Gujarat budget analysis project

PA 512 INSTRUCTOR: DR. C. COE GUJARAT: BUDGET PROJECT SHANTANU BASU NORTH CAROLINA STATE UNIVERSITY RALEIGH, NC 27695 DATE OF SUBMISSION: DEC 3 2008

I-D: 000796781 Basu 1 Table of Contents 1. Gujarat: Brief Background, ............................................................................................. 2 2. Budget & Accounts ......................................................................................................... 3 2.1 Budget Process ............................................................................................................ 4 2.2 Fiscal Management ..................................................................................................... 4 3. Sources of Revenue......................................................................................................... 6 3.1 State’s Own (Internal) Revenue .................................................................................. 7 3.1.1 Non-Tax Revenue ....................................................................................................... 8 3.1.2 Public Debt.................................................................................................................. 8 3.1.3 Transfers from the Central Government ..................................................................... 8 4. Expenditure ..................................................................................................................... 9 4.1 Quality of Expenditure .............................................................................................. 10 4.2 Assets & Liabilities ................................................................................................... 11 4.2.1 Return on Investment ................................................................................................ 11 4.3 Undischarged Liabilities ........................................................................................... 12 4.3.1 Fiscal Liabilities ........................................................................................................ 12 4.3.2 Guarantees................................................................................................................. 13 4.4 Debt Sustainability .................................................................................................... 13 4.4.1 Debt Stabilization...................................................................................................... 14 4.4.2 Sufficiency of Non-debt Receipts ............................................................................. 14 4.4.3 Net Availability of Borrowed Funds......................................................................... 14 4.5.1 Deficit Trends ........................................................................................................... 15 4.5.2 Quality of Deficit/Surplus ......................................................................................... 16 4.6 Fiscal Ratios .............................................................................................................. 16 5. Externally Aided Projects (EAP) .................................................................................. 17 6. Foreign Investment ....................................................................................................... 17

I-D: 000796781 Basu 2 1. Gujarat: Brief Background1,2 The state of Gujarat is located on the western shoreline of India adjoining the Arabian Sea. Its history stretches back to about 3500BC when it was home to Iron Age settlements belonging to the Indus Valley Civilization. Ruled by various dynasties, Hindu and Muslim, over the last 3000 years, the state has a checkered history. At Independence in 1947, the local principalities merged into the erstwhile Bombay State. In 1960, following reorganization of states on linguistic basis, Gujarat became a separate state of the Indian Union. The state has a 1000-mile coastline and a population of about 55 million, 37.36% of which is urban. The average literacy Fig. 1: Growth of State Gross Domestic Product rate is 70%. The Chief 350000 20 Minister, Mr. Narendra Modi, 18 300000 is the elected head of 16 Percentage Growth Rupees in Crore 250000 14 ($1 = Rs. 50) government and Council of 200000 12 10 Ministers while the Governor, 150000 8 Mr. NK Sharma, is the 100000 6 4 constitutional head. The state 50000 2 0 0 has a per capita income of Rs. 2003-04 2004-05 2005-062006-07 2007-08 37532 (PPP $ 7506) at current Fiscal Year prices against an all-India GSDP Growth of GSDP(%) average (2006-07) of Rs. 20734 (PPP $ 4145). The GSDP (2007) is estimated at approximately $52.06 billion at current prices with India’s highest annual growth rate of 14.32% per capita per annum from 2005-06 to 2008-09 and NSDP of Rs. 57048 (PPP $11410) at current prices as shown in Fig. 1. With over 300,000 small scale units, over 2200 large and medium industries, 83 closely integrated industrial clusters, 182 industrial estates and 33 Special Economic Zones with flexible labor laws and an easy exit policy Gujarat is one of the most industrialized states of India. Gujarat has a 1 To the extent available, figures in this paper relate to fiscal years 2004-05 to 2008-09 (inflation adjusted). Where accounts figures have had to be utilized, comparison from 2002-03 to 2006-07 (inflation adjusted) is used, since accounts for 2007-08 are not yet available online. 2 Sources for this paper include the Finance, Revenue & Foreign Investment Departments and Chief Minister’s Office of the Government of Gujarat, and Reserve Bank of India, Ministry of Finance Government of India, and Comptroller &Auditor General of India, Asian Development Bank, The Economic Times and Financial Express (India).

