Sub-national revenues and expenditure are generally found to move in line with business cycles in many
decentralised economies. In the Indian context, however, a panel data analysis covering non-special category states
during 1980-81 to 2012-13 reveals that there are differences in the cyclical behaviour across different components
of government expenditure. Capital outlay displays pro-cyclicality, implying the government’s tendency to cut
and expand this component at the time of business cycle downswing and upswing, respectively. Primary revenue
expenditure, on the other hand, is found to be acyclical, reflecting the underlying rigidity in adjusting such
expenditures in accordance with growth cycles. Institutional frameworks and rules that target government
spending, if formulated and implemented appropriately may, however, enable sub-national governments to
undertake counter-cyclical fiscal policies in the medium-term.
1. Introduction
6.1 Cyclicality of fiscal policy refers to the
direction in which the government’s revenues and
expenditures move in relation to output. A fiscal
policy is said to be pro-cyclical if it moves with
the business cycle, i.e., it is expansionary during
economic booms and contractionary during
economic recessions. Conversely, a countercyclical
fiscal policy is one which moves against
the business cycle i.e., it is contractionary during
booms and expansionary during recessions.
6.2 Generally, the cyclicality of certain
components of fiscal policy tends to be fixed almost
by definition, due to the presence of automatic
stabilisers. Tax structures which are more
progressive in nature act as automatic stabilisers
during business cycle upturns and downturns.
Likewise in-built automatic stabilisers with respect
to government transfers such as unemployment
benefits tend to generate a counter-cyclical
pattern as the number of claimants falls during
expansions and rises during recessions.
6.3 Pro-cyclicality of fiscal policy precludes
the stabilising role that is expected of fiscal policy
in macroeconomic management. Theoretically,
neoclassical tax smoothing, the Keynesian and the
new growth theory, all advocate a counter-cyclical fiscal policy, which requires governments to lower
taxes and increase spending during a downswing
in the business cycle so as to augment aggregate
demand; and reduce expenditure, and increase
savings during an upswing in the business cycle.
In practice, however, the pro-cyclicality of fiscal
expenditures in many countries is so strong
that it leads to deterioration in fiscal outcomes
with fiscal expansions. To ensure medium-term
fiscal sustainability, deficits run during economic
downturns should be offset by generating
fiscal surpluses during upturns. However, most
economies have a tendency to adopt pro-cyclical
fiscal policies during an upswing, which creates a
deficit bias, fuelling debt accumulation. Moreover,
countries with volatile output and dispersed
political power are the most likely to run procyclical
fiscal policies (Lane, 2002).
6.4 Factors identified in literature to explain
pro-cyclicality in fiscal policies of developing
economies are: (1) formulation and implementation
lags in fiscal policy combined with problems in
assessing the extent of output gap; (2) heavy
government spending pressures during economic
booms; (3) borrowing constraints and limited
access to international capital markets, forcing
authorities to tighten fiscal expenditure during economic downturns; (4) moral hazard spending
behaviour of sub-national governments, reflecting
the implicit and/or explicit guarantee of a bailout
by the central government; (5) free rider behaviour
of sub-national governments as they may benefit
from nationwide market access conditions which
do not differentiate between fiscally disciplined
states and those which do not adhere to their
fiscal rules; and (6) time inconsistency problems
associated with policy decisions which are
not subsequently implemented (Gutiérrez and
Revilla, 2011).
2. Cyclicality in Fiscal Policy: A Review of
Literature
6.5 Fiscal policies of developed economies
were, in general, found to be either acyclical or
counter-cyclical. In contrast, a high degree of
pro-cyclicality was seen in the fiscal policies of
developing economies (Gavin and Perotti, 1997;
Lane, 2002; Telvi and Vegh, 2005). Halland and
Bleaney (2011) generated cyclicality estimates
for 85 advanced and developing countries for
1980-2004 and found that pro-cyclicality was
higher, on an average, with a much wider range
of variation, in developing countries than in OECD
countries. A study by Ilzetzki and Vegh (2008)
on government consumption expenditures of 49
developing countries showed that fiscal policies in
these countries were not only pro-cyclical but also
expansionary, thereby exacerbating the effects of
business cycles. A pro-cyclical fiscal policy stance
which exacerbated output volatility also hampered
fiscal sustainability (De Ferranti et al. 2000 and
Gavin et al. 1996).
