Fiscal Tightrope: Balancing State Finances in India

A National Council of Applied Economic Research paper urges collaboration among India's Union government, RBI, and Finance Commission for fiscal discipline in states. Debt relief for heavily indebted states is suggested in exchange for central oversight. Market discipline and fiscal reforms can prevent mounting state debts in India.

A recently published research paper from the National Council of Applied Economic Research (NCAER) recommends a collaborative approach involving India's Union government, the Reserve Bank of India (RBI), and the Finance Commission to enforce fiscal discipline in states. The report suggests offering debt relief to heavily indebted states as an incentive for conceding greater oversight by the central government.

The NCAER paper, titled 'The State of the States: Federal Finance in India,' emphasizes limiting RBI's market interventions to promote fiscal discipline. It also highlights the need for reformation in the allocation of resources by the Finance Commission, which currently favors states with larger revenue deficits, thus creating a moral hazard.

To address rising state debts, the paper proposes various measures, including a forensic examination of poorly performing states, streamlining administrative processes to boost revenue, and shifting expenditures towards infrastructure and capacity-building. The report notes that a significant portion of India's public debt is state debt, urging comprehensive fiscal reforms to rectify financial disparities among states.