I-D: 000796781 Basu 3 16.2% share in India’s industrial production and the lowest percentage of person-days lost of 0.52% due to labor unrest. It is home to three major private ports, the world’s sixth largest integrated petroleum refinery (580,000 bpd) and lately, the 500,000 cars per annum plant for the world’s cheapest passenger car, the TATA Nano. 2. Budget & Accounts Due to the unitary system of government in the Indian Constitution, Gujarat follows the central government’s rules and schedule on the budget, accounts and audit. The fiscal year is from April 1 to March 31 for all state governments and the central government. While the Budget Estimates (BE) are drawn and presented to the state’s legislature as Department wise demands for grants on the last working day of February every year, this exercise repeated again in November every year when the budget is updated and corrected mid-year and Revised Estimates (RE) presented to the legislature during its winter session. The departments are required to submit their Estimates to the Finance Department by October 31 of the preceding year for BE and by August 31 of the current fiscal for the RE. Budget figures in gross terms and net expenditure worked out at the end of each fiscal year, after taking into account receipts and adjustments. For revenue proposals, the legislature passes an omnibus Finance Act while expenditure covered by a corresponding Appropriation Act. The budgets are line item and the legislature has full powers to curtail/add to it by a simple majority. However, such modifications are rare since the majority party in the legislature also leads the government in the state. The Governor does not have any powers of modification of the budget and only assents to legislative Acts. The prescribed format splits the proposed expenditure in two parts – administrative (non- Plan) and developmental (Plan) and within them revenue and capital. These parts again have a central and state component each to account for the sources of funds. The budget is accounted using three funds – Consolidated and Contingency Funds and Public Account (for debt). The format of accounts and budget, compiling consolidated accounts and audit of the state accounts done by the Comptroller & Auditor General of India, in terms of Articles 149-151 of the Constitution, through the Principal Accountant General/Accountants General of the State. The report and certified accounts presented to the legislature, generally in the budget session of the legislature in the following calendar year.

I-D: 000796781 Basu 4 2.1 Budget Process The Finance Department issues a circular on May 31 to all departments of the state containing guidelines and formats in which the BE is to be submitted to them. Upon receipt of this circular, the departments addressed their constituent units, subordinate and attached offices for their respective Budget Estimate (BE) by July 31 with proper justification based mainly on immediate and intermediate outcomes using measures of output and efficiency in support of their proposals and budget figures. Each unit head meets his/her officers (not in retreat) while finalizing revenue and expenditure projections. Thus, the Commercial Taxes and Excise Departments would work out revenue projections based on current legislation and cost of collection for each collection zone. The Public Works and Irrigation Departments would similarly, work out their revenue (for irrigation farm supply or revenue from toll roads) and expenditure (by schedule of sanctioned works within the capital improvement plan) by executing division. Each head of department consolidates the BE for his/her department and submits it to the Finance Department by Aug 31. The Principal Finance Secretary of Gujarat then circulates a schedule for meetings with department heads to finalize the BE. During these meetings, final adjustments carried out so that the fiscal deficit, if any, minimized and the government’s political priorities taken into account. 2.2 Fiscal Management The State Government enacted the Gujarat Fiscal Responsibility Act, 2005 to ensure prudence in fiscal management and fiscal stability by progressive elimination of revenue deficit, sustainable debt management consistent with fiscal stability, greater transparency in fiscal operations of the government and conduct of fiscal policy in a medium term fiscal frame work. To give effect to the fiscal management principles as laid down in the Act and /or the rules framed there under, the Government prescribed the following fiscal management targets: Reduce the revenue deficit in each financial year commencing from April 1, 2005 to eliminate it by March 31 2008 and maintain it at that level or generate revenue surplus thereafter. Reduce fiscal deficit in each financial year commencing from April 1 2005 to bring it down to not more than three per cent of GSDP by March 31 2009.

