Social Scientist Expenditure India

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Levels and Composition of Public Social and Economic Expenditures in India, 1950-51 to 2005-06Author(s): R. RamakumarSource: Social Scientist, Vol. 36, No. 9/10 (Sep. - Oct., 2008), pp. 48-94Published by: Social ScientistStable URL: http://www.jstor.org/stable/27651819 .

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Levels and Composition of Public Social andEconomic Expenditures in India, 1950-51 to 2005-06

EEa? This paper is concerned with analysing changes in the levels and?L composition of spending by the state in India on the social andeconomic sectors. The analysis is undertaken for the Central

government and the State governments separately. The "functionalclassification" of expenditures in the budget documents is used as thebasis for the analysis. While the broad period of analysis in the paper is1950-51 to 2005-06, there is special emphasis on understanding changesin the expenditure patterns in the 1990s and 2000s.The paper is divided into six sections. The first section is anintroduction, where I try to contextualise the analysis in relation to theliterature on public expenditure analysis. In Section 2,1 shall discuss thedatabase used in this study

aswell as themethodological

framework. InSection 3 and 4, I analyse trends in expenditure by the Centralgovernment and State governments respectively. Section 5 is a shortassessment of the significance of some recent trends in expenditure.Section 6 has the concluding comments.I. Introduction

The centrality of the role of the government in fulfilling the basic needs ofpeople has been well argued in the literature. Over the years, the laissezfaireview of the role of government - that economic affairs of the societyare best guided by decisions of individuals and not by a collectiveauthority - has undergone severe criticism and revision even within themainstream literature. Alongside, there has emerged amore sober viewof the role of government. The phenomenon of "market failures" hascome to be recognized almost universally. In theoretical terms, it isnowaccepted that the equilibrium attained in afree market need not bePareto-optimal, and certain goods may not be provided at theequilibrium in socially optimal or desirable levels.1In developing countries, given the incompleteness, and oftenabsence, of markets in a large number of spheres and the pervasivenessof information asymmetry, the role of the government becomes evenmore crucial (Stiglitz, 1996). One of the important indicators ofgovernment involvement in the economy is the nature of its fiscal policy.Fiscal policy encompasses both resource mobilisation and expenditure

48 strategies. While an analysis of the role of government should include


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Public Social and Economie Expenditures in India

both, a study of expenditure strategies has the advantage that one can analyse the T3directions of flow of public funds in the economy. It becomes possible to g3understand the prioritisation of expenditures by the government, aswell as the 3factors thatwould influence changing priorities over time. For instance, one can ?Tattempt to study the extent to which government has intervened in human 3priority sectors like education and health, as compared to sectors like defence. "^The present paper is an attempt to study the changing role of the government inIndia with respect to the priorities in its expenditure strategies.

Of course, any study of public expenditure strategies is incomplete withouta discussion on the political economy of fiscal policy (seeO'Connor, 1973; Block,1981 ). Studies of this variety have argued that it is the political stance of the statethat has often determined its commitment to expenditures in social andeconomic sectors.2 However, before one discusses the political economy ofpublic expenditure, it isnecessary to understand the levels and composition, aswell as changes in the levels and composition, of public expenditures. The currentstudy is a limited attempt at the latter.

Studies have shown that the level of public expenditure on the social sectorsis significantly associated with improvements in human development. Ofcourse, a one-to-one relationship between social spending and indicators ofhuman development is difficult to make. However, higher levels of publicexpenditure on the social sectors do denote a particular "public policy stance", asChakraborty (2003, p. 2) puts it, and public expenditure can be used as a goodproxy tomeasure it.

In a recent study using panel data from 120 developing countries between1975 and 2000, Baldacci et al (2004) argued that public spending in educationand health had "apositive and significant direct impact on the accumulation ofeducation and health capital" (p. 28). They argued that "an increase in educationspending of 1 percentage point of GDP is associated with 3 more years ofschooling on average.. .Similarly, an increase inhealth spending of 1percentage

point of GDP is associated with an increase of 0.6 percentage points in the under5 child survival rate..." (ibid.). These positive impacts were strongest in the caseof low-income countries and countries from Africa. In their widely-cited studyof 22 countries, Anand and Ravallion (1993) argued that the effect on lifeexpectancy rates of an increase in public spending on health was twice assignificant as an increase in per capita income. They concluded that "certaincomponents of public spending can matter greatly in enhancing humandevelopment in poor countries, and that they matter quite independently ofwhat they do or don't deliver in terms of reduced income poverty" (p. 147).Chakraborty's (2003) analysis for selected developed and developing countriesshowed that "public spending on education and health has a stronger impact onhuman development than the growth of per capita income". A number of other 4^


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? studies have reached similar conclusions in varying degrees (seec3 Psacharopoulos, 1994; Bhalla and Gill, 1991; Hojman, 1996; Bidani andfo Ravallion, 1997; Psacharopoulos and Patrinos, 2002).

"o Given the importance of public spending inhuman development, the recentQ policy emphasis on fiscal adjustment has led to concerns that levels of pro-poor? spending may be cut. Fiscal adjustment has been at the heart of the policies of

-g stabilisation and structural adjustment in developing countries since the 1980s.a? According to Ebel (1991), "the rapidly changing economic environment of the8~ 1980s characterised by government debt obligations has left governments

0 scrambling to juggle budgetary priorities.. .In themajority [of countries], theshare of social sector expenditure has been squeezed by higher priority debtservicing requirements" (p. 11-12). An early study in this regard by Cornia(1987) had shown that out of 78 countries thatwere implementing IMF-guided^o structural adjustment reforms, 91 per cent had put a constraint on government_ expenditure, 83 per cent had reduced the budget deficits and 65 per cent followed> a policy of wage restraint. Studies have also noted strong associations betweenreduction in social sector expenditures and social indicators. In a cross-countryanalysis with respect to education, Rose (1995) found thatIn countries that have undertaken World Bank-supported adjustment

programmes, a slow-down in the increase in average female combinedfirst- and second-level gross school enrolment rates is observed betweenthe pre-adjustment and adjustment phase. Furthermore, there has beenan absolute decline in female enrolment rates in a number of adjustingcountries over this period. The gap between male and female enrolmentrates has narrowed on average for ... countries that have undertakenadjustment programmes and for the control group that have not. For theadjusting group of countries, however, the closing of the gender gap isdueto the average male enrolment rate falling toward the lower average femaleenrolment rate,whereas for the non-adjusting group of countries the gaphas narrowed due to an increase in the averages of both male and femaleenrolment rates (Rose 1995, p. 1931, cited inRamachandran, 1997).

A country case studied in detail in this regard is that ofMexico. In the postpeso crisis years of the 1980s, the Mexican economy was subjected tostabilization and structural adjustment measures under the advice of the IMF.Between 1983 and 1988, social expenditure (85 per cent of which went toeducation and health) inMexico fell by 33.1 per cent; the expenditure oneducation alone fell by 29.6 per cent (Lustig, 1992; see also Morley, 1995).According to Stewart (1995), between 1981 and 1988, educational spending perstudent fell by 41 per cent, and real state spending on primary education fell by

50 49.3 per cent. According toAppendini (1992, p. 3), through the 1980s, "the social


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costs of the adjustment and stabilization programmes became dramatic". 7?Stewart (1995) notes that jjOThe growth in primary and secondary enrolment rates fell sharply in the 31980s, compared with the 1970s; gross primary school enrolment rates fell ?Tfrom 1980-85 rising subsequently, while secondary ratios stagnated. The 3rate of primary school desertion in the rural areas rose from 7.2 per cent to ^12.2 per cent, 1981-85, theworst period of the recession. There was a fall inthe percentage of students continuing from the first stage of education tothe next with primary to secondary absorption falling from 86.8 to 82.2per cent, 1981-88...Indicators suggest a decline in educational quality(Stewart, 1995, p. 203).

In this general context, an analysis of the levels and composition ofgovernment expenditure from Indiawould be interesting. India had, in 1991-92,entered into a programme of fiscal adjustment, which continues to guideeconomic policy thinking. From 1991 onwards, concerns have been raised byscholars on the impact of the new policies on public expenditure in the socialsectors. The present paper attempts also to analyse changes in the levels andcomposition of public expenditure in India over the period of fiscal adjustment inthe 1990s and after.

