Rakesh Mohan: Human development and state finances
Speech by Mr Rakesh Mohan, Deputy Governor of the Reserve Bank of India, at the inaugural
session of the 3rd Programme on "Human Development and State Finances", Mumbai, 7 November
2005.
* * *
Introduction
It is a pleasure to be amidst officials of the State Governments who are instrumental in implementing
government policies that aim to improve economic and social welfare. In India, bulk of the
responsibilities pertaining to expenditure in social services including education and health are placed
in the domain of the State Governments. Thus, the nature of state finances has important implications
for improving human development in India. In this context, the theme of today's discussion 'Human
Development and State Finances' is very topical as well as relevant.
The Reserve Bank of India (RBI) bears a special relationship with the State Governments in its
multiple role as the banker, debt manager and fiscal adviser. The interactions between the RBI and
the State Governments have been stronger through the interface provided by the bi-annual Finance
Secretaries' Conference organised by the Reserve Bank since 1997. This Conference has provided a
common platform to discuss all aspects concerned with the fiscal affairs of the States and facilitated
the evolution of a consensual approach on various key issues through active participation of State
Government officials. Some of the outcomes include setting up of Consolidated Sinking Funds (CSF)
for debt servicing, constitution of Guarantee Redemption Funds (GRF) to meet guarantee obligations,
setting of Ways & Means Advance (WMA) limits for States, fixing limits for guarantees, and most
recently, enactment of the Fiscal Responsibility Legislation (FRL).
In this forum, in two earlier occasions, my colleague Deputy Governor Shyamala Gopinath had
focused on the broad contours of human development and state finances while Deputy Governor Shri
V. Leeladhar had dwelt on certain critical aspects of human development in the Indian context. Today I
will first discuss the importance of economic growth for human development, poverty eradication and
overall social welfare; second, I will briefly give an overview of the performance on the human
development at both the national level and across the states; third, I will review the stylized facts
relating to finances of the State Governments as they relate to their impact on expenditure in the
social sector; fourth, I will mention some of the new initiatives taken by the Government both at the
Centre and States' level for accelerating human development in India; and finally, I will touch upon
some further policy options.
Economic growth and human development
The concept of human development signifies improvement in the quality of life of the people in terms
of various health and educational indicators. Through betterment of health, education and skills,
human development creates human capabilities that can then lead to productivity enhancement and
acceleration in economic growth. In a broader sense, human development also implies improvements
in terms of human rights and participation and freedom of choice. The credit for bringing special focus
to human development can mainly be attributed to the noted economist Mahbub Ul Haq. He was
instrumental in the evolution of the Human Development Index (HDI), which has emerged as a
composite measure of development across the countries. The HDI is an index measuring the basic
dimensions of human development, namely, long and healthy life, education and decent standard of
living. Indian economist and Nobel laureate Amartya Sen has also made valuable contributions
towards the formulation of HDI. According to the Human Development Report, 2005, published by the
United Nations Development Programme (UNDP), all the countries (177 in total) are categorized into
three broad groups, such as, (i) High Human Development, (ii) Medium Human Development, and (iii)
Low Human Development. India is placed in the group of Medium Human Development countries and
ranks at 127 amongst total of 177 countries in 2005.
High economic growth facilitates reduction of poverty. Growth in production of goods and services
leads to growth in incomes and, hence, to poverty eradication. As might therefore be expected,
acceleration of economic growth in India has led to a marked reduction in poverty in recent decades.
Compared to average economic growth rate of close to 3.5 per cent in the first three decades since
Independence, the Indian economy moved to a higher growth trajectory experiencing an average
growth rate of around 6 per cent during 1980s and 1990s, and in the most recent period, the growth
rate has been hovering around 7 per cent. More importantly, per capita income growth has witnessed
a spectacular rise to about 5.5 per cent in the recent years as against a rise of around 1 - 1.3 per cent
in the three decades after Independence. Reflecting this there has been significant decline in poverty
in India. Between 1977-78 and 1999-2000, the proportion of people living below the poverty line (BPL)
came down from 51.3 per cent to 26.1 per cent. In absolute numbers, the reduction has been from
about 330 million to 260 million during the comparable period.
It is important to note that with lower economic growth of the first three decades it was not possible to
reduce the high levels of poverty that had existed in India for generations. However, the foundations of
modern economic growth were laid in that period and we have observed significant growth
acceleration since the 1980s. It is being increasingly recognized that eradication of poverty requires
achievement of higher growth as it is only higher economic growth that can reduce poverty and
provide sustainable economic security. No distribution can take place when there is nothing to
distribute.
