Problem with the Delhi model: Freebies may deliver quick political results but impose high economic costs

This is the second part of a two-part series on the recent discussion on freebies and the associated politics. The first part was a discussion on good and bad subsidies. This article looks closely at the Delhi model.

The ongoing crisis in Sri Lanka has brought back the discussion around fiscal sustainability. Not surprising given that India had experienced a balance of payments crisis after running high fiscal deficits throughout the 1980s.

Higher subsidy spending is not sustainable. Those who do not agree with this are sadly forced to learn this lesson as markets can be very unforgiving. In fact, markets do a good job of imposing discipline on politicians and preventing them from making promises that impose heavy financial costs. Most countries that have ignored these lessons have found their currency to lose its value, thereby leading to all kinds of social unrest. Sadly, in India we do not have such discipline in state governments.

The bond markets for state government bonds and their corresponding bond yields do not reflect the reality of fiscal health of various state governments. This is largely due to the structure of the Indian bond market and the nature of its participants. As a consequence, we have states that spend as much as up to and over 20 percent of their budgets on debt servicing while other states have managed to maintain lower debt levels.

Higher revenue expenditures relative to capital expenditures is a common feature amongst many of the high debt states as is the prevalence of badly designed subsidy programmes and competitive populism. Such competitive populism drives growth away from these states and this imposes a revenue constraint that becomes more binding over time. Recent electoral contests in India have seen a reversion to such a brand of politics which has opened up a political economy question regarding the need to restrict competitive populism. Such restrictions are necessary to prevent a convergence in Indian states towards high debt levels given that our bond markets are unable to penalize fiscally irresponsible states.

However, most opposition to such restrictions has come from the Chief Minister of Delhi. Delhi government regularly claims that they are revenue surplus since 2015. In fact, they claim that they are the only government that is revenue surplus.

However, there are 10 other states that were revenue surplus in 2019-20 and these include states such as Uttar Pradesh, Gujarat and Karnataka.

Moreover, Delhi being a revenue surplus state has nothing to do with the current administration as Delhi was a revenue surplus state before 2015. As a matter of fact, Delhi’s revenue surplus in 2010-11 was Rs 10,642 crores which has decreased to Rs 4,271 crore. This decrease has happened despite the GST windfall and the guaranteed compensation of tax revenue growth at 14 per cent under the GST compensation rule. Additionally, this revenue surplus is because of pension liabilities of the Delhi Government employees being paid by the Government of India and the expense of Delhi Police also comes under the same. Therefore, despite inheriting a revenue surplus state along with windfall gains due to GST, the revenue surplus has decreased in Delhi.

Moreover, this decrease coincides with a 122.48 per cent increase in grants in aid from the Government of India between 2015-16 and 2019-20. As per the revised estimates for 2021-22, this revenue surplus is expected to reduce to Rs 3,039 crore. On the overall fiscal situation, there has been steady expansion in debt by the Delhi government even as the city’s urban infrastructure has crumbled.

While the debt levels of Delhi and its overall revenue deficit numbers may not be alarming compared to other states such as Punjab or West Bengal, the pace of deterioration in Delhi’s finances is a sign of troubled times ahead.

In fact, many of these freebies have come at the expense of developmental work. The CAG report presented in the Delhi Assembly pulled up the Delhi Government for absence of a strategic plan to provide water and sewer in unauthorised colonies. Moreover, grants-in-aid received for the development of capital assets were irregularly diverted and utilised for other purposes, without the approval of the Urban Development Department.

In addition, the city’s public transportation infrastructure has also been on a decline, perhaps due to lack of adequate funds as the bus fleet has reduced from 6,342 buses to 3,910 in 12 years. Many irregularities have also been found regarding several state public sector undertakings and the increase in their losses over the last few years. These losses would invariably have to be borne by the state exchequer which would further constrain the ability of the Delhi government to invest in development of capital — either physical or human.

A scrutiny of the GNCTD’s finances would show the early signs of the fiscal costs associated with the “Delhi” model. These costs and fiscal drags are despite windfall gains due to increased devolution to states and introduction of the Goods and Service Tax. Freebies may deliver quick political results in the short run but in the medium to long run, they only impose economic costs. As the saying goes, the road to hell is paved with good intentions.

The author is a New York-based researcher who is pursuing PhD in Econometrics & Quantitative Economics. Views expressed are personal.

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