I-D: 000796781 Basu 5 Cap within a period of three years commencing from April 1 2005 and ending on March 31 2008, the total public debt of the State Government at thirty per cent of estimated GSDP for that year. Cap outstanding guarantees within the limit provided in the Gujarat State Guarantees Act, 1963. The revenue deficit and the fiscal deficit may exceed the specified limits due to unforeseen circumstances or natural calamity to the extent of actual fiscal cost spent to meet the situation. Following the recommendations of the 12th Finance Commission (TFC) and the State Fiscal Responsibility and Budget Management (FRBM) Act, the State developed its own Fiscal Correction Path; indicating the milestones of outcome indicators with target dates of implementation from 2004-05 to 2009-10. As prescribed in the Act, the State Government was required to lay the following statements of fiscal policy along with the budget before the Legislature: The Medium Term Fiscal Policy Statement (MTFPS) and The Fiscal Policy Strategy Statement setting forth the fiscal objectives, strategic priorities of the State Government and a three-year policy target for fiscal management. The State Government in its MTFPS estimated own tax revenue at Rs 162.44 billion for 2006-07. The State estimated its own nontax revenue at Rs 33.34 billion in 2006-07 and estimated growth rates of 7% and 4.95% for plan and non-plan revenue expenditure respectively, for 2005-06 and onward. Average cost of borrowing for 2006- 07 estimated at 9.33% while growth rates of salaries and pension payments at 3.8-4% and 9% respectively. The State achieved the fiscal targets laid down in the Gujarat Fiscal Responsibility Act, 2005, one year ahead of schedule, with 2006-07 ending in a revenue surplus of Rs 17.70 billion. Fiscal deficit at Rs 56.48 billion during 2006-07 remained at 2.38% of GSDP. The guarantees given were also well within the limit prescribed in the Act. The ratio of Public Debt to GSDP at 30.60% during current year stood a little higher than the Act-prescribed cap of 30% at the end of 2007-08. In view of the fiscal performance of the State measured by trends in revenue and fiscal deficits relative to their base year values and improvements over 2005-06, the State received debt

I-D: 000796781 Basu 6 waiver of Rs 8.46 billion as an incentive under Debt Consolidation and Relief Facility (DCRF) from the Government of India in fiscal 2006-07. 3. Sources of Revenue Fig. 2 shows the receipts of the State from 2004-05 to 2008-09. Total revenues of the State have increased by 55.52% in the past five years at current prices. Fig. 2: Growth of Revenues 2004-05 to 2008-09 900 700 Rs in Billion 500 300 100 -100 2004-05 2005-06 2006-07 2007-08 2008-09 (Est) Fiscal Year Revenue Capital Public Account Total Revenues The profile of revenue sources also has changed from 2004-05 to 2008-09 as shown in Figs. 3 & 4. Gujarat’s own revenues, as a proportion of gross revenue receipts, have increased by 13.65% while central transfers expected to increase by 4.86% from 2004-05 to 2008-09. Fig. 3: Profile of Revenue Sources 2004-05 Fig. 4: Profile of Revenue Sources 2008-09 Own Taxes Non-tax Central Transfers Grant-in-Aid Own Taxes Non-tax Central Transfers Grant-in-Aid

I-D: 000796781 Basu 7 3.1 State’s Own (Internal) Revenue Revenue receipts of the state projected to rise by 88.90% in 2008-09 over 2004-05. Based on Census 2001 projections, this translates to Rs. 14216 per capita in 2006-07 and further to Rs. 18355 in 2008-09 at current prices, a rise of 29.11% in three fiscals. However, return on investment from state undertakings remains a cause for concern having risen marginally from 0.84 in 2002-03 to 1.92 in 2006-07. Continuous improvement in revenue account that show a surplus during the current year, declining fiscal deficit and increasing trend in the share of capital expenditure in total expenditure of the government have resulted in the improvement in the ratio of assets to liabilities to 66% in 2006-07 from 56% in 2004-05. The fund balance of the State rose to Rs. 93.61 billion in 2006-07 at current prices, an increase of 28.79% over 2005-06. The largest single rise of 104.87% is in sales tax since the State implemented the Value Added Tax (VAT) from April 2006. Buoyancy of revenues is evident from a negative Rs. 67.32 billion in 2002-03 to a surplus of Rs. 17.70 billion in 2006-07 at current prices, a 126.29% improvement; primary deficit of all states together was Rs. 134.75 billion (-0.29 ratio to GDP). This buoyancy has reflected in improving the revenue to fiscal deficit ratio from 1.03 in 2001-02 to a surplus in 2006-07 and led to an increase in the asset base of the state. Overall revenue buoyancy ratio has risen from 0.81 in 2002-03 to 2.48 in 2006-07. A highlight is the 75.73% Fig. 5: Elasticity of Revenue 2003-04 to 2007-08 16000 14000 12000 INR in Crore 10000 8000 6000 4000 2000 0 2003-04 2004-05 2005-06 2006-07 2007-08 Fiscal Year Sales Tax Profession Tax Electricity Duty Motor Vehicle Tax Passenger Tax Stamp Duty Entertainment Tax Luxury Tax (hotels) Prohibition & Excise Duty