Human capital enhancement is essential to productivity growth. As higher physical capital investment
takes place labour productivity is also enabled to grow. But such productivity can grow even faster
with corresponding or even faster growth in human capital investment. Thus, per capita income
growth is accelerated significantly by improvement in human development all round. Hence, we have
a positive sum game: economic growth enables human development, and human development itself
contributes to the acceleration of economic growth. Furthermore, for its own sake, in terms of
augmenting people's own potential, human development is important.
Performance in human development: an overview
Key indices of human development relate to measures of health and education. Life expectancy at
birth in India has grown from about 32 years in 1951 to 62 years in 1996. In 2003, it was 63 years. The
literacy rate in India also witnessed significant improvement since independence from 18 per cent in
1951 to 52 per cent in 1991, and further to 65 per cent in 2001. In 2003, life expectancy index for India
at 0.64 was close to the world average of 0.70. The education index at 0.61 and GDP index at 0.56
were however farther away from the world averages of 0.77 and 0.75, respectively.
A perusal of the human development indicators across the States in India reveals that life expectancy
does not exhibit significant variation across the States. In 2001-06, life expectancy at birth for males
(all India average of around 64 years) varied from 59 years in Assam and Madhya Pradesh to around
70 years in Kerala and Punjab. For most of the States, the life expectancy at birth for males was in the
range of 62 to 67 years. For the same period, life expectancy at birth for females (all India average of
around 67 years) varied from 58 years in Madhya Pradesh, 60 years in Orissa to 72 years in Punjab
and 75 years in Kerala. For most of the States the life expectancy at birth for females was in the range
of 64 to 70 years. However, the National Human Development Report (NHDR) has revealed wide
disparities in the level of human development across the States. States like Bihar, Uttar Pradesh,
Madhya Pradesh, Rajasthan and Orissa had HDI close to just half of that of Kerala in 1981 (Table 1).
The situation has improved since then. Besides Kerala, among the major States, Punjab, Tamil Nadu,
Maharashtra, and Haryana have done well on HDI. In general, HDI is better in smaller States and
Union Territories. In terms of the pace of development, Tamil Nadu, Rajasthan, Madhya Pradesh,
West Bengal and Bihar improved their HDI significantly in the 1980s. In the 1990s this momentum was
maintained in Rajasthan, Madhya Pradesh and Uttar Pradesh while it appeared to slow down in other
less developed States. Nevertheless, state-wise analysis in the NHDR indicated a decline in such
regional disparity during the last two decades. Further convergence can take place alongwith
substantial improvement in the national human development index if efforts are focused on those
states that have low levels of measured HDI. Strengthened policy measures and improvement in
health, education and other aspects of rural development in these states will contribute greatly to the
overall improvement in human development in the country.
It must be noted that inequalities across the States on HDI are less than the income inequalities in
terms of per capita SDP (Graph 1). At a fundamental level, there is no conflict between economic
growth and human development. Economic growth implies an improvement in the material well being
of the people including better health, education and sanitation. However, the effect of economic
growth on human development may be muted if the growth is not well distributed across all sectors
and geographical areas. Even in a particular sector, the distribution of benefits of growth amongst all
stakeholders in a just way is also important.
Table 1: Human Development Index for India - Combined
States 1981Value 1981Rank 1991Value 1991Rank 2001Value 2001Rank
Andhra
Pradesh 0.298 9 0.377 9 0.416 10
Assam 0.272 10 0.348 10 0.386 14
Bihar 0.237 15 0.308 15 0.367 15
Gujarat 0.360 4 0.431 6 0.479 6
Haryana 0.360 5 0.443 5 0.509 5
Karnataka 0.346 6 0.412 7 0.478 7
Kerala 0.500 1 0.591 1 0.638 1
Madhya
Pradesh 0.245 14 0.328 13 0.394 12
Maharastra 0.363 3 0.452 4 0.523 4
Orissa 0.267 11 0.345 12 0.404 11
Punjab 0.411 2 0.475 2 0.537 2
Rajasthan 0.256 12 0.347 11 0.424 9
Tamil Nadu 0.343 7 0.466 3 0.531 3
Uttar Pradesh 0.255 13 0.314 14 0.388 13
West Bengal 0.305 8 0.404 8 0.472 8
All India 0.302 0.381 0.472
Source: National Human Development Report, 2001, Planning Commission, New Delhi
Graph 1
Human development Index and Income Across States - 1991
0.65 6
0.6
5
Index
(Rs.