In India's federal system of governance, the responsibility of public spendingfalls not just on the Centre, but also on the States. Under the IndianConstitution, government responsibilities are divided into three lists: Centrallist, State list and the Concurrent list. Thus, any analysis of public expenditures

has to take into account both Central and State expenditures. There have beensome earlier studies on this topic, but these have been for shorter periods and forspecific sectors (seeGuhan, 1995; Prabhu, 1997;Mahendra Dev andMooij, 2002;

Mohan, 2005; ERF, 2006) .3 n this study, Iuse data on public expenditure of bothCentre and the States on different social and economic sectors over a longerperiod than the available studies.The major questions that I ask in this paper are as follows:

1. What have been the trends in the levelsof social and economic expendituresby the Centre and States?2. What have been the changes in the composition of social and economicexpenditures by the Centre and States?3. Has public expenditure in social and economic sectors shrunk in the periodof fiscal adjustment in the 1990s and 2000s?

II.The data base and methodologyThe data used in this paper are mainly from different publications of theMinistry of Finance (MoF) and the Reserve Bank of India (RBI). For data on thefinances of the Centre, I relied on two sources: Chandhok (1990) for Ci


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o information between 1950-51 and 1988-89 and various issues ofMoF's IndiancN Public Finance Statistics for information between 1989-90 and 2005-06. For datav on the finances of the States, I relied completely on the publications ?f the RBI.o Data until 1999-00 were collected from the annual reviews on State finances

Q published in the RBI Bulletin. From 2000-01 onwards, the RBI began publishing

ON

a separate annual report on State finances, titled State Finances: A Study ofBudgets. Data for the years after 2000-01 were taken from various issues of thisEc; report.cd Iused the GDP deflator and the SDP deflator for deflating the time series on

0 expenditures. The GDP deflator (base year 1999-00) was used for deflating theexpenditure series of the Centre and all States. The respective SDP deflators (baseyear 1980-81) were used to deflate the expenditure series for States. The GDP and

2 SDP data were collected from various issues of the RBTs Handbook of Statisticsso on the Indian Economy.?While collecting data on expenditures, I focussed primarily on thefunctional> classification of expenditures of the government. The functional classification isa detailed classification of the functions that government units aim to achievethrough various kinds of outlays. The use of this classification permits a study ofinter-temporal trends in government outlays on particular functions.There have been major changes in the organisation of the functionalclassification between 1950-51 and 2005-06. For instance, the expenditureclassification under Social Services and Economic Services is available only after1973-74; data prior to 1973-74 are available only under two broad heads:developmental and non-developmental expenditures. As a result, the analysis ofsocial and economic expenditures by the Centre in this paper begins only from1973-74. However, expenditure on certain sub-sectors (such as education) areavailable from 1950-51 onwards; for such series, the analysis in this paper coversthe period between 1950-51 and 2005-06.There has always been a controversy over what items of expenditure shouldbe classified under revenue expenditure and capital expenditure. Steering clear ofthis controversy, this paper uses only total expenditure (revenue plus capital) forboth the Centre and the States.

An analysis of expenditures of the government has to be undertaken atmany levels. First, one has to analyse the absolute levelsof expenditures. Such ananalysis is attempted in this paper using growth rates of per capita realexpenditures in each sector. Secondly, this paper attempts to analyse changes inthe size of expenditure in each sector relative to the size of economy aswell as tothe size of total expenditure. Here, I tried to compute the expenditure in eachsector as a share of GDP/SDP aswell as the total expenditure. Following theanalysis in the UNDP's Human Development Report 1991, this paper uses four

52 ratios to analyse changes in social expenditure patterns. They are,


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(a) Public Expenditure Ratio (PER): the percentage of national income (GDP) 7?thatgoes intopublicexpenditure; ^(b) Social Allocation Ratio (SAR): the share of public expenditure earmarked 3forthesocialsector; j?T(c) Social Priority Ratio (SPR): the share of social sector expenditure 3earmarked for human priority areas; "^(d) Human Expenditure Ratio (HER): the share of national income (GDP)

devoted to human priority areas.Itmust be obvious that theHER is obtained as the product of PER, SAR andSPR. In this paper, social sector expenditures are defined as the sum of revenueand capital expenditures on Social Services and Rural Development.5 For the

Centre, social services are defined as (1) all items in "Social and CommunityServices" (except Scientific Services and Research, Broadcasting and Informationand Publicity) and (2) "Social Security andWelfare" (that comes under nondevelopmental expenditure). Thus, the items of expenditure included underSocial and Community Services are (a) Education, Arts and Culture; (b)

Medical, Public Health, Sanitation and Water supply; (c) Family Welfare; (d)Housing; (e)Urban Development; (f) Labour and Employment; and (g) SocialSecurity andWelfare (plan). In a slight deviation from the UNDP definition, Ihave defined human priority areas in this paper as the items of (i) Education; (ii)

Medical, Public Health, Sanitation andWater supply; (iii) Family Welfare; and(iv) Rural Development.6For the State governments, social sector isdefined as all items under Social

Services and Rural Development. Social Services, thus, include (a) Education,Sports, Art and culture; (b)Medical and Public Health; (c) Family Welfare; (d)

Water Supply and Sanitation; (e)Housing; (f)Urban Development; (g)Welfareof Scheduled Castes, Scheduled Tribes and Other Backward Castes; (h) Labourand Labour Welfare; (i) Social Security andWelfare; (j)Nutrition; (k) Relief onaccount of Natural Calamities; and (1) Other Social Services. Again, in adeviation from the UNDP definition, Ihave defined human priority areas in thispaper as the items of (i) Education, Arts and Culture; (ii)Medical and PublicHealth; (iii) Family Welfare; (iv) Nutrition; (v)Water Supply and Sanitation;and (vi) Rural Development.7

III.Analysis of Expenditures - Central GovernmentIn this sub-section, I discuss trends in the levels and composition of publicexpenditure for the central government. I shall structure the discussion in termsof the different ratios outlined in Section 2.Public Expenditure and Developmental ExpenditureIn 1950-51, the total expenditure of the Centre as a share of the GDP (the PER)


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00ooLK^A^VV^ ^VV^\# JPjbJ&r&J!' JPj>JPsP+& J?_Year;_

?PER as% of GDP -?- TD?as% ofGDP

54

Table 1provides period-wise growth rates of per capita expenditure of theCentre under selected heads between 1960-61 and 2005-06. The periodisationadopted in this paper has been designed to capture shifts in growth rates acrossdifferent policy regimes (for instance, the 1980swere a period of fiscal expansion


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and the 1990s a period of fiscal adjustment) as well as to reflect short-termimprovements or declines in the recent periods (for instance, the 2000s). Thegrowth rate of per capita developmental expenditure was negative in the 1960s,primarily owing to the absolute fall in its levels after the mid-sixties. Following arise in the levels after 1973-74, per capita developmental expenditure grew atabout 6 per cent per annum in the 1970s and 1980s.However, the growth rate fellto negative levels in the 1990s, even while the per capita GDP growth rate in the1990s was higher than in the 1970s and 1980s. The growth rate recovered in the2000s, mainly owing to a rise in its levels in the three years after 2002-03.

3C3

Table 1Compound annual growth rates of per capita expenditure of the Central governmentunder selected heads, revenue and capital, 1960-61 to 2005-06, in per cent per annumItem

1. Developmental expenditure(a) Social and Community Services*

Education, Art and CultureMedical, Public Health, Sanitationand Water supply*Family welfare*

Housing*(b) Agriculture and Allied Services*

2. Non-Developmental expenditure3. Total Expenditure4. Per Capita GDP at constant prices

1960-61to

1969-70-1.6

-2.4

7.40.71.3

1970-71to

1979-806.05,42.6

7.7-1.519.4-3.91.94.81.1

1980-81to

1989-906.1

11.813.1

5.17.40.56.68.26.63.2

1990-91to

1999-00-0.79.04.9

5.43.5

21.36.64.31.43.8

2000-01to

2005-067.69.19.9

8.25.53.49.32.42.45.2

Source. Computed from data in Chandhok (1990) and various issues of Indian PublicFinance Statistics, Ministry of Finance.Note* denotes that the growth rates for Period 2 are from 1974-75 to 1979-80.