6.6 Variations in cyclicality have been
observed across different components of fiscal
policy, viz., government expenditure and revenue.
Researchers have found evidence of interference
with the operation of automatic stabilisers in both
developed and developing economies, as the cyclical sensitivity of fiscal balances has been
lower than that warranted by the existing automatic
stabilisers, implying the offsetting impact of
discretionary fiscal policy actions (Balassone and
Kumar, 2007, as cited by Guiterrez and Revilla,
2010).
6.7 Empirical literature has, by and large,
focused more on assessing the degree of cyclicality
in central government revenues and expenditures
rather than the revenues and expenditures of
sub-national governments in multi-tier systems.
Fiscal policies of sub-national governments tend
to be inherently and systematically pro-cyclical
due to their reliance on narrow and sensitive
revenue streams, discretionary transfers from the
centre and their limited access to credit markets.
If spending by sub-national governments is procyclical,
the need to offset this spending pattern
imposes an additional burden on the central
government’s fiscal policy. On the other hand,
pro-cyclical actions by the central government
could affect the cyclical behaviour of subnational
governments through inter-governmental
transfers, thereby amplifying rather than mitigating
the pro-cyclicality of sub-national fiscal policies.
6.8 Empirical evidence using both time-series
and cross-section data at the Brazilian state
level for 1991-2006, suggested the existence
of pro-cyclical fiscal policies of the sub-national
governments which were more pronounced during
economic downturns (Arena and Revilla, 2009).
Tax structures of Brazilian states – and not federal
transfers – were found to be the primary cause
of pro-cyclicality of state spending. However,
evidence also suggested that introduction of the
Fiscal Responsibility Law (and the resultant hard
budget constraints) implied some dampening of
the pro-cyclicality in Brazilian states’ spending.
Further, smaller states were found to be more
pro-cyclical than larger states for all revenue and
expenditure categories, with the exception of inter-governmental transfers, where the evidence
was found to be inconclusive. Transfers from the
centre to the states were found to be pro-cyclically
associated with changes in national GDP and
not with gross state product, which could amplify
the pro-cyclical behaviour of sub-national
expenditures.
6.9 A study of the cyclicality of budget items,
such as, overall provincial revenue, own-source
revenue, grants, revenue sharing receipts,
discretionary grants, expenditures and budget
surplus, among provincial governments in eight
federations, viz., Argentina, Australia, Brazil,
Canada, Germany, India, Spain and the United
States, using separate panel regressions for each
country, showed that while own-source taxes were
generally highly pro-cyclical, contrary to common
wisdom, revenue sharing and discretionary
transfers were either acyclical or pro-cyclical
(Wibbels and Rodden, 2010). Expenditure was
found to be pro-cyclical in all the countries except in Australia. A positive co-efficient of budget
surplus reveals that the US states, Canadian
provinces and Australian states all attempt to
smooth income shocks by borrowing during bad
times and possibly saving during good times.
6.10 Studying the sources of pro-cyclicality in
sub-national government spending in Argentina
and Brazil, Sturzenegger and Werneck (2006)
found that much of the pro-cyclicality came from
the sub-national government’s own tax revenues
rather than tax devolution from the centre. Crossjurisdiction
evidence was found to support the
claim that pro-cyclicality in spending resulted from
pro-cyclical revenues, through the ‘voracity effect1’.
The findings of the above studies are summarised
in Table VI.1.
3. Institutional Framework for State Government
Expenditure
6.11 Two significant differences exist between
sub-national government finances and central government finances in terms of the structure
and institutional framework, which could have
a bearing on the former’s ability to undertake
counter-cyclical fiscal policy. First, as expenditures
are more decentralised than revenues, subnational
governments rely, to a great extent, on
inter-governmental transfers in the form of tax
devolution and grants and/or loans for a significant
part of their total receipts. Second, many subnational
governments function under balanced
budget rules, which requires them to refrain from
accumulating deficits. Even those countries where
sub-national governments are allowed to run
deficits, strict limits are placed on borrowings from
domestic or external sources (external funding is
mostly routed through the central governments).
