State Fiscal Responsibility Laws Improve Deficits But Fail To Curb Debt: World Bank

New Delhi, Feb 5 (KNN) A World Bank report submitted to the 16th Finance Commission has found that nearly 20 years of Fiscal Responsibility Laws (FRLs) at the state level in India have not fully succeeded in reducing debt levels across major states, even though they have helped improve headline fiscal deficits, the report said.

According to the analysis, while FRLs are linked with deficit reduction, debt levels have remained elevated and uneven among several large states. Highly indebted states such as Kerala, Punjab, Rajasthan, Andhra Pradesh and West Bengal continue to carry significant debt burdens, whereas states like Gujarat managed to reduce debt substantially. 

The report highlights that consolidation efforts often came at the expense of capital and development expenditure rather than through stronger revenue measures or structural reforms, reported the Business Standard.

Rising contingent liabilities, off-budget borrowings, and high committed expenditures on salaries, pensions and interest were cited as key drivers behind persistent debt levels.

Recommendation: Move to Risk-Based, Debt-Anchored Framework

The World Bank has proposed replacing the uniform 3 percent fiscal deficit limit for states with a debt-linked, risk-based framework. 

Under a proposed ‘traffic light’ system, high-risk states would be capped at 2.5 percent of  Gross State Domestic Product (GSDP), states under observation at 2.8 percent, and fiscally sustainable states allowed to borrow up to 3.25 percent, all anchored to a medium-term debt-to-GSDP ratio of 25 percent.

The report also emphasised the need to strengthen institutional capacity, such as introducing accrual accounting and setting up an independent fiscal institution, and to improve flexibility in central transfers, including rationalising rigid Centrally Sponsored Schemes, to support long-term fiscal sustainability.

The 16th Finance Commission’s own recommendations, tabled recently in Parliament, include maintaining a 3 percent fiscal deficit cap for states and a target of lowering the Union government’s fiscal deficit to 3.5 percent of GDP by 2031. 

(KNN Bureau)