special article

Macro policy reform and sub-National Finance: Why is the Fiscal space of the states shrinking?
Pinaki Chakraborty, Anit N Mukherjee, H K Amarnath

In the post-economic liberalisation era, financial sector and fiscal reforms by the central government have adversely affected sub-national finances. The centres fiscal consolidation measures have contributed to the sharp decline in vertical transfers and the financial liberalisation-induced increase in interest rates has widened the resource gap of the states through an increase in the interest outgo on the stock of debt. This paper examines the effect of the fiscal imbalance on the sub-national fiscal space. Econometric estimates reveal that though the effect of the cost of debt on total expenditure is expansionary, it is negative with respect to the fiscal space. As the sub-national fiscal space has been shrinking, corrective measures are required to increase the states ability to fulfil developmental fiscal needs.

1 introduction
n federal countries, the fiscal relationships across levels of governments are broadly defined in terms of functions and finances with a specified design of intergovernmental transfers to correct for vertical and horizontal imbalances.1 However, within this broad defined relationship, there could be an asymmetric impact of exogenous shocks on a particular tier of government compared to the other tiers, depending on the nature and the process of shocks. Such shocks could be many, for example, changes in macroeconomic policy, financial liberalisation and deregulation of the interest rate or a fiscal restructuring programme. There could also be shock-induced changes in the nature and the degree of interdependence across levels of governments.2 There has been a macro policy reform and a large-scale fiscal restructuring programme underway both at the central and state level in India over the past one and half decades. The reform programme was initiated due to the unprecedented macroeconomic crisis of 1991 reflected in burgeoning public sector deficits and debt, widening current account deficits in the external account and dwindling foreign exchange reserves.3 In the face of this crisis, the central government has undertaken a large-scale fiscal reform programme since the beginning of 1990s and different states have undertaken fiscal consolidation measures at different points of time during the 1990s and also during the current decade.4 The fiscal restructuring programmes at both levels of governments are aimed at achieving fiscal sustainability through restructuring of tax and expenditure policy of both tiers of government. Fiscal restructuring at the central level comprises rapid reform in direct and indirect taxes, expenditure restructuring and disinvestment of public sector enterprises. In the face of a declining tax to GDP ratio, the fiscal correction at the central level was achieved through a large cut in discretionary government expenditure, primarily, capital expenditure.5 Also during this period, there was a decline in the central transfers to the states, particularly the transfers through grants, which has adversely affected the states fiscal situation. The fiscal reforms affecting sub-national finances in India in the last one and half decades are many and relate to all aspects of sub-national fiscal policy, viz, tax, expenditure and debt management and interest rate policies and intergovernmental transfers. It has been observed that economic liberalisation since the early 1990s has unleashed competition among sub-national governments, and this has brought to the fore the central role of incentives in ensuring sound fiscal practices at all levels of governments
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Pinaki Chakraborty (pinaki@nipfp.org.in), Anit N Mukherjee and H K Amarnath are at the National Institute of Public Finance and Policy, New Delhi.

