Recent Fiscal Trends in Tamil Nadu and the Sustainability of Fiscal Stance

Executive Summary This paper reviews budget expenditure trends in Tamil Nadu and the key indicators of fiscal performance, during the period 1980/81-1998/99. The review indicates the emergence of large and persistent current and fiscal deficits from 1987/88. Revenue financed expenditures have grown rapidly as successive five year plans have led to increasing magnitudes of committed non-plan development expenditure. Plan expenditures in the current budget are also quite substantial in Tamil Nadu. The rising current account deficits coupled with large annual increases on wages and subsidies have emerged as major structural problems in the budget. Currently, a very large proportion of the current budget is allocated to wages, interest payments, subsidies and grants making it extremely difficult to bring about any realignment of expenditures. The trends in debt/SGDP ratio are also reviewed as well as the recent increases in the average cost of financing the deficits. Using a simple analytical framework, this paper then analyzes the sustainability of the government's fiscal stance taking into account the magneto of annual debt flows into the budget. Tentative projections of the likely fiscal trends in the medium term are made on the basis of a number of assumptions about the variables that influence sustainability. Three alternative scenarios are presented each reflecting a different fiscal stance. Scenario 1 is a base line scenario and assumes that primary deficits will be controlled at 2.0% of the SGDP and current revenues will amount to 15% of the SGDP each year. Scenario 2 assumes moderate fiscal reform with primary deficit remaining at 1.5% of the SGDP each year throughout the projection period with current revenues remaining at 15% of SGDP each year. Scenario 3 assumes strong fiscal reform including a substantial reduction in subsidies coupled with revenue increases. In this scenario a primary deficit of 1.0% of the SGDP is assumed for the projection, with current revenues increasing to 16% of the GSDP each year during the first five years of the projection and increasing to 16.5% of the GDP in the remaining five years. The base line projection (Scenario 1) results in an increase in the debt/GSDP ratio from 18% in 1998/99 to 28% in five years and to 37% in ten years. In this scenario interest payments will account for 17% of the current revenues in five years and 24% in ten years. Scenario 2 also results in large-3-increases in the debt ratio and share of …