Are Fiscal Transfers Pushing the FRBM Targets Beyond Centre’s Reach?

This paper considers the interdependence of fiscal transfers and fiscal imbalances. It argues that the vertical transfers particularly tax devolution shifted in favour of the states to a significant extent under the recommendations of the Thirteenth and Fourteenth Finance Commissions (FC13 and FC14) and remained at these high levels under FC15. This led to a fall in Centre’s share in the combined primary expenditures and therefore combined fiscal space of the Centre and the states. Political economy considerations forced the central government to rely on additional borrowing and regain some of its lost share in combined primary expenditures. It also reduced tax devolution to states by increasing the non-sharable cesses and surcharges. Occurrence of global crises such as the 2008 global financial and economic crisis and 2020–21 Covid crisis also forced the central government to inordinately increase its fiscal deficit to GDP ratio. As a result, targets set under Centre’s FRBM including its 2018 amendment have remained beyond Centre’s reach. The state governments have been far more successful in remaining close to these targets. There is also an inconsistency in the combination of fiscal deficit and debt relative to GDP that pertains both to the central and state governments in this amendment. These also require corrections. The extent of vertical transfers is to be reconsidered by FC16. It is an opportune time for the Commission to examine the vertical distribution of resources between the central and state governments along with a recasting of the FRBM targets so that these provide a sustainable and feasible combination.