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(Rao 2003). Some of the important changes in sub-national fiscal policy worth highlighting in this context are: (i) the introduction of state level Fiscal Responsibility and Budget Management (FRBM) Acts to institutionalise rule-based fiscal control by 14 states, (ii) incentivising the system of transfers to fiscal performance by successive finance commissions, (iii) increasing reliance on state-specific discretionary transfers through memorandum of understanding (MoU) with the central government,6 and (iv) sub-national adjustment lending based fiscal correction in selected states at instances of multilateral institutions, primarily the Asian Development Bank and World Bank. Both the Eleventh Finance Commission (Government of India 2000) and the Twelfth Finance Commission (Government of India 2004) also prepared a fiscal restructuring plan intended to improve the finances of the centre and states to achieve a sustainable debt and deficit regime and thereby establish macroeconomic stability and growth. Along with this, even the statutory transfers to the states from finance commissions have become linked to state-level fiscal performance due to the inclusion in the horizontal distribution formula of resources of indicators like the index of fiscal self-reliance and tax efforts. Apart from the reforms that are directed towards fiscal consolidation of the states, fiscal policy reform at the central level as well as the financial sector reforms, particularly the deregulation of interest rates, have adversely affected state finances. The centres efforts towards its own fiscal consolidation contributed to a sharp decline in the overall volume of transfers to the states. Financial sector reform and the consequent deregulation of the government securities market and interest rates have fuelled the already existing large resource gaps in terms of a larger interest outgo on the stock of state debt. The stock of outstanding debt for the centre and the states shows a sharp increase over the years.7 It is to be noted that the growth of interest payment of the states, which was lower than that of centre during the decade of 1980s, exceeded it during the 1990s (Chakraborty 2005). The divergence in growth of interest payments has further widened between 2000-01 and 2003-04, when the centres interest payments grew at the rate of 8.50% per annum, the rate of growth of states interest payments remained as high as 16.82%, despite a lower growth of fiscal deficits and debt of states, compared to the centre during the same period.8 Aggregate central transfers to the states as a percentage of GDP declined from 4.89% in 1990-91 to 3.79% in 1999-2000 and thereafter increased to 4.30% in 2003-04 RE. The average cost of debt to the states also increased from 9.20 to 13.21% during 1990-91-1999-2000 and declined to 12.23% in 2003-04. During this entire period, the share of non-interest expenditure of the states steadily declined from 93.88 to 81.25%. Several studies note that during the 1990s, central transfers to the states declined and the average cost of debt went up due to financial sector reform. However, the causal effect of these changes on sub-national finances requires rigorous analytical investigation. This paper is an attempt to examine the effect of these changes on the sub-national fiscal space in 14 major states of India. The sub-national fiscal space is defined in terms of total expenditure as well as the primary expenditure of the state
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government. Our objective in this paper is to show, econometrically, how financial deregulation, particularly the deregulation of the interest rate and the decline in the volume of aggregate federal transfers, has affected the fiscal space of the 14 major states under consideration over a period of 23 years from 1980-81 to 2002-03, for which latest figures are available. In Section 2 we define fiscal space and identify the key variables affecting it due to macroeconomic policy reforms and analyse their inter-temporal movements spreading over the pre- and postreform periods. In Section 3, we analyse the sub-national fiscal situation in a comparative perspective in both pre- and postreform periods and examine whether the fiscal space is shrinking in the post-reform periods and the possible reasons thereof. Section 4 specifies a model of the fiscal space for sub-national governments in India and provides estimates in a panel data framework. Section 5 summarises the findings and draws some policy conclusions.

2 policy reform and sub-National Fiscal space

The major macroeconomic policy reform that was initiated in India since 1991 consisted of a stabilisation and structural adjustment programme through reform in trade, industrial, fiscal and financial policies. The fiscal policy reform that was introduced as a fiscal consolidation measure for the central government, has gradually spread to the states for fiscal consolidation through reforms in state taxes, expenditure policy and power sector reform. Fiscal policy reform initiated at the state level can be classified into the following groups: (i) through MOUs with the centre, (ii) those at the instance of finance commissions for the purpose
Figure 1: all state revenue profile and its components (as % of GDP)
13 13.0 12 12.0 11.0 10.0 9.0 9 8.0 7.0 6.0 6 5.0 4.0 3.0 3

Revenue Receipts Own Revenue

Percent

Transfers
1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03

of continuity of transfers linked to performance, (iii) multilateral Year adjustment lending-based fiscal reform, and (iv) reforms related to macroeconomic policy changes. As mentioned above, the primary objective of state level fiscal reform programmes is to achieve fiscal consolidation through revenue enhancement, reducing and restructuring of expenditure, reducing subsidies and power sector loss and thereby overall fiscal restructuring and consolidation. Our focus in this paper is not to assess the effect of state level fiscal reform on fiscal consolidation in the states, but to evaluate the impact of reforms that are largely outside the control of the state governments and are macroeconomic in nature, and their impact on their fiscal space. Heller (2005) defined fiscal space as room in a governments budget that allows it to provide resources for a desired purpose without jeopardising the sustainability of its financial position or stability of the economy. As mentioned by Heller, fiscal space can be created by generating extra resources through taxation, securing

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Figure 2: average cost of state Debt 1981-82 to 2003-04 (in %)
14.00 14