Table VI.1: Studies on Cyclicality in Sub-national Fiscal Revenues/Expenditures |
|
Authors |
Methodology |
Sample |
Results |
1 |
Arena and
Revilla (2009) |
Panel regressions |
1991 -2006
Brazil (27 states) |
Total and primary expenditures show
pro-cyclical behaviour. Expenditures
on personnel have a higher degree of
pro-cyclicality than maintenance and capital expenditure. |
2 |
Sturzenegger
and Werneck
(2006) |
Correlation, and
panel regression |
1992-2002
Argentina (24 provinces) and
Brazil (26 provinces) |
Total expenditure was found to be
pro-cyclical in both Argentina and Brazil. Much of the procyclicality
came from sub-national governments’ own tax
revenues rather than tax devolution from the centre. |
3 |
Wibbels and
Rodden (2010) |
Panel Regression |
USA (1977-1997)
Canada (1968-1997)
Germany (1974-1995)
Australia (1990-2001)
Spain (1984-2001)
India (1980-1998)
Brazil (1986-2000)
Argentina (1980-2001) |
While own-source taxes were generally highly pro-cyclical,
revenue sharing and discretionary transfers were either
acyclical or pro-cyclical. Total expenditure was found to
be pro-cyclical in most of the countries except Australia. |
6.12 If government revenues are pro-cyclical, the
fiscal policy response of sub-national governments
in terms of spending could be expected to be procyclical,
particularly during a downturn, unless
there are: (a) additional compensating transfers
from the central government, (b) withdrawals from
contingency funds, or (c) adequate flexibility in the
borrowing rules for sub-national governments to
respond to cycles within sustainable limits.
6.13 The ability of sub-national governments to
undertake counter-cyclical fiscal policies during
a downturn is determined by the level of debt
and interest rates facing individual sub-national
governments. Some sub-national governments
may be able to provide more fiscal stimulus
than others if they have created adequate fiscal
space by practicing greater fiscal discipline during
upswings. A minimum target for sub-national fiscal
policy is avoiding unplanned cuts in developmental
expenditure, even if it is unable to increase its
overall expenditure due to resource constraints.
6.14 With regard to Indian states, on the
resources side, they have their own revenues comprising tax and non-tax sources. Over 97 per
cent of the states’ own tax revenues are from indirect
taxes, concentrated mostly on consumption.
Taxes which are earmarked for states under the
Constitution of India, inter alia, include, state value
added tax (VAT), excise duty on liquor, stamp duty
and registration fees on real estate transactions,
motor vehicle taxes, entertainment taxes, and
electricity duties.
6.15 Indian states also receive resource
transfers from the central government in three
forms – tax devolution, grants and loans. The
mandated shares of total central tax collections are
revised every five years on the basis of formulas
set by successive Finance Commissions. The
Finance Commissions also decide on the nonplan
grants to be given to the states to address
horizontal imbalances. States also receive plan
grants distributed mainly according to their
absorptive capacities and developmental needs.
With the delinking of plan loans from plan grants
on the basis of the recommendations of the Twelfth
Finance Commission, plan loans from the centre
have been discontinued from 2005-06.
6.16 Most economies place restrictions on
the borrowings of sub-national governments as
excessive borrowing by states not only destabilises
their own economies but also threatens the
finances of the centre if it is called upon to bail
out the distressed states. Under the provisions
of Article 293(3) of the Indian Constitution, a
state has to obtain the approval of the central
government for its domestic borrowings as long as
it has any loans outstanding with the centre. Since
all states are indebted to the centre, they are
restrained from indulging in excessive borrowings.
Furthermore, only the central government is
permitted to undertake external borrowings.
