Critically assess the role of fiscal policy in addressing the financial challenges faced by States post-pandemic. What measures can be taken to enhance State finances?

Question

PocketIAS · Accepted Answer

Context The COVID-19 pandemic severely strained State finances due to sharp revenue contraction and rising expenditure obligations, making fiscal policy central to post-pandemic recovery and stability.

Role of fiscal policy in addressing State-level challenges

Fiscal flexibility: Relaxation of FRBM limits enabled States to increase borrowing to meet health, welfare, and relief expenditures.
Liquidity support: Back-to-back GST compensation loans and special borrowing windows mitigated short-term cash flow stress.
Investment support: Interest-free loans for capital expenditure encouraged States to sustain infrastructure spending during recovery.
Macroeconomic stabilisation: Higher aggregate public spending by Centre and States helped support demand in the post-pandemic phase.

Limitations and concerns

Revenue expenditure financing: Increased reliance on borrowing for salaries, pensions, and subsidies has weakened fiscal sustainability.
Debt and interest burden: Rising debt servicing costs are crowding out developmental and capital expenditure.
GST-related constraints: Uncertainty after the end of GST compensation and limited tax autonomy restrict revenue mobilisation.
Reduced fiscal autonomy: Rigid design of centrally sponsored schemes limits States’ discretion and prioritisation.
Pro-cyclicality risks: Fiscal consolidation pressures constrain counter-cyclical spending during future shocks.

Measures to enhance State finances

Revenue augmentation: Improve GST compliance, rationalise exemptions, and reform property, excise, and user-charge systems.
Expenditure rationalisation: Target subsidies, contain committed expenditure, and adopt outcome-based budgeting.
Strengthening federal transfers: Ensure timely and predictable devolution and revisit vertical and horizontal sharing arrangements.
Debt management: Reorient borrowing towards capital expenditure and eliminate revenue deficits under FRBM norms.
Institutional reforms: Enhance fiscal transparency and Centre–State coordination.

A balanced fiscal strategy combining flexibility with discipline is essential for restoring State financial health post-pandemic.

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