Photographer: Prashanth Vishwanathan/Bloomberg

India Caps State Governments' Deficit to Curb Reckless Spending

  • States to curtail deficit to 3% of gross domestic product
  • Can widen to 3.5% if interest payments, debt levels in check

Indian Prime Minister Narendra Modi’s administration approved a proposal to cap states’ budget deficits as it looks to shrink Asia’s widest shortfall.

State governments will have to limit the gap to 3 percent of their gross domestic product in a financial year, Frank Noronha, the federal government’s spokesman, wrote on Twitter. The state governments can exceed the target by 0.5 percentage point if they keep interest payments and the debt-GDP ratio within specified limits.

Continued fiscal consolidation is key to protecting India’s credit rating and winning more interest-rate cuts from central bank Governor Raghuram Rajan. At the same time, states also need room to maneuver under a plan to reorganize about $5 trillion of debt piled up at power utilities.

The move to cap the states’ fiscal deficit is based on the recommendation of the finance commission, a panel that decides every five years how tax revenues should be divided between the federal and state governments. The government had earlier implemented the panel’s advice to share a record 42 percent of total tax collections with states instead of 32 percent.

Modi has been advocating for greater autonomy of states and increased coordination with the federal government to ensure faster project approvals and boost investment. 

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