I-D: 000796781 Basu 8 increase in non-debt receipts from 2002-03 to 2006-07 that has served to fully cover primary revenue and partly capital expenditure with a Rs. 12.48 billion surplus at current prices in 2006- 07; all states together covered only 5.6% of the fiscal deficit from budgetary surpluses in 2007- 08. The primary sources of Gujarat’s own revenue have remained mainly inelastic except for passenger and entertainment taxes as shown in Fig. 5 that have helped to keep revenue projections stable over a span of time. The state has limited excise tax revenue from alcohol owing to a historical prohibition policy, the state having been home to Mahatma Gandhi, a staunch prohibitionist. 3.1.1 Non-Tax Revenue Non-tax revenue estimated to increase by 44.27% to Rs. 44.59 billion in 2008-09 at current prices over 2004-05. In fact, the State exceeded the target set by the TFC by 39.29% in 2006-07. However, there is a decline of 7.57% from 2001-02 to 2006-07 as part of total revenue receipts. 3.1.2 Public Debt Public debt capital receipts have been steadily declining since their peak in 2003-04. Such receipts have declined from 98.68% in 2003-04 to 89.66% in 2006-07 of total capital receipts. Such decline is mainly due to steep increase in revenues that have offset the need to borrow. 3.1.3 Transfers from the Central Government The Finance Commission (FC) set up every five years by the central government determines sharing of tax resources between states and the central government. Share of taxes from the Central Government per the formula of the 12th Finance Commission (TFC) has increased such revenues for the State by 172.44% in 2008-09 over 2004-05 in real terms. The increase in Central tax transfers was mainly due to increase in Corporation Tax, Union Excise Duties, and Taxes on Income other than Corporation Tax, Customs and Service Tax. With manifold increase in tax collection, particularly on income and services, transfers to states have increased substantially over the last five years. The FC also gives states that achieve revenue collection targets beyond the benchmark approved by the FC, additional transfer incentives.

I-D: 000796781 Basu 9 4. Expenditure Revenue expenditure maintains the current level of services and payments for past obligations and does not result in any addition to the State’s infrastructure and service network. Therefore high revenue expenditure is symptomatic of a state’s less than average fiscal health. Fig. 6 shows the profile of expenditure on revenue account from 2004-05 to 2008-09 at current prices. Fig. 6: Revenue Expenditure Profile 2004-05 to 2008-09 35 Percentage of 25 total expdn. 15 5 -5 2004-05 2005-06 2006-07 2007-08 2008-09 Fiscal Year General Services Social Services Economic Services Miscellaneous Services The ratio of non-plan revenue expenditure to total expenditure declined from 84.59% in 2001-02 to 62.68% in 2006-07, except in 2004-05 (post-earthquake fiscal). The ratio of non-plan revenue expenditure to revenue receipts declined from 1.31 in 2001-02 to 0.76 in 2006-07, indicative of better expenditure management by the State. However, non-plan revenue expenditure in 2006-07 exceeded the normative assessment by TFC by 28.15%. Although the State Government in its Medium Term Fiscal Policy Statement projected 7% and 4.95% growth rate for plan and non-plan revenue expenditure respectively, the actual growth rates substantially exceeded the limit prescribed for 2006-07. Correspondingly, revenue expenditure buoyancy to GSDP increased from 0.29 in 2005-06 to 1.55 in 2006-07 while buoyancy of revenue expenditure to revenue receipts increased by 15% in 2006-07 as compared to 5% in 2005-06. Expenditure on salaries and wages at Rs 26.69 billion in 2006-07 was the lowest during 2002-07. Measures like abolition of vacant posts, re-deployment of existing staff to avoid filling up of vacant posts and recruitment of essential staff mostly on fixed pay basis, initiated by the State Government, helped in containing the expenditure on salaries and wages. As percentage of

I-D: 000796781 Basu 10 GSDP, expenditure on salaries and wages declined during 2002-07. During 2006-07, the expenditure on salaries and wages stood at 1.12% of the State’s GSDP and 8.60% of revenue receipts. However, with improving health, pensions constituted 8% of revenue expenditure and 1.01% of GSDP; this trend would rise in the coming years. The State had projected in the FRBM Act, interest payment as 20.59% of revenue receipts in 2006-07. However, interest payments as a percentage of revenue receipts were 22% in 2006-07 primarily due to increasing small savings collections in the State. Interest payments during 2006-07 exceeded the normative assessment of TFC (Rs 69 billion) by Rs 3.20 billion owing to higher borrowings in previous years. A positive side has been the decline of subsidies on electricity and agriculture from 16.50% in 2001-02 to 7.51% in 2006-07 that has reduced pressure on revenue expenditure. 4.1 Quality of Expenditure Fig. 7 shows an overview of capital vs. revenue expenditure, in terms of total expenditure and as a percentage of GSDP. It is evident that revenue expenditure continues to account for about 60% of total expenditure. Fig. 7: Quality of Expenditure 2002-03 to 2006-07 100 Percentage 10 1 2002-03 2003-04 2004-05 2005-06 2006-07 Fiscal Year Capital (% of total exp) Capital (% of GSDP) Revenue (% of total exp) Revenue (% of GSDP) Even within capital expenditure on revenue account, there are wide divergences. For instance, the ratio of capital to revenue expenditure for social services such as health is .05, education .05 and other social services .07; water supply and sanitation however, is healthier at .55 in 2006-07. Although, such outlays may seem negligible, yet the situation has improved substantially considering the corresponding figures of .0016, .018, .17 and .57 in 2001-02. The State has fared