Itwould, however, be premature to read the rise in the growth of per capitadevelopmental expenditure in the 2000s as a reversal of the trends in the 1990s.First, the high growth rate of the 2000s represents a growth over the negativegrowth rate of the 1990s. Secondly, the growth rate of per capita totalexpenditure rose at only 2.4 per cent per annum in the 2000s, which was higherthan the corresponding growth rate for the 1990s ( 1.4 per cent) but significantlylower than the corresponding growth rate for the 1980s (6.6 per cent). A real andsustained expansion of per capita developmental expenditure would be feasibleonly under the scenario of growing per capita total expenditure. In a scenariowhere the total expenditure grows slowly, the increase in developmentalexpenditure is likely to hit a ceiling very soon. 55


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56

In this context, itmay be instructive to look at how the shares ofmajor subheads of expenditures within total expenditure have changed in the period ofanalysis. As Table 2 shows, the share of developmental expenditure increasedfrom 31.3 per cent in 1974-75 to 36.9 per cent in 1985-86. After 1985-86, therewasa significant fall in the share of developmental expenditure through the 1990s.There was a recovery in the share of developmental expenditure in the 2000s, butthe share in 2005-06 remained lower than the corresponding share for the mideighties.

Table 2Share of selected heads of expenditures in total expenditure of theCentral government, revenue and capital, 1974-75 to 2005-06, in per cent

Item1.Developmental expenditure

(a) Social and Community Services(i) Education, Art and Culture(ii)Medical, Public Health,Sanitation andWater supply(iii) Familywelfare(iv)Housing

(b)General Economic Services(c)Agriculture andAllied Services2.Non-Developmental expenditure

(a) Interest payments(b)Defense services(c)Administrative services(d) Pension, other retirementbenefits

3.Other expenditures4. Total Expenditure

1974-7531.3

5.81.8

0.80.7031.0

5.647311.424.13.702

21.4lOOlO

1980-8135.4

5313

0.80.60.42332

43.712218.12703

20.91000

1985-8636.9

621.6

0.71.0

031.7

2344514916.9230.4

18.610O0

1990-913436.422

0.70.8024032

4832131532821172

IOOjO

1995-9627.46311

0.90.90.4-0252

59328.715.43323

133WOO

2000-012928.028

1.00.80.441

63.931.715.943437.0

1000

2005-0635.7933.7

121.1

0.7635.8

59326.116.4

415.0

10O0Source.Computed from data inChandhok (1990) and various issues of Indian Public Finance Statistics,Ministry of Finance.

An important factor that has been constraining the growth ofdevelopmental expenditures is the rising share of non-developmentalexpenditures. The share of non-developmental expenditures of the Centre grewfrom 44.5 per cent in 1985-86 to 59.3 per cent in 1995-96 and 63.9 per cent in2000-01 (Table 2).Within non-developmental expenditure, the item that grewthe fastest was the share of interest payments. Interest payments increased from14.9 per cent in 1985-86 to 28.7 per cent in 1995-96 and 31.7 per cent in 2000-01.While interest payments fell in share in the first half of the 2000s, they continuedto remain very large, constituting about one-fourth of the total expenditure in2005-06 (see below for a detailed discussion). The share of total expenditurespent on administrative services and pensions rose in the 1990s, contributing tothe increase in non-developmental expenditure.


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Social Sector Expenditure and Social Allocation RatioSocial sector expenditure (SSE) isdefined as the sum of expenditures on socialservices and rural development. It must be noted here that what ismoreimportant with respect to social services expenditure is the expenditure by theState governments, and not the central government. Given the division ofresponsibilities between the Centre and the States in India, on an average, onlyabout 15 to 20 per cent of the total spending in social services isundertaken by thecentral government (CBGA, 2006). In a sector like education, the share of

Centre's expenditure in total expenditure was only 11 per cent in 1999-00(Shariff, Ghosh and Mondai, 2002). Thus, trends in SSE of the Centre should

not lead us to a generalised understanding of changes in expenditure patterns inthe country as awhole.

The share of SSE of the Centre in the GDP, after remaining stagnant for along period, began to rise in themid-1980s and then fell for a short period in thebeginning of the 1990s (Figure 2). Between 1992-93 and 1995-96, the SSEincreased marginally from 0.8 per cent of GDP to 1.3 per cent of the GDP.

Thereafter, the SSE as a share of the GDP remained almost stagnant; in 2005-06,the corresponding sharewas 1.5 per cent.As a share of the total expenditure (TE), however, SSE shows differenttrends. After a period of stagnation, the share of SSE in TE rose significantlybetween 1984-85 and 1989-90 (Figure 2). In 1989-90, the share of SSE inTE was7.8 per cent. In the beginning of the 1990s, there was a sharp fall in the share of

73tu3C3

Figure 2Social Allocation Ratio and Social Sector Expenditure as share of GDP, Centre,

Revenue and Capital, 1974-75 to 2005-06, in per cent

Year-SAR% ?~-SSEas%ofGDP 57


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SSE inTE, which later recovered to reach 8.7 per cent in 1995-96. Between 199596 and 2001-02, the share of SSE in TE declined from 8.7 per cent to 7.9 per cent.Between 2001-02 and 2005-06, the share of SSE inTE increased again to reach10.8 per cent in 2005-06.

Thus, while the share of SSE in the GDP remained almost stagnant throughthe 1990s and 2000s, the share of SSE in TE increased. If one considers theendpoints, the share of SSE inTE was 5.2 per cent in 1990-91,8 per cent in 200001 and 10.8 per cent in 2005-06. However, this rise in the share of SSE in TE in the1990s and 2000s does not represent any significant rise of SSE in its absolutes. Asthe total expenditure itself was growing very slowly, this increase of SSE as ashare of TE meant little; as Table 1 shows, the growth rate of social serviceswithin SSE in the 1990s and 2000s was actually lower than its growth rate in the1980s.

Social Priority RatioAs a share of the SSE, the expenditure devoted to Education, Medical, PublicHealth, Sanitation andWater supply, Family Welfare and Rural Developmentwas defined as the Social Priority Ratio (SPR). The SPR of the Centre recorded adecline in the years between 1983-84 and 1986-87 (Figure 3). Between 1986-87and 1989-90, the SPR rose sharply from 67.8 per cent to 84.6 per cent. The trendsin SPR in the 1990s could be described as fluctuating over a generally decliningtrend. Between 1989-90 and 2000-01, the SPR of the Centre declined from 84.6per cent to 76.7 per cent. The trends of SPR in the 2000s appear to be fluctuating

Figure 3Social Priority Ratio of Centre, as share in SSE, Revenue and Capital,1974-75 to 2005-06, in per cent

Year58 -SAR% - SS?as% of GDP


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over a positive slope and the sharp rise observed in 2002-03 was short-lived; 7?there was a regular fall in the SPR for three consecutive years after 2003-03. g3 3Human Expenditure Ratio 7TThe Human Expenditure Ratio (HER), as noted, is the share of expenditure in 3human priority areas expressed as a share of the GDP. The HER of the Centre, ^after fluctuating till the end of the 1970s, recorded an increase through the yearsof the 1980s (Figure 4). Between 1980-81 and 1988-89, theHER increased from0.43 per cent to 0.75 per cent. However, after 1988-89, the HER increased at a

much slower rate than in the 1980s. In addition, the changes inHER in the 1990sand 2000s fluctuated significantly around its slope. In Figure 4,1 have plotted thetrend line for theHER for the 1980s and then projected it forward until 2005-06.

This trend line allows us to seewhat theHER would have been in 2005-06 had itcontinued to grow at the same rate as in the 1980s.As can be seen from the figure,in all the years of the 1990s and 2000s (but one), the HER was below the trendline. In other words, the growth rate of the HER in the 1990s and 2000s wassignificantly lower than in the 1980s.