Role of Fiscal Rules
6.17 In the interest of promoting fiscal discipline
so as to achieve medium-term fiscal sustainability,
several countries have instituted fiscal frameworks
since the 1990s, which have been operationalised
through the enactment of fiscal responsibility
legislations. Apart from promoting credibility and
transparency in fiscal policies, these legislations
set out budgetary rules which are designed to
prevent the misuse of discretionary fiscal policy
which is one of the main sources of ‘deficit bias’
and overall pro-cyclicality of fiscal policies.
6.18 In the Indian context, all the state
governments have enacted their FRBM Acts and
all states except Goa2 have amended their FRBM
Acts and have adopted the annual debt targets set
by the Thirteenth Finance Commission (FC-XIII).
While the design of fiscal rules, as per their original
FRBM Acts, varied across states, there has been
a move towards standardisation in the amended
FRBM Acts. Under the FRBM Acts, states are
committed to gradually bridge the deficits, if any,
in their revenue accounts. The central government
sets annual ceilings on borrowings for each state
consistent with a sustainable medium-term fiscal
framework.
4. Measuring the Cyclicality of Fiscal
Expenditures of Indian States
6.19 There is no consensus among researchers
on how fiscal cyclicality should be measured.
Economists have used different methods to
empirically estimate the cyclicality of fiscal policy.
The simplest way to measure fiscal cyclicality is
to work out the correlation between the cyclical
component of output and that of the relevant fiscal
variable (Kaminsky et al. 2004 and Talvi and Végh, 2005). This method has been employed to test
for cyclicality of fiscal expenditures of the states
in India. The chosen fiscal variables are primary
revenue expenditure, capital outlay and aggregate
expenditure. Going by the general practice, the
cyclical components of the output and fiscal
variables (both in real terms) are extracted, using
the Hodrick Prescott (HP) filter method, and the
co-efficients of the correlation between cyclical
components of the select fiscal expenditure
variables of the states and their GSDP are
computed.
6.20 The results of the correlation test, as given
in Charts VI.1a to VI.1c, are statistically significant
for only a few states. The correlation co-efficients
of aggregate expenditure and GSDP for Andhra
Pradesh, Haryana, Kerala and Tamil Nadu are
positive and statistically significant, indicating the
existence of pro-cyclicality. To exclude the impact
of interest payments and repayments which are
a part of total expenditure, a correlation test has
been done on the cyclical components of primary
revenue expenditure and GSDP which showed
that the pro-cyclicality seen in the aggregate
expenditure of Tamil Nadu and Andhra Pradesh
is due to primary revenue expenditure. The
capital outlay in these states does not exhibit
any cyclicality. On the other hand, aggregate
expenditure of Kerala is pro-cyclical on account
of the pro-cyclical behaviour of primary revenue
expenditure as well as capital outlay.
6.21 As the unadjusted correlation co-efficient
may potentially be misleading when variables have
different levels of volatility, many researchers prefer
regression-based measures, which are generally
considered to be more precise (Lane, 2002;
Akitoby et al. 2004; and Woo, 2009). Therefore, a panel regression has been undertaken to test
the cyclicality of fiscal expenditures of non-special
category states3.
Panel Regression
The Model
6.22 The estimation strategy, following Granado
et al. (2010) involves regression of log differences
of state governments’ per capita real capital outlay
and per capita real primary revenue expenditure
on log difference of per capita real GSDP and
select control variables in a panel data framework.
The control variables consist of primary balance
as per cent of GSDP with one period lag and an
election dummy reflecting the year prior to state elections. The sign of the co-efficient of lagged
primary balance is likely to be positive since states
with lower primary deficit or a primary surplus will
have more headroom for public expenditure. A
dummy variable has been introduced to represent
the year prior to the state elections, under the
assumption that the effect of elections will be the
greatest on public service delivery in the period
leading to the election. Accordingly, we estimate
the following specification:
6.23 Here, EXP is the per capita real government
expenditure, Y is per capita real GSDP, PB is the
primary balance to GSDP ratio and D is election dummy. The subscripts i and t denote state
and time period, respectively. β1 measures the
cyclicality co-efficient of government expenditure,
i.e., the elasticity of government spending with
respect to output growth. A positive value of β1
implies pro-cyclical behaviour; a value above
unity implies a more than proportionate response
to output fluctuations; and a negative value
indicates counter-cyclical behaviour. As per our
assumptions, the signs of β2 and β3 are expected
to be positive.