0.55
States
4
0.5
Net
Product
0.45
3
Thousand)
Development
capita
0.4
Per
2 Domestic
0.35
Human
0.3 1
HDI Series3 State Domestic Product
Source: National Human Development Report 2001, Planning Commission, New Delhi
It turns out that the economically less developed States are also the ones with low HDI and
economically better off States are the ones with relatively better performance on HDI. However, the
relation between the HDI and the level of development does not show any correspondence among the
middle-income States in the country. In this category of States, some States like Kerala, have high
attainments of HDI, at the same time, there are States like Andhra Pradesh, or even West Bengal,
where HDI values are not as high.
Finances of state governments and social sector expenditure
Progress on human development requires adequate provision of funds. State Governments are
responsible for most public expenditures for the provision of social services including health and
education. Furthermore, the States are responsible for most infrastructure services except for
telecommunications, civil aviation, railways and major ports. They are also responsible for law and
order. Thus, the ability of the States to spend on social services has important implications for human
development.
As widely documented, States have experienced significant fiscal stress since 1998-99 due to a
variety of factors. While factors like 5th Pay Commission recommendations, decline in Central
transfers, increase in committed expenditure, such as, interest payments and pensions, and low
economic growth rate account for the acuteness of the ailment, there are also underlying structural
reasons for the persistence of fiscal deterioration. As evident from Table 2, average revenue deficit of
all States combined as a percentage of GDP more than doubled from 0.71 during 1990-95 to 1.65
during 1995-2000. It increased further to 2.41 per cent during 2000-04. Similar movement was
exhibited by the gross fiscal deficit (GFD) as well. This has had a significant deleterious impact on the
States' social expenditures including on education and health. Developmental expenditure as a
percentage of GDP had declined from 9.92 per cent during 1990-95 to 8.97 per cent during
1995-2000. Expenditure on social services in general and education and health in particular witnessed
a fall as a percentage of GDP during the second half on the 1990s as compared to the first half. The
fall in States' expenditure on education and health due to fiscal deterioration impeded their role in
promoting human development.
Table 2: Deficit Indicators and Social Expenditure of States
(As Percentage of GDP)
Developme Social
Period RD GFD ntal Services Education Health
Expenditure Expenditure Expenditure Expenditure
1990-95 0.71 2.82 9.92 4.88 2.62 0.81
1995-2000 1.65 3.45 8.97 4.84 2.59 0.75
2000-04 2.41 4.28 9.35 4.98 2.67 0.71
2004-05 RE 1.44 4.00 10.18 5.08 2.47 0.69
2005-06 BE 0.75 3.21 9.35 4.94 2.39 0.70
RE: Revised Estimates, BE: Budget Estimates
Notes: RD: Revenue Deficit, GFD: Gross Fiscal Deficit
Education includes Sports, Art and Culture Health includes Family Welfare
With active initiatives of the States towards fiscal correction and consolidation, some signs of
improvements have been visible in state finances in the recent period. The revenue deficit as a
percentage of GDP came down to 1.44 in 2004-05 (RE) which is budgeted to further decline to 0.75
per cent in 2005-06. Similarly, GFD as a percentage of GDP was reduced to 4.00 per cent in 2004-05
from the average of 4.28 per cent in 2000-2004 and is budgeted to decline further to 3.21 per cent in
2005-06. With improvement in state finances, there is a reversal of the trend of developmental
expenditure also. The ratio of developmental expenditure to GDP increased to 10.18 per cent in
2004-05 compared to an average of 9.35 per cent during 2000-04. States' expenditure on social
services witnessed similar movement during the comparable period. However, expenditures on health
and education as a percentage of GDP, during 2004-05, still remain below the level of the 1990s and
early 2000s. In 2005-06, development expenditure and social expenditure of the States as percentage
of GDP are budgeted to be lower than the previous year.
New initiatives
The Union Budget 2005-06 has provided a special focus on enhancing human capital investment in
the country in an accelerated manner. Particular emphasis has been given to significant increases in
allocations to the flagship schemes of Sarva Shiksha Abhiyan (SSA), National Rural Health Mission
(NRHM), Employment Guarantee Scheme (EGS), Rural Electrification, and the like. Sarva Shiksha
Abhiyan is the cornerstone of the Government's support in basic education for all children. The
allocation for this programme has been enhanced to Rs. 7,156 crore in 2005-06 as against Rs.