12.00 12

10.00 10

8.00 8

6.00 6

4.00 4 1981-82 1983-84 1985-86 1987-88 1989-90 1991-92 1993-94 1995-96 1997-98 1999-00 2001-02 2003-04 RE

outside grants, cutting lower priority expenditure and through borrowing. In other words, it could be a combination of greater public savings through expenditure rationalisation and tax reform, and extra resources that can be mobilised from borrowing and grants. In this context, when we talk about reforms that have affected states fiscal space in India but are outside the control of the state governments, they are the fiscal consolidation measures of the central government and consequent reduction in the volume of transfers to the states. It can be seen from Figure 1 (p 39) that the central transfers to the states as a percentage of GDP tended to decline from early 1990s and that trend continued up to 19992000. Though, the transfers to GDP ratio increased marginally thereafter, it remained below the level reached during the mid1980s and the early years of the 1990s. The decline in central transfers reduced the availability of resources at the state level and thereby the fiscal space. It is also to be noted that the own revenue to GDP ratio of states, which remained stagnant at around 6% of GDP, tended to increase from 2000-01 onwards. Consequently, the total revenue to GDP ratio increased despite a decline in the overall volume of transfers. This also implies that a further decline in the fiscal space has been arrested in recent years due to higher own revenue mobilisation by the state governments. As mentioned earlier, the other macroeconomic policy change, viz, deregulation of the interest rate and the consequent increase in the rates of interest on government securities, has had a significant effect on the fiscal situation of the states. The average cost of state debt increased from 6.01% in 1981-82 to 9.2% in 1990-91 and thereafter sharply to 13.21% in 1999-2000. Interest payment still constitute the single largest component of revenue expenditures of the state government, although there has been a softening of interest rates and in turn a decline in the average cost of debt in recent years. The decline in central transfers and the increase in the average cost of debt have adversely affected the fiscal scene in the states, particularly during the 1990s. The state-level fiscal deficit increased sharply over the years (see Table 1) and was driven by the widening of the revenue deficits. If one looks at the movement of the fiscal deficit to GDP ratio from Table 1, one observes that it shows an increasing trend during the 1990s, an after initial correction. However, the gradual rising trend became sharper from 1997-98 onwards, primarily due to the salary-induced hike in revenue expenditure arising out of the implementation of the Fifth

Pay Commissions recommendations. Thereafter, some degree of fiscal correction seems to have been achieved between 1999-2000 and 2002-03, for which the final accounts data is available. The revenue deficit is the gap in resources between the current consumption expenditure and revenue resources. Table 1 also indicates that an increase in the revenue deficit has adversely affected the quality of the overall fiscal deficit. As can be seen from Table 1, the share of the revenue deficit in the total fiscal deficit increased from 9.10% in 1987-88 to 61.66% in 2001-02. The ratio tended to decline in the succeeding two years reaching a little over 50% of the fiscal deficit. In other words, more than 50% of current borrowing is diverted to finance consumption expenditure of the state government, comprising mainly wages and salaries, pension and debt servicing obligation. These three components together constituted more than 60% of the total revenue expenditure of the states. Interest payment as a percentage of total revenue expenditure increased from 8.27% in 1908-81 to as much as 21.80% in 2003-04. During the same period, the total expenditure as a percentage of GDP also increased from 13.92 to 15.60% primarily driven by the increase in debt servicing obligations, pensions and an increase in wages and salaries. Primary expenditure, which is net of interest payments, as a percentage of GDP showed a trend of a decline indicating the shrinking of the fiscal space of the states. If we exclude the other committed expenditures, viz, wages and salaries and pension payments, the residual of expenditure available for both operation and maintenance and much needed fresh investment for the provision of various publicly provided services under social and economic services is on the decline.
table 1: state-level Fiscal scene selected indicators
Fiscal Deficit to GDP Revenue Deficit as Percentage of Fiscal Deficit Interest Payments Total Primary as Percentage of Expenditure as Expenditure as Revenue Expenditure Percentage of GDP Percentage of GDP

(Average cost of Debt in Percent)

1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

2.58 2.41 2.65 2.90 3.34 2.71 2.98 3.17 2.77 3.17 3.30 2.89 2.79 2.40 2.73 2.65 2.72 2.90 4.27 4.72 4.28 4.23 4.15 4.40

-40.02 -33.94 -17.81 -3.30 11.26 -8.70 -1.83 9.70 15.48 23.86 28.26 29.90 24.48 18.51 22.23 26.10 43.26 36.95 58.77 58.81 59.83 61.66 53.97 50.43

8.27 8.43 8.42 8.25 8.70 8.97 10.78 10.86 11.36 11.93 12.06 12.70 13.73 14.45 15.11 15.13 15.14 16.13 16.30 17.31 17.74 19.85 20.91 21.80

13.92 13.36 13.87 13.84 14.51 14.73 15.26 15.58 14.73 14.80 14.99 15.22 14.96 14.68 14.81 14.16 13.89 14.09 14.40 15.42 15.67 15.48 15.53 15.60

13.06 12.50 12.96 12.94 13.51 13.67 13.95 14.20 13.32 13.32 13.47 13.55 13.20 12.84 12.89 12.31 12.02 12.11 12.34 13.09 13.20 12.73 12.68 12.68

Source: (Basic Data), Reserve Bank of India (2005), Handbook of Statistics on the Indian Economy 2004-05.