The Data4
6.24 The panel consists of 14 non-special
category states and covers the time period 1980-
81 to 2012-13. For the three states of Bihar,
Uttar Pradesh and Madhya Pradesh, the data on
respective fiscal variables and GSDP from 2000-01
onwards also include data relating to Jharkhand,
Uttarakhand and Chhattisgarh, respectively. This
has been done for two reasons: first, data for
Jharkhand, Uttarakhand and Chhattisgarh are
available only since 2000-01, i.e., the year when
these states were created; second, the data for
the original states of Bihar, Uttar Pradesh and
Madhya Pradesh for the earlier period (prior to
2000-01) are not strictly comparable with the data
for the later period (post-2000-01) when these
states were bifurcated for creating the new states.
The variables have been converted into real terms
using GSDP deflator for the respective states.
Unit Root Analysis
6.25 Before proceeding with the estimations,
the stationarity properties of the dependent,
explanatory and control variables have been tested
through panel unit root tests. There are different
methods to carry out panel based unit root tests. While tests by Levin et al. (2002) and Hadri (2000)
assume that there is a common unit root process
across the relevant cross-sections, the tests
suggested by Im et al. (2003) and Maddala and
Wu (1999) assume individual unit root process.
Table VI.2: Results of Panel Unit Root Test |
|
LLC
t
statistics |
IPS
W
Statistics |
ADF-
Fisher
Chi
Square |
Maddala &
Wu
PP- Fisher
Chi Square |
1 |
2 |
3 |
4 |
5 |
Variables (Levels) |
|
|
|
|
Log (Per capita capital outlay) |
4.72 |
4.65 |
16.71 |
15.11 |
Log (Per capita primary revenue expenditure) |
3.95 |
7.76 |
1.89 |
1.19 |
Log (Per capita GSDP) |
7.68 |
12.10 |
0.21 |
0.12 |
Primary Balance (% of GSDP) |
-6.16* |
-5.28* |
77.67* |
84.51* |
Variables (Differences) |
|
|
|
|
d log (Per capita capital outlay) |
-16.47* |
-17.29* |
280.04* |
312.36* |
d log (Per capita primary revenue expenditure) |
-21.58* |
-21.54* |
341.81* |
356.64* |
d log (Per capita GSDP) |
-17.64* |
-17.85* |
280.24* |
312.92* |
Note: 1. LLC = Levin, Lin, Chu (2002); IPS = Im, Paseran, Shin
(2003).
2. * indicates the rejection of the null hypothesis of nonstationarity
at 1 per cent level of significance.
3. The statistics are asymptotically distributed as standard
normal with a left hand side rejection area.
4. Automatic selection of lags through Schwarz Information
Criteria (SIC).
5. All panel unit root tests are defined by Bartlett kernel and
Newly West bandwidth. |
6.26 The results of the panel unit root tests are
given in Table VI.2. It may be seen that the tests (Levin et al.; Im et al.; and Maddala and Wu) have
failed to reject the null hypothesis of a unit root
for each of the variables in level form. The tests,
however, reject the null of a unit root in the first
difference. Overall, the results reveal that the three
variables, viz., per capita capital outlay, per capita
primary revenue expenditure and per capita
GSDP in logarithmic form are non-stationary
but integrated of order 1, i.e., I (1). The primary
balance series, which is expressed as per cent of
GSDP, was found to be stationary.
Estimation Results
6.27 Equation 1 is estimated using the pooled
least square technique. The estimation results
are reported in Table VI.3. The model was also
estimated using the two-stage least square
technique (2SLS) to take care of endogeneity
issues. The results obtained from 2 SLS were
broadly in line with the results of the pooled least
square estimations. It may be observed from Table
VI.3 that the co-efficient for the growth in per capita GSDP is positive and significant for capital outlay,
which indicates pro-cyclical behaviour. However,
primary revenue expenditure seems to be acyclical
as the co-efficient for growth in per capita GSDP is
found to be statistically insignificant.
