Sub-National Development Policy Lending (DPL) in South Asia

Deepak Mishra

South Asia PREM (SASPR) Unit

The Rationale for Sub-National DPLsin South Asia

I. Legislative power vs. Revenue allocation between

Center and States*

II. In the late 1990s, the States were in a fiscal crisis; Public finance

of the Center was weak

III. Impact worse in poorer states; Can MDGs be met?

WB/ADB stepped in to fill the fiscal

gap of SGs

*Note on terminologyIndia: Center and StatesPakistan: Federation and Provinces

I. Separation of Legislative Powers

Union or Federal

List

Concurrentor Joint

List

State or Province

List

Legislative powers of the government, that is the power to make laws on a specific subject, are separated by means of the three lists - union list, state list and concurrent list. Local Government

India: 97 subjects in UL; 66 in SL and 47 in CL Pakistan: 57 subjects in FL; 47 in CL and rest in the PL

I. Vertical Imbalance: revenue allocation vs. the legislative division of power

Expenditure and Revenue Position of India's Central Government

0%

2%

4%

6%

8%

10%

12%

14%

16%

1985

–86

1987

–88

1989

–90

1991

-92

1993

–94

1995

–96

1997

–98

1999

-00

2001

-02

2003

-04

Center's Revenue / GDP

Center's Expenditure / GDP

Expenditure and Own Revenue Position of Indian State Governments

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1985

–86

1987

–88

1989

–90

1991

-92

1993

–94

1995

–96

1997

–98

1999

-00

2001

-02

2003

-04

State's Ow n Revenue / GSDP

State's Expenditure / GSDP

Need for a Fiscal Transfer (India)

The vertical imbalance is more pronounced in Pakistan as its provinces don’t have access to VAT/GST.

II. Indian States faced a fiscal crisis in the late nineties……

State fiscal deficit: poor and 11 major states

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

85-8

6

86-8

7

87-8

8

88-8

9

89-9

0

90-9

1

91-9

2

92-9

3

93-9

4

94-9

5

95-9

6

96-9

7

97-9

8

98-9

9

99-0

0

00-0

1

01-0

2

02-0

3 R

E

Per

cen

t o

f G

DP

Poor States

O ther States

II. This reduced the developmental role of the state governments…

Aggregate expenditure trends for India’s states as a percentage of GDP

9

10

11

12

13

14

15

16

91-9

2

92-9

3

93

-94

94

-95

95

-96

96-9

7

97-9

8

98-9

9

99-0

0

00

-01

01

-02

Pe

rce

nt

Total expenditureExpenditure excluding interes t and pensionsExp. Excl. in t., pensions & cost of 5th CPC

II. The situation was not too different in the Pakistani Provinces

Pakistani Provinces: Expenditure in Social and Community Services(% of GSDP)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

2003

/04

2004

/05

Punjab

Sindh

III. The developmental impact of the crisis felt disproportionately in the poorer states…

Low Income States Other States 1990/91- 1996/97 1996/97- 2000/01 1990/91- 1996/97 1996/97- 2000/01 Education 2.8% -0.2% 3.3% 2.6% Health 2.2% -2.6% 2.8% 0.3% Irrigation maintenance 2.6% -2.0% 6.0% 4.5% Roads maintenance 1.5% 1.0% 0.4% 5.0% Capital Expenditure -4.4% 2.9% 3.8% 7.6%

Average real growth rates of expenditures in some key sectors

(Low-income and other major India States)

Notes: Education and health expenditure also adjusted for cost of 5 th Pay Commission Salary Increases

Experience so far ….

Sub-National DPLs in India

Uttar Pradesh -2000; $250m

Karnataka – 2001 & 2002, $150m & $100m

AP- 2001 & 2004; $250m & $220 m

Orissa - 2005; $200m

ADBWB

Sub-National DPLs in Pakistan

Sindh -2001; $100m

North West Frontier Province2002, 2004, 2006

$90m, $90m, $90m

WBADB

Overarching ObjectiveCreate a conducive environment

for rapid and sustained growth with poverty reduction

I. Fiscal Adjustment and Reforms

V. SectoralReforms, e.g.

power/education

IV. Public Sector

Reforms

II.ImprovingInvestment

Climate

Objective and Program Coverage of DPLs•Tax policy & administration•Budget management•Expenditure rationalization•Protection of social sec. expd.•Financial management

•Disinvestments / Privatization

•Entry and Exit restrictions•Agricultural marketing

•Labor market reform

•Civil service reforms: (VRS, Transfers, Anti-corruption)•Service delivery: (Right to information, e-governance, procurement reforms)

•Reducing Cross-subsidy•Unbundling / Corporatization•Metering and reducing T&D losses

III. Poverty Monitoring

•Monitoring &Evaluation•Quarterly IIP •GSDP forecasting

Indian Experience

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

T-3 T-2 T-1 T T+1 T+2 T+3

Post-SALPre-SAL

UP: 2000

Karnataka: 2001

Andhra Pradesh: 2001

Beginning of Bank's involvement in the State(I.e. one year priorto the actual

disbursement of the loan)

