Indian fiscal federalism: a study of factors affecting resource position of the state governments

Abstract

The finances of state governments in India have been facing a hard budget constraint as there is a legislative mandate to run the finances with a ceiling on fiscal deficit at 3% of gross state domestic product (GSDP) and the debt-to-GSDP ratio at 20%. In this paper, we have elucidated the limitations of fiscal deficit as the sole target, particularly in the context of availability of resources to the state budgets. These include: (a) tax devolution and grants based on finance commission awards, (b) discretionary transfers in terms of grants from the union government and (c) borrowings from the market. . Keeping in view the constitutional and institutional flow of resources to the state budget, a resource gap model has been designed in this paper. This is named as Basic Resource Gap (BRG) with three variants (BRG 1, BRG 2 and BRG 3). Based on the BRG, fiscal dependency ratio (FDR) and fiscal stress ratio (FSR) have been worked out in this paper. The empirical findings broadly suggest that in respect of the consolidated position (all states together) nearly 50% of the total resource originated from the dependent and stressed sources. A further breakup of this reveals that while resources from dependent sources were 22%, the resources from stressed source were 28% of the total available resources. This analysis is an analytical improvement over the conventional approach of fiscal deficit. BRG model, besides filling the gap in the literature of fiscal federalism, will be operationally helpful to the state governments in terms of a holistic picture of the resource gap incorporating the constitutional and institutional resource flows to the state budgets based on the accounting arrangements in conformity with consolidated fund and public accounts. In essence, BRG along with FSR and FDR will add analytical rigor to the analysis of hard budget constraints in terms of resource availability to the state governments.