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Maharashtra: the growth-fiscal nexus

July 14, 2003

In terms of per capita income, Maharashtra is among the richest Indian states. Its fiscal situation, however, does not reflect its relative income position.

As a per cent of GDP, its revenue deficit, fiscal deficit and debt stood at 3, 3.5 and 17.3 per cent respectively in 2000-01. Over 87 per cent of its borrowings were financing consumption expenditure adding to the unsustainability of the debt being contracted.

The fiscal health of any given state is obviously a function of its revenue and expenditure situation. Expenditures of the states, particularly on the revenue account, have become quite rigid as a majority of these expenditures are committed in nature.

On the other hand, the revenue cycles of the states mimic the trends in their revenue bases, tax effort and transfers from the Centre. With inflexibility in expenditures, a downturn in revenues is bound to accentuate fiscal stress.

With almost 85 per cent of the GDP originating in the non-agricultural sector (industry and services) Maharashtra's dependence on agriculture is much below the national average. Being a rich state, its reliance on Central transfers is also among the lowest in India.

In 2000-01, its own tax and non-tax revenues accounted for almost 85 per cent of its total revenue receipts compared with the all-India average of around 60 per cent. Thus, for a state like Maharashtra, the performance of its own revenues has a significant connotation for its fiscal health.

How do Maharashtra's own revenue relate to its economic structure? What were its sectoral growth patterns during the 1990s? How did it alter its economic structure? What were its implications for the revenue situation and hence the fiscal situation? We answer these questions in the context of the transactions on the revenue account.

Since our interest is primarily in the post-reform period, we divide the 1990s into the high-growth phase (1993-94 to 1996-97) and the slowdown (1997-98 and 2000-01).

Between these two sub-periods, there was a severe shrinkage in agriculture, a deceleration in industrial growth and a mild pick-up in the services sector.

In 2000-01, however, all the three sectors -- agriculture, industrial and services -- witnessed growth deceleration trimming overall GDP growth to an anaemic 2.7 per cent.

Let us now examine the revenue situation in Maharashtra vis--vis its expenditures and link it to its growth performance. Revenue expenditure continued to grow at an average rate of 15.9 per cent a year between 1997-98 and 2000-01 the same as in the preceding four years of industrial boom (1993-94 to 1996-97).

The growth in its total revenue receipts, however, fell from 15.6 per cent to 11 per cent in the corresponding period. Consequently, the revenue deficit in 2000-01 was three times that in 1997-98.

A closer look at the disaggregated revenue receipts shows that the sharpest decline in revenues came in grants from the centre. The annual growth in grants fell from 16.5 per cent to 1.5 per cent between the high-growth phase and the slow down.

The growth in tax devolutions from the Centre too fell in the same period. The own tax revenues of Maharashtra, however, registered a modest fall in growth from 16 per cent to 14 per cent.

From the point of revenues, the changing economic structure in favour of non-agricultural activities is a positive indicator (as agriculture contributes little to the exchequer). This is reflected in the relatively better performance of its own tax revenues (relative to other sources of revenue).

High dependence on its own revenues makes Maharashtra more vulnerable to the cyclical swings in its revenue base, that is, the non-agricultural sector. It clearly show that the own-tax revenue cycle closely follows the GDP growth cycle of industry.

As government revenues disproportionately rely on the industrial sector, the synchronised movement of revenue growth and industrial growth does not come as a surprise.

Although the services sector is under-taxed, its performance has implications for the tax revenues of the states. The association of consumption expenditure is much stronger with services growth than with industry.

The increase in consumption demand as a result of growth in services could either be met from production within the state or out of imports from other states. Either way, it translates into an increase in states' sales tax revenues.

Without doubt, the service sector in general is under taxed and hence the full tax potential of services growth has not been realised. Despite this, services growth has a positive and a significant connotation for the revenue growth of states.

To sum up, the increasing fiscal stress in Maharashtra on the revenue account can be traced to:

  • Rigidity in revenue expenditures.
  • A decline in the growth rate of transfers from the Centre - both share in central taxes as well as grants.
  • The increased reliance on its own revenues. This made the state more susceptible to the growth cycles in industry and services. The industrial slowdown was a double whammy. It dampened own tax revenues as well as reduced the share in central taxes because central taxes too depend on the performance of industry.
  • Declining inflation in the industrial sector. Between 1993-94/1996-97 and 1997-98/2000-01, inflation in the industrial GDP fell from 8.5 per cent to 2.8 per cent. As the revenue base is nominal GDP, this also contributed to a reduction in tax revenues, especially when the industrial growth decelerated in real terms too.
  • However, it must be said that even though the rate of growth of own revenues declined, the slow-down was less than the combined impact of slowing industrial growth and declining inflation might have warranted. This suggests an improvement in efforts to collect revenues.
  • The more general point is that for states that depend more on their own revenues, cyclical swings in industrial activity can worsen an already precarious fiscal situation. As for many other things, sustained industrial growth is a big part of the solution for the states' fiscal problems.
The writer is a senior economist at Crisil

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