## 1indea2020001 — Visit to Chennai, Tamil Nadu, December 3–December 17, 2019 ## Source details **Canonical URL:** [1indea2020001 — Visit to Chennai, Tamil Nadu, December 3–December 17, 2019](https://www.imf.org/-/media/files/publications/cr/2020/english/1indea2020001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1indea2020001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1indea2020001.pdf.json) --- ### Mission, stakeholders, and purpose - At the request of the Tamil Nadu State authorities, a team from the IMF’s Fiscal Affairs Department (FAD) and SARTTAC visited Chennai, Tamil Nadu, from December 3–December 17, 2019, to review and provide advice on Tamil Nadu State’s public financial management (PFM) reforms, notably budget formulation and fiscal risks. - Mission leadership and composition: - Team led by Lesley Fisher (SARTTAC); comprised Murray Petrie, Gemma Preston, and Claude Wendling (IMF FAD Experts). Andrew Ceber (SARTTAC) joined on December 16–17. Mr. Sukhwinder Singh (Director, SARTTAC) attended meetings on December 9–10. - Mr. S. Krishnan, IAS, Additional Chief Secretary to Government (ACS), Finance Department, briefed and received the mission. - Stakeholder engagement included senior Finance Department officers, officials from other agencies involved in budget formulation and fiscal risks, senior officials from line ministries, senior representatives from several Public Sector Undertakings (PSUs) including TANGEDCO, a meeting with the Accountant General of Tamil Nadu, and attendance at an IFHRMS presentation. ### Key findings — fiscal performance and practices - Fiscal rules and outcomes: - Tamil Nadu has largely observed the Fiscal Responsibility Act targets on debts and deficit (25 percent and 3 percent to GSDP, respectively) except during the electricity bailout in 2016–17. - Exception: deficit reached 4.4 percent of GSDP in 2016/17 due to UDAY-related bailout (loan to TANGEDCO). - Sources of meeting targets: - Controlling and delaying expenditure. - Underallocating mandated payments to various reserve funds. - Allowing off-budget borrowing by PSUs. - Composition and constraints: - More than 63 percent of the State’s spending on current items is committed to salaries, pensions, and interest payments. - Gross State government debt remains slightly below 25 percent of GSDP. - Limited fiscal space to address priorities in education, health, electricity, roads, water, and growing infrastructure pressures. - Climate change likely to exacerbate fiscal risks from water stress and natural disasters. ### Budget formulation and credibility — findings - Process characteristics: - Budget formulation is annual, bottom-up, incremental, control-oriented, and focused on approving/controlling spending. - Budget calendar compressed into six months (in practice five months in some descriptions); departments have brief windows (three weeks in September) to prepare requests. - Revenue estimates adjusted to meet unrealistic expenditure estimates; revenue estimates typically 15–20 percent higher than actual outturns. - Frequent reallocations with up to three supplementary budgets in some years. - Institutional capacity: - Finance Department (FD) has experienced and skilled staff capable of building macrofiscal forecasting, top-down budgeting, budget challenge function, and fiscal risk management. - Planned IFHRMS implementation could accelerate modernization: streamline information exchanges, facilitate multiyear expenditure forecasting, and allow performance examination with the budget. ### Fiscal risks, PSUs, and quasi-fiscal activities — findings - PSU performance and systemic risks: - Finances of some large PSUs are on an unsustainable path despite significant fiscal support. - Sectors with large losses: electricity and transport. - Under UDAY (2016–17) the Government loaned INR 228 billion to TANGEDCO as an interest-free loan, to be converted into a grant over five years; this added 1.8 percent of GSDP that year to the fiscal deficit. - PSU financial indicators and examples: - Historical PSU profits (INR, 2013–14 to 2016–17): 7.18; 7.12; 8.98; 8.27 - Historical PSU losses (INR, 2013–14 to 2016–17): 13.59; 24.95; 28.27; 31.13 - Passenger Transport Group negative net worth: INR 90.47 billion in 2013–14 and INR 164.79 billion in 2016–17. - Around 40 percent of eligible electricity customers have opted for alternative suppliers (open access). - Drivers of PSU losses / noncommercial obligations: - Selling services below cost (electricity tariff not adjusted since 2014; bus fares lag costs). - Free services to defined beneficiaries (e.g., free electricity to farmers). - Cross-subsidies and cross-subsidy surcharges on business customers. - Use of PSUs for off-budget borrowing and accumulation of arrears by government departments. - Unquantified fiscal cost of noncommercial obligations and lack of disclosure in budget documents. - Consequences: - Ongoing annual losses, increasing negative net worth, arrears to solar, thermal, and wind producers; need for periodic large injections of fiscal support. - Risk of erosion of tax base as business customers switch to private suppliers. - Potential vicious cycle: reduced investment, poor service quality, resistance to paying for services. ### Fiscal risk disclosure and monitoring — findings - Current disclosure: - Detailed disclosure exists for guarantees, loans, and PSUs; limited disclosure for macroeconomic risks, legal claims, and pension liabilities. - Guarantees increased sharply in 2018–19; available data for 2018/19 (INR billion): - Total Outstanding Guarantees as of March 31, 2018: 361.3 - As a share of revenue receipts: 24.7% - As a share of GSDP: 2.5% - Ratio of GRF to outstanding guarantees: 0.7% - New Guarantees issued in 2018–19: 188.2 - Share of new guarantees to existing stock: 52.0% - Share of new guarantees issued to TANGEDCO: 97.0% - Gaps: - No comprehensive fiscal risk statement; reporting is largely historical and backward-looking. - No systematic records or public data on expenditure arrears, legal claims, or full cost of PSU noncommercial activities in budget documents. - Debt management lacks a medium-term debt management strategy and formal debt sustainability analysis. - Pension liabilities not actuarially calculated; rate of return on government financial assets (percent): 0.2 (2013–14); 0.62 (2016–17); 0.45 (2017–18). Government average rate of borrowing: 8.53 percent in 2017–18. - Revenue arrears as of March 31, 2018: INR 301 billion (32 percent of SOTR and 75 percent of the fiscal deficit). - Quantified cost of tax exemptions reported as INR 200 million in 2017–18. ### Budget execution, committed expenditure, and fiscal space — key statistics and trends - Revenue and deficit evolution (INR, bn and percent): - Total revenue receipts: 2013/14 1,080 ; 2014/15 1,224 ; 2015/16 1,290 ; 2016/17 1,402 ; 2017/18 1,463 - Total revenue deficit: 2013/14 -18 ; 2014/15 -64 ; 2015/16 -120 ; 2016/17 -130 ; 2017/18 -216 - Revenue deficit (% of total receipts): 2013/14 -1.7 ; 2014/15 -5.2 ; 2015/16 -9.3 ; 2016/17 -9.3 ; 2017/18 -14.8 - Committed expenditure (INR, bn and percent): - Committed Revenue Expenditure: 2013/14 665 ; 2014/15 753 ; 2015/16 833 ; 2016/17 948 ; 2017/18 1,063 - Total Revenue Expenditure: 2013/14 1,098 ; 2014/15 1,288 ; 2015/16 1,410 ; 2016/17 1,532 ; 2017/18 1,679 - Committed Expenditure to Total (%): 2013/14 60.6 ; 2014/15 58.5 ; 2015/16 59.07 ; 2016/17 61.9 ; 2017/18 63.3 - Revenue performance: - Tamil Nadu contributes around 8.8 percent to India GDP (2016/2017). - Per capita GSDP (USD): Tamil Nadu 2,548 ; India 1,399. - Economic growth averaged more than 7 percent from 2011 to 2019; India average 7.1 percent. - State’s own tax buoyancy with respect to GSDP ranged from 0.26 to 0.84 over the past five years and stood at 0.74 in 2017–18. - Liquor taxes: 20 percent of SOTR in some context; in 2017–18 taxes on alcohol comprised 28 percent of the SOTR. SOTR made up 89 percent of total revenues in 2017–18. - Debt repayment schedule and exposures: - During 2021–22 to 2024–25, 31.81 percent of the current outstanding debt—totaling INR 918.5 billion—will become due for repayment. - Consolidated Sinking Fund (CSF) balance as of March 31, 2018: INR 58.66 billion (approximately 2 percent of total debt); CSF requires annual contribution of 0.5 percent of outstanding liabilities at end of previous financial year. ### Reform recommendations — summarized (short term / medium term / technical assistance as indicated) - Organization and capacity - Request a FAD mission to evaluate and upgrade FD capacity. Short term: ✔ - Develop macrofiscal unit and a fiscal risk management unit in FD; FD to assume coordination within a cross-departmental committee with clear deadlines and shared assumptions. - IMF technical assistance recommended to evaluate FD functions and support reorganization. - Strengthening macrofiscal forecasting and medium-term frameworks - Develop macrofiscal capability within FD, supported by SARTTAC. Short term: ✔ ; Medium term: ✔ - Implement a medium-term fiscal framework (MTFF) to anchor budget formulation. Short term: ✔ ; Medium term: ✔ - Extend budget calendar to introduce macrofiscal forecasting (April–June) and allow departments at least two months to prepare proposals after ceilings communicated. Short term: ✔ - Annual and medium-term budgeting, top-down approach, and budget challenge - Introduce a budget challenge function to improve credibility of annual estimates. Medium term: ✔ - Seek political mandate for transition to top-down budgeting; pilot with select departments. Short term: ✔ ; Medium term: ✔ ; Technical Assistance: ✔ - Gradually introduce medium-term budgeting once annual estimates improve. Medium term: ✔ ; Technical Assistance: ✔ - Publish a brief citizens’ budget alongside the budget 2020–21. Short term: ✔ - Develop a fiscal strategy report based on macrofiscal forecast with budget 2021–22. Medium term: ✔ ; Technical Assistance: ✔ - Fiscal risk management and PSUs - Require TANGEDCO and the Transport Passenger Group to prepare three-year financial forecasts and estimates of costs of noncommercial obligations. Short term: ✔ - Instruct TANGEDCO to file for a tariff increase as soon as practicable. Short term: ✔ - Appoint external professional advisers to analyze accounts of TANGEDCO and the Transport Passenger Group and identify beneficiaries of subsidized prices. Short term: ✔ - Include progressively in the budget the full costs of meeting noncommercial obligations in energy and transport. Medium term: ✔ ; Technical Assistance: ✔ - Conduct a debt sustainability analysis; develop a medium-term debt management strategy within Ways and Means. Short term: ✔ ; Technical Assistance: ✔ ; Medium term: ✔ - Review legal framework for PPPs to ensure formal budget gatekeeper role for each proposed PPP; FD to instruct line departments to maintain registers of expenditure arrears and legal actions. Short term: ✔ ; Technical Assistance: ✔ ; Medium term: ✔ - Fiscal risk reporting and institutional arrangements - Establish a central fiscal risk function within FD. Short term: ✔ - Develop a comprehensive approach to fiscal risk reporting, including in-year reporting using a fiscal risk register as a starting point. Short term: ✔ ; Technical Assistance: ✔ - Publish a Fiscal Risk Statement with the budget documents. Short term: ✔ ; Medium term: ✔ - Introduce fiscal risk disclosure requirements into the TNFRA 2003. Short term: ✔ ; Medium term: ✔ ### Practical tools, sequencing, and templates - Medium-Term Fiscal Framework / Fiscal Strategy Report: - Fiscal strategy report should be produced by late August as a pre-budget statement when aggregate resource envelope determined and should include: macroeconomic environment, fiscal outturns and assumptions, medium-term fiscal targets and assumptions, aggregate and sectoral expenditure ceilings, and qualitative/quantitative fiscal risk assessment. - Short-term action: Publish a brief citizens’ budget alongside budget 2020–21. - Medium-term action: Develop fiscal strategy report with budget 2021–22. - Fiscal risk register and phased Fiscal Risk Statement: - Short term: qualitative fiscal risk register covering main risks and sensitivity analysis of revenue/expenditure variances versus outturns; publish qualitative discussion of PSU financial performance and quasi-fiscal activities; publish list of approved PPP projects with qualitative discussion. - Medium term: publish quantitative sensitivity analysis and PSU financial risk ratios; quantify PPP multiyear liabilities; publish pension obligation analysis. - Longer term: assess linkages among risks, probabilistic scenarios, full disclosure of legal claims above materiality thresholds. - Quantifying quasi-fiscal costs (illustrative approaches) - Example A (reduced rail tariff): Student fare tickets sold in 2015: 23,000 ; assumed price elasticity: zero ; estimated cost of 2015 quasi-fiscal activity: $17,250 = 23,000 × $0.75. - Example B (subsidized bus route): Operating costs 2015: $56 million ; Interest paid: $4 million ; Ticket sales: $20 million ; Average surplus on other routes: 10 percent of ticket sales ; Estimated economic cost 2015: $56 + $4 – $20 = $40 (millions) ; Compensation paid 2015: $46 (millions) = ($56 + $4) × 1.1 - $20. ### Governance, monitoring, and systems modernization - IFHRMS: - New IFHRMS being developed; will provide platform for real-time payroll and non-payroll expenditure data, enable automated budget submissions, minimize manual errors, and facilitate greater scrutiny and multiyear forecasting. - Budget Challenge Function: - Current status: compliance challenge aspects exist; policy challenge function is almost totally absent. - FD should shift from execution/control focus to a budget challenge role emphasizing policy relevance, value-for-money, and forward-looking scrutiny. - Annex I provides checklist and guidance for standard expenditure analyses and policy-oriented questions. - PSU oversight: - FD should require PSUs to seek prior approval for investment plans and report in-year (for example, quarterly) to FD and line departments. - BPE capacity needs medium-term strengthening to provide forward-looking oversight. *IMF mission report: PREFACE (1indea2020001) — Visit to Chennai, Tamil Nadu, December 3–December 17, 2019* ### PREFACE _________________________________________________________________________________________ 5 ### PREFACE ### Mission and purpose - At the request of the Tamil Nadu State authorities, a team from the IMF’s Fiscal Affairs Department (FAD) and the IMF’s South Asia Regional Training and Technical Assistance Center (SARTTAC) visited Chennai, Tamil Nadu, from December 3–December 17, 2019, to review and provide advice on Tamil Nadu State’s public financial management (PFM) reforms, notably with respect to budget formulation and fiscal risks. - The mission team was led by Lesley Fisher (SARTTAC) and comprised Murray Petrie, Gemma Preston, and Claude Wendling (all IMF FAD Experts). Andrew Ceber (SARTTAC) joined the mission on December 16–17. Mr. Sukhwinder Singh, Director of SARTTAC, attended mission meetings on December 9–10. - Mr. S. Krishnan, Indian Administrative Service (IAS), Additional Chief Secretary to Government (ACS), Finance Department, briefed the team at the beginning of the mission and received the mission team at the end for a wrap-up meeting and handover of a draft technical assistance report. ### Stakeholder engagement (meetings held) - Senior Finance Department officers, including: M. A. Siddique, IAS; Dr. R. Anandakumar, IAS; P. Kulkarni, IAS; H. Krishnanunni, IAS; M. Arvind, IAS; S. Arunraj, IAS; S. Girirajkumar; M. Raja; C.R. Balaji; T.V. Permgopal. - Officials from other agencies involved in budget formulation and fiscal risks, including: Dr. T. V. Somanathan, IAS; K. Ravichandran; K. Gnanasekaran; B. Arun Satya; B. Geetha; S. Senthu Baskar; Dr. K. Radhakrishnan; Dr. P. Balasubramanian; D. S. Barathi; D. Sridhar; P. Velusamy; R. Muthukumar; K. Selvakumar; D. Mahesh Babu; P. G. Babu. - Senior officials from line ministries: Dr. K. Manivasan, IAS; Dr. P. Umanath, IAS; Dr. Swathi; Dr. Narayana Babu; N. Muruganandam, IAS; Dheeraj Kumar, IAS. - Senior representatives from several Public Sector Undertakings: Vikram Kapur, IAS (ACS, Chairman and Managing Director, TANGEDCO); representatives from TANGEDCO and Tamil Nadu Transmission Corporation; J. Kumaragubaran, IAS; P. Annamalai, IAS; M. Gnanasekaran; K. Sekar. - A meeting with Mr. Jaisankar (IA&AS), the Accountant General of Tamil Nadu, and his team. - Attendance at a presentation of the new Integrated Financial and Human Resource Management System (IFHRMS) by M. Srinivasa Ragavan, Programme Head for Wipro. ### Acknowledgements - The mission thanked State government officials for hospitality and cooperation and expressed special thanks to H. Krishnanunni and his team, in particular Mr. R. Narasimha Ragavan, for organizing the mission, setting up meetings, and providing documentation. ### Key findings from the Executive Summary - Fiscal performance and practices - Tamil Nadu has largely observed the Fiscal Responsibility Act targets on debts and deficit (25 percent and 3 percent to GSDP, respectively) except during the electricity bailout in 2016–17. - The targets appear to have been met by: (1) controlling and delaying expenditure, (2) underallocating mandated payments to various reserve funds, and (3) allowing off-budget borrowing by Public Sector Undertakings (PSUs). - More than 63 percent of the State’s spending on current items is committed to salaries, pensions, and interest payments. - The State’s borrowing capacity is restricted, leaving limited fiscal space to address high priority needs in education, health, electricity, roads, and water sectors, and growing infrastructure pressures. - Climate change is likely to exacerbate fiscal risks from water stress and natural disasters. - Budget formulation and credibility - Budget formulation practices are incremental, have weak links to resource availability, and focus on approving and controlling spending. - The budget calendar is compressed into six months, leaving departments inadequate time to develop credible estimates. - Revenue estimates are adjusted to meet unrealistic expenditure estimates and are not informed by an actual assessment of revenue potential. - The budget is characterized by frequent reallocations, with up to three supplementary budgets in some years, undermining credibility and the exercise of the “challenge function.” - Institutional capacity and systems - The Finance Department is well-positioned to address budget formulation challenges, with experienced and skilled staff capable of developing macrofiscal forecasting, top-down budgeting, a budget challenge function, and fiscal risk management. - The planned implementation of IFHRMS could accelerate modernization by streamlining information exchanges, facilitating multiyear expenditure forecasting, and introducing examination of performance outcomes with the budget. - Fiscal risk management and PSUs - Urgent attention required to avoid recurring crisis in the electricity industry and problems in the passenger transport sector. - Imbalance between electricity revenue and tariff costs has produced funding gaps at Tamil Nadu Generation and Distribution Corporation Limited (TANGEDCO): ongoing annual losses; increasing negative net worth; and arrears to solar, thermal, and wind producers. - Consider bringing in professional advisors to assist reform of electricity and passenger transport sectors and to quantify quasi-fiscal activities (e.g., free electricity to farmers). - Untargeted electricity and passenger subsidies add to PSU fiscal stress. - Tamil Nadu Infrastructure Development Board (TNIDB) needs further government capacity to manage PPPs and monitor fiscal risks from a pipeline of 169 new planned PPPs; PSUs currently rely on consultants to evaluate PPP proposals. - Finance Department should review the legal framework for PPPs to ensure an adequate formal budget gatekeeper role for each proposed PPP project. - Large PSUs in electricity and transport prepare only annual budgets and do not provide in-year reports to oversight departments on fiscal pressures; ex-ante monitoring of PPPs, PSUs, local government debt, and major legal claims is recommended. - Other areas requiring closer scrutiny and regular reporting: natural disasters, pensions, off-budget borrowing. - Fiscal risk disclosure - Comprehensive fiscal risk reporting and disclosure is in its infancy; complete picture of risks is not yet built. - Detailed disclosure exists in some areas (guarantees, loans, PSUs), limited disclosure in others (macroeconomic risks, legal claims, pension liabilities). - Reporting fiscal risks helps understand sources, likelihood, and potential fiscal