I-D: 000796781 Basu 11 better in providing economic services, particularly in irrigation (in a drought endemic state) that showed an improvement from .29 in 2001-02 to 7.4 in 2006-07. There is also major improvement with ratios of .668 in energy (-.13 in 2002-02) and transportation of .58 (up from .42 in 2001-02). The overall ratio of capital to revenue expenditure for economic services stood at a relatively healthy 0.96. Financial assistance to local governments also increased from 13.08% of revenue expenditure in 2001-02 to 19.73% in 2006-07. 4.2 Assets & Liabilities The historical Government accounting system does not provide for comprehensive accounting of fixed assets like land and buildings owned by the Government. Nonetheless, Government accounts capture the financial liabilities of the Government and the assets created from expenditure incurred. While the liabilities consist mainly of internal borrowings, loans and advances from the GOI, receipts from the Public Account and Reserve Funds, assets comprise capital outlay, loans and advances given by the State Government and cash balances. 4.2.1 Return on Investment Return on capital investment in 2006-07 in irrigation projects was only 10.48% in 2006- 07. A similar situation, though improved, shows in the public sector enterprises where percentage of return has risen from 0.55 in 2001-02 to 1.92 in 2006-07 that leaves an uncovered gap of 6.27% between the return and the interest paid by government on loans taken by these entities. If all loans and advances made by the State to the public sector and cooperative sector (primarily dairy farming) are considered, the State has, while paying an average of 8.19% interest rate on borrowings, gets a -7.19% rate of return; primarily by way of unpaid installments of principal, interest and dividend. Outstanding balance awaiting repayment as on March 31, 2007 was Rs. 46.65 billion. Adding to this are 261 incomplete projects upon which Rs. 159.76 billion was cumulatively spent until March 31, 2007. Apart from other reasons, thin spread of resources is one of the reasons for delay in completion of the projects that not only blocked limited resources, caused time and cost overruns and delayed accrual of benefits from the projects to the State. The State has implemented Phase-I of its Public Sector Restructuring Program (PSRP) from 1996 to 2003 with Asian Development Bank (ADB) support covering 24 state-owned enterprises (SOEs). Under PSRP seven SOEs have been shut down, two privatized, three

I-D: 000796781 Basu 12 partially disinvested, two merged while eight were in advanced stages of restructuring. 21924 employees were voluntarily for which compensation of Rs.4.9 billion was paid to ex-employees. This exercise has closed/restructured/ transferred Rs. 33.75 billion to the private/joint Sector with savings of Rs. 4.77 billion and annual recurring savings of Rs. 1.11 billion from State Budget because of voluntary separation of workers. Simultaneously, the State created a Social Safety Net and constituted the State Renewal Fund (SRF) in Sept 1996 to provide funds for voluntary separation expenses to SOEs covered under the PSRP (Phase – I).The second phase of this project is in the initial planning stage. 4.3 Undischarged Liabilities 4.3.1 Fiscal Liabilities The overall fiscal liabilities of the State increased from Rs 453.01 billion in 2001-02 to Rs 879.71 billion in 2006-07. The average growth rate from 2002-03 to 2006-07 was 14.26% although it declined to 8.12% during 2006-07 over 2005-06. The ratio of fiscal liabilities to GSDP ranged narrowly between 36.66% and 38.18% during 2001-07 as shown in Fig. 8. These liabilities stood at 284% of revenue receipts and 376% Fig. 9: Ratio of Fiscal Liabilities 2002-03 to 2006-07 15 of the State’s own resources in 2006-07. The buoyancy of 10 fiscal liabilities steadily Percentage declined from 1.17 in 2001- 5 02 to 0.85 in 2006-07 as shown in Fig. 9. A significant 0 decrease in buoyancy of 2002-03 2003-04 2004-05 2005-6 2006-07 Fiscal Year fiscal liabilities to revenue GSDP Revenue Resources Own Resources receipts during 2006-07 was