We can delineate two broad reasons for the slow growth rate of HER in the1990s and 2000s. First, the total expenditure of the Centre - in a sense, the size ofthe pie - had grown in the 1990s and 2000s at a rate significantly slower than inthe 1980s. As a result, even when certain sub-sectors recorded increase in shares

figure 4The Human Expenditure Ratio of the Centre and the Projected Trend Linefor the 1980s, Revenue and Capital, 1960-61 to 2005-06, inper cent

? HPE s% ofGDP -?- HPE s% ofGDP,1980s ? Linearrendline orHPE n he 1980sonly


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? of expenditures to total, the levels of absolute increase in expenditures wouldrs have been smaller. Secondly, the composition of SSE appears to have movedfc away from the human priority areas in the 1990s and 2000s, compared to the"o 1980s. As a result, the growth of expenditure on human priority areas by the

Q centre slowed down, leading to a slowdown inHER.?-Q Sector-wise expenditures as a share of the GDP

Q0)

os

a) Ifwe consider each important sub-sector within developmental expenditure,and analyse changes in their levels of expenditure as a share of the GDP, thefollowing broad conclusions emerge (see Figure Panel 5).(a) Education, Arts and Culture: Until 1983-84, the share of expenditure by theCentre on education, arts and culture in the GDP does not show any

H specific trend (Figure Panel 5). Between 1983-84 and 1988-89, the share55more than doubled from 0.23 per cent to 0.48 per cent. The share fell after^ 1988-89 to reach 0.3 per cent in 1996-97. After 1996-97, there was an

> increase in the share of expenditure on education; this increase was owingto the introduction of theMid Day Meal Scheme in schools and the newWorld Bank-funded District Primary Education Programme (DPEP).However, until 2005-06, the share of educationalexpenditure inGDP didnot rise above the corresponding share attained in 1988-89. The increase ineducational expenditure in the two years from 2004-05 was because thegovernment introduced an educational cess in order to be exclusivelyinvested in the Sarva Siksha Abhiyan (SSA) and theMid Day Meal Scheme.As a result of the investment of this cess, the share of expenditure increasedfrom 0.41 per cent in 2003-04 to 0.52 per cent in 2005-06. The point to notehere is that the sharp and prolonged fall in the share of expenditure oneducation in the 1990s delayed the step up in educational expenditure bynearly a decade.

(b) Medical, Public Health, Sanitation andWater Supply and Family Welfare:Broadly speaking, the above areas could be classified as expenditures on"health". The share of expenditure on health, thus classified, in the GDPrecorded a rise from 0.2 per cent in 1980-81 to 0.31 per cent in 1986-87.Between 1986-87 and 1996-97, the share fell sharply, in 1996-97, the shareof health expenditure in the GDP was 0.23 per cent. Even though the sharerose after 1996-97, itwas not until 2002-03 that it regained the shareachieved in 1986-87.Within Health, the largest increase in expenditure tookplace for Reproductive and Child Health that is included under FamilyWelfare (Shariff, Ghosh and Mondai, 2002; Mahendra Dev and Mooij,2002). After 2002-03, the share remained almost stagnant; in 2005-06, theshare of expenditure by the Centre on health in the GDP was almost the

?Q same as in 1996-97, that is, 0.32 per cent.


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(c) Housing: The share of expenditure on housing in the GDP declined 7?through the 1980s till 1993-94. Between 1993-94 and 1999-00, the share g3rose slightly from 0.05 per cent to 0d4 per cent. However, it isunclear if this 3risewas real, as from 1996-97 onwards the expenditure under the Indira g~Awas Yojana (LAY)began to be included under Housing, instead of Rural 3

Development. Between 1999-00 and 2005-06, the share declined again; in ""*2005-06, the share of expenditure on housing in the GDP was 0.1 per cent,

which was almost the same share attained in the year 1996-97.(d) In the sub-sectors of Urban Development, Labour and Employment and

Water and Power Development, there was significant rise in the shares ofexpenditures in the GDP in the 1980s. However, in the 1990s, there was afall in the shares of expenditures in the GDP in these sectors. In the case of

Urban Development, the share recovered after 1995-96, but the shareattained in 2005-06 was still lower than in 1990-91. In Labour andEmployment, and Water and Power Development, there was no suchrecovery, and the fall in share continued into the 2000s.

(e) In Social Security andWelfare, therewas a fall in the share of expenditure inthe GDP from 1986-87 onwards. Even though there was a slight recoveryfor a fewyears in themid-1990s, the share continued to fall after 1996-97.

(f) Agriculture and Allied Services: The share of expenditure on agricultureand allied services in the GDP recorded a fluctuating trend through theperiod of analysis. However, after 1993-94, there were more number ofyears when the share of expenditure in GDP declined than when itincreased. In 2005-06, the share of expenditure in the GDP was 0.81 percent. Rural Development is a separate head within Agriculture in thebudgets. In Rural Development, which includes a large number of antipoverty programmes in the rural areas, therewas amajor fall of expenditureas a share of GDP in the 1990s (see alsoMundle and Rao, 1997). This fallwasdue tomajor cutbacks in the components of employment creation withinRural Development (see Figure 6). In addition, the fallwas partly the result ofthe non-inclusion of expenditure under the IndiraAwas Yojana (IAY) under

Rural Development from the year 1996-97. The rise in expenditure noted inthe 2000s was owing to 2 reasons: first, the introduction of the PradhanMantri Gram Sadak Yojana (PMGSY) in 1999-00; and secondly, the

introduction of new schemes forwage- and self-employment creation (suchas the Sampoorna Gramin Rozgar Yojana or SGRY and the SwarnajayantiGram Swarozgar Yojana or SGSRY) in the rural areas, both of which areincluded under Rural Development.

(g) Transport and Communications: Here, the share of expenditure in theGDPrecorded a falling trend between 1980-81 and 1996-97. After 1996-97, theshare began to rise from 0.23 per cent to reach 0.61 per cent in 2005-06. g |


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public works schemes and self-employment schemes. Secondly, the governmentplayed a more direct role in the expansion of employment.9 Thirdly, thegovernment invested significantly in rural infrastructure, particularly roads andtransport (see Sen, 1998).

The problem with the economic strategy of the 1980swas that the increasedgovernment expenditure was financed largely through external borrowings, andnot through different forms of domestic resource mobilization like taxation. Anincrease in government expenditure financed largely by higher tax collectionwould have considerably reduced the debt burdens associated with this strategy.India historically has had one of the lowest tax-GDP ratios in the world.10Between themid-1970s and late- 1980s, the attained increase in the tax-GDP ratioof the Centre was insufficient to finance the rising expenditure bill (Table 3). Asa result, the total liabilities of the Centre that averaged 43 per cent of the GDPduring 1981-85 rose to 53 per cent during 1986-90 (Table 3). The gross fiscaldeficit increased from 5.9 per cent during 1981-85 to 7.7 per cent during 1986-90.This also represented amovement of Central government finances from a stateof revenue surplus to revenue deficit, which averaged 2.4 per cent during 1986-90.Given the dependence on external debt, combined with a host of exogenousreasons including the Gulf War, the economy slowly walked into a balance ofpayments crisis, which became the background for the introduction of economicliberalisation policies by the then government in 1991.

3C3

Table 3Selected fiscal indicators of the Central government, 1976 to 2005,as share in GDP, in per cent

Item Shares in GDP (per cent)1976-80 1981-85 1986-90 1991-95 1996-00 2001-05

Gross tax revenue 9.3 9.4 10.5 9.7 9.0 8.9Total liabilities 42.8 53.1 54.2 50.8 61.1Interest payments 1.7 2.1 3.2 4.1 4.4 4.6

Gross fiscal deficit 4.4 5.9 7.7 6.3 5.5 5.2Revenue deficit -0.3 1.0 2.4 3.0 3.1 3.8

Source. "Handbook of Statistics on the Indian Economy", RBI, various jssues.