impact, and supports targeted mitigation. - With the State reaching debt limits, future surprises (bailouts of PSUs and local governments) will be difficult to accommodate without active and comprehensive management. - The 2003 Tamil Nadu Fiscal Responsibility Act could be amended to require disclosure of more information on fiscal risks. - Developing a fiscal risk register and publishing a fiscal risk statement are recommended steps. ### Recommendations summary (reproduced from Table 1) - Organization of the Finance Department (FD) - Request a FAD mission to evaluate and upgrade the capacity and capability of the FD to implement reforms. Short term: ✔ - Reinforcing budget credibility — Strengthening macrofiscal forecasting - Develop the capacity, supported by SARTTAC, to create a macrofiscal capability within the FD. Short term: ✔; Medium term: ✔ - Implement a medium-term fiscal framework to anchor the overall budget formulation process. Short term: ✔; Medium term: ✔ - Annual and medium-term budgeting - Extend the budget calendar, to introduce macrofiscal forecasting (April-June) and update regularly. Short term: ✔ - Introduce a budget challenge function to improve the credibility of annual budget estimates. Medium term: ✔ - Seek a political mandate for a transition to a top-down budgeting process. Short term: ✔ - Pilot the process with selected departments, e.g., industry, and provide them with spending ceilings in exchange for reliable estimates. Medium term: ✔; Technical Assistance: ✔ - Gradually introduce medium-term budgeting, once annual budget estimates improve. Medium term: ✔; Technical Assistance: ✔ - Publish a brief citizens’ budget alongside budget 2020–21. Short term: ✔ - Develop a fiscal strategy report based on the macrofiscal forecast with budget 2021-22, and gradually improve the quality and content of the report. Medium term: ✔; Technical Assistance: ✔ - Fiscal risk management — Managing exposure to fiscal risk - Establish an FD requirement that TANGEDCO and the Transport Passenger Group prepare three-year financial forecasts and estimates of costs of their noncommercial obligations. Short term: ✔ - Implement an FD decision to seek an immediate government decision to instruct TANGEDCO to file for a tariff increase. Short term: ✔ - Appoint external professional advisers to analyze accounts of TANGEDCO and the Transport Passenger Group, identify beneficiaries of subsidized prices, and report options for turning around the companies’ finances. Short term: ✔ - Include progressively in the budget the full costs of meeting noncommercial obligations in the energy and transport sectors. Medium term: ✔; Technical Assistance: ✔ - Build gradual capacity to provide forward-looking oversight of the energy and transport sector PSUs. Short term: ✔ - Request IMF support to develop and implement a medium-term revenue strategy. Short term: ✔; Technical Assistance: ✔ - Conduct a debt sustainability analysis. Short term: ✔; Technical Assistance: ✔ - Develop a medium-term debt management strategy within Ways and Means unit. Short term: ✔; Medium term: ✔ - Implement review of legal framework for PPPs to include a formal budget gatekeeper role with respect to each proposed PPP project. Short term: ✔; Technical Assistance: ✔ - Instruct all line departments to maintain registers of expenditure arrears and legal actions, and report the information to FD. Short term: ✔; Technical Assistance: ✔ - Introduce system of monitoring finances of local governments. Short term: ✔; Medium term: ✔ - Fiscal risk reporting - Establish a central fiscal risk function within FD. Short term: ✔ - Develop a comprehensive approach to fiscal risk reporting, including in-year reporting using a fiscal risk register as a starting point. Short term: ✔; Technical Assistance: ✔ - Publish a Fiscal Risk Statement with the budget documents. Short term: ✔; Medium term: ✔ - Introduce fiscal risk disclosure requirements into the TNFRA. Short term: ✔; Medium term: ✔ ### Capacity and technical assistance needs - The Finance Department needs further capacity enhancement, including establishing a macrofiscal unit and a fiscal risk management unit. - IMF technical assistance is recommended to evaluate current FD functions and identify necessary reorganization to shift from traditional spending control to strategic functions, including fiscal oversight and monitoring policies. - The State would require approval from the Department of Economic Affairs to develop a workplan supported by SARTTAC. *IMF mission report: PREFACE (1indea2020001) — Visit to Chennai, Tamil Nadu, December 3–December 17, 2019* ### 1. Tamil Nadu’s economy and public finances compare favorably to other Indian States. ### 1. Tamil Nadu’s economy and public finances compare favorably to other Indian States. ### Current situation - Tamil Nadu contributes around 8.8 percent to the overall GDP of India (2016/2017). - The economy is diversified, with a significant industrial base and a per capita GSDP that is more than 80 percent above the Indian average. - Per capita GSDP (in USD) is 2,548 in Tamil Nadu, as opposed to 1,399 for India as a whole. - Economic growth averaged more than 7 percent from 2011 to 2019, similar to an average of 7.1 percent for the whole of India. - Gross State government debt remains slightly below 25 percent of GSDP. - The Tamil Nadu Fiscal Responsibility Act (TNFRA 2003, amended in 2017) provides: - a debt-to-GSDP ceiling of 25 percent; and - a deficit ceiling of 3 percent. - These fiscal rules have been generally adhered to, except in 2016/2017 when the deficit reached 4.4 percent of GSDP due to the bailout of Tamil Nadu Generation and Distribution Corporation (TANGEDCO) under the Ujwal DISCOM Assurance Yojana (UDAY). - The TNFRA requires a Medium-Term Fiscal Plan (MTFP) with multiyear rolling targets, underlying assumptions, and elements on fiscal performance and prospects. ### Fiscal and fiscal-framework weaknesses - The MTFP appended to the 2019–20 budget: - provides projections two years beyond the next year’s budget (advanced estimates, AE) but lacks detail on assumptions; and - presents nominal growth assumptions (nominal growth increasing from 8 percent in 2019/20 to 10 percent in 2020/21 and 2021/22) that are not explicitly presented or defended. - Significant discrepancies exist between AE and actual outturns: - revenue collection has typically been 15–20 percent lower than advanced estimates. - Macro- and fiscal-forecasting capacity is limited: - Directorate for Economics and Statistics produces GSDP estimates twice a year (July and January), but no entity is tasked with producing a macroeconomic framework for the State and assessing fiscal implications. - Current projections often derive from an iterative process led by the Finance Department (FD) that adjusts revenue forecasts to meet broad fiscal targets. - Specific inconsistencies noted: - State Own Tax Revenue (SOTR) scenario in the MTFP 2019–22 assumes nominal growth of 13 percent per year despite consistently much lower nominal GSDP growth. - Liquor taxes constitute 20 percent of the SOTR and face downward pressures (including closure of 500 State-run alcohol shops and restricted opening hours). - The MTFP preparation appears driven more by legal compliance than by strategic budget formulation. ### Key risks and uncertainties - Any slowdown in the national economy may adversely affect Tamil Nadu’s industrial sector, reducing income and government revenues. - The end of the Goods and Services Tax (GST) compensation planned for 2022 could further strain finances. - A reduced share of central government transfers anticipated in the 15th Finance Commission recommendations may exert further pressure on the State’s fiscal position. ### Recommended institutional reforms and capacity building - Introduce a Medium-Term Fiscal Framework (MTFF) to enhance fiscal planning capacity. Key components: - realistic and consistent medium-term macrofiscal projections; - a medium-term fiscal strategy described in a specific document; and - a comprehensive assessment of the potential impacts of fiscal risks. - Prerequisites and priorities for MTFF implementation: - develop stronger methodologies and analyses for macrofiscal forecasting; and - set formal procedures for preparation of MTFF projections and underlying fiscal strategy. - Practical steps and tools: - use simple Excel-based templates initially for macrofiscal estimations and buoyancy analysis, progressing to more advanced statistical software as capacity grows; - leverage SARTTAC’s course on developing a macrofiscal forecasting tool for State governments. - Regular analyses to support MTFF: - understand macrofiscal linkages by analyzing historical fiscal series, identifying long-term correlations, and assessing buoyancy and fiscal multipliers; - explain forecast revisions and deviations to improve forecasting methods and credibility; - prepare sustainability analyses and alternative scenarios to address macroeconomic uncertainty. - Strengthen process and coordination: - FD should assume coordination within a cross-departmental committee with clear deadlines, shared assumptions, and sound data management practices; - establish a calendar for the macrofiscal planning process that (1) leaves sufficient time for detailed analysis, (2) provides for multiple updates before the budget proposal, and (3) sequences data exchanges consistent with key data-release dates; - share and disclose key assumptions publicly to support forecast credibility; - create a repository of assumptions and forecasts tied to specific vintages of historical data. - Sensitization and training: - raise awareness at senior levels on the usefulness of the planning process; - issue regular memorandums on the space for new policies or on forecast revisions; - provide technical training to staff on forecasting tools and macrofiscal planning benefits. ### Budget formulation: strengths, shortcomings, and process recommendations - Strengths: - Fiscal management has been relatively conservative and TNFRA rules broadly complied with. - The FD has experienced and skilled staff and a clearly written annual budget circular. - Current budget formulation is annual, bottom-up, incremental, and control-oriented: - budget manual dates to 1992 and emphasizes FD control rather than strategic prioritization; - scope of budget preparation is limited to the upcoming fiscal year; no