Also, various states introduced their own fiscal measures to combat the crisis. But the effect of all these measures on the state-level fiscal situation and the state economy is still not clear.

This article critically reviews the findings of the RBI study on state finances in 2009-10. Despite the fact that the period of analysis is only up to 2009-10 budget estimates (BE) in the RBI report, this note is significant to understand in what way the crisis-induced economic downturn impacted on state-level fiscal imbalances and subnational expenditures. The Economic Outlook 2010-11 (GoI 2010) released by the prime minister’s economic advisory council (EAC) at the end of July 2010 contains an analysis of the fiscal variables in 2009-10 revised estimate (RE) and 2010-11 (BE), which shows no major changes in the trends in the last two years. The recent data in the Economic Outlook revealed that the budgeted consolidated fiscal deficit in 2010-11 stands at 8.4% of gross domestic product (GDP) (almost 1.8 percentage points less than the RE for 2009-10), while the revenue deficit as a ratio of GDP is expected to decline from 6.3% in 2009-10 to 4.6% in 2010-11. On the revenue front, the EAC report highlighted that the unexpected bonanza from the telecom auctions and the decontrol of the petroleum products is likely to provide some additional cushion in revenue collections. The chapter on government finances in the EAC report also reveals that the budget estimates for 2010-11 do not show a serious fiscal imbalance at the state-level as well and place on board the requirement to initiate an “exit” from the expansionary fiscal policy stance ex post to the financial crisis. Against this backdrop, this note analyses the RBI state finances study