3.2 States’ Fiscal Adjustment In 2000, the ratio of debt to own revenues for all India’s states combined stood at 203 percent.<sup>33</sup> Canada was next with 189 percent, followed by Brazil with 170 percent and Pakistan with 100 percent. In addition to reducing this indebtedness, which is a source of vulnerability, existing fiscal deficits leave the state governments with little fiscal space even for productive new spending to support the current rapid growth. In spite of significant recent progress in fiscal adjustment, these challenges remain particularly acute in the poorer states, which have suffered greater variability in revenues, are more indebted and have high salary bills. Interest payments as a share of own revenues are nearly twice as high in poor states as in other states.

As Figure 7 shows, India’s states had a fairly constant fiscal deficit for most of the 1990s; but in 1998/99, the fiscal deficit jumped from 2.9 percent of GDP the previous year to 4.3 percent catalyzed by the 1997 CFPC award, around which level it then stabilized for the next 6 years or so.<sup>34</sup> Despite central government control over state government borrowings being enshrined in the Constitution, state governments were able to increase their borrowing by drawing on sources over which GoI exercises no active control: ‘small savings’, central government-owned financial institutions, and state provident funds. As a result, the state-level debt stock increased from 22.5 percent in 1991 to 33.5 percent in 2005. Off-budget liabilities, mostly in the power sector, also grew quickly – as did state government guarantees. In September 2003, state governments issued “power bonds” of approximately 1 percent of GDP (Rs 29,000 cores) cover the arrears of SEBs to the central Public Sector Undertakings as of October 1, 2001 in accordance with the provisions of the Ahluwalia Committee (“Report of the Expert Group, Settlement of SEB Dues”, May 2001).

**Figure 7: State Deficits and Debt Levels**

Debt as a share of GDP (left axis) and fiscal deficit as a share of GDP (right axis) <!-- Start of picture text --> 40.0 5.0<br>35.0 4.5<br>4.0<br>30.0<br>3.5<br>25.0 3.0<br>20.0 2.5<br>15.0 2.0<br>1.5<br>10.0<br>1.0<br>5.0 0.5<br>- -<br>Debt/GDP Fiscal Deficit/GDP<br>90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01 01-02 02-03 03-04 04-05 05-06 RE<br><!-- End of picture text --> _Source: Reserve Bank of India (2005) and World Bank States Database_ As also highlighted by Reserve Bank of India (2005), India’s poorer states have seen larger increases in their debt ratios over the past decade (Figure 8). As of March 2005, the debt to GSDP ratio was 53 percent in the poor states, versus 38 percent in the other states. India’s poorer

> 33 For the general government, the ratio is even higher at over 400% whereas for the poor states it is about 600%. Interest payments / own revenues are in excess of 60% for the poor states. 34 While large pay awards and revenue shortfalls were the immediate cause for the abrupt fiscal deterioration, the worsening in the current balance of the state governments can be traced to the early 1990s. The growing revenue deficit was prevented from translating into a higher fiscal deficit until the second half of the 1990s only because capital expenditure was compressed.

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