ex ante ceilings are set by FD; - process is incremental and line-item focused, without evaluation of existing performance or value-for-money assessment. - Process limitations and consequences: - compressed calendar spans five months (September–January); departments have three weeks in September to prepare requests, which is insufficient for credible estimates and costing. - routine introduction of new schemes through post-budget announcements; the Directorate for Special Program Implementation tracked 10,000 announcements between 2011 and 2019, with only 7 percent made during the budget speech. - frequent supplementary budgets (two to three per year), often starting within the first quarter, undermining credibility and contradicting international good practice recommending one midyear supplementary budget. - Decentralized Budget Meetings (DCBs) do not use performance information or assess quality of spending; discussions center on inputs rather than strategic priorities. - absence of spending ceilings forces an iterative and time-consuming process to align department requests with realistic resources. - Process recommendations (implicit in reforms above): - implement MTFF to provide top-down, multiyear budget anchors and allow departments at least two months to prepare budget proposals after ceilings are communicated; - set indicative or binding spending ceilings to focus departmental requests and enable strategic prioritization; - limit supplementary budgets to one midyear instance and reserve revisions for unforeseen and unavoidable circumstances; - incorporate performance information and value-for-money assessments into Decentralized Budget Meetings and budget evaluations. *Source: 1indea2020001 - 1. Tamil Nadu’s economy and public finances compare favorably to other Indian States.* ### 21. Under these circumstances, only makeshift measures, such as expenditure control, ### 1indea2020001 - 21. Under these circumstances, only makeshift measures, such as expenditure control, ### Budget credibility and in-year execution - Over the past four years, revenues are lower than budget estimates by 4 to 10 percent. - Expenditures are also—with the exception of 2014–15—significantly lower than authorized appropriations. - Despite these deviations, Tamil Nadu managed—with the exception of the impact of the UDAY scheme in 2016–17—to achieve its headline fiscal balance targets. - The practice of meeting fiscal targets through expenditure control, accumulation of arrears, and off-budget borrowing demonstrates in-year control over execution rather than sound budget formulation. - Off-budget financing is captured in the evolution of the debt stock because the debt stock definition is broader than liabilities accruing to the Consolidated Fund. ### Fiscal risks and sustainability - The current process does not contribute to a sustainable fiscal path, given looming fiscal risks from revenue reductions and spending pressures. - Sustainability risks arise from: - Limited safety margin vis-à-vis debt and deficit ceilings. - Deterioration of the coverage ratio of revenue receipts to revenue expenditures. - Whereas the State is -12.0% not allowed to run a revenue deficit 15 under the Tamil Nadu Fiscal Responsibility Act, the State now covers only around 85 percent of its expenditure with revenue receipts, down from 98 percent as recently as 2013–14. - Table — Evolution of the Revenue Deficit (bn INR) - Total revenue receipts: 2013/14 1,080 ; 2014/15 1,224 ; 2015/16 1,290 ; 2016/17 1,402 ; 2017/18 1,463 - Total revenue deficit: 2013/14 -18 ; 2014/15 -64 ; 2015/16 -120 ; 2016/17 -130 ; 2017/18 -216 - Revenue deficit (% of total receipts): 2013/14 -1.7 ; 2014/15 -5.2 ; 2015/16 -9.3 ; 2016/17 -9.3 ; 2017/18 -14.8 ### Committed expenditure and limited fiscal space for infrastructure - The weight of “committed expenditure” (nondiscretionary expenditure, such as wages, pensions, and debt interest) has strongly increased and now represents more than 63 percent of total revenue expenditure. - Table — Evolution of the Share of Committed Expenditure in Total Revenue Expenditure (bn INR) - Committed Revenue Expenditure: 2013/14 665 ; 2014/15 753 ; 2015/16 833 ; 2016/17 948 ; 2017/18 1,063 - Total Revenue Expenditure: 2013/14 1,098 ; 2014/15 1,288 ; 2015/16 1,410 ; 2016/17 1,532 ; 2017/18 1,679 - Committed Expenditure to Total (%): 2013/14 60.6 ; 2014/15 58.5 ; 2015/16 59.07 ; 2016/17 61.9 ; 2017/18 63.3 - This composition reduces margins for new schemes and for capital expenditure and calls for a renewed approach to budgeting to cut spending or curb expenditure growth. ### IT system and modernization opportunity - A new Integrated Financial and Human Resource Management System (IFHRMS) is being developed and will provide a platform for real-time data collection on payroll and non-payroll expenditures. - IFHRMS will enable automated budget submissions—minimizing errors from manual estimates and facilitating increased scrutiny. - Historical attempts (1992 budget manual) to supplement incremental budgeting with zero-based budgeting had little traction. ### Reforms: process changes, top-down budgeting, and contingency design - Restoring the credibility of the annual budget is the first priority: end the practice where the FD focuses on execution/control at the expense of thorough budget preparation. - A longer budget calendar is recommended: an earlier start giving more than a few weeks to line departments to prepare spending estimates, anchored in a strong top-down dimension. - Policy planning should be articulated with budget formulation; a Fiscal Strategy Statement early in the process could secure Cabinet engagement and discipline among line departments. - Contingency reserve recommendations: - A Tamil Nadu Contingency Fund of INR 1.5 billion (less than 0.1 percent of total expenditure) exists but is not adequate for substantial in-year policy priorities. - An adequate contingency reserve would amount to 2 or 3 percent of total expenditure. - Design issues to address: transparent access criteria, FD gatekeeping role, transparent reporting, and appropriate size to avoid undermining budget discipline. - Top-down budgeting: - Determining ceilings at the start puts onus on departments to prioritize. - Expenditure ceilings should be derived from the first year of the MTFF with an internal FD breakdown across departments. - Compliance may increase over time; mechanisms needed to avoid rewarding departments that “game the system.” - Top-down budgeting shifts FD focus to a budget challenge function—scrutinizing policy and expenditure choices to ensure alignment with government objectives and “value for money.” - A clear political mandate (Cabinet-level discussion and ownership) is required for implementation. - Pilot the approach with one or two departments (Department of Industry indicated readiness) to trade budget flexibility for resource predictability and performance commitments. - Medium-term budgeting (MTBF/MTBF-like frameworks): - Advantages: (1) predictability of resources over a longer horizon; (2) clearer shifts in resource allocation reflecting priorities; (3) better decision-making with visibility on medium-term impacts. - Prerequisites are not yet in place. The FD should restrict AE requests to key schemes and run internal medium-term projections before a full MTBF rollout. - FD tools and manuals: - The 1992 budget manual requires a thorough overhaul. - IFHRMS adjustments may be needed to ensure consistency with top-down budgeting and increased managerial freedom. - Annex II suggests a new budget calendar aligned with the reformed process. ### Recommendations (explicit) - Short term: - FD should introduce an extended budget calendar, whereby an early phase (April-June) would be devoted to an internal exercise to develop its own vision of the next year’s budget divided per big policy areas, in light of overall fiscal constraints and policy orientations. - FD should introduce a budget challenge function to improve the credibility of annual budget estimates. - Medium term: - FD should seek political mandate for a transition to a top-down budgeting process. - FD should pilot the process with more responsive departments and provide predictable resources in exchange for commitments, in terms of policy outcomes, to respect ceilings and minimize reallocations. - FD should gradually introduce medium-term budgeting once annual budget estimates improve. ### Budget documents and transparency - Tamil Nadu produces comprehensive, technical, and detailed budget documents; most can be downloaded from the Government of Tamil Nadu website. - Documents contain significant volumes of numbers but are not user friendly and lack analysis and policy focus; historical trends are not provided to relate to proposed estimates. - Documents prepared (per budget manual and TNFRA) include: Annual financial statement; Demand for grants (56 demands); Introduction to budget; Budget memorandum; 22 appendices; Budget speech; MTFP (appendix); Appropriation bill; Policy notes; Performance budgets. - Gap: No pre-budget document/fiscal strategy statement or concise citizens’ budget is produced despite voluminous documentation. - Best practice: produce a fiscal strategy report early in the budget process to guide and constrain upcoming budget discussions and empower FD budget officers to engage with Cabinet. *Source: 1indea2020001 (excerpt).