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table 2: states revenue and Fiscal Deficits (% of GSDP)
Revenue Deficit (-)/Surplus(+) 1993-96 2000-03 Fiscal Deficit (-)/ Surplus(+) 1993-96 2000-03 Revenue Deficit as % to Fiscal Deficit 2000-03

Andhra Pradesh Bihar Gujarat Haryana Karnataka Kerala Madhya Pradesh Maharashtra Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh West Bengal Total GCS All States

-0.51 -1.83 0.10 -0.75 -0.07 -1.18 -0.61 -0.09 -2.00 -1.88 -1.09 -0.71 -1.77 -1.53 -0.86 -0.72

-2.03 -1.87 -4.66 -1.32 -2.21 -4.17 -2.05 -3.09 -4.91 -4.53 -3.87 -2.50 -2.98 -5.47 -3.19 -3.15

-3.16 -2.85 -1.82 -2.50 -2.71 -3.32 -2.16 2.16 -4.63 -4.37 -4.51 -1.99 -4.04 -3.18 -2.93 -2.96

-4.57 -4.52 -5.74 -3.69 -4.37 -5.13 -3.94 -4.12 -7.84 -6.14 -6.05 -3.75 -5.07 -7.31 -4.97 -5.08

44.4 41.4 81.2 35.8 50.6 81.3 52.0 75.0 62.6 73.8 64.0 66.7 58.8 74.8 64.2 62.0

Source: Twelfth Finance Commission Report.

Percent

As is evident from Figure 3, all the committed expenditures, viz, interest, wages and salaries and pension constituted around 65% of the total revenue receipts in 1994-95, which increased to more than 85% in 1999-2000. Subsequently, this ratio declined to around 80% in 2002-03. As a percentage of total and revenue expenditure, this ratio went up sharply with the implementation of the Fifth Pay Commissions recommendations at state level. Though, the share of these expenditures declined marginally after 1999-2000, the ratio still remained higher than the ratio that prevailed prior to the implementation of the Fifth Pay Commissions recommendations.

of the total fiscal deficit, whereas in Karnataka, Madhya Pradesh and Uttar Pradesh, it constituted between 50 and 60%. However, the share of the revenue deficit was relatively lower in Andhra Pradesh, Bihar and Haryana. A comparative profile of debt accumulation of individual states shows that those with lower per capita income and a high level of fiscal deficits have a higher debt stock. A higher stock of debt implies a larger interest burden and consequently lower fiscal space available for primary expenditure. As is evident from Table 3 (p 42), the severity of the debt burden differs significantly across states with the interest payment to revenue expenditure ratio varying from 18.07% for Karnataka to 44.33% for West Bengal. Within this range, the states with a very high interest outgo are Kerala, Orissa, Punjab, Rajasthan and Uttar Pradesh. As the interest outgo for some of the states is higher than the rest, it implies that the space available for primary expenditure is much less relative to states with lower interest outgo. One of the components of discretionary or primary expenditure is state level capital expenditure. It can be seen from Table 3 that the capital expenditure to GSDP percentage of all the major states declined from 2.51% to 2.11% of their aggregate GSDP. But during the same period, the revenue expenditure to GSDP percentage increased from 13.33% to 16.05% of GSDP. A sharp fall in
Figure 3: salaries, pensions and interest payments (as % of Revenue Expenditure and Total Expenditure of States)
95 85 75
Percentage of Revenue Expenditures Percentage of Revenue Receipts

3 sub-National Fiscal situation: a comparison

Although, the aggregate fiscal scene depicts a gloomy picture of state finances in India in general, the severity of the fiscal crisis differs widely across states in terms of the levels and quality of the fiscal deficit, debt-servicing obligations, the level of the debt stock and the fiscal space. In this section we examine these variations in fiscal performance and corresponding fiscal space for major states. As can be seen from Table 2, fiscal imbalance worsened for all the states particularly during the 1990s in a very significant way. As estimated by the Twelfth Finance Commission, the fiscal deficit for all the states increased from an average of 2.93% in 1993-96 to 4.97% for the period 2000-01 to 2002-03. The average fiscal deficit to the gross state domestic product (GSDP) ratio shows that deficit is significantly high for Orissa, West Bengal, Punjab, Rajasthan, Gujarat, Kerala and Uttar Pradesh, whereas medium level fiscal deficits states are Andhra Pradesh, Bihar, Karnataka and Maharashtra. The relatively low level fiscal deficit states are Haryana, Madhya Pradesh and Tamil Nadu. Efforts to contain fiscal deficits have contributed to the decline in their quality. To start with, the quality of the deficit of Gujarat, Maharashtra, Kerala and West Bengal was principally current expenditure driven. In Gujarat, Maharashtra, Kerala, Punjab and West Bengal, the revenue deficit constituted between 70 and 80% of the total fiscal deficits. In states like Orissa, Rajasthan and Tamil Nadu also, the revenue deficit constituted more than 60%
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65 55 45 1994-95 1995-96 1996-97 1997-98

