RBI flags states' rising subsidies, says will hinder spending on development

The Reserve Bank of India on Thursday in its report flagged concerns around the rising subsidies announced by multiple states.

The central bank has said that the rising expenditure on non-merit subsidies may raise the share of committed expenditure in states' spending. This is likely to constrain the fiscal space available to states for developmental and capital spending, the RBI said in its Financial Stability Report, December 2022.

By definition, subsidies linked to basic education have significant positive externalities and are called merit-based but most subsidies are non-merit subsidies.

States' expenditure on subsidies has grown by 12.9% and 11.2% in FY21 and FY22 respectively after contracting in FY20. Commensurately, the share of subsidies in their total revenue expenditure has also risen from 7.8 per cent in 2019-20 to 8.2 per cent in 2021-22, RBI said.

"Notwithstanding the gains from fiscal consolidation, there are concerns about rising subsidies announced by many states. The 15th Finance Commission’s report has also flagged the issue of the rising share of subsidies in some of the states’ revenue expenditures," the RBI said.

In a report earlier this year, India Ratings had warned states against their competitive subsidies and said five states, led by Punjab, are on the brink of a deep fiscal crisis as their subsidies are much higher than sustainable levels in terms of a percentage of GSDP. The other top states with a very high level of subsidy burdens as cited in the report were Chhattisgarh, Rajasthan, Karnataka and Bihar between FY19 and FY22.

States tend to fund subsidies, which are mostly non-merit ones, by compressing the capex, due to competitive politics, Devendra Pant, chief economist and head of public finance at the agency, said.

The growing culture of doling out subsidies ahead of elections has lately been a topic of public discussion, with NK Singh, chairman of the 15th Finance Commission, publicly speaking against it, highlighting the fiscal unsustainability of these freebies.