I-D: 000796781 Basu 13 essentially due to much higher growth in revenue receipts. The spike in 2003-04 is primarily due to a major earthquake that adversely affected the state’s finances. Table 1 gives an overview of the basic parameters of the State’s fiscal liabilities. Table 1 2002-03 2003-04 2004-05 2005-06 2006-07 Fiscal Liabilities (Rupees in billion) 525.72 628.76 710.83 813.67 879.71 Rate of Growth (%) 16.05 19.60 13.05 14.47 8.12 Ratio of Fiscal Liabilities to GSDP (%) 37.14 37.41 38.18 37.56 37.07 Revenue Receipts (%) 294.10 344.56 350.77 324.60 283.76 Own Resources (%) 389.00 435.27 442.91 427.11 375.73 Buoyancy of Fiscal Liabilities to GSDP (ratio) 1.10 1.04 1.21 0.88 0.85 Revenue Receipts (ratio) 1.36 9.39 1.18 0.61 0.34 Own Resources (ratio) 4.12 2.85 1.18 0.77 0.35 4.3.2 Guarantees Guarantees are liabilities contingent on the Consolidated Fund of the State in case of default by the borrower. The FRBM Act of State prescribed capping of outstanding guarantees within the Rs 200 billion limit provided in the Gujarat State Guarantees Act, 1963. The outstanding guarantees (Rs 124.48 billion) accounted for 40% of the revenue receipts (Rs 310.02 billion) of the State Government and were therefore within the ceiling limit prescribed under the Act. This percentage has declined to 40% from 109% in 2002-03 while in absolute terms guarantees have declined by Rs. 645.03 billion from 2002-03 to 2006-07. The State Government has also set up the Guarantee Redemption Fund to cover contingent liabilities arising out of the State’s guarantees and the Consolidated Sinking Fund to utilize interest accrued and accumulated in the fund towards the redemption of outstanding liabilities of the Government. 4.4 Debt Sustainability Debt sustainability is the ability of the State to maintain a constant debt-GDP ratio over a span of time; embodies the concern about the State’s ability to service its debt. Sustainability of debt therefore also implies sufficiency of liquid assets to meet current or committed obligations and the capacity to balance costs of additional borrowings with returns from such borrowings.

I-D: 000796781 Basu 14 Thus, rise in fiscal deficit should match increase in debt servicing capacity of the State. A prior condition for debt sustainability is debt stabilization defined by the debt/GSDP ratio. 4.4.1 Debt Stabilization A necessary condition for stability is that if the rate of growth of economy exceeds the interest rate or cost of public borrowings, the debt-GSDP ratio is likely to be stable provided primary balances are either zero or positive or are moderately negative. Given the rate spread (GSDP growth rate–interest rate) and quantum spread (Debt x rate spread), debt sustainability if quantum spread together with primary deficit is zero, debt-GSDP ratio would be constant and debt would eventually stabilize. On the other hand, if primary deficit together with quantum spread were negative, debt-GSDP ratio would rise; in case it is positive, debt-GSDP ratio would eventually decline. The quantum spread together with primary deficit during 2001-07 was positive except in 2001-02 and 2004-05 and indicates a constant or sustainable debt–GSDP ratio. The fiscal liabilities to GSDP ratio which remained stagnant at around 37% from 2002-07 exceeded the positive quantum spread; this indicated sustainable position. The positive sum of quantum spread and primary deficit as well as declining fiscal deficit led to a decline in fiscal liabilities to GSDP ratio in 2005-06 and 2006-07. 4.4.2 Sufficiency of Non-debt Receipts Adequacy of incremental non-debt receipts of the State to cover the incremental interest liabilities and incremental primary expenditure is another indicator for debt stability and its sustainability. Debt sustainability would significantly improve if incremental non-debt receipts meet the incremental interest burden and the incremental primary expenditure. The positive resource gap between 2001-03 turned negative during 2003-04 but turned positive again in 2004- 07 indicating signs of improvement. 4.4.3 Net Availability of Borrowed Funds Another important indicator of debt sustainability is the net availability of funds after the payment of the principal on previously contracted liabilities and interest. From its peak in 2003- 04, internal debt receipts have declined by 44.57% in 2006-07. Loan receipts from Government of India have also declined by 77.62% in 2006-07 from 2002-03. However, net funds available from borrowed funds, after providing for the interest and repayment, declined sharply from

