Establishing Independent Fiscal Councils in Indian States

The National Council of Applied Economic Research (NCAER) has proposed that state of Indias establish independent fiscal councils. This recommendation aims to enhance the institutional capacity of state governments. The paper titled The State of the States – Federal Finance in India marks the need for transparency and accountability in fiscal management. It suggests that these councils should comprise academics, financial market experts, and other professionals.

Purpose of Fiscal Councils

Fiscal councils will evaluate state government forecasts on revenues and expenditures. They will provide independent analyses and offer their own forecasts. This will help in assessing the realism of state budgets. The councils will also analyse contingent liabilities, ensuring better fiscal health.

International Examples

The NCAER paper cites the European Union as a model. Each EU member state has a fiscal council. The European Commission acts as a quasi-fiscal council at the union level. This structure allows for a comprehensive assessment of member states’ fiscal forecasts. Such arrangements enhance budgetary oversight and accountability.

Previous Recommendations

Several bodies have previously suggested the establishment of a Fiscal Council for the central government. The Thirteenth Finance Commission recommended an autonomous body reporting to the Ministry of Finance. The Fourteenth Finance Commission also noted the global trend of fiscal councils aiding in fiscal policy evaluation. However, the central government has resisted these proposals, citing concerns over potential encroachment on its powers.

Need for Forensic Analysis

The NCAER paper calls for forensic analysis of revenue shortfalls and expenditure overruns in poorly performing states. About past fiscal failures is crucial for preventing future issues. This analysis will help identify specific areas needing improvement in financial management.

State Debt Variations

State debts in India show variation. For instance, Punjab’s debt is nearly 50% of its state gross domestic product (SGDP), while states like Odisha and Gujarat have debts below 20%. Over the last decade, most larger states have seen their debt-to-SGDP ratios increase . This trend raises concerns about fiscal sustainability.

Role of the Reserve Bank of India

The NCAER recommends that the Reserve Bank of India (RBI) reassess its market intervention policies. Currently, the RBI caps bond spreads for heavily indebted states. Reducing such interventions could strengthen market discipline. The authors argue that without market discipline, fiscal discipline cannot be achieved.

Reconsidering the Finance Commission’s Role

The paper suggests that the role of the Finance Commission should be reviewed. The current allocation mechanism may inadvertently encourage fiscal irresponsibility. The Finance Commission allocates more resources to states with larger revenue deficits, which can perpetuate poor fiscal management.

Implications for Fiscal Policy

The establishment of independent fiscal councils could lead to improved fiscal governance in states. These councils would enhance transparency and accountability. They would also provide a framework for better financial planning and management.

Questions for UPSC:

1. Critically analyse the impact of establishing independent fiscal councils on the financial management of state of Indias.
2. Estimate the significance of forensic analysis in understanding fiscal shortfalls in state of Indias.
3. Point out the differences in state debt levels across India and their implications for fiscal policy.
4. What is the role of the Reserve Bank of India in managing state debts? How can its policies affect fiscal discipline?

Answer Hints:

1. Critically analyse the impact of establishing independent fiscal councils on the financial management of states of Indias.

1. Independent fiscal councils enhance transparency and accountability in state financial management.
2. They provide objective assessments of state revenue and expenditure forecasts, improving budget accuracy.
3. These councils can identify and analyze contingent liabilities, reducing fiscal risks.
4. Similar to the EU model, they can strengthen budgetary oversight and encourage fiscal discipline.
5. Ultimately, they can encourage better financial planning, leading to sustainable economic growth in states.

2. Estimate the significance of forensic analysis in understanding fiscal shortfalls in states of Indias.

1. Forensic analysis identifies specific causes of revenue shortfalls and expenditure overruns.
2. It helps in understanding past fiscal failures to prevent future issues in financial management.
3. This analysis can guide policymakers in making informed decisions regarding budget allocations.
4. It enhances accountability by pinpointing areas needing improvement in fiscal practices.
5. Such insights can lead to more effective fiscal policies and better resource management.

3. Point out the differences in state debt levels across India and their implications for fiscal policy.

1. State debts vary , with Punjab at nearly 50% of SGDP and states like Odisha under 20%.
2. Higher debt levels can lead to increased interest payments, limiting funds for development projects.
3. States with high debt-to-SGDP ratios may face challenges in accessing future borrowing.
4. Debt disparities can influence fiscal policy decisions and resource allocations from the central government.
5. About these differences is crucial for promoting fiscal sustainability and equitable development.

4. What is the role of the Reserve Bank of India in managing state debts? How can its policies affect fiscal discipline?

1. The RBI currently intervenes in the bond markets to cap spreads for heavily indebted states.
2. This intervention can create a false sense of security, reducing market discipline among states.
3. Limiting such interventions may encourage states to adopt more responsible fiscal practices.
4. RBI’s policies can influence borrowing costs, affecting states’ fiscal strategies and debt management.
5. Without market discipline, states may lack incentives to maintain fiscal prudence, risking long-term economic stability.