Percentage of Total Expenditures

1998-99

1999-00

2000-01

2001-02

2002-03

capital expenditure was observed in Kerala, Maharashtra and Rajasthan. A moderate fall in capital expenditure was also observed in Andhra Pradesh, Karnataka, Punjab and Tamil Nadu. However, there has been an increase in the capital expenditure to GSDP ratio in few states, viz, Bihar, Gujarat, Haryana, Madhya Pradesh, Orissa, Uttar Pradesh and West Bengal. It is to be noted that among these states except for Bihar, Haryana and West Bengal, the other four have undertaken structural adjustment lending-based fiscal consolidation measures in recent years at the instance of the Asian Development Bank and World Bank.

4 Determining Fiscal space: Model specification and estimation

Having examined the state level variation in detail, in this section we undertake an econometric exercise to determine the impact of the deregulated interest rate regime on sub-national fiscal space. We use the panel dataset described above for a period of 23 years from 1980-81 to 2002-03, the latest year for which final accounted data is available. We carry out the analysis for 14 major states, for which the fiscal arrangements are homogeneous under

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Figure 4: Debt profile and per capita income an interstate comparison
Debt to GSDP Ratio 70.0 70
60.0 60 (Debt to GSDP Ratio) 50.0 40.0 40 15000 15,000 30.0

(Per capita income in Rs) 30000 30,000 Debt/GSDP Per capita/GSDP

25000 25,000 20000 20,000 (Percapita Income in Rs.)

20 20.0
10.0 0.0 0 Uttar Pradesh Bihar West Bengal Andhra Pradesh Karnataka Tamil Nadu Madhya Pradesh

10,000 10000 5,000 5000 0 0 Maharashtra Mahartashtra

Rajasthan Gujarat Haryana Punjab Orissa Assam Kerala

the Constitution. The period captures the decade before the Per the experience thereafter, financial liberalisation Debt/GSDP of 1991-92 andcap GSDP to give us an opportunity to capture the changes in the fiscal space described in Section 2 and the determinants thereof. On the basis of the previous discussion, we define fiscal space in two ways total expenditure and primary expenditure, both taken as a percentage of the respective states GSDP. The latter nets out interest payments from total expenditure and is therefore an indicator of the discretionary element in total expenditure. Ideally, pure discretionary expenditure should exclude other committed expenditures incurred by the state governments, viz, pension obligations and wages and salaries. As we do not have long time series data on wages and salaries, we have excluded it for the purpose of analysis. We would expect primary expenditure to be sensitive to changes in the cost of borrowing (which is also true of total expenditure). However, the research question here is to identify the sign of the sensitivity, and therefore the impact of an exogenous change in the cost of borrowing on the states fiscal space. In terms of the determinants of fiscal space, we test our model with three variables, which have no significant correlation between themselves, as well as with the determinants of fiscal space. First, we take the share of own revenue in GSDP of the states, to instrument for internal fiscal capacity. Second, transfers as a percentage of GSDP will have an impact on the total fiscal space. Transfers are mandated by the Constitution, and include both plan and non-plan transfers from the union government to the sub-national entities. Third, we account for the changes in the average cost of debt that accrues to the states as a percentage of GSDP. One of the main objectives of this econometric exercise is to determine the impact of the cost of debt on fiscal space over the last two decades in India, in the context of a policy of gradual deregulatory policy environment. This has not been undertaken until now in the literature on India. We specify log-linear estimation equations for the model as follows: ln (Totexit) = 0 + 1 ln ownrev it + 2 ln transfit (1) + 3 ln acdebtit + mi + uit ln (Primexit) = b0 + b1 ln ownrev it + b2 ln transfit (2) + b3 ln acdebtit + hi + x it The variable nomenclature is self-explanatory. State-specific factors are denoted by mi and hi, while uit and x it are the error

