In a recent report, the Reserve Bank of India (RBI) has cautioned multiple state governments against distributing freebies, while pointing out the sorry state of affairs in multiple states’ finances. The freebies which have become a common exercise to lure voters have also drawn the attention of the supreme court, which observed it to be a serious issue. The culture of loan waivers and freebies has drawn criticism time and again from multiple national and international economists. In 2013, Dr. Raghuram Rajan, the then RBI governor warned strictly against the culture of freebies, as the benefits often reach the wrong hands and not the intended recipients. The freebies, subsidies, and waivers done by the government do attract more votes in their favor but these ultimately have an impact on the financial health of the state.
The recent economic crisis in Sri Lanka has garnered international attention and has been a massive lesson for multiple international economies which made it the pretext of the RBI report. The Sri Lankan economic collapse is attributable to a lot of factors, but the most significant lesson for the Indian economy has been the culture of freebies and waivers. The Sri Lankan crisis is a case where the treasury was laden with a twin deficit, both in the current and fiscal accounts, financed by international loans and grants. In such a situation further tax cuts by the Rajapaksa government dried up the revenue streams for the government leading to the deepening of the financial crisis. This is the classic case of how freebies by the governments put additional pressure on the state treasury, often leading to a financial crisis leading to an economic collapse. The lesson here for the Indian states lies in the fact that freebies can be a deterrent to economic development over a welfare scheme which was thought to be a macroeconomic automatic stabilizer aimed at insulating the economy from demand-supply shocks.
The Fiscal Responsibility Legislation (FRL) binds the fiscal discipline of all Indian states at 3% of GSDP and the national average of the Gross Fiscal Deficit to nominal Gross Domestic Product (GFD-GDP) ratio is modest at 2.5%. However, this fact can be highly misleading as there are substantial interstate variations in the cumulative figure. The states of Andhra Pradesh, Kerala, Punjab, and Rajasthan have this ratio at more than 3.5%, whereas, Assam, Gujrat, Maharashtra, Odisha, and Delhi hold this ratio to even below 2%. This inter-state disparity is worrying and certain states’ financial health needs a complete revamping. The states of Rajasthan, Punjab, Kerala, West Bengal, Andhra Pradesh, Jharkhand, Madhya Pradesh, and Uttar Pradesh turned out to be the most debt-laden states in India. In these states, the Interest Payments to Revenue Receipts (IP-RR) ratio often exceeds 10 percent. This presents a worrisome trend especially when the COVID 19 pandemic has resulted in a sharp decline in revenue for all the Indian states.

Adding to this are the rising energy prices due to international conflicts, increasing commodity prices, tightening of monetary policy around the world, a decline in tax revenue, and effects of unpredictable natural disasters, which present further risks to the state economies. In the wake of such a crisis, the economic cost of freebies, subsidies, and waivers become all the higher. The debts are also not being used to create instruments to finance the deficits of the states as 80-90% of the budget is going towards revenue expenditure, while in some states, the freebies even amount to even 50% of the total expenditure. The adverse impacts of these are the rising debt ratios, leading to higher primary surpluses, and hence a progression in difficulty to finance the debt. These situations are likely to worsen as the effects of the pandemic wear off from the economies since the wearing off of the effects will come along with the relief and shelter provided by the central government to states. In June 2022, as the subsidy on Central GST to state governments comes to an end, the financial cushion will wear off leading to an increase in problems for the states. The states need to get their finances in order before any further subsidies, freebies, or waivers are given. A critical rethinking of the schemes is required by the state governments to avoid any financial crisis.

Table from Reserve Bank of India 2022 Report

According to the data issued by the office of the Comptroller and Auditor General (CAG) the expenditure on freebies climbed from 11.2% in the financial year (FY) 2020-21 to 12.9% in FY 2021-22. Further, the subsidies increased from 7.8% in FY 2019-20 to 8.2%in 2021-22. The states of Jharkhand, Kerala, Odisha, Telangana, and Uttar Pradesh had the highest increase in subsidies over the last 3 years. The problem with subsidies lies in the fact that it crowds out the resources from useful policy and capital interventions. The waivers, subsidies, and freebies further encourage a negative credit culture, leading to behavioral implications and discouraging private sector participation by the virtue of cross-subsidization. Additionally, the subsidies, freebies, and waivers lead to higher demand for leisure amongst the workforce, thereby disincentivizing working at the current wage rates. Certain subsidies and waivers like electricity and water subsidies even incentivize environmental degradation inadvertently.
The subsidies, freebies, and waivers are a critical part of public welfare but a certain and clear distinction needs to be made between the subsidies provided for the welfare of the people and the subsidies which would harm fiscal growth. They can prove to be quite advantageous and lead to the welfare of the economy if done with proper targeting and without leakages. The implementation procedures of the government should also be efficacious enough so that the freebies reach the targeted population.

Kushagra Dubey

Research Intern at CPRG