•Sharp increase in consolidated deficit prior to the DPLs•Gradual but systematic reduction afterwards•In the medium-term, the size of fiscal corrections in AP and KN are almost identical

1. Significant and Systematic Reduction in Consolidated Deficit to GSDP ratio in All SAL States

UP: 2.46%

KN:2.94%AP: 2.07%

0%

1%

2%

3%

4%

5%

6%

7%

8%

T-3 T-2 T-1 T T+1 T+2 T+3

Post-SALPre-SAL

Consolidated Deficit to GSDP

Beginning of Bank's involvement in the State(I.e. one year prior to the actual

disbursement of the loan)

Fiscal Deficit to GSDP

Primary Deficit to GSDP

Revenue Deficitto GSDP

2. Considerable Decline in All Forms of Deficit Between the Pre- and Post-DPL Periods

• Sharp correction in consolidated (fall in power sector borrowing) and primary deficits • The decline in revenue and fiscal deficit is less steep due to growing interest payments and conscious decision to protect capital expenditure

Capital Expenditure to GSDP

Interest Payments to GSDP

3. Impressive Gains in Power Sector Reform

5.0

2.0

5.0

7.3

6.8

3.5

4.5

12.6

8.5

13.0

10.0

12.5

13.5

8.0

0.0

13.0

10.0

15.0

2.0

2.0

11.5

11.0

16.0

16.0

15.0

18.0

6.5

11.0

8.0

8.6

8.5

16.0

18.0

14.1

15.0

13.5

14.5

14.0

19.0

10.0

18.5

7.0

6.5

10.6

19.5

19.5

11.3

22.0

17.0

19.5

22.0

17.0

2.0

1.0

0.0

3.5

2.0

4.0

3.5

2.0

3.5

4.5

4.0

4.5

4.0

0 10 20 30 40 50 60 70 80

MP

Kerala

Orissa

WB

UP

Punjab

Tamil nadu

Gujarat

Maharashtra

Haryana

Rajsthan

Karantaka

AP

State government related parameters

SERC-related parameters

Business risk analysis

Financial risk analysis

Others

(Power Sector Ratings of Selected States)

Source: ICRA-CRISIL Study commissioned by Ministry of Power, GoI

Substantial increase and rebalancing of power tariff rates; Unbundling in KN; Anti-theft drive in AP

4. Less Tangible Benefits of DPLs: Higher Credit Ratings

0

2

4

6

8

10

12

14

16

1996 1997 1998 1999 2000 2001 2002

Maharashtra

Gujarat

AP

Karnataka

CRISILRatings

(Default )

AAA

AA

A+

BBB

BB+

BB-

C

Credit Ratings of Selected Indian States, 1996-2002

Source: CRISIL

States with DPLs

States without DPLs

5. Some of the Major Policy changes brought about by the DPLs

Fiscal Sustainability MeasuresFiscal Responsibility Act (Karnataka, later emulated by Tamil Nadu, Punjab and Kerala; similar decision has also been announced in UP )

Fully developed MTFPs; Departmental MTEFs (Karnataka)

Improvements in budget execution (e.g. timely cash release in AP, public investment spending reallocation in Orissa)

Parametric pension reforms (TN and KN) and defined contribution pension scheme for new staff (TN)

5 (contd.). Some of the Major Policy changes brought about by the DPLs

Investment Climate MeasuresSingle Window Clearance Act (AP)

Amendment to Contract Labor Act (AP)

Karnataka Industry Facilitation Act (Karnataka)

Public transport deregulation (Karnataka)

Governance reformsRight to Information Act made effective (Karnataka)

Strengthened anti-corruption enforcement (AP)

Criticism of Sub-national DPLs

Can’t deal with aggregate / national-level shocks?

Unwieldy in coverage of sectors / areas

Difficult to undertake a pure technical assessment of all triggers

Pushing neo-liberal policies through backdoor

Political fall-out: SGs that were the most active borrowers of DPLs in India lost elections

Summary (India)

Pros

Significant and systematic fiscal improvements

Benefits go beyond fiscal adjustment - Impressive gains in power sector reform; Other benefits

Major policy / legislative changes brought about by the DPLs that are expected to make state-level reforms in India more durable

Cons

Not everyone is convinced about the superiority of DPLs vs. Investment loans.

Policy reforms supported by DPLs are highly unpopular

Victim of its own success!

Pakistani Experience

Considerably Different Experience than India

DPLs enjoy high political support

Three successive DPLs to NWFP is some sort of a record in the Bank’s history

Almost 70 percent of loans / credits to Pakistan are now being channeled through DPLs

DPLs / DPCs in education, irrigation, health sector etc.

Sindh experience however shows that change of government continues to remain one of the main risk to the sustainability of DPLs

Lessons from Sub-National DPLs

Have full clarity in the division of legislative power between different layers of government

Need for greater transparency and objectivity in policy-based budget support instruments

Work across both sides of the political aisle to get bipartisan support for policies being supported by DPLs