terms. We estimate the two sets of equations separately with alternative specifications of the error terms, testing for heteroscedasticity and autocorrelation between the error terms and the explanatory variables. The summary of the data is given in Table 4 (p 43). The number of observations is quite large, and we have taken care to choose the period with no missing values in the data. The dataset (and the adjustments made thereof) is homogeneous across all states in the study. Table 1 reveals that there is enough variability in the data to make the estimation worthwhile. Most of the variables have moved in a broad range over the time period. The interesting point, however, is that the standard deviations are not very different across the variables. This gives us hope of getting consistent standard errors to test the sensitivity of the model. The estimation results are given in Tables 5 and 6 (p 43). As noted above, we carry out the same methodology for both the models, attempting therefore to identify the differential impact of the explanatory variables on fiscal space as alternatively defined. We estimate the model in four specifications. First, we could not reject the null hypothesis of non-systematic errors in the panel through the Hausmann test. Therefore, we carry out the first set of estimations with fixed effects in the panels. Second, we control for the possibility of contemporaneous error assuming they are homogeneous across panels, using generalised least squares (GLS1). Third, we further control for the possibility of heteroskedasticity between panels (GLS2). Fourth, since we take level variables, we need to control for autocorrelation in the dataset, which we undertake in GLS3. The GLS estimations are carried out with state-level dummies, but do not include time dummies. The estimation results throw up some interesting observations. Comparing the parameter estimates in the two tables, we find that all our explanatory variables are strongly significant across the alternative specifications, both in the case of total expenditure and primary expenditure. The fit of the models is also
table 3: expenditure profile and Debt servicing an interstate profile
Revenue Expenditure as % of GSDP States 1993-96 2000-03 Capital Expenditure as % of GSDP 1993-96 2000-03 Interest Payments as % of Total Revenue Receipts 2000-03

Andhra Pradesh Bihar Gujarat Haryana Karnataka Kerala Maharashtra Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh West Benal General states Special states All states

13.47 16.5 12.52 13.06 13.96 14.93 10.68 16.49 12.75 15.43 13.95 14.28 11.8 13.33 26.27 13.94

15.56 18.11 18.37 13.45 15.33 16.11 16.74 14.1 22.22 15.33 18.06 15.6 16.78 15.02 16.05 27.66 16.67

3.87 1.04 2.37 2.33 3.08 2.23 1.90 2.56 2.83 2.65 3.89 1.85 2.63 1.78 2.51 5.71 2.66

2.93 2.67 2.43 2.52 2.44 1.07 2.37 1.47 3.23 2.11 2.3 1.51 2.23 1.94 2.12 4.69 2.26

22.37 24.92 24.59 23.35 18.07 27.34 18.36 20.75 35.85 38.51 30.57 18.61 28.27 44.33 25.4 16.98 24.57

Madhya Pradesh 13.29

Source: Twelfth Finance Commission Report.

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table 4: summary statistics
Variable Observations Mean Standard Deviation Min Max

Total expenditure Primary expenditure Own revenue Transfer Average cost of debt

322 322 322 322 322

17.60 15.49 8.79 4.88 9.80

2.68 2.22 2.09 2.39 2.56

11.11 9.83 4.47 1.28 0.78

30.47 24.53 20.43 15.74 15.8

table 5: estimation results for total expenditure

Fixed Effects GLS1 GLS2 GLS3

Constant Lnownrev Lntransf Lnacdebt R-squared Wald Chi-sq

1.371 (13.54) 0.464 (10.72) 0.205 (7.19) 0.083 (5.30) 0.425

1.317 (12.57) 0.464 (11.01) 0.205 (7.39) 0.083 (5.44) 741.41

0.573 (13.85) 0.145 (15.76) 0.061 (6.13) 1.221 (4.85) 843.50

1.394 (14.89) 0.532 (14.56) 0.134 (5.42) 0.033 (2.29) 477.59

proxy of fiscal space also, GLS3 gives the best fit among all the alternatives considered. To summarise, the impact of own revenue, transfers and cost of debt on total expenditure is unambiguously expansionary. The highest partial elasticity is either for own revenue or the average cost of debt, depending on the chosen specification. Our model selection criterion based on Wald test indicates that the impact of the cost of debt is significantly above unity. The impact of own revenue and transfers on primary expenditure is positive and significant. However, in contrast to total expenditure, the elasticity of primary expenditure vis--vis the average cost of debt is unambiguously negative of the order of around 3.8%. Therefore, in the past two decades, the subnational fiscal space as defined by primary expenditure has been shrinking in the face of an increase in their cost of borrowing by states.