* ### 40. The authorities could build on existing documents and produce a comprehensive fiscal ### 1indea2020001 - 40. The authorities could build on existing documents and produce a comprehensive fiscal ### Fiscal strategy report: purpose and minimum contents - Purpose: produce a comprehensive fiscal strategy report (a “pre-budget statement”) by late August to support a fully-fledged MTFF/MTFP; publish when the aggregate resource envelope has been determined. - The fiscal strategy report should contain at least: - (1) A description of the macroeconomic environment of the previous, current, and forward years. - (2) A description of the fiscal outturns in the previous year and of revised fiscal estimates for the ongoing year, and their underlying assumptions. - (3) Presentation of medium-term fiscal targets for broad aggregates and underlying assumptions, plus narrative about available fiscal space and fiscal policy measures envisaged for the medium-term. - (4) Aggregate and sectoral expenditure ceilings for the budget year. - (5) Qualitative and quantitative assessment of fiscal risks. - Additional content: overview of how expenditure is aligned with service delivery needs and government priorities; reconciliation of past fiscal outcomes with plans and explanations of deviations and mitigating actions when required. ### Implementation guidance and supporting materials - Proposed outline for the fiscal strategy report: see Annex III. - Requirement: forecasts from the previous fiscal strategy document should be systematically provided as a reference, with explanations on revisions and deviations. - Citizens’ budget: recommended to be produced alongside the budget. Tamil Nadu’s current budget speech and budget highlights are a good basis. - Characteristics: brief, non-technical, include visual aids such as charts, diagrams, photographs, use local languages, printed in color and uploaded to the website. - Box 3 provides further guidance on citizens’ budget formats and examples. ### Recommendations - Short term: - Publish a brief citizens’ budget alongside the budget 2020–21. - Medium term: - Develop a fiscal strategy report based on the macrofiscal forecast with budget 2021–22 and gradually improve the quality and content of the report. ### Citizens’ Budget: rationale and quality standards (Box 3) - Purpose: accessible, nontechnical presentation to reach and be understood by as large a segment of the population as possible; help the public make sense of the budget, frame realistic expectations, and build support for difficult choices. - IMF Fiscal Transparency Code principle: a citizens’ guide enables interested citizens to conveniently obtain key information on fiscal policies. - Quality standards: comprehensiveness, objectivity, relevance, reliability, ease of understanding, and timeliness. - Timing: disseminate at the same time that the government presents the annual budget to the legislature. ### Fiscal risk management: overview - Definition: fiscal risks are factors that may cause fiscal outcomes to deviate from expectations or forecasts; include shocks to revenues, expenditures, assets, or liabilities not reflected in forecasts or reports. - Examples of specific fiscal risks: realization of contingent liabilities; natural disasters; bailout of a troubled public corporation; collapse of a bank. - These events can create explicit obligations (legal or contractual) or implicit obligations (“insurer of the last resort”). ### Public corporations — current situation and quantitative indicators - Statement: finances of some large PSUs are on an unsustainable path despite significant fiscal support from the Tamil Nadu government. - Sectors with large losses: electricity and transport. - Government action under UDAY: - In 2016–17, Government of Tamil Nadu loaned INR 228 billion to TANGEDCO as an interest-free loan, to be converted to a grant over five years. - Fiscal impact: this action added 1.8 percent of GSDP that year to the fiscal deficit. - Historical PSU profit and loss figures (Figure 10, 2013–14 to 2016–17, INR, in billions): - Profits: 7.18; 7.12; 8.98; 8.27 - Losses: 13.59; 24.95; 28.27; 31.13 - PSU negative net worth examples: - Passenger Transport Group negative net worth: INR 90.47 billion in 2013–14 and INR 164.79 billion in 2016–17. - Open access and private suppliers: - Around 40 percent of eligible customers have already opted for alternative suppliers. ### Drivers and effects of PSU noncommercial obligations (Box 4 and narrative) - Types of noncommercial obligations imposed on PSUs: - Requirements to sell services to consumers below the cost of supply (example: electricity tariff not adjusted since 2014; bus passenger tariffs lag costs). - Requirements to provide services free of charge to specific consumers (example: electricity free to farmers and some business consumers under industrial development incentives). - Cross-subsidies between customer categories (households supplied at low cost financed by higher charges to business sector). - Cross-subsidy surcharge levied on businesses using open access and purchasing electricity from private suppliers. - Use of a PSU to conduct off-budget borrowing for government programs conducted outside of the State budget (past example: PSU borrowed funds and loans repaid from government-provided funds). - Arrears of payments by some government departments of their electricity bills to TANGEDCO. - Unintended impacts of subsidized/free public services that increase fiscal costs in other policy domains (example: free electricity for farmers can increase pump use and overconsumption of water, exacerbating fresh-water stress). - Consequences: - Substantial and chronic PSU losses and negative net worth indicate a significant part of the cost of noncommercial obligations is not borne by the State budget. - Potential need for periodic large injections of fiscal support with major impacts on State budget and public debt. - Cross-subsidy regime reduces private-sector competitiveness, harming economic growth, tax revenue growth, and development. - Business customers are switching to private suppliers, risking erosion or collapse of the tax base used to subsidize households. - Risk of a vicious downward spiral: difficulties financing new investment, poor service quality, consumer resistance to paying for services. - Legal/compliance note: - Comptroller and Auditor General Report No. 1 of 2019 notes past off-budget borrowings are not permissible under Article 293(3) of the Constitution of India. ### Governance, information gaps, and monitoring - Oversight arrangements: - PSUs overseen by Boards of Directors, officials from relevant line departments, and the Finance Department (FD). - PSUs required to seek approval from line departments and FD for capital expenditures above INR 100 million and for land acquisition. - Bureau of Public Enterprises (BPE) in FD monitors PSU performance; BPE publishes an Annual Report on financial results but its oversight is backward looking and passive. - BPE Annual Report is usually submitted to the legislature about 15 months after the end of the financial year. - The report contains balance sheet and profit & loss details for each PSU and Statutory Board but lacks forward-looking information, assessment of strengths/weaknesses, or discussion of government plans to improve performance; BPE does not report internally to government on these issues. - Information gaps: - No quantitative information published on the cost of PSU noncommercial activities in the annual budget documents. - No information included in PSU Annual Reports or in the Policy Notes produced by departments regarding noncommercial obligations or undercompensation. - Unclear whether any additional information exists on financial impacts on PSUs of their noncommercial activities. ### Challenges and recommended analytical steps to address PSU fiscal risks - Overarching challenge: turn around performance of key loss-making PSUs while meeting social policy objectives more effectively. - Recommended steps (challenges identified): - 1) Require TANGEDCO and the Passenger Transport Group to produce three-year forecasts of financial performance and position under current policies, extending budgets for 2020/21 by two additional years; forecasts should cover all operating and capital expenditures and rely on careful analysis of recent cost and revenue trends, macroeconomic developments, timing of capital expenditures, and specific risk factors; chief executives to prepare forecasts for boards and transmittal to line departments and FD. - 2) Ensure PSUs file for tariff increases in a timely manner: TANGEDCO should file as soon as practicable with TNERC; Passenger Transport PSUs should submit regular and timely tariff filings. - 3) Estimate financial impacts on each PSU of noncommercial obligations and identify beneficiaries of subsidized public services by using detailed PSU accounts and administrative data; contract a small team of professional advisers to work confidentially for the Government of Tamil Nadu with full access to PSU records and staff (complexity discussed further in Annex IV). - 4) Use forecasts, estimated costs of noncommercial activities, and beneficiary information to generate broad options for improving PSU performance, including consideration of targeted subsidies (for example, means-testing) rather than blanket subsidies. - 5) Phase in tariff reforms combined with targeted compensation mechanisms for the poor, finding space within the annual budget to progressively increase annual subsidies paid to TANGEDCO and the Passenger Transport Group to bring them closer to full compensation for the financial impact of these activities. *Source: Extract from IMF content unit 1indea2020001 - 40.* ### 58. Finally, oversight of PSUs by FD needs to be extended to forward-looking monitoring ### 58. Finally, oversight of PSUs by FD needs to be extended to forward-looking monitoring ### Oversight of PSUs — current situation and needs - To be an effective advisor to the government on whether PSUs are operating effectively and efficiently and on fiscal risks to the government’s budget, the FD and line department need to be forward-looking and proactive. - Required actions include: - introduction of new requirements for PSUs to seek prior approval of their investment plans, as well as of large individual investments; - requiring PSUs to report in-year (for example, quarterly) to FD and the line department. - This shift will require significant capacity building over the medium term in the BPE. - Annex V contains further discussion of this PSU oversight role. ### Recommendations — PSU oversight - Short Term - FD should require TANGEDCO and the Transport Passenger Group to prepare three-year financial forecasts and estimates of costs their noncommercial obligations. - FD should seek a government decision to instruct TANGEDCO to file for a tariff increase as soon as practicable. - FD should appoint external professional advisers to analyze the accounts of TANGEDCO and the Transport Passenger Group, identify beneficiaries of subsidized prices, and report options for turning around the companies’ finances. - Medium Term - FD should seek to progressively include in the budget the full costs of meeting noncommercial obligations in the energy and transport sectors. - FD should progressively build its capacity to provide forward-looking, proactive