There isone strand of the literature that argues that the debt-build up of the1980swas policy-induced (see Singh and Srinivasan, 2004; Kletzer, 2004; P. Sen,2007). According to this argument, which overlaps substantially with the

monetarist argument, the regulated interest rate regime in the 1980swas markedby "financial repression", which engendered the fiscal crisis of 1991. Financialrepression is a situation where the degree of financial intermediation isweak dueto negative real rates of interest on deposits and a large spread between 63


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borrowing and lending rates. As a result, while private savings and investmentsare discouraged on the one hand, the government is encouraged to borrow andspend beyond itsmeans by the low interest rate regime.11 Inaddition* a few otherwriters have argued that a large part of the spending of the government in Indiawas in services where "cost recovery" was poor (Mundle and Rao, 1997). Inother words, spending on "unproductive subsidies" added to the"unsustainab?ity" of the fiscal policy.To state in brief, the above arguments stand on weak grounds for at leastthree reasons. First, the theory behind the monetarist argument on financialrepression assumes, among other things, that changes inmoney supply in aneconomy affect neither real sector activities nor output growth* and thatmoneysupply is exogenous to the system* which can be successfully controlled by thegovernment. Both these assumptions have been subjected to serious criticismand rebuttal (see Kaldor, 1978; Bhaduri, 1986; Patnaik, 1995).

Secondly, to argue that the financial system in India was underdevelopedand savings were discouraged in the period of the so-called "financialrepression" does not stand up to facts. The unparalleled growth of the Indianfinancial system in India took place under the larger poKey of financial repression(see Rakshit, 1.98?; Shetty, 2005). In fact, the work of Vijay Joshi and I. JVL.Little - two protagonists of economic reform in India - show thatnationalisation of banks in 1969was amajor driver of financial intermediationin India. The share of deposits toGDP rose from 13per cent in 1969to 38 per centin 1991 and the share of advances toGDP rose from 10per cent in 1969 to 25 percent in 1991 (Joshi and Little, 1998; p. 36). They noted thatthe increasing degree of inancial intermediation was closely associated withthe very rapid spread of commercial banking throughout the country after

bank nationalisation in 1969.. .This spread has also surely contributed tothe rapid rise in household financial savings and probably also to the risein the overall rate of saving (p. 36)...Financial repression was therefore mild and any deleterious effects onsavings were offset by the rapid spread of banking (Joshi and Little, 1998,

p. 255; emphasis mine).

Thirdly, the argument that an expansion in subsidy outlays have resulted infiscal stress is also based on questionable assumptions and methodology (seeChandrasekhar and Ghosh, 2002). Many of the subsidies in India are aimed atencouraging producers to adopt modern methods of production and to addressmarket failures in sectors like food distribution. Even while private valuations ofcertain goods may vary from their societal value, such variations may be

?4, "socially desirable" (ibid, p. 75). Further, subsidies, including implicit subsidies,

00oorsS(L>JQOti

O?E

LO

OntoO

Z

o>


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are ways of maintaining certain levels of aggregate economic activity under Fcounter-cyclical demand management policies. ?$The crux of the critique presented here is that itwould be erroneous to argue 3that "financial repression" and "unproductive subsidies" led to the fiscal crisis in g"1991. Itwas indeed a policy failure that the results of carrying out expenditures 3under a lax tax regime were not anticipated. As we argued earlier, a vibrant and ^progressive tax regime could have considerably reduced the debt burdensassociated with the spending strategy of the 1980s, even in the presence ofregulated interest rates and subsidies. With the rise in tax-GDP ratios notcommensurate with the rise in spending, the crisis of 1991 was waiting tohappen.Fiscal consolidation was at the heart of the new package in 1991, aided by theIMF, of stabilisation and structural adjustment. The solution to the fiscal crisisof the statewas sought, not on the revenue side (bywhich a rise in tax collectionswould have at least partly financed the interest obligations), but on theexpenditure side. A strict policy of fiscal control was followed in the early 1990s.Expenditure cuts were effected in the important social sectors aswell as on capitalexpenditures.12 In many social sectors that were starved for more funds,expenditures were not raised, which adversely affected the quality of theseservices. Thus, the fiscal deficit of the Centre was brought down to 6.3 per centduring 1991-95 and 5.5 per cent during 1999-00.The array of associated policies that accompanied fiscal adjustment after1991 further exacerbated the fiscal crisis (Chandrasekhar and Ghosh, 2002). Forinstance, customs duties on a range of commodities were reduced as part of thetrade liberalisation policy. As financial liberalisation led to higher interest rates,the interest outgo of the government against borrowings went up; the largerinterest burden that resulted was a direct result of abandoning interest rateregulation. In the overall context of lower growth rates resulting from lowerlevels of public spending, all the above measures adversely affected the fiscalhealth of the central government.

In 2000, the Fiscal Responsibility and Budgetary Management (FRBM) Billwas introduced in the Parliament. The FRBM Act was passed by Parliament in2003. In this version of theAct, the Government had to reduce the revenue deficitto zero by 2005-06. In July 2004, the Act was amended to postpone the year ofelimination of revenue deficit to 2008-09. In the amended form, the Act statedthat the governments should initiate "appropriate measures to reduce the fiscaldeficit and revenue deficit so as to eliminate revenue deficit by 31stMarch 2008and thereafter build up adequate revenue surplus". Towards achieving this goal,the government was to set annual targets for fiscal and revenue deficits so thatthe final targets in 2008-09 could be met.

Thus, from the early 2000s, fiscal compression became a legally binding ?r


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o policy for the government. The falling PER for the Centre from the early 1990sfNuntil 2005-06, which we noted in our discussion above, was a direct result of thisv fiscal compression. As we noted, within the framework set by shrinking totalo expenditure in the 1990s and 2000s, therewas a slowdown in the flow of funds to

Q human priority areas relative to the size of the economy. As one.study argued,? .. .this decline [in allocations] isparticularly conspicuous in terms of thev seems to have ignored its commitment to sustain budgetary allocations to

8" key social sectors including education. As a result, investment in educationoONtoOPO

structural adjustment and stabilisation policies of the government that

has been seriously affected, and this will undoubtedly impact on thequantity and quality of education in future (Shariff, Ghosh andMondai,2002, p. 6).

^o In this section, we discussed the trends in expenditures of the Centralgovernment alone. However, while total expenditure by the Centre has

> significant implications on macroeconomic variables, the share of the Centre'sexpenditure on social services is small. Roughly 80 to 85 per cent of the spendingin social services in India isundertaken by the State governments. In a sector likeeducation, the share of States* expenditure in total expenditure was 89 per cent in1999-00. In other words, it is the ability of the States, rather than the Centre, tospend on social services that matters more for human development. Further,States are responsible for most of the infrastructure services (excepttelecommunications, civil aviation, railways and major ports), and law andorder. It is to the analysis of the expenditure patterns of States thatwe turn to inthe next section.

111.Analysis of expenditures - State GovernmentsIn this section, as in the previous section, I shall discuss trends in the levels andcomposition of expenditure by States in terms of the different expenditure ratios.Public Expenditure Ratio and Developmental ExpenditureBetween themid-seventies and 1991-92, the PER of States increased significantlyfrom about 11 per cent to 16.5 per cent (Figure 7). However, between 1991-92and 1997-98, therewas a decline in the share of expenditure of States in theGDP.There was a recovery in the PER between 1997-98 and 2003-04, followed by a fallin the last two years. The fall in the last two years was sharp enough to bringdown the PER in 2005-06 to 16.6 per cent, which was actually lower than the PERin 1987-88 and almost equal to the PER in 1991-92.When we consider the share of developmental expenditure in the GDP for allStates, a different conclusion emerges for the 1990s and 2000s. After risingsignificantly from 6.6 per cent in 1974-75 to 10.4 per cent in 1991-92, the share of66 developmental expenditure in theGDP declined to 9.5 per cent in 2000-01 and 8.8


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Figure 7Shares of Total Expenditure and Developmental Expenditurein the GDP, AH States, 1972-73 to2005-06, in per cent

Year>Shareof TE inGDP - Shareof OE inGDP

per cent in 2005-06 (Figure 7). There was no recovery in the share ofdevelopmental expenditure to the GDP in the 2000s as noted for the PER. The fallin share here was almost continuous between 1991-92 and 2005-06. In other

words, the rise in PER for States noted for certain years of the 1990s actuallyrepresented a rise in non-developmental expenditures.InTable 4,1 have presented period-wise rates of growth of selected items ofexpenditure by the States. The total expenditure of the States, which grew at 4 percent per annum in the 1980s, grew at a slower rate of 3.2 per cent per annum inthe 1990s. However, in the 2000s, the growth of total expenditure picked upsignificantly to 6.7 per cent per annum. Clearly, these trends in growth ratesconform to our discussion on the changing shares of total expenditure by Statesin the GDP. In the case of developmental expenditure also, the growth rate in the2000s was higher than that in the 1990s (Table 4). However, this higher growthrate in the 2000s was not sufficient to raise the share of developmentalexpenditure in the GDP to levels higher than in the early-1990s (see Figure 7).Within developmental expenditure, the increase in the growth rate in the 2000swas driven primarily by a rise in expenditures in Economic Services, andspecifically, Rural Development where the growth ratewas negative in the 1990sbut 9 per cent per annum in the 2000s.

