Multilateral adjustment lending to states in India: Hastening fiscal correction or softening the budget constraint?

The widening fiscal deficit of sub-national governments has made the task of macroeconomic stabilisation much more difficult and complex. In many countries, including India, multilateral lending institutions provide assistance for sub-national fiscal reforms through structural adjustment loans (henceforth SAL) with conditionalities heavily loaded with fiscal correction measures. This paper examines the fiscal impact of SAL in Indian states by analysing the quantitative and qualitative aspects of SAL-induced fiscal reforms. Econometric investigation of fiscal impact reveals that state specific effect of SAL in terms of fiscal consolidation has been mixed. There is evidence of softening of the budget constraints in some states, but there is also evidence of greater reduction in fiscal imbalances of SAL states than non-SAL states. It is also seen that much of the fiscal gains have occurred through improved revenue productivity of the tax system and not through expenditure restructuring. It is also seen that the poorer states have preferred to reduce their developmental expenditures to deal with fiscal stress and to comply with fiscal correction targets. This, in turn, has had adverse growth implications. The paper concludes that the benefits and the acceptability of SAL at the sub-national level in India would critically depend on factors such as the qualitative change in government expenditure in meeting deficient delivery of public services at state level, and the removal of state level social and infrastructural bottlenecks for promotion of growth by releasing government resources through expenditure restructuring and reform.