oversight of energy and transport sector PSUs. ### C. Revenue Risks — Current Situation - Revenue performance has lagged behind expenditure growth, and tax buoyancy is low, pointing to a structural problem. - The revenue deficit increased from INR 18 billion in 2013–14 (0.18 per cent of GSDP) to INR 216 billion (1.51 per cent of GSDP) in 2017-18. - Revenue expenditure grew 2.22 times faster than revenue receipts in 2017-18, while total revenue receipts grew by only 4.3 percent. - The State’s own tax buoyancy with respect to GSDP has ranged from 0.26 to 0.84 over the past five years and stood at 0.74 in 2017–18. - Taxes on alcohol: - In 2017–18, taxes on alcohol comprised 28 percent of the SOTR. - In Tamil Nadu, SOTR made up 89 percent of the State’s total revenues in 2017–18. - There is risk around the future path of these revenues. - Compensation from GOI for GST revenue shortfalls is expected to end by 2021–22. - Revenue arrears and exemptions: - Revenue arrears as of March 31, 2018, were INR 301 billion, equivalent to 32 percent of SOTR and 75 percent of the fiscal deficit. - Of this amount, 53 percent was under recovery process, 33 percent was under litigation, and action was yet to be initiated on the remaining 14 percent. - The quantified cost of tax exemptions was reported as INR 200 million in 2017-18 (less than 1 percent of the fiscal deficit); other unquantified exemptions may be more significant. - Rate of return on government financial assets: - Average rate of return increased from 0.2 percent in 2013–14 to 0.62 percent in 2016–17, before declining to 0.45 percent in 2017–18. - This compares with the government’s average rate of borrowing of 8.53 percent in 2017–18. - Causes include poor financial results of PSUs and poor management of government loans (for example, poor record keeping of government loans to various borrowers, including TANGEDCO, contributed to write-downs). - The CAG noted investment of defined contribution pension scheme contributions in 90 day T-Bills, which earned interest ranging from 6.03 percent to 7.85 percent between 2015–2018; the interest paid to individual pension account holders ranged from 7.60 percent to 8.70 percent in the same period. - The CAG observed that by not joining the Government of India’s National Pension Scheme, the Government of Tamil Nadu incurred an avoidable additional expenditure on pensions for 2015–18 of INR 7.97 billion due to low returns on T-Bills. ### C. Revenue Risks — Challenges - There is a pressing need for a medium-term revenue strategy given structural issues in revenue performance. - Nominal tax or rates that have not been adjusted are insufficient and unsustainable. - A medium-term perspective is required to assess underexploited or untapped revenue sources, supported by adequate revenue forecasting capabilities developed as part of an overall macrofiscal function (see I.A). ### C. Revenue Risks — Recommendation - Short Term - Request IMF support to develop and implement a medium-term revenue strategy. ### D. Other Specific Fiscal Risks — Current Situation - Tamil Nadu is exposed to a range of fiscal risks: debt management, expenditure arrears, contingent liabilities, legal claims, PPPs, disasters, and climate change. - Debt management risks: - During 2021–22 to 2024–25, 31.81 percent of the current outstanding debt—totaling INR 918.5 billion—will become due for repayment. - Exchange rate risk is indirect through GOI borrowing internationally and on-lending; foreign exchange exposure may be small. - Institutional arrangements: - Public debt is managed by FD staff who are also responsible for other functions. - Market operations are conducted by the Reserve Bank of India on behalf of the Government of Tamil Nadu; the CAG performs record keeping for debt. - Debt management operates in the absence of a medium-term debt management strategy and of a formal debt sustainability analysis. - A Consolidated Sinking Fund (CSF) requires an annual contribution of 0.5 percent of the outstanding liabilities at the end of the previous financial year. - CSF balance as of March 31, 2018, was INR 58.66 billion—approximately 2 percent of total debt—invested mainly in GOI securities. - Expenditure arrears and reserve funds: - Systematic expenditure arrears exist; government financial statements do not present arrears as a liability. - CAG notes shortfalls in required contributions to Public Account Funds (Debt Sinking Fund, Pension Scheme Fund, Guarantee Redemption Fund). - Expenditure arrears create control risk and can accumulate unexpectedly. - Guarantees and GRF: - Good practices present but exposures increased by 52 percent in 2018–19. - Practices include charging guarantee fees, existence of a Guarantee Redemption Fund (GRF), and TNFRA 2003 cap on outstanding risk-weighted guarantees at 75 percent of revenue receipts of the previous year or 7.5 per cent of GSDP, whichever is lower. - In practice, guarantee fees are set at a flat rate and are not always paid. - Guarantees jumped by 52 percent in 2018–19 due to new guarantees issued to TANGEDCO. - Balance of the GRF was 0.7 percent of total guarantees outstanding as of March 31, 2018. - Table 4. Guarantees and the Guarantee Redemption Fund 2018–19 - 2018/19, INR billion - Total Outstanding Guarantees as of March 31, 2018 361.3 - As a share of revenue receipts 24.7% - As a share of GSDP 2.5% - Ratio of GRF to outstanding guarantees 0.7% - New Guarantees issued in 2018–19 188.2 - Share of new guarantees to existing stock 52.0% - Share of new guarantees issued to TANGEDCO 97.0% - Legal claims: - The State is respondent to a range of legal claims, including claims against tax and duty assessments. - Departments are not required to record the existence or details of claims; no data available on stock, amounts, or stages of legal proceedings. - FD centrally monitors significant legal claims to which FD itself is a respondent. - PPPs: - A small number of PPPs is under implementation; government intends to significantly expand PPPs. - Existing projects include five road and water supply projects, partly financed through viability gap funding. - Available data are sketchy; total annual payment commitments for two projects amount to INR 2.93 billion for up to 25 years. - Tamil Nadu Infrastructure Development Board (TNIDB) established under Tamil Nadu Infrastructure Development Act 2012; roles include appraisals, evaluating proposed PPPs against a public sector comparator, and recommending financial support. - TNIDB has a pipeline of 169 PPP projects; status and stage of each remain unclear. - Disasters and climate change: - Annual expenditure on natural calamities since 2010–/11 ranged from INR 3.75 billion in 2014/15 to INR 29.84 billion in 2015–16. - Costs shared between State Disaster Relief Fund and GOI National Disaster Relief Fund; National Fund pays 75 percent of the costs. - Cyclone Gaja in November 2018 damaged the electricity network; total damages estimated at INR 23.8 billion. - Climate-related spending pressures include increased investment in renewable energy sources and public infrastructure resilience; exposure to slow-onset disasters like water scarcity necessitates spending on emergency drinking water deliveries and planning for three significant water desalination plants as PPP projects. - Local governments: - Although risks from local governments have not been apparent, FD should monitor their finances. - Local governments must obtain State government approval before borrowing; FD should routinely monitor local government deficits, expenditure arrears, and risk exposures. ### D. Other Specific Fiscal Risks — Challenges - Oversight of fiscal risks is currently only one year ahead, at best. - Bottom-up forecasts of government revenues are produced only for the next budget year. - Three-year expenditure forecasts exist on paper but have little credibility and are not relevant to fiscal management. - Debt management lacks a medium-term strategy and the ability to conduct formal debt sustainability analysis. - Pensions focus one year ahead with no actuarial calculation of the government’s pension liability. - Large PSUs only produce one year ahead financial forecasts; oversight of PSUs is largely backward-looking and passive. - No medium-term orientation to fiscal policy or identification of fiscal risks. - Data and monitoring gaps: - Information is not recorded or aggregated on expenditure arrears (liabilities) or on legal action against the State (contingent liabilities), although a PPP register and pipeline are being populated. - Capacity and systems: - FD needs to move to proactive and forward-looking management of fiscal risks from a passive and reactive approach. - Improved awareness and capacity for fiscal risk management within FD is needed. - The new IFHRMS piloted in January 2020 has the potential to improve record keeping in FD, reduce operational risks (for example, in loans management), and improve forecasting capacity (for example, of multiyear pension expenditures). ### D. Other Specific Fiscal Risks — Recommendations - Short Term - FD should conduct a debt sustainability analysis with external support. - Ways and Means should develop a medium-term debt management strategy. - FD should review the legal framework for PPPs to ensure an adequate formal budget gatekeeper role with respect to each proposed PPP project. - FD should instruct all line departments to maintain registers of expenditure arrears and legal action against their departments and report the information to FD. - Medium Term - FD should introduce system of monitoring finances of local governments. *Source: 1indea2020001 - 58. Finally, oversight of PSUs by FD needs to be extended to forward-looking monitoring* ### 78. Elements of good practice fiscal risk reporting exist in Tamil Nadu. Information on some ### Elements of good practice fiscal risk reporting exist in Tamil Nadu. ### Current fiscal risk disclosure practices - Information on some sources of fiscal risk is transparently published across various government documents. - Guarantees: - Information published on the value of outstanding guarantees by sector, by entity, and by risk weighting. - Details disclosed on mechanisms to manage guarantee risks, including guarantee fees owed and received and available contingency funds. - Loans: - Extensive information on loans from the State government outstanding is disclosed by entity, rate