However, the higher growth rate of States' developmental expenditure in the2000s does not appear to reflect in arise in its share in total expenditure. As Table5 shows, the share of developmental expenditure in total expenditure increasedin the 1980s, but declined in the 1990s and 2000s. Between 1990-91 and 2004-05,

703

3a)

67


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Table 5Share of selected heads of expenditures in total expenditure of State governments,*revenue and capital, 1974-75 to 2004-05, in per cent

Item1.Developmental Expenditure

(a) Social Services(i) Education, Arts and Culture(ii)Medical and Public Health(iii) FamilyWelfare(iv)Water Supply and Sanitation(v)Housing(vi)Urban Development(vu)Welfare of SC, ST and OBC(viii) Labour and employment(ix) Social Security andWelfare(x)Nutrition

(b)Economic Services(i)Agriculture andAllied Services(ii) Rural Development(iii) SpecialArea Programmes(iv) Irrigation and Flood Control(v)Energy(vi) Industry andMinerals(vii)Water & Power Development(viii) Transport&Communication(ix)General Economic Services

2.Non-Developmental Expenditure3.Others4. Total Expenditure

1974-75 1980-81 1985-86 1990-91 1995-96 2000-01 2004-0560229.516373

0.7

0.523

30.711.7

1.8965.027

21.917.9

60227.813.97.1

0.6

0.932

31412.4

1.610.71514183213

63.431.415.4

100.60.6100.61.70.4

31.9825.00310.01.0

10

411.1

20.915.7

633311

53

220.60.71103130.6

31.47.6530.67.8221.9

1317

243112

10O0 lOOuO lOaO HXXO lOOD 100.0

60331.716.5401.0230.60.8100.4

1228.76.03.8037.63.91.4

420.4

30.98.8

57231.817.4400.7140.6

1.90.41.4

0.7253

320.75.65.00.9

330.4

83

49.626.413.1

032203132.0031.60.6

23.43.9330.4535.70.8

330.6

32817.6

?oaoSource.Computed from RBI Bulletin, various issues; State Finances: A Study of Budgets, RBI, various issues.

States has almost continuously fallen from 1990-91 onwards (Figure 8). TheSocial Allocation Ratio (SAR) for all States had risen considerably in the 1980s,from 27.8 per cent in 1980-81 to 37.3 per cent in 1990-91. Between 1990-91 and2003-04, the SAR for all States fell from 37.3 per cent to 27.7 per cent - a levellower than that in 1980-81. In the last two years, therewas a small recovery in theSAR from a long-term falling trend.As a share of the GDP, the SSE declined in the 1990s and 2000s after a longperiod of rise from the late-1970s (Figure 8). In 1990-91, the share of SSE in theGDP was about 6 per cent; the corresponding figures in 1999-00 and 2005-06were 5.7 per cent and 5.3 per cent.

3

3-"5

Social Priority RatioThe Social Priority Ratio (SPR) of States, as in the case of SAR, increased in the1980s until the early-1990s (Figure 9). Between 1980-81 and 1993-94, the SPR 69


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COoo(Ni_CU_o%o?O)-OELO

toOZm>

increased from 75.4 per cent to 83.1 per cent. After 1993-94, however, there wasa sharp fall in the SPR right up to 2005-06. The sharpest fall in the SPR took placein the 2000s.While between 1993-94 and 2000-01, the SPR declined from 83.1 percent to 81.1 per cent, the SPR for 2005-06 stood at a lower level of 77.2 per cent.

Figure 8Social Sector Expenditure as share of GDP and Total Expenditure,All States, Revenue and Capital, India, 1972-73 to 2005-06, inper cent

YearSSE s shareof GDP SSE s shareof TE

Figure 9Social Priority Ratio of State Governments, as share of SSE,All States,Revenue and Capital, 1972-73 to 2005-06, in per cent

70 Year


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Our results show that while there was a general shift of SSE away from thehuman priority areas in the 1990s, the phenomenon worsened in the 2000s. Alook at the changing shares of expenditures under different sub-heads inTable 5shows that in all but one of the human priority areas, the fall in share ofexpenditures in the 2000s was sharper than the fall in share of expenditures in the1990s. For instance, the share of expenditure on education in total expenditure,after remaining almost stagnant in the 1990s, fell from 17.4 per cent in 2000-01 to13.1 per cent in 2004-05. Similarly, the share of expenditure on Medical, Public

Health and Family Welfare together in total expenditure declined from 4.6 percent in 2000-01 to 3.7 per cent in 2004-05. Even inRural Development, whichregistered a high growth rate in per capita terms in the 2000s, the share ofexpenditure in 2004-05 was lower than that in 1995-96.

733DJ7TC3-5

Human Expenditure RatioThe changes in the Human Expenditure Ratio (HER) of all States can beexplained in terms of two phases: a period of rising levels from themid-seventiestill about 1990-91 and a period of decline from 1990-91 to 2005-06 (Figure 10).Between 1990-91 and 2005-06, theHER of all States declined from 4.9 per cent to4.1 per cent. In other words, in the 1990s and 2000s, there was a fall in theexpenditure in human priority areas as a share of the GDP, a trend opposite tothat in the 1980s. It isnotable that the HER did not exhibit a rise in the 2000s even

while one of its components - Rural Development - registered a sharp rise in itsgrowth rate.

Figure 10Human Expenditure Ratio of State Governments, as share in GDP,All States, Revenue and Capital, 1972-73 to 2005-06, inper cent

^ A -f) c^


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? In sum, our discussion on broad expenditure patterns of States shows thatS the total expenditure of States as a share of GDP rose in the 1980s, fell in the first

CD half of the 1990s and then continued to rise into the 2000s. However, this"o increased total expenditure was not flowing into developmental expenditure, but

Q non-developmental expenditure, which included different forms of debt? servicing. The share of developmental expenditure of States inGDP declined in-g the 1990s aswell as the 2000s. Reflecting this shift away from developmentala) expenditure, the share of SSE in total expenditure, the share of human priorityQ_CO

OON

8" expenditure in SSE and the share of human priority expenditure inGDP declinedin the 1990s and the 2000s. In other words, the trends in social and economicexpenditures of the States in the 1990s and 2000s represent amajor reversal oftrends in this front in the 1980s.13?Z

vD Sector-wise expenditures as a share of GDP__ In Figure Panel 11,1 have presented trends in the expenditures under selected> items by the States as a share of the GDP. It isnotable that there emerges amoreor less uniform trend formost of the items of expenditure examined here. Itmay

be convenient to group the trends into three:(a) In sectors like Education, Housing and Rural Development, therewas arisein the share of expenditure by States in theGDP in the 1980s.The above trend

progressed at least till the second half of the 1980s. In the 1990s and 2000s, inall the above sectors, the share of expenditure inGDP declined sharply.(b) In sectors likeHealth, Water Supply and Sanitation, Agriculture and Allied

Sectors, Welfare of SC, ST and OBC, Labour and Employment and SocialSecurity andWelfare, the share of expenditure inGDP began to decline inthe 1980s itself. This decline continued into the 1990s and 2000s, resultingin a long-term fall in the share of expenditure in GDP.