table 6: estimation results for primary expenditure

Fixed Effects GLS1 GLS2 GLS3

Constant Lnownrev Lntransf Lnacdebt R-squared Wald Chi-sq

1.442 (15.33) 0.470 (11.66) 0.238 (9.01) -0.032 (-2.19) 0.611

1.407 (14.45) 0.470 (11.98) 0.238 (9.26) -0.032 (-2.25) 839.34

1.328 (15.41) 0.526 (14.37) 0.218 (9.53) -0.038 (-3.41) 892.35

1.361 (14.48) 0.519 (13.56) 0.194 (7.82) -0.030 (-2.22) 575.51

5 conclusions
On the basis of the above findings it can be concluded that in the post-economic liberalisation era in India, fiscal reforms at centre and the financial sector reforms have adversely affected subnational finances. The centres fiscal consolidation measures contributed to the sharp decline in the vertical transfers and the financial liberalisation-induced, increase in interest rates has widened the states resource gap through an increase in interest outgo on the debt stock. This paper has examined the effect of the shock-induced increase in the fiscal imbalance on subnational fiscal space. Though there are sharp interstate differences, the analysis revealed that fiscal and macro-policy shocks have reduced the fiscal space across states with varying degrees. It has also been revealed that the problem is more for low per capita income states with a larger stock of outstanding debt vis--vis high and middle-income states. The econometric estimates revealed that the impact of own revenue, transfers and cost of debt on total expenditure is expansionary, but the elasticity of

satisfactory, it is generally better for the latter. The parameter estimates are also robust to alternative specifications, and no random changes in signs are noticed. We can therefore say with confidence that our model captures in a significant way the impact of state level own revenue, transfers and average cost of debt on the fiscal space. Coming to the specific estimate for total expenditure in Table 5, we observe that there is no significant difference in parameter estimates between the fixed effects regression and GLS1. However, they are sensitive when we control for heteroskedastic panels and for autocorrelation. For GLS2, the estimated elasticity of own revenue and transfer vis--vis total expenditure is reduced, while that of the average cost of debt rises significantly to more than one. If we correct for autocorrelation in GLS3, the estimated elasticities of own revenue and transfer increase, while that of average cost of debt falls significantly. The best fit as determined by Wald chi-square statistics however is for GLS2, which indicates a high positive and significant impact of average cost of debt on fiscal space in terms of total expenditure by sub-national entities. In Table 6, the estimates for primary expenditure are far more robust. This might be due to the construction of the proxy for fiscal space, where we net out interest payments from total expenditure. The most striking difference is that the estimated elasticity of primary expenditure and the average cost of debt is significantly negative. This would point to a differential impact of financial market liberalisation on fiscal space as defined by total expenditure and primary expenditure. The parameter estimates show an increase between GLS1 and GLS2 for own revenue, while it is the opposite in the case of transfers. The negative impact of the average cost of debt is strengthened when we control for heteroskedasticity across panels. For this
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Medical pluralism in contemporary india

(Forthcoming april/May 2009)
The Patient as a Knower: Principle and Practice in Siddha Medicine Medicine as Culture: Indigenous Medicine in Cosmopolitan Mumbai Medicine, State and Society: Indigenous Medicine and Medical Pluralism in Contemporary India Commercialising Traditional Medicine: Ayurvedic Manufacturing in Kerala Recovering from Psychosocial Traumas: The Place of Dargahs in Maharashtra Strengthening Childbirth Care: Can the Maternity Services Open Up to the Indigenous Traditions of Midwifery? V Sujatha Leena Abraham V Sujatha, Leena Abraham M S Harilal Bhargavi V Davar, Madhura Lohokare

Mira Sadgopal 43

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primary expenditure vis--vis the average cost of debt is negative of the order of around 3.8%. Thus, it can be concluded that in the past two decades, the sub-national fiscal space has been
Notes
1 The vertical imbalance arises due to the asymmetric assignment of functional responsibilities and financial powers between different levels of governments and horizontal inequalities are the existing disparities in the revenue capacity across the constituent units of federation, which mainly arise due to the differences in their levels of income. A fiscal restructuring shock and associated fiscal austerity measure at the central government level could reduce the volume of transfers to the lower tier of government and thus the degree of dependence. This has particularly been the case in India after fiscal reform was introduced. For a detailed analysis of the factors contributed to the crisis of 1991, see Joshi and Little (1994). Also see Buiter and Patel (1992, 1996, 1997), Srinivasan (2001). For an account of the state-level fiscal reform see World Bank (2005). For an analysis of the fiscal reform outcome see Joshi and Little (1997), Pinto and Zahir (2004) and Mohan (2000). The central government has signed MOUs with most of the states and introduced additional incentive-based bailout schemes such as the accelerated power development programme and accelerated irrigation programme (Rao 2002). The debt to GDP ratio of the centre increased from 8