of interest, concessional terms. - Lists of loans issued to entities in arrears are identified. - Public Sector Undertakings (PSUs) and corporations: - Schedules of transfers between entities and the State are published. - Financial situation of individual PSUs available in their annual financial reports and in a consolidated report produced by the FD (BPE) that looks at aggregate PSU sector performance. - The consolidated report identifies loss-making entities in a table, though it is produced with some time lag. ### Gaps, limitations, and challenges in reporting - Uneven reporting practices across sources of fiscal risks; some risks not fully identified, analyzed, or disclosed. - Publicly available information is absent or limited for: - Macroeconomic risks: the Government of Tamil Nadu does not assess or publish the impact of macroeconomic risks. - Potential obligations from contingent liabilities for legal claims or outstanding arrears. - Performance of local governments. - Expenditure arrears. - Future pension obligations, debt repayments, or PPPs. - Financial impacts of noncommercial obligations in PSU reporting. - Existing disclosures are often detailed and quantified (usually tabular) but lack supporting analysis, narrative assessment of likelihood, and mitigation actions. - Fragmentation and dispersion of disclosures across different reports make it difficult to build a comprehensive picture of overall fiscal risks and their interconnectedness. - Fiscal risk reporting primarily focuses on historical outcomes and is typically historical or at most one year ahead; forward-looking analysis of nature, potential impacts, likelihood, and management strategies is generally absent. - FD and ministers have limited information and capacity to identify, analyze, and report the impact of macroeconomic risks on State finances. - As fiscal constraints bind and debt limits are reached against a potentially declining and narrow revenue base, the State’s capacity to respond to fiscal risks will become more challenging. ### Importance and benefits of comprehensive, forward-looking reporting - A summary report of fiscal risks could: - Help the State better understand and manage vulnerabilities by providing the totality of potential threats to the fiscal position. - Over time inform an integrated understanding of conditions under which risks are likely to materialize and their interconnectedness. - Publishing summary information on fiscal risks: - Reinforces credibility of government forecasts among creditors and across markets. - Enables decision-makers, the public, and the legislature to better grasp risks and potential budget impacts. - Can, in some cases, reduce borrowing costs. - A forward-looking internal reporting approach could feed into the budget process, increase preparedness to respond to adverse shocks, and strengthen monitoring and management of fiscal risks. ### Institutional arrangements and options - A comprehensive approach requires sound institutional arrangements and a central function for fiscal risk management to: - Oversee fiscal risk management and facilitate coordination across government. - Put together the overall picture on fiscal risk management while individual departments remain responsible for risks within their functions. - Box 6 (Options for a Fiscal Risk Function) highlights centralization benefits: - Assess aggregate risk exposures and interactions among risks. - Establish risk-warning indicators; undertake war-gaming exercises. - Assess adequacy of mitigation practices and recommend actions. - Potentially establish a high-level oversight committee within FD to regularly discuss risks during budget preparation. ### Country examples and international guidance - Brazil: - Annual statement of fiscal risks provides sensitivity analysis (impact of a 1 percentage point change in GDP, inflation, the exchange rate, policy interest rate, and the wage bill) on selected revenues; and sensitivity of expenditure and debt to 1 percentage changes in the exchange rate, inflation rate, and policy interest rate. - Presents an alternative macroeconomic scenario for 2016 and 2017 with consequences for selected revenue and expenditure projections, though not covering the budget balance and gross financing needs. - Other countries producing fiscal risk statements or consolidating fiscal risk information include Australia, Brazil, Chile, Colombia, Georgia, Indonesia, Kenya, New Zealand, Pakistan, the Philippines, and South Africa. - South and Southeast Asia trailblazers include Pakistan, the Philippines, and Indonesia in publishing comprehensive fiscal risk statements. - Odisha (an Indian State) has been working to strengthen fiscal risk reporting following an IMF Technical Assistance mission. - International standards supporting fiscal risk disclosure include the Government Finance Statistics Manual 2014, the International Public Sector Accounting Standards, and the IMF’s Fiscal Transparency Code 2014. ### Suggested sequencing and content for a Tamil Nadu Fiscal Risk Statement - Initial Fiscal Risk Statement could contain: - A simple, qualitative assessment of prevalent risks (a fiscal risk register) and, as available, quantitative information. - Coverage initially of macroeconomic risks and the most significant specific fiscal risks. - For each risk: a short paragraph explaining the nature of the risk, key features, likelihood of occurrence, and mitigation measures. - Over time the statement could be extended to other risk types, become more detailed and quantitative, and comprise more complex analyses; potentially become a standalone document published alongside the budget. - Annex VI in the source provides an example fiscal risk register template; Annex VII proposes an outline for an evolving fiscal risk statement. ### Recommendations - Short Term: - FD should establish a central fiscal risk function within the Finance Department. - FD should develop a comprehensive approach to fiscal risk reporting, including in-year reporting using a fiscal risk register as a starting point. - Medium Term: - The FD should publish a Fiscal Risk Statement with the Budget documents. - The FD should introduce fiscal risk disclosure requirements into the Tamil Nadu Fiscal Responsibility Act 2003. *Source: 1indea2020001* ### Annex I. Budget Challenge Function ### Annex I. Budget Challenge Function ### Definition of the Budget Challenge Function - The challenge function describes how the finance ministry investigates and scrutinizes the policy and expenditure choices of other public entities. - The Budget Challenge Function can be divided into two main categories: - The compliance challenge function relates to the enforcement of public financial management (PFM) rules governing budget preparation, execution, accounting, and reporting. It relies on establishing and communicating clear regulations and flows of information, as well as fostering a compliance culture and ensuring credibility of enforcement mechanisms. - The policy challenge function relates to the use of financial and nonfinancial information to assess spending and other policy decisions made by line departments—beyond immediate matters of expenditure compliance and control—with the aim of aligning these with wider government and/or sector objectives. - The distinction between the two types of challenge function is not always clear; a finance ministry will often engage on both types simultaneously (for example, checking both compliance to financial rules and the policy relevance of a new spending request). - Typical pattern by country development level: - In many developing countries, the focus is more on the compliance challenge function; the finance ministry challenge function tends to look at detailed spending decisions and compliance with budgeting rules. - In more advanced and emerging countries, the challenge function usually puts a greater emphasis on the policy challenge dimension, starting with the high-level policy choices of spending agencies. ### Exercise of the Budget Challenge Function - The budget challenge function is centered on interactions between the Finance Department and line departments, notably during budget formulation. - Capabilities required differ between compliance and policy challenges. For example: - Access to and the ability to analyze nonfinancial information are fundamental features of a policy-based challenge function, which may not always be true of a compliance challenge. - A brief checklist of questions for the exercise of the Budget Challenge Function includes: a) Standard analysis of expenditure patterns: - Calculating real growth levels in resource allocations to assess whether they are in line with the cost of providing services - Comparing original budgets to actual spending (for example, are some areas or types of spending consistently under- or over-budgeted?) - Monitoring changes in spending in different sectors to calculate the evolution of spending shares - Calculating the unit cost of outputs and how it changes over time - Calculating the cost of providing services per beneficiary, how this cost changes over time, and how this change in cost over timeis affected going forward. b) Elements more related to policy, especially when confronted with new spending requests: - Is the policy consistent with government strategic plans, and to what extent is it a priority? Is the level of resources proposed commensurate with these priorities? - What is the overall policy objective, and are there more cost-effective ways of delivering the same objective? - Does spending set a new precedent or introduce a financial commitment that will be hard to reverse for political, technical, or legal reasons? - Does the policy create any significant fiscal risks? - Does the policy directly affect other aspects of the macroeconomic or policy environment, for example, tax base, inflation, growth, employment? - Who stands to lose or benefit from the policy, and by how much? - Does the agency have the capacity to deliver the policy change? - Is the policy or proposed expenditure consistent with the government’s systems of central and local government fiscal relations? c) Situation-specific questions (applied in practice to assess capacity and compliance). ### Situation of the Budget Challenge Function in Tamil Nadu - Overall assessment: - The Budget Challenge Function in Tamil Nadu is largely in its