(c) InUrban Development, therewas a slow rise in the share of expenditure inGDP in the 1980s, but in the 1990s and 2000s, the share increasedsignificantly. InNutrition, the share of expenditure inGDP was stagnant inthe 1980s, but it rose slightly in the 1990s and 2000s over a fluctuating trend.

The Crisis in State Finances and Expenditure CompressionAs we have seen, the total expenditure and developmental expenditure of theStates declined as a share of GDP in the 1990s. In the 2000s, even while totalexpenditure grew moderately as a share of GDP, the share of developmentalexpenditure in GDP continued to fall. Such a trend owes its origin to thespecificities of the crisis in State finances in India from the late-1980s and theresponse of the central government to this crisis.

The nature of the crisis in State finances may be briefly stated as follows.j * Until themid-1980s, States as awhole in Indiawere recording revenue surpluses


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in their budgets. However, from themid-1980s onwards, the surplus turned into T3a deficit. This period also marked the end of the era of low and administered g3interest rates. The interest rates sharply increased thereafter, but its impact was 3masked by the presence of pre-existing cheap debt that the States had availed gT

(Chaudhary, 2000). From the latter half of the 1990s, the high cost debts 3incurred since themid- 1980s took their toll on the interest burden of States and "*started a process of debt escalation.

The role of the Central government was critical in the process ofdeterioration of State finances (see Isaac and Ramakumar, 2006). As part ofinterest rate deregulation, the rates of interest on borrowings of States increasedsharply after the mid-1980s, and especially so after 1990-91 (Table 6). Thecoupon rates of State government securities were raised sharply by the RBI from1990-91 onwards. The weighted average of coupon rates,which was 11.5 per centin 1990-91, reached itshistoric peak of 14per cent in 1995-96. In the same period,the interest rates on small saving borrowings by States also increased from 13per cent in 1990-91 to 14.5per cent in 1992-93, and remained stable until 1997-98.These rates of interest that the States had to pay were clearly usurious, muchhigher than the growth rate of the GDP and thus, a sure recipe for a financialdisaster. Even though the interest rates started falling thereafter, the financialburden that these periods of high interest rates placed on State finances wassignificant. As a share of total revenue receipts, these interest paymentsamounted to 13per cent in 1990-91,16 per cent in 1995-96 and 24 per cent in2001-02 (ibid.).

In the period inwhich the Centre was raising the rates of interest on States'borrowings, the rates of interest on the Centre's borrowings were not only lowerin levels, but were also rising at amuch slower rate. The result was that thedifferential between the rates of interest faced by the Centre and the Stateswidened significantly in the 1990s, which has continued into the 2000s (seeChandrasekhar and Ghosh, 2005, EPWRF, 2004; Isaac and Ramakumar, 2006).The average rate of interest of States' borrowings was above 10per cent even in2004, while that of the Centre was below 7.per cent.

In 1997-98, there was another shock" to State finances when therecommendations of the Fifth Pay Commission were implemented. This

measure sharply raised the levels of revenue deficit of States from 1997-98onwards. In just one year, the revenue deficit of Statesmore than doubled - from1.1per cent in 1997-98 to 2.5 per cent in 1998-99. While Ido not wish to neglect

other factors, the rise in interest burden and higher salary payments constitutethe two most prominent factors responsible for the deterioration of Statefinances. The outcome of these two factors was a sharp rise in the debt burden ofStates. As a share of GDP, the total debt outstanding of States increased from22.7 per cent during 1995-00 to 31.7 per cent during 2000-05 (Table 7). Interest 73


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00oorsi_

74

Table 6Key interest rates on State government borrowings from the Centre and the market,1990-91 to 2005-06, in per cent per annum

Year

1990-911991-921992-931993-941994-951995-961996-971997-981998-991999-002000-012001-022002-032003-042004-052005-06

Coupon rates on Stategovernment securities

(weighted average)11.511.813.013.512.514.013.812.812.411.911.09.27.56.16.47.6

Interest rates onSmall Savings

borrowings by States

13.013.514.514.514.514.514.514.514.013.512.511.010.59.59.59.5

Interest rates onPlan and non-Plan

loans from the Centre

10.310.811.812.012.013.013.013.012.5

Source. Isaac and Ramakumar (2006).payments of States more than doubled as a share of the GDP between 1986-90and 2000-05.

These changes are clearly visible when we analyse the long-term trends in thelevels of revenue deficit and fiscal deficit of all States (Table 7). Through the1970s, States as awhole were enjoying a revenue surplus. Itwas only by the late1980s that the revenue account of States fell into deficit. The revenue deficitincreased gradually during 1986-90 and 1991-95, and thereafter increasedsharply during 1996-00 and 2001-05. Driven by the rise in the revenue deficit, thefiscal deficit of States rose sharp'ly after themid-1990s.The trends in different heads of expenditures of States discussed in thispaper are better understood in the context of the above fiscal crisis. The debtburden of States - a result of long-term distortions in centre-State economicrelations in India - have prevented them from raising the levels of developmentalexpenditures in general aswell as expenditures in specific human priority areas.Given the fact that about 80 to 85 per cent of the expenditure in social services isundertaken by the States, the fall in social sector and human priorityexpenditures at the State-level has ominous implications.The response of the central government to the crisis in State finances has


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Table 7Selected fiscal indicators of States as awhole, 1976 to 2005, as share in GDP, in per centItem

Gross transfers from the centreNet transfers from the centreTotal liabilitiesGross fiscal deficitRevenue deficitExpenditure on:Interest payments

Administrative servicesPensions and other services

Shares in GDP (per cent)1976-80 1981-85 1986-90 1991-95 1996-00

6.05.2

2.0-1.1

0.81.00.2

6.75.9

19.22.8

-0.4

0.91.10.3

7.66.7

22.33.00.2

1.31.20.5

6.96.3

22.12.80.7

1.71.2

0.8

5.55.0

22.73.41.6

2.01.11.1

2001-05

Source. "Handbook of Statistics on the Indian Economy", RBI, various issues.

5.23.9

31.74.12.2

2.81.11.4

7337TC

3

been unsatisfactory. From the late- 1990s onwards, the centre began to persuadethe States to pass State-level fiscal responsibility legislations. In addition, for thefirst time, the Eleventh Finance Commission (EFC) started the process of linkingresource transfers and other benefits from the Centre to fiscal consolidation byStates. The passage of the FRBM Acts at the State-level became an indicator ofthe progress achieved by States in fiscal consolidation. States were asked to

model their legislations on the legislation prepared by the Centre. As on August2006,23 States had passed State-level FRBM Acts (Ministry of Finance, 2006).

Further, there have been a number of criticisms over the FinanceCommissions of the Centre exceeding their constitutional brief and proposingconditionalities on central transfers to States. In fact, under Article 275 of theConstitution, the Finance Commissions have no powers to imposeconditionalities on resource transfers to States. However, the terms of referenceof the Eleventh Finance Commission (EFC) included themandate to "draw a

monitorable fiscal reforms programme aimed at reduction of revenue deficit ofthe States and recommend themanner inwhich grants to States.. .may be linkedto progress in implementing this programme". The Twelfth FinanceCommission (TFC) recommended a fiscal restructuring plan for States,according towhich (a) the revenue deficit had to be eliminated by 2008-09; and(b) the fiscal deficit had to be brought down to 3 per cent in 2008-09. The TFC,in order to address the rising debt burden of States, also recommended a generalscheme of debt relief and a loan write-off scheme. The benefits of both theseschemes were to be made available to only those States that had passed fiscalresponsibility legislations. These strictures by the FCs, apart from being anintrusion into the federal autonomy of States, also shut out the possibilities of 75


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o any immediate increase in the developmental and social expenditures by thecni States.

fo The argument that a rise in the developmental and social expenditures may"o be impossible in the presence of FRBM Acts was raised recently by an officialQ agency itself: the Planning Commission. In the draft approach paper to the 11th? Five Year Plan, the Commission outlined a strategy that included a number of-g new initiatives, such as the expansion of school education and programmes fora? provision of health care, drinking water and rural infrastructure. However, it8" noted that none of the new programmes could be implemented if the FRBM/

o^TFC targets of elimination of revenue deficit are stuck to. Itmay be apt to quotefrom the draft of the approach paper:.. .itmay not be easy for the Centre to cut the revenue deficit from 2.1 per