Table VI.3: Estimation Results for Cyclicality
of Government Expenditure in India |
Explanatory Variables |
Dependent Variables |
Per capita
capital outlay |
Per capita primary
revenue expenditure |
1 |
2 |
3 |
Constant |
|
0.07** |
|
|
(0.00) |
Per capita GSDP |
0.59* |
0.04 |
|
(0.03) |
(0.58) |
Primary Balance |
0.03** |
0.01** |
(One period lag) |
(0.00) |
(0.00) |
Election Dummy |
0.12** |
-0.01 |
|
(0.00) |
(0.51) |
AR (1) |
-0.25** |
-0.24** |
|
(0.00) |
(0.00) |
Number of states |
14 |
14 |
Number of observations |
428 |
434 |
Note: 1) Figures in the parentheses represent respective P values.
2) ** and * denote significant at 1% and 5% levels,
respectively. |
6.28 Primary balance with one period lag is
found to have a significant positive impact on both
capital outlay and primary revenue expenditure.
This confirms that the states with lower primary
deficit/higher primary surplus have more
headroom for carrying out their fiscal expenditure.
The election dummy is found to have a positive
and statistically significant relationship with capital
outlay. This indicates that states tend to undertake
higher capital outlays in the year prior to state
elections. Khemani (2000) also found that capital
expenditure increased in the year leading up to
the elections; capital spending is widely regarded
as a more convenient tool for political patronage
of specific groups or individuals, since new
construction contracts can be given selectively.
6.29 The pro-cyclical behaviour of capital outlay
reflects the state governments’ tendency to cut and
expand this component during a business cycle
downswing and upswing, respectively (Mukherjee,
2013). The acyclical behaviour of primary revenue
expenditure at the sub-national level largely
reflects the underlying rigidity in adjusting such
expenditure in the short run in accordance with
growth cycles.
6.30 As a further extension of the analysis, the
cyclical pattern of social sector expenditures of the
states has been undertaken, the results of which
are presented in Box VI.1. While overall social
sector expenditures of the states are observed to
be acyclical, education spending is observed to
be pro-cyclical. The results also show that higher
fiscal deficit in year t leads to lower social sector
expenditure in year t+1. Transfers are also found
to play an important role in influencing states’
capacity to incur social spending.
Box VI.1:
Cyclicality of Social Sector Expenditure: Evidence from Indian States
Given the importance of social sector expenditure in the
Indian context and considering that social sector expenditure
is primarily the responsibility of state governments, it is
crucial to examine the pattern of social expenditure during
periods of economic volatility. This is particularly relevant
in the post-crisis scenario and in the current low growth
scenario that India is witnessing. There are two reasons
for analysing this pattern. First, the conventional Keynesian
argument in support of counter-cyclical policy for any kind of
government expenditure holds for social sector expenditure
as well. An increase in social spending could be used as
countercyclical policy response to support aggregate
demand and foster economic recovery. Second, as in the
case of other developing countries, an increase in social
spending in India during a cyclical downturn may be a useful
policy tool for providing adequate social protection and
mitigating the adverse human development implications of
output shocks, and ensuring that the crises do not generate
long-term harm to children, women and poor families. Thus,
social spending, if undertaken efficiently and in a countercyclical
manner, could be an important engine for promoting
sustainable social and economic development.
In India, pro-cyclicality has generally been tested for
central/general government revenues and expenditures.
With regard to social sector expenditure, including that
on education and health, across Indian states, empirical
studies have, in general, used trend analysis to examine the
improvement, if any, in such expenditure in the post-reforms
period and its impact on the social sector in India (Dev et al.