infancy. - Compliance aspects: - Elements of a Compliance Challenge Function exist, underpinned by a budget circular that asks line departments to provide a series of elements on expenditure drivers, notably, detailed notes on all new or existing schemes totaling more than INR 200 million. - Policy aspects: - The Policy Challenge Function is almost totally absent. - The budget system is geared to control (for example, micro-control over line items), not policy. - The chart of accounts and other classification systems focus on budget inputs rather than outputs; this supports effective micro-budget controls but not necessarily policy analysis. - There is little or no reporting on policy implementation. - Nonfinancial performance data are scarce and are not used in the budget discussion; rather, they are produced by line departments for the purpose of documents (policy notes) that are disconnected from the budget formulation process (available in June/July) and are not used in the budget discussions. - Organizational potential: - The organization of the budget wing of the Finance Department provides in theory a suitable set-up for developing sectoral policy challenge capabilities. - The budget wing is organized into cross-cutting units (coordinating aspects of PFM processes, such as budget preparation or execution) and sectoral units. - These sectoral units (so-called PCB units—“Program cum Budget” units) that handle discussions with line departments in a specific policy area may be the focus for development of customized budget challenge capabilities. ### Isolated successful exercises (examples) - Health sector reforms where the Finance Department played a key role: - Supported establishment of Tamil Nadu Medical Services Corporation (TNMSC) as a unique purchaser of all essential drugs and medicines in the State Government Medical Institutions. - Outcomes: streamlined procurement, storage, and distribution; provided a buffer to pre-finance and procure medicines urgently needed without waiting for budget appropriations. - Advocated outsourcing of maintenance and cleaning of government hospitals. - Outcomes: significant savings through progressive reduction of headcount of non-medical staff at public hospitals, and improved quality of service through maintenance contracts that integrate key performance indicators. *Source: Annex I. Budget Challenge Function (1indea2020001).* ### Box 11 describes two general approaches to estimating the cost of noncommercial activities. These ### 1indea2020001 - Box 11 describes two general approaches to estimating the cost of noncommercial activities. These ### Quantifying quasi-fiscal cost: Two illustrative approaches (Box 11) - Purpose: Illustrate general approaches to estimating the financial impact of noncommercial activities by PSUs (also referred to as “Public Service Obligations”). - Methods rely on simplifying assumptions (for example, price elasticity assumptions) to provide first approximations. ### Example A: Reduced rail tariff for students - Policy: Government requests Public Railway Corporation to transport college students from the Central Station to the University Station at one-fourth of the regular fare ($1 per trip). - Activity details for 2015: - Student fare tickets sold in 2015: 23,000 - Assumed price elasticity: price elasticity equal to zero (demand does not change when price changes). - Estimated cost of 2015 quasi-fiscal activity: - $17,250 = 23,000 × $0.75 ### Example B: Subsidized bus route to a rural community - Policy: Government requests Public Bus Corporation to maintain a loss-making route between the capital city and a rural community without raising fares. Corporation allowed to borrow to cover deficit; government agreed to pay compensation sufficient for the corporation to achieve a financial surplus on this route comparable to the surplus on other routes. - 2015 operational details: - Operating costs: $56 million - Interest paid: $4 million - Ticket sales: $20 million - Average surplus on other routes: 10 percent of ticket sales - Calculations (2015): - Estimated economic cost of 2015 quasi-fiscal activity (millions): $56 + $4 – $20 = $40 - Compensation paid in 2015 (millions): $46 = ($56 + $4) × 1.1 - $20 ### Fiscal risk register: objectives and template highlights - Objectives: - Collect information on fiscal risks and obtain an aggregate perspective on government fiscal exposures. - Monitor evolution of fiscal risks and inform internal reporting and an external Fiscal Risk Statement published alongside budget papers. - Key steps in developing the register: - Identify sources of fiscal risks; over time differentiate and become more exhaustive (for example, foreign currency and interest rate risk). - Identify risk exposures; for difficult-to-quantify risks (e.g., natural disasters) use proxies such as maximum probable losses or worst historic realizations. - Analyze likelihood and severity of risk materialization using appropriate methods (risk rating for PSUs, risk modeling for PPP demand risks); analysis should be forward-looking and start with historical realizations. - Develop risk mitigation measures for important fiscal risks and capture risk owners to coordinate management across government. - Template fields (illustrative): - Indexed items: Source of fiscal risk; Estimated exposure; Description; Likelihood of materialization; Severity of risk materialization; Mitigation actions; Risk owner; Source of information. - Example risk categories: 1 Revenue risks; 2 Expenditure risks; 3 Natural disasters; 4 Loans issued by the government; 5 Financial performance of PSUs; 6 Risks to the debt portfolio; 7 Outstanding payables (Arrears); 8 Pension liabilities; 9 PPPs; 10 Government guarantees; 11 Legal claims; 12 Other contingent liabilities; 13 Other fiscal risks. ### Phased approach to a Comprehensive Fiscal Risk Statement (short, medium, longer term) - Basic practice: List and discuss main specific risks qualitatively if cost or likelihood estimates are not available; collate into a single report. - Short-term priorities (examples): - Provide qualitative summary of main fiscal risks. - Analyze variance of revenue and expenditure BEs versus outturns in recent years. - Publish qualitative explanation of sensitivity of revenues and expenditures to variations in real state GSDP growth and inflation. - Publish qualitative discussion of financial performance of PSUs, including quasi-fiscal activities. - Publish complete list of approved PPP projects with qualitative discussion. - Publish rationale and criteria for provision of major government guarantees. - Publish qualitative disclosure associated with major loans and pension schemes. - Publish qualitative discussion of major legal claims and natural disaster fiscal risks. - Medium-term actions (examples): - Publish quantitative sensitivity analysis of aggregate revenues and expenditures to variations in real state GSDP growth and inflation. - Publish quantitative discussion of PSUs including financial risk ratios for leverage and solvency and ownership policy for major PSUs. - Publish aggregate annual service payments and receipts for PPPs and multiyear liabilities of current PPP program. - Quantify risks associated with loans above certain thresholds; publish quantitative pension obligation analysis. - Publish rationale and criteria for guarantees with discussion of risk mitigation measures and risk weighting factors. - Longer-term enhancements (examples): - Publish assessment of linkages and correlations among risks and aggregate gross exposure. - Include sensitivity analysis and alternative macroeconomic and fiscal forecast scenarios (for example, probabilistic fan charts). - Publish multiyear liabilities of PPPs and full disclosure of government’s PPP policy/strategy. - Publish quantitative pension obligation analysis and comprehensive lists of outstanding legal claims above materiality thresholds. - Notation: Items marked with an asterisk (*) in the template indicate areas of high priority/quick wins. ### Outline elements recommended for a Comprehensive Statement of Fiscal Risks - Macroeconomic Risks: comparison of recent budget assumptions against outcomes; sensitivity of aggregate revenues, expenditures, budget balance, and debt to variations in key economic assumptions; alternative macrofiscal scenarios or probabilistic fan charts. - Public Debt: sensitivity of debt stock and debt-servicing costs to interest rate and exchange rate variations; debt management strategies; debt-sustainability analysis summary. - Government Lending Programs: policy framework; stock of outstanding loans in aggregate and by borrower; loan performance details including nonperforming loans and restructuring history. - Government Guarantees: policy purpose and programs; total guaranteed amounts (gross exposure); likelihood of guarantee calls and associated costs; history of guarantee calls and recoveries; guarantee fees; budget provisions. - PPPs: government obligations under PPPs including contingent liabilities and direct commitments. - Public Corporations: explicit obligations, aggregate financial position, recent financial performance (including loss-making entities and key financial risk indicators), transactions with government, and quasi-fiscal activities. - Subnational Governments: recent financial performance and position; financial exposures of local governments; explicit central government obligations to subnational governments. - Financial System: explicit liabilities to financial sector not disclosed under guarantees; size and soundness of the financial system; assessment of regulation and financial stability. - Natural Disasters: exposure to natural disasters; direct fiscal impact in recent years; budget allowance for disaster-related costs; government disaster risk management strategy including catastrophe risk insurance. - Legal Claims: major pending legal claims and, where feasible, estimates of gross exposure. - Other Material Fiscal Risks: geopolitical/security risks where relevant; gross exposure of indemnities, warranties, uncalled capital; obligations with uncertain timing or magnitude; risks to tax and nontax revenues (for example, tax base erosion, avoidance, and evasion). *Source: Adapted from IMF. 2016. “Analyzing and Managing Fiscal Risks: Best Practices.” Report. IMF, Washington, DC.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1indea2020001.pdf_