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State after state is falling deeper into deficit. A collapse of essential services like health, education and transport is imminent if the trend persists.

By Rohit Saran

If you pay your employees extravagantly. If you hire staff indiscriminately. If you borrow money recklessly. And if you dole out freebies generously, you must be really rich. Or on the verge of bankruptcy. Just like state governments in India are. One after the other, states rich and poor, big and small, stable and unstable, are falling deeper and deeper into deficits -- their spending running far ahead of their incomes. "It is a regime of deficits, deficits and deficits," remarks A.M. Khusro, economist and chairman of the 11th Finance Commission.

In just two years between 1997-98 and 1999-2000 the income-expenditure imbalance of all states (revenue deficit) has more than doubled -- from Rs 16,000 crore to Rs 41,000 crore. The total debt of all state governments, which was Rs 2,43,525 crore three years ago, touched a staggering Rs 4,09,258 crore in 1999-2000. That translates into a per capita debt of Rs 4,308. "State governments are in the midst of an unprecedented financial crisis," warns K.C. Pant, deputy chairman, Planning Commission. A crisis far greater in significance than the Union budget which Finance Minister Yashwant Sinha will present three weeks from now.

To know what the crisis could mean to you, imagine hospitals without diagnostic equipment; schools without blackboards and books; homes without electricity; and roads without repair. These are just some of the services state governments fund directly and indirectly. True, many of these services are already dysfunctional, but if states continue to hurtle towards bankruptcy an outright collapse in infrastructure and essential services is not an impossibility.

The probability of such a collapse is evident all over the country. Rajasthan is borrowing crores of rupees from financial institutions to meet its burgeoning salary bill. "Every state is facing an economic crisis. It's a national crisis," declares Chief Minister Ashok Gehlot. In Punjab, India's richest state, salaries of 5,000 officials, including the chief secretary, were held up for a week recently when a civil court sealed the state treasury following a payment default. The state's revenue-expenditure mismatch is Rs 100 crore a month. "We are existing on borrowed money," laments Finance Minister Kanwaljit Singh.

Maharashtra, the most industrialised state in the country, is in a shambles. Out of every rupee that the state earns, 73 paise go into footing the wage bill. The state's revenue deficit has shot up by 200 per cent in two years (see graphic). The administrative expenses in Madhya Pradesh have galloped by 400 per cent since 1996-97. In the less endowed states of Bihar, Assam and Orissa wages have long overtaken the governments' tax revenues.

More money for employees and administration means less money for development. Plan expenditure (the most productive of all state spending) on new power projects by states has fallen by more than 50 per cent (Rs 219 crore to Rs 110 crore) between 1996-97 and 1997-98. Maharashtra has slashed plan spending on education from Rs 489 crore to Rs 393 crore during the same period. Punjab was forced to cut plan expenditure on transport and communications.

Says Pant: "By diverting funds from investment to consumption, states are feeding on the future." Elaborates N.J. Kurian, senior adviser with the Planning Commission: "Cut in plan spending could mean hospitals without medicines, schools without teaching aids, transport without buses, power stations without power."

What's eating into state finances? The most immediate cause is obviously the new pay scale, which has overnight bloated the salary bills of states by Rs 20,000 crore. That's about half of the revenue deficit of all states. In states like Gujarat, Madhya Pradesh and Maharashtra, administrative expenses have jumped three to four times since 1996-97. Says Punjab Chief Secretary M.S. Mann: "Several state governments have become governments of the employees, by the employees and for the employees."

States blame the Centre for burdening them with the wage hike. After all, it was the Central government that uncorked the genie by implementing the Fifth Pay Commission award in 1996-97. Says a frustrated S.P. Tekriwal, Bihar's finance minister: "The Centre should bear 50 per cent of our wage bill."

While that may be wishful thinking, Gujarat has a more reasonable complaint. In 1998, the Centre granted a 12 per hike in dearness allowance (DA) to its employees. That triggered demands for a similar DA hike from state employees. "Such a steep hike in DA in times of low inflation was unreasonable and a recipe for disaster for states," complains Gujarat's Economic Affairs Secretary Hasmukh Adhia. Unable to concede a similar demand, Rajasthan Chief Minister Gehlot has asked government employees to choose between DA and timely payment of salary.

The Centre's wage-push apart, states have themselves to blame for their plight. A lethal combination of populism and mismanagement has been eroding the financial viability of the states for years. Punjab is a case in point. Right from the day it came into power, the ruling Akali Dal-BJP coalition has championed itself as a give-away government. While sales-tax concessions to industrialists and traders have been slicing the state's tax revenues, unwarranted sops like free electricity to farmers have caused expenditure to spiral out of control. The state, which has the highest per capita income in the country, has the potential to collect Rs 4,200 crore from sales tax every year. Instead, it gets only Rs 1,400 crore. Though Chief Minister Parkash Singh Badal dismisses the power subsidy as chickenfeed, there is no doubt that it has plunged the state electricity board into the red. Worse, the World Bank recently withdrew a soft loan of Rs 715 crore to the state because of the Government's refusal to charge farmers for the power they use.