2002; Joshi, 2006,). Social sector expenditure has generally
been observed to have a positive impact on social outcomes
and hence, enhancing such expenditure from its low levels
in India is considered crucial for achieving overall human
development goals (Kaur and Misra, 2003). While the
literature on the cyclicality of social sector expenditure at the
state level is scant in the Indian context, Darby and Melitz
(2008) showed that some of the fiscal expenditure items
like health, retirement benefits, incapacity and sick pay and
unemployment compensation responded in a stabilising
manner to business cycle fluctuations in 21 OECD countries.
A recent paper shows that the government spending on
education and health is pro-cyclical in developing countries
and acyclical in developed countries. Furthermore, education
and health expenditures follow an asymmetric pattern in
developing countries; they are pro-cyclical during periods of
positive output gaps but acyclical during periods of negative
output gaps (Granado et al. 2013).
To empirically examine the relationship, we have estimated
the following regression equation using panel data
where β0 represents state fixed effect which controls for
heterogeneity across states, EXP denotes real social sector
expenditure including that on education,5 Y denotes GSDP
in real terms, FD denotes state’s fiscal deficit as a per cent of
GSDP, TR denotes real gross transfers from the centre and
u is an error term. The subscripts i and t denote state and
time period, respectively. The co-efficient β1 measures the
degree of cyclicality of public spending. A positive value of β1
implies pro-cyclical behaviour and a negative value implies
counter-cyclical behaviour. A non-significant β1 implies
acyclical behaviour. Fiscal deficit as a per cent to GSDP
and transfers from the centre have been used as control
variables in line with other studies. The analysis is done for
the 17 non-special category states over the period 2000-01
to 2012-136. Results of the panel generalised least squares
(GLS) estimation are reported in Table 1. Empirical evidence
suggest that while overall social spending is acyclical in India
at the state level, education spending is pro-cyclical, with the
pro-cyclicality being more pronounced during upturns and
being more significant for high income states.
Table 1: Cyclicality of Social Sector Expenditures:
Panel GLS Regression Co-efficients |
|
Total Social Sector
Expenditure |
Education
Expenditure |
Constant |
0.15** |
0.13** |
GSDP |
0.20 |
0.41** |
Fiscal deficit (Lagged) |
-0.03** |
-0.03** |
Gross Transfers |
0.18** |
0.08* |
Note: 1. ** and * indicate significance of co-efficient at 1 per cent and 5 per
cent levels, respectively.
2. Based on the Hausman test, the fixed effect model has been chosen. |
References:
Granado Javier Arze, Sanjeev Gupta, and Alejandro
Hajdenberg (2013), “Is Social Spending Procyclical?
Evidence for Developing Countries” World Development
Vol.42, pp 16-27.
Balbir K and Sangita M (2003), “Social sector expenditure
and attainments: An analysis of Indian states”, Reserve
Bank of India occasional papers, Vol.24, Nos 1&2.
Balbir K, Sangita M and A K Suresh (2014), “Cyclicality of
Social Sector Expenditures: Evidence from Indian States”,
work in progress.
5. Conclusion
6.31 Studies on cyclicality of sub-national
finances have found a preponderance of procyclicality
in revenues and expenditure in many
decentralised economies. In the Indian context,
however, the results of panel regression tests on
the fiscal expenditures of non-special category
states during 1980-81 to 2012-13 indicate that
while capital outlay is pro-cyclical, primary revenue
expenditure does not exhibit any cyclical pattern.
Fiscal consolidation undertaken during 2004-08
in India, both at the central and state government
levels, enabled the governments to undertake
counter-cyclical fiscal policies in the aftermath of the global financial crisis. Without much headroom
in the years following the crisis, it is important
for the central and state governments to return
to the path of fiscal consolidation. Sub-national
governments seem to be ahead of the centre in
fiscal consolidation, with most state governments
recording surpluses in their revenue accounts and
keeping their GFD targets within those stipulated
by their FRBM Acts. However, it may not be fiscally
prudent to build large revenue surpluses at the cost
of development expenditures. If revenue surpluses
are effectively used in building capital assets, this
could contribute to higher growth, given the large
multipliers for capital outlay, particularly at the
state level.
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