How freebies are wrecking the Indian economy

Several states have proposed incentives in their 2024-25 budgets, such as free electricity, transportation and financial allowances, observes The Squirrels' Editor Bhupendra Chaubey in the video above. These measures may potentially redirect funds away from critical social and economic infrastructure initiatives, as highlighted in an article from the Reserve Bank of India's (RBI) December bulletin titled "State Finances: A Study of Budgets of 2024-25."

The report indicates that the total outstanding liabilities of states amounted to 28.5% of GDP as of March 2024. Although this figure is lower than the peak of 31% recorded at the end of March 2021, it still significantly exceeds the prudential debt-to-GDP ratio of 20% established for states under the relevant legislation.

A state government's fiscal management indicator is the ratio of revenue expenditure (RE) to capital outlay (CO). Revenue expenditure, which encompasses costs such as salaries, wages, pension obligations and subsidies, primarily funds non-asset generating activities. In contrast, capital outlay is directed towards creating capital assets, thereby establishing a basis for future income streams. A greater focus on capital outlay is deemed fiscally responsible, while an overemphasis on revenue expenditure may result in fiscal instability. The performance of many states in this critical area is concerning. Total expenditure across all states rose from approximately Rs 34,28,000 crore in 2020-21 to an estimated Rs 57,60,000 crore in 2024-25. Revenue expenditure increased from Rs 30,18,000 crore in 2020-21 to Rs 48,40,000 crore in 2024-25, while capital outlay grew from Rs 4,10,000 crore in 2020-21 to Rs 9,20,000 crore in 2024-25. This data results in a revenue expenditure to capital outlay ratio (RECO) of 5.2 (48,40,000/9,20,000).

In various states, the RECO significantly exceeds the national average. For example, Punjab has a RECO of 17.1, which is more than three times the average, followed by Puducherry at 14.1, Kerala at 10.6 and Delhi at 10.3. Conversely, some states demonstrate better performance, such as Manipur, which boasts the highest ratio at 2.4, followed by Gujarat at 2.9 and Sikkim and Arunachal Pradesh at 3.1. Nevertheless, the exceptionally high RECO figures from certain states elevate the national average.

Regarding the comparison of state figures with those of the Centre, the total expenditure of the union government rose from Rs 30,42,000 crore in 2020-21 to Rs 48,20,000 crore in 2024-25. The revenue expenditure (RE) increased from Rs 26,03,000 crore in 2020-21 to Rs 37,09,000 crore in 2024-25. In contrast, the capital outlay (CO) grew from Rs 4,39,000 crore in 2020-21 to Rs 11,11,000 crore in 2024-25. Consequently, the RECO for the Centre stands at 3.3 in 2024-25 (37,09,000/11,11,000), compared to 5.2 for the states.

Aside from a few exemplary performers like Gujarat, which surpasses the Centre's performance, most states have exhibited imprudent revenue spending, particularly with a notable increase in subsidy expenditures.

Since 2018-19, state subsidies have surged 2.5 times, reaching over Rs 470,000 crore as per the budget estimate for FY 2024-25. The Reserve Bank of India (RBI) identifies farm loan waivers, free or subsidized services such as electricity, transportation, gas cylinders and cash transfers to farmers, youth and women as significant sources of emerging fiscal stress. The RBI advocates for states to implement "next-generation" fiscal rules, establish time-bound paths for fiscal consolidation and curtail subsidies and freebies to prevent them from overshadowing more productive expenditures. Such recommendations have been reiterated numerous times by the RBI and various government committees focused on expenditure reforms.

The Reserve Bank of India (RBI) anticipates that state governments will not only implement policy reforms and enhancements to more effectively target welfare schemes—primarily aimed at the impoverished segments of society—but also invigorate the administrative framework and institutions to ensure efficient delivery of benefits while preventing misuse or diversion through optimal utilization of technological interventions.

Do the states comprehend this expectation?

The response is a definitive ‘no’. Rather than establishing a well-structured system as envisioned by the RBI and various government committees, many states have resorted to implementing rudimentary and opaque subsidy systems, often referred to as freebies—essentially meaning “something provided at no cost”—designed to entice voters and secure electoral victories. Political parties have sought to encompass under this term virtually every aspect of an individual's life, including free food, healthcare, education, LPG cylinders, laptops, transportation and state assistance for marriages and pilgrimages for senior citizens; the list is extensive.

In recent years, the promises of freebies have become increasingly audacious, with parties introducing ‘cash transfers’ directly to voters' accounts. These initiatives, primarily targeting women, have proven successful in securing electoral victories for the respective parties in the elections held in 2023 and 2024 across Madhya Pradesh, Rajasthan, Chhattisgarh, Maharashtra, Jharkhand and Haryana. The competition among parties has intensified, with a prevailing question being, “Who will offer more?”

In the budget for 2024-25, for instance, the finance minister of Delhi, Atishi, unveiled the Mukhyamantri Mahila Samman Yojana (MMSY), under which the AAP government will provide Rs 1,000 per month to all women over the age of 18 in the national capital. Subsequently, former Chief Minister Arvind Kejriwal has raised this amount to Rs 2,100 per month.

The BJP has reportedly committed to an even higher cash transfer of Rs 2,500 per month. In contrast to standard budgetary expenditures, which are strategically planned and supported by organized revenue generation efforts, the additional financial burdens introduced by the promised freebies in the election manifesto disrupt the state's budgetary framework in an entirely unregulated and unplanned fashion. Furthermore, these freebies lack a defined expiration, implying that they will persist indefinitely, regardless of which party is in power. This situation poses a significant risk of fiscal disaster.

Consider the situation in Delhi. Currently, even without the implementation of the MMSY, the financial condition of the Delhi government has deteriorated to the extent that Chief Minister Atishi has recently submitted a request to the Centre for a loan of Rs 10,000 crore from the National Small Savings Fund (NSSF). Should the AAP regain power, the MMSY, at a rate of Rs 2,100 per month, would impose an additional annual cost of Rs 17,000 crore on the treasury.

Since the fiscal year 2018-19, state subsidies have surged 2.5 times, exceeding Rs 470,000 crore by 2024-25, largely due to the culture of freebies. This trend is expected to escalate dramatically, undermining state budgets and rendering the much-publicized fiscal consolidation efforts ineffective. The Supreme Court has repeatedly remarked that "freebies are detrimental." Will this prompt lawmakers to pass legislation to limit them?