I-D: 000796781 Basu 15 16.21% in 2005-06 to negative net availability in 2006-07. The State Government did not raise any market loan in 2006-07. As on March 31 2007, 22% of the existing market loans of the State Government carried interest rates exceeding 10%, i.e. beyond current market rates. However, there has a decline of about 4.5% in the cost of debt as shown in the graph below. Thus, the effective cost of borrowings on the past loans was much higher than the rate at which the State was able to raise resources at present from the market. 4.5 Deficit Management The deficit in Government accounts represents the gap between its receipts and expenditure. The nature of deficit is an indicator of prudent fiscal management of the Government. Financing of deficit, raising and applying resources are important pointers to the State’s fiscal health. 4.5.1 Deficit Trends The revenue surplus of the State indicates the excess of its revenue receipts over revenue expenditure stood at Rs 17.70 billion in 2006-07, up from (-) Rs.35.65 billion in 2002-03 – an improvement of Rs. 53.35 Fig. 10: Fiscal Imbalance Ratios 2002-03 to 2006-07 billion. The fiscal deficit 60 0 50 declined by 6.03% in 2006- 40 -1 07 over 2002-03 while the 30 -2 primary deficit declined by Percentage 20 10 -3 55.7% at current prices 0 from 2002-03 and turned -10 -4 into a primary surplus in -20 -5 -30 2006-07. The ratio of -40 -6 revenue deficit to GSDP Fiscal Year Rev Def/GSDP Prim Def/GSDP declined from 5.45% in Rev Def/Fisc Def Fisc Def/GSDP 2001-02 to 0.18 per cent in

I-D: 000796781 Basu 16 2005-06. The turnaround in revenue account in 2006-07 was mainly because of an increase of 23.7% in revenue receipts, against an increase of 14.8% in revenue expenditure. Primary revenue deficit is the gap between non-interest revenue expenditure of the state and its non-debt receipts. It indicates the ability of non-debt receipts of the State to meet primary expenditure incurred under revenue account. The primary deficit, which continued in the State, turned into a primary surplus in 2006-07 because of a moderate decline in fiscal deficit and an increase in interest payments. Fig. 10 shows the fiscal imbalance of revenue, fiscal and primary deficits to GSDP and revenue to fiscal deficit. 4.5.2 Quality of Deficit/Surplus The ratio of revenue deficit (RD) to fiscal deficit (FD) and the breakdown of primary deficit into primary revenue deficit and capital expenditure (including loans and advances) is indicative of the quality of deficit in State finances. The RD/FD ratio that indicates the extent of usage of borrowed funds for current consumption sharply declined from 59.13% in 2002-03 to 6 per cent in 2005-06 expanding the asset base of the State. From 2001-2007 the primary deficit was because of capital expenditure incurred and loans and advances disbursed by the State Government. In other words, non-debt receipts of the State were enough to meet the primary expenditure requirements in the revenue account; left some residuary receipts to meet expenditure under capital account. However, the State had to borrow to meet capital account requirements from 2001-06 which is desirable to improve the productive capacity of the State’s economy. The State’s fiscal deficit owed to interest payments of Rs 69.32 billion in 2006-07 - a substantial improvement from (-) Rs. 23.05 billion in 2002-03. 4.6 Fiscal Ratios The finances of a State need to be sustainable, flexible and relatively less vulnerable. Table 2 presents a summarized position of Government finances over 2002-07, with reference to certain key indicators that help to assess the adequacy and effectiveness of available resources and their applications, highlights areas of concern and captures its important facts. The ratio of revenue receipts and State’s own taxes to GSDP indicate the State is increasing access to resources and the nature of the tax regime. Revenue receipts comprise not only tax and non-tax resources of the State but also the transfers from the Central Government.