Andhra Pradesh is another big victim of populism. While subsidised power will cost the state Rs 2,400 crore this year, cheap rice will leave the exchequer poorer by Rs 1,300 crore. Many states have compounded the fallout of populism by indulging their ministers and bureaucrats. Each minister in the 90-member ministry in Uttar Pradesh enjoys perks worth Rs 1 lakh a month. All members of Punjab's Legislative Assembly were given new Tata Sumos two years ago -- with 500 litres of diesel free every month; ministers enjoy unlimited supply of free petrol.

Political instability has exacted its own price. In Uttar Pradesh, the change of nine governments in 10 years has taken its toll. In the past five years, around 800 district magistrates and 1,000 superintendents of police (SPs) have been transferred. Nearly half the number of IAS officers in the state have had less than one year's tenure in the past five years. The consequence: state's spending on transfer allowance skyrocketed from just Rs 1.6 crore in 1995-96 to Rs 23 crore in 1998-99.

A recent Planning Commission study on state finances, which identifies poor and corrupt governance as a major cause of the financial meltdown in the states, proposes to develop a stability index of key government posts and prescribe a minimum average tenure for all official postings.

Perpetually sick state-owned enterprises are another financial drain. State electricity boards alone have combined accumulated losses of Rs 20,000 crore. The reluctance of states to tax optimally hasn't helped either. West Bengal, for instance, collects just Rs 300 crore from excise and sales taxes on liquor, whereas Tamil Nadu -- a state not too different in size -- raises Rs 3,000 crore. West Bengal's sales-tax rate for petrol is 12 per cent, compared to Tamil Nadu's 25 per cent. In fact, the three southern states of Tamil Nadu, Karnataka and Kerala are in less of a financial mess than other states.

Till recently, states had also bled each other by offering a host of tax concessions in a bid to attract investments. "In competing for business states followed the policy of live and let die," says Gujarat's Finance Minister Vajubhai Vala.

Then there is the issue of unfair division of economic powers between the Centre and the states. Despite its promises, the Centre is yet to adopt a tax-devolution system under which 29 per cent of all Central tax revenues are to be distributed among states. Right now states only share collections from income tax (77.5 per cent) and excise duty (47.5 per cent) with the Centre.

The financial mess at the Centre and economic slowdown over the past three years have also stifled the flow of funds to the states. According to an RBI report, the transfer of resources from the Centre to states has fallen from 7.6 per cent of the GDP in the early '90s to 6.4 per cent of GDP in 1998-99.

Just as the economic crisis of 1991 triggered some fundamental reforms at the Centre, optimists hope that the current crisis will usher in some bold reforms in the states. Says Pant: "Almost all states now understand the magnitude of the crisis and know what they need to do about it. That itself is some achievement." He cites the states' unanimous decision to impose uniform sales-tax rates throughout the country from January 1, 2000 as a major victory for reforms. This, in one stroke, is expected to end the inter-state tax wars.

To be sure, some states have already initiated financial restructuring. In the past three years Gujarat has trimmed public-sector staff strength by 17,000 through voluntary retirement schemes. The net saving: Rs 150 crore a year. All government departments have been asked to cut non-plan expenditure by 10 per cent. Anticipated savings: Rs 550 crore. Declares a confident Vala: "We will enforce austerity measures with an iron will."

Andhra Pradesh, which boldly dismantled the financially disastrous prohibition scheme in 1997, is trying to scale down subsidies. The fares of state transport buses have recently been hiked by 30-70 per cent. The state also intends to raise the power tariff by 15 per cent every year over the next three years. Rajasthan too is in the process of raising power and water charges. The state has also barred bureaucrats from using official cars for commuting within a city. Though the ban has not been very effective, it does signal the state's resolve to stem the rot.

In addition to these individual efforts, nine states (including Punjab, Assam, Orissa and Andhra Pradesh) have signed a memorandum of understanding (MOU) with the Centre promising some bold reforms in lieu of special assistance. The Centre last year created a dedicated fund of Rs 10,000 crore to help bail out states. The reforms to which the states are committed include downsizing of government by abolition and freezing of posts, mobilising of additional tax revenues and increase in user charges of power, water and transport. The progress of these MOUs has been mixed. States like Punjab and Andhra Pradesh have failed to fulfil their commitments in the first year, citing Lok Sabha and assembly elections held last year as the reason for the increased expenditure.

The unprecedented nature of the crisis calls for some unusual measures. For instance, states could freeze DA for five years and link future hike to productivity. Recruitment age of employees could be raised to 50 years. This will shorten the period of service and save on pension liabilities.

The same can also be achieved by encouraging employees to work for NGOs for a few years of their service. To improve governance and alleviate corruption, administration should be made more transparent. States can enact a Right of Information Act which would help expose arbitrariness and corruption. Agencies like state vigilance departments, Lok Ayukt must be strengthened to pursue probes independently. States could also consider setting a statutory ceiling on their annual borrowings.

Observers hope that the return of the pro-reform Chandrababu Naidu Government in Andhra Pradesh after last year's elections would spread the message of reforms across other state capitals in the country. Right now there aren't many definitive signs of that happening, confirming that the recovery in state finances will be slow and staggered.

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