3,057 crore in the previous year's budget. A non-lapsable fund called 'Prarambhik Shiksha Kosh' has
been created for funding this programme. NRHM envisages strengthening primary health care through
grass root level public health interventions based on community ownership. Total allocations for the
Department of Health and the Department of Family Welfare will be enhanced from Rs. 8,420 crore in
the current year to Rs. 10,280 crore in the next year when NRHM will be launched. Increase in the
funding is envisaged to finance NRHM and its components like training of health volunteers, providing
more medicines and strengthening the primary and community health centre system. The allocation
for the Integrated Child Development Scheme (ICDS) has also been enhanced significantly.
The Union Budget 2005-06 also proposed launching of a massive rural electrification programme
beginning in 2005-06 with the objective of covering 1,25,000 villages in five years with high emphasis
on the deficient States. Similarly, higher allocations have been made for provision of drinking water
and sanitation facilities in rural habitations. Furthermore, a corpus of Rs 8,000 crore was provided in
the current year for the Rural Infrastructure Development Fund for improving the basic infrastructure in
the rural India. The Pradhan Mantri Gram Sadak Yojana (PMGSY) was launched in December 2000
as a 100 per cent centrally sponsored scheme to provide rural connectivity. It is funded by the diesel
cess in the central road fund and through borrowings from domestic financial institution and
multilateral funding agencies. Without appropriate connectivity, it is difficult to bring about the kind of
improvements envisaged for human development.
It is also important to note that following the recommendations of the Twelfth Finance Commission
(TFC), it has been decided by the Government of India to provide specific grants for education and
health to those States which are unable to spend adequately in these sectors because of deficiencies
in fiscal capacity. TFC has recommended specific grants amounting to Rs 10,171 crore to eight
States1 for education and Rs 5,887 crore to seven States2 for health over its award period of 2005-10.
The grants for both the sectors are an additionality over and above the normal expenditure to be
incurred by the States in these sectors. Furthermore, it recommended specific grants to local bodies
amounting Rs. 25,000 crore meant to improve basic amenities, viz., water supply, sanitation, solid
waste management, etc. which are expected to improve the quality of life both in rural and urban
areas.
As regards States' initiatives, many States have embarked upon the path of fiscal correction and
consolidation in the recent period. Increase in the Central transfers in the light of TFC
recommendation has a comforting impact on State finances. With the debt relief benefits linked to
enactment of the Fiscal Responsibility Legislation (FRL) by the TFC, there has been increasing
incentive to observe fiscal discipline. As of now, while 15 States have already enacted FRL, 2 States
have introduced the Bill and 2 more States have proposed to introduce FRL Bill in their respective
Budget for 2005-06. As all the states put into effect fiscal improvement measures, their ability to make
focused expenditures on health, education, nutrition and rural infrastructure will increase substantially.
Policy options
For sustained social sector development, it is important that the high growth rate of the economy is
maintained over a sustained period. Similarly, macroeconomic stability in terms of lower inflation is
also critically important to protect the poor and vulnerable segment of the population. It is here that the
role of the Reserve Bank and Monetary Policy becomes important. In addition, prudent fiscal
management through expenditure prioritization and revenue augmentation is also essential. Thus, the
recent initiatives by the State Governments to enact FRL is a welcome move.
As I have been emphasizing in many of my writings and speeches, widespread and bold imposition of
user charges on all non-merit goods is very important for revenue augmentation of the States. The
pattern and organization of provision of public services in India has been done in such a way that the
public has got used to not paying economic charges for these services. This includes key services,
inter alia, power, water supply, irrigation and transport. The larger consumers of these services are
typically the better off. Thus, appropriate levy of user charges also promotes better income
distribution. Moreover, by strengthening the finances of the agencies that supply these services, it also
enhances their capacity to improve and expand services and to serve the less well off. According to
one estimate, the hidden subsidies on these non-merit goods amount to as much as 10.7 per cent of
GDP on an annual basis. The combined fiscal deficit of the Centre and States in recent period is
around 2 to 3 percentage points lower than this as a percentage of GDP. This highlights the need for
augmenting revenue from user charges. However, it can be noted that with the poor quality of public
services provided in India, the public is loath to pay higher charges. Hence, imposition of higher user
charges has to be accompanied by perceptible improvements in the quality of services.
Apart from the above, rural connectivity plays a critical role for higher human development index.
Evidence suggests that the states like Kerala, Tamil Nadu, Goa, Punjab and Himachal Pradesh that
have invested heavily in the provision of better rural connectivity are also better placed in terms of
human development. Thus, better rural infrastructure and connectivity is necessary to accomplish
developmental programmes related to human development. The direct benefits of rural development
and connectivity in terms of better roads, electrification and communication also enable the doctors,
health workers, and teachers to stay in the villages. Such personnel, who have with great effort and
difficulty, educated themselves can scarcely be expected to stay in habitations that lack basic
infrastructure and connectivity. They obviously have aspirations for their own children and families.