shrinking in the face of an increase in the cost of borrowing. Corrective measures are required to widen the fiscal space for developmental fiscal needs.
GoI (2000): Eleventh Finance Commission Report (New Delhi: Government of India). (2004): Twelfth Finance Commission Report (New Delhi: Government of India). Heller, P (2005): "Back to Basics Fiscal Space: What It Is and How to Get It, Finance and Development h t t p : // w w w. i m f . o r g /e x t e r n a l / p u b s / f t / fandd/2005/06/basics.htm#author Joshi, Vijay and I M D Little (1994): India-Macroeconomics and Political Economy, 1964-1991, First Edition (New Delhi: Oxford University Press). (1997): Indias Economic Reforms, Second Edition (New Delhi: Oxford University Press). Mohan, Rakesh (2000): Fiscal Correction for Economic Growth: Data Analysis and Suggestions, Economic & Political Weekly, 10 June, pp 2027-36. Pinto, Brian and Zahir Farah (2004): Why Fiscal Adjustment Now, Economic & Political Weekly, 6 March, pp 1039-48. Rao, M Govinda (2003): Incentivising Fiscal Transfers in the Indian Federation, Publius: The Journal of Federalism, 33, pp 43-62. (2002): State Finances in India: Issues and Challenges, Economic & Political Weekly, 3 August, pp 3261-71. Srinivasan, T N (2000): Indias Fiscal Situation: Is a Crisis Ahead?, http://www. econ.yale.edu/~ srinivas/FiscalSituation.pdf World Bank (2005): State Fiscal Reforms in India: Progress and Prospects, First Edition (New Delhi: Macmillan).

40.44 to 63% between 1981-82 and 2002-03. During the same period, the increase in the debt ratio of the states was from 16.77 to 27.80%. Chakraborty (2005) noted that in the deregulated interest rate regime, the structure of the outstanding market loans of the state government is heavily skewed towards high cost loans compared to the central government and that the debt contracted at a higher rate by the states vis--vis centre has increased the interest cost of debt in a significant manner.

References
Buiter, W and U Patel (1992): Debt, Deficits and Inflation: An Application to the Public Finances of India, Journal of Public Economics, 47, pp 171-205. (1996): Solvency and Fiscal Correction in India: An Analytical Discussion in S Mundle (ed.), Fiscal Policy in India (New Delhi: Oxford University Press). (1997): Budgetary Aspects of Stabilisation and Structural Adjustment in M Blejer and T TerMinassian (ed.), Macroeconomic Dimensions of Public Finance: Essays in Honour of Vito Tanzi (London and New York: Routledge), pp 363-412. Chakraborty, Pinaki (2005): Debt Swap in a Low Interest Rate Regime: Unequal Gains and Future Worries, Economic & Political Weekly, 1 October, pp 4357-62.

4 5 6

1. Ford Foundation Chair in Women and Food Security

Job Description: Develop and carry out a programme of research and education, guide research, conduct training and orientation for policy makers and trainers, and undertake advocacy in the area of women and food security. Qualification: Ph.D. in any Social Science (preferably Economics) and at least ten years experience, with evidence of strong interest in womens/gender studies, and good record of work in research and teaching, and /or field programme related to womens/gender issues and food security. Qualifications in womens/gender studies will be an advantage. Salary scale: Appropriate level in 22000-1000-30000 grade, with permissible allowances (under revision).

2. Coordinator, The Hindu Media Resource Centre

Job Description: Identify communication strategies to use mass media as a tool for communication; prepare themebased films; organize media workshop/seminars/lectures/public forum on topical scientific issues; establish network with universities, colleges, media houses, organizations, NGOs and other related institutions; training and capacity building on development journalism; image management, media relations, strengthen science and society linkages through media. Qualification: Candidate should possess Post graduate in JMC/Media Science/Visual Communication/Public Relation with 4-5 years of relevant experience. Strong language skills in English, Hindi and Tamil and operational knowledge in computer packages, such as, MS Office, are mandatory. Candidates should also have strong inter-personal skills. Salary scale: Appropriate level in 17000-1000-25000 grade, with permissible allowances (under revision). Application should include complete biodata showing academic record, area of specialization, field and duration of experience, names and addresses of two referees who during the last five years have had close familiarity with the candidates professional strength and address of past employers, if any. Application should be sent to Manager (P&A), M. S. Swaminathan Research Foundation, 3rd Cross Road, Taramani Institutional Area, Chennai 600 113, email: hari@mssrf.res.in before April 15, 2009.

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April 4, 2009

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EPW

Economic & Political Weekly