^ cent in 2006-07 to 0 per cent in 2008-09 while also achieving large increases5> in Plan expenditure with a high revenue component. Indeed, the very__ thrust of the approach to the 11thPlan presented in this paper, which> involves combining innovative financing of infrastructure with amassivedecentralised thrust on education, health and agriculture, may be defeatedif the FRBM discipline is insisted upon... (Gol, 2006).V.A short comment on expenditure trends in the recent yearsThe expenditure on the social sectors by the Central government has receivedrenewed emphasis in the recent years, especially after theUPA government tookover in 2004. Pointing to this new emphasis, many commentators have arguedthat allocations to the social sectors have picked up significantly in the 2000s,reversing the trends in the 1990s. It is indeed the case that social sectorexpenditures of the Central governmenthave risen significantly in the 2000s, bothas a share of GDP and as a share in total expenditure. However, this conclusiondoes not appear to justify the further conclusion that total social sectorexpenditure has risen in the 2000s. The reason is that the increase in the share ofexpenditure by the Centre appears to have been offset by a fall in the share ofexpenditure by the States (see Table 8).

Figures in Table 8 represent the sum of expenditures by the Centre andStates, expressed as a share of GDP and total expenditure by the Centre andStates. First, the share in theGDP of the total expenditure increased from 31A percent in 2000-01 to 32 per cent in 2003-04, and then declined to 30.6 per cent in2005-06 (the second year of the UPA government, and the last year for whichcomparable data are available). Secondly, the share in theGDP of social sectorexpenditures by the Centre and States declined from 7 per cent in 2000-01 to 6.6per cent in 2003-04, rose to 6.9 per cent in 2004-05 and then fell to 6.8 per cent in2005-06. By no measure can the above fluctuating trend be termed a "revival".

y > Thirdly, the share in the GDP of expenditure on human priority sectors by the


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Selected expenditure ratiosrevenue and capital, 1980-81 toTable 8

of Central and State governments combined,2005-06, as share of GDP, TE and SSE, in per cent

Year1980-811985-861990-911991-921992-931993-941994-951995-961996-971997-981998-991999-00

2000-012001-022002-032003-042004-052005-06

TE/GDP30.333.933.733.032.131.930.929.528.728.529.530.931.431.732.032.031.630.6

SSE/GDP4.96.66.96.76.56.66.66.66.36.56.87.07.06.76.86.66.96.8

SSE/TE16.319.6

20.420.320.320.621.222.222.022.723.122.622.221.221.220,621.722.3

HPE/SSE75.078.681.881.081.982.782.781.580.280.280.?81.580.479.780.879.778.378.2

HPE/GDP3.75.25.65.45.35.45,45.35.15.25.55.75.6.5.45.55.25.45.3

Source. RBI Bulletin, various issues; State Finances: A Study of Budgets, RBI, various issues;Chandhok (1990); Indian Public Finance Statistics, Ministry of Finance, various issues.

Notes: TE - Total Expenditure; SSE - Social Sector Expenditure; HPE - Human PriorityExpenditure. All figures are derived from sums of expenditures by the centre and States.

Centre and States declined from 80.4 per cent in 2000-01 to 797 per cent in 200304 and further to 78.2 per cent in 2005-06. Thus, taking the country as awhole,there isno evidence to show that there was a rise in the social sector allocationsrelative to the size of the economy.

Indeed, even if the shares inGDP of expenditures may have stagnated, oreven fallen, the fact that GDP itselfwas rising at a rapid rate in the 2000s wouldhave increased the absolute levelsof allocations to social sectors. However, such arise in allocation does not appear to represent a shift in the spending priorities ofgovernments in the recent years.

Such a shift may have towait until the Stategovernments in India become willing and able to spend significantly higheramounts of resources on the social sectors.

70?3&>7TC3CD

VI. Concluding commentsThis paper was an enquiry into changes in the levels and composition ofexpenditure by the Central and State governments in India on the social and 77


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? economic sectors. Using the "functional classification" of expenditures in thees budget documents, I tried to discuss trends in expenditure between 1950-51 and2005-06, with special emphasis on understanding trends in the period ofo economic reforms in India in the 1990s and 2000s.

QAn important concern raised bymany development economists during theimplementation of economic reforms in India was that the fiscal adjustment-Q strategy might adversely affect the social sector expenditures. Itwas argued thatQj the single-minded emphasis on reducing budget deficits might result in the

S" relative reduction of expenditures in the 'soft" sectors (see Chandrasekhar and^? Ghosh, 2002).

{/)oZ

The results of this paper show that, overall, these fears were largely real. Along run outcome of the fiscal policy in Indiawas the inability of the state to raisetax collections towards meeting expenditure requirements. In the 1980s, thevo expenditure by the government in India had increased significantly in a large_ number of anti-poverty programmes and employment-creating activities. As> these higher levels of expenditures were financed out of borrowings, the debtGDP ratio of the government rose sharply. A fiscal crisis followed, which led to afiscal adjustment policy from 1992 onwards. The fiscal crisis was most severe forthe Central government. The fiscal crisis of the Centre adversely affected thetransfer of statutory funds to the States; the transfers from the Centre to theStates declined in the 1990s. In addition, the deregulation of interest rates after1991 led to a sharp rise in the interest rates that States had to pay, which led to asharp rise in the debt burden of States. In sum, the finances of the States alsoentered into a period of crisis.In India, while the expenditure stance of the Centre has greater influence onthe generation of aggregate demand, the expenditure stance of the States ismorecritical in the financing of social sector schemes. About 80 to 85 per cent of all theexpenditure in the social services ismet by the State governments.The response of the state in India to the fiscal crisis has been to go in for strictfiscal control measures, including a legally set ceiling on budget deficits throughfiscal responsibility legislations. Our results show that the public expenditure ofthe central government declined sharply in the 1990s and 2000s, as compared tothe 1980s. While there was some increase in the share of social sector expendituresand human priority expenditures as a share of the total expenditure, threeimportant qualifications may be inorder. First, aswe tried to show, real per capitaexpenditure on human priority areas actually slowed down in the 1990s and 2000srelative to the 1980s. Secondly, in the framework of a slowdown in publicexpenditure as awhole, rising sharesmay mean little absolute increase in spendingand rising growth rates may be unsustainable. Thirdly, on the ground, thesemoderate increases in expenditure by theCentre have mattered little because most

7g of the expenditure is through the State governments.


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For the State governments, the conclusions that emerge are at variance with 7?those of the Centre. The total expenditures by the States as a share of the GDP jjrose in the 1990s and early-2000s, but this rise was primarily to finance non- 3developmental expenditures like interest payments. Within total expenditure, theshare thatwent into developmental expenditure declined in the 1990s and 2000s. 3

Developmental expenditure as a share of the GDP also fell in the same period. Inthe case of social sector expenditures and human priority expenditures by States(the sphere where majority of the social sector expenditure took place), therewere

unambiguous falls relative to GDP and total expenditure. Within specific subsectors like education and health too, this relative decline in expenditure was visible.Expenditure by the government on social and economic services is a crucial

necessity for fulfilling the basic needs of people in developing countries. In India,this democratic function of the government faces a serious threat from thenature of fiscal crisis that has developed. A transcending of this fiscal crisis iscritical to liberating the government from constraints in spending, and reducingthe social costs of spending cuts. However, to transcend the present fiscal crisis,a progressive transformation of the nature of fiscal policy would be required.

R. Ramakumar is at the Tata Institute of Social Sciences, Mumbai.

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Figure Panel 5Expenditure in selected sectors as a share of the GDP, Central government1974-75 to 2005-06, in per cent

Education, Arts and Culture0.60

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0.09 Labour and Employment

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Year

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Year

Figure Panel 11Expenditure in selected sectors as a share of the GDP, All States,1974-75 to 2005-06, in per cent

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Year


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Year

Medical, Public Health and FamilyWelfare

88 Year


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