Investment in social sectors like health and education is unlikely to be successful unless accompanied
by complementary investment in rural infrastructure. The indirect benefits of better communication
would be in terms of better dissemination of information on all aspects of agricultural products,
particularly that on agricultural prices. Farmers suffer greatly from the large difference between market
prices of agricultural products and farm level prices due to large transportation costs and lack of
information. Thus, better rural connectivity in terms of both transportation and communication, will
promote better price discovery and help in improving farmers' income and, hence, their human
development. The extension of institutional credit, be it through banking institutions or microfinance
institutions, will also be enabled by better rural connectivity. The improvement in farmers' income
from better rural connectivity will itself improve their credit worthiness leading to lower applicable
interest rate and further improvements in incomes and human development.
Besides, physical connectivity, economic empowerment of the vast segment of our population who
have hitherto remained financially excluded is an important issue for human development. The
programme of linking Self Help Groups (SHGs) with the banking system has emerged as the major
micro-finance programme in the country. At present, micro-finance institutions (MFIs) depend on the
banks including commercial banks, Regional Rural Banks (RRBs) and cooperative banks to obtain
finance according to the guidelines issued by the RBI. There is an increasing emphasis to promote
MFIs which provide small-scale credit and other financial services to low income households and
small informal businesses. Empowering MFIs will facilitate their role as intermediary between the
lending banks and the beneficiaries. The Union Finance Minister, in his Budget Speech 2005-06, has
prescribed that the commercial banks should appoint MFIs as the 'banking correspondents' to provide
transaction services on their behalf.
In response, RBI appointed an Internal Group on Rural Credit and Micro-finance to look at the broad
aspects of increasing "financial inclusion" and promoting MFIs. I am glad, indeed, that the Principal
and the faculty of this College, have been associated with the preparation of the report which is now
being closely examined for implementation.
The report has recognised both the supply and demand side constraints and circumstances that has
made mass scale financial inclusion elusive. Pragmatically appreciating that the large-scale expansion
of physical infrastructure supported by multifarious policy initiatives could not accelerate the inclusion
of a vast majority of rural population into the ambit of formal financial institutions, the report suggested
that if "financial inclusion" is to be made a reality, we need to leverage socially active organizations
and persons to work with people, particularly those with small means, empower them and bring them
closer to financial services provided by the formal financial institutions on the one hand. On the other,
these agencies and persons can be harnessed to bring aggregation of quantities so that the
constraints of reaching large numbers of dispersed, far-flung and socio-economically disadvantaged
clientele is minimized. To translate this into action, the report has suggested that banks may use the
services of the "Business Facilitators" to bring people and the banks together without having to handle
cash and the "Business Correspondents" who will bring them together and will also handle cash for
providing doorstep services. NBFCs, NGO-MFIs, Section 25 Companies, Cooperative societies,
corporate entities, post-offices, etc. can be identified as possible correspondents while even informal
entities like farmers' clubs, NGOs, cooperatives, Rural Kiosks, socially conscious individuals, etc. can
work as the facilitators.
All of us at RBI and our Governor, in particular, have appreciated the suggestions and we hope that
the banks will use these avenues to accelerate the process of financial inclusion.
Before I conclude let me compliment CAB, UNDP and the Planning Commission for very thoughtfully
designing the programmes mainly for the State Government officials who are at the cutting edge of
human development initiatives.
The programme on "Human Development and State Finances" covers substantially the whole gamut
of human development and financing issues. All of you will have the opportunity to hear and interact
with well-known academicians and practitioners like Shri Sridharan, Dr. Seeta Prabhu, Prof. J B G
Tilak, Prof. D K Srivastava, Dr. Amarjeet Sinha besides UNDP Administrator, Dr. Kemal Dervis, Shri
Jayant Patil, Finance Minister, Government of Maharashtra and other experts in the high power panel
discussion scheduled in Mumbai. I will also urge you to use this programme as a platform to interact
among yourselves and share experiences as seldom you have an occasion when so many
development practitioners come together at one place and get also to hear from so many renowned
people. I am sure this programme will help you realize the importance of your role in the process of
the country's development and reinvigorate you intellectually and emotionally to seize the opportunity
to realize the Millennium Development Goals of the UN and human development goals of the Tenth
Five Year Plan.
I wish your deliberations in the programme a grand success.