I-D: 000796781 Basu 17 The ratio of revenue receipts to GSDP in 2006-07 was 13 per cent, an increase of 0.37% since 2002-03. During 2002-07, the ratio of the State’s own taxes to GSDP increased by 1.05%. Revenue expenditure to total expenditure declined by 10.81% while capital expenditure to total expenditure rose by 11.25% while total expenditure to revenue receipts declined by 14.18%. Thus, increasing reliance on revenue receipts to finance total expenditure (83% in 2006-07) indicated decreasing dependence on borrowed funds. Decreasing ratio of financial liabilities to revenue receipts also reflects this trend. The ratio of salary and wages to revenue expenditure on social and economic services continuously declined from 2002-07 while non-salary remained little more than half during the same period; indicated better quality of expenditure and improvement in social and economic services. The improving balance of current revenue of the State improved continuously during 2001-07 and large huge surpluses in 2005-06 and 2006-07 indicated more availability of funds for additional infrastructure support and other revenue generating investments. Continuing improvement in revenue account, declining fiscal deficit and increasing share of capital expenditure in total expenditure of the government have resulted in the improvement in the ratio of assets to liabilities from 0.55 in 2002-03 to 0.66 in 2006-07. However, low returns of 0.27 in 2003-04 to 1.92% in 2006-07 remain a major concern for the State. 5. Externally Aided Projects (EAP) From Apr 1 2005, the Central Government (Principal Borrower) transfers external aid to the State on the same terms and conditions on which it has availed such assistance. Normally, rate of interest of such external assistance links to current LIBOR rates. Presently, the State has five ongoing EAPs for Rs. 42.20 billion in various sectors sanctioned by various multilateral and bi-lateral agencies such as the World Bank, Japanese Bank for International Cooperation (JBIC) and the Asian Development Bank (ADB). Of the five EAPs, one is for earthquake rehabilitation and reconstruction program while four are for Road, Technical Education, Water Resources and Forestry sectors. 6. Foreign Investment The economic survey for 2007-08 fiscal of the state government says it has received investments worth Rs 4529.83 billion between 1991 and 2007. This investment does not involve commitments made through memorandum of understanding. This investment has come through

I-D: 000796781 Basu 18 routes like the industrial entrepreneur memorandum (IEM), letter of intent, and 100% export oriented units. Gujarat has fetched an investment of Rs 4528.3 billion on 9440 proposals, The closest competitor, the adjoining state of Maharashtra, clocked Rs 3891.90 billion spread over 14,069 proposals. Table 2 (Figures in percentage unless specified in row) Fiscal Indicators 2002-03 2003-04 2004-05 2005-06 2006-07 I Resources Mobilization Revenue Receipt/GSDP 12.63 10.86 10.88 11.57 13.06 Revenue Buoyancy 0.81 0.11 1.03 1.45 2.48 Own Tax/GSDP 6.73 6.65 6..96 7.25 7.78 II Expenditure Management Total Expenditure/GSDP 17.05 16.41 15.65 15.29 15.78 Total Expenditure/Revenue Receipts 134.98 151.19 143.80 132.15 120.80 Revenue Expenditure/Total Expenditure 88.86 79.57 83.39 76.87 78.05 Salary &Wage expenditure on Social and Economic Services / Revenue Expenditure 7.69 7.44 7.04 6.86 4.75 Non-Salary &Wage expenditure on Social and 53.10 49.97 51.12 48.39 53.33 Economic Services / Revenue Expenditure Capital Expenditure/Total Expenditure 9.70 11.64 14.07 21.01 20.95 Capital Expenditure on Social and Economic Services/Total Expenditure 9.55 11.43 13.78 20.74 20.78 Buoyancy of TE with RR (-) 0.20 6.88 0.51 0.58 0.55 Buoyancy of RE with RR (-) 0.48 1.15 0.97 0.20 0.62 III Management of Fiscal Imbalances Revenue deficit (Rs in Billion) 35.65 37.06 40.37 3.98 +1770 Fiscal deficit (Rs in Billion) 60.29 91.42 86.91 62.68 56.48 Primary Deficit (Rs in Billion) 10.80 32.67 26.12 1.25 +1284 Revenue Deficit/Fiscal Deficit 59.13 40.54 46.45 6.35 +31.34 IV Management of Fiscal Liabilities Fiscal Liabilities/GSDP 37.14 37.41 38.18 37.56 37.07 Fiscal Liabilities/RR 294.10 344.56 350.77 324.60 283.76 Buoyancy of FL with RR 1.36 9.39 1.18 0.61 0.34 Buoyancy of FL with Own Resources 4.12 2.85 1.18 0.77 0.35 Primary deficit vis-à-vis quantum spread 0.54 0.72 2.46 0.02 1.18 Net Funds Available 14.54 14.23 11.21 16.21 - 1.48 V Other Fiscal Health Indicators Return on Investment 0.84 0.27 0.28 0.92 1.92 Balance from Current Revenue (Billions of Rupees) - 237 - 177.1 - 97.7 283.3 646.1 Financial Assets/Liabilities 0.55 0.56 0.56 0.61 0.66

Gujarat budget analysis project

by Shantanu Basu

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