The Medium Term Fiscal Reforms Programme for the states has failed to effectively tackle their rising revenue deficits and burgeoning debt, according to a review by the finance ministry.

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The ministry acknowledged that the prescriptions of the Tenth and Eleventh Finance Commissions were inadequate. The programme needed to focus on the issues of debt, guarantees and borrowings by the states, ministry officials said.

The Centre needs to limit borrowings by the states, which take resort to this measure to support arbitrarily high Plan sizes. An attempt has been made to try and limit the states' borrowings to the extent that they are consistent with the MTFRP. As the MTFRP is reviewed annually, it helps keep a check on borrowings.

Incremental plans tend to worsen the debt burden as 60 per cent of all borrowings feed current revenue expenditure, and a large part of the remaining 40 per cent is used to repay past loans. A cut in Plan borrowings, including small savings loans to states, was a must to correct the debt overhang, the officials said.

The extraordinary growth in small savings collections during the last 10 years, so far ignored by the Centre, is also a matter of serious concern. From Rs 5,000 crore (Rs 50 billion) in 1992-93, net small savings loans are set to top Rs 61,000 crore (Rs 610 billion) in the current fiscal - a 12-fold increase in the last 10 years. Unless checked, this may result in destabilising state finances.

The ministry's debt swap plan assumes significance in this context. Earmarking 20 per cent of the small savings collections by the states to retire earlier high-cost loans not only limits the build-up of debt, it also reduces future outgo on interest payments. If the soft interest rates regime continues over the next two years, the states will be able to pay off all Central loans, costing 12 per cent or more.

According to the finance ministry's estimates, loans carrying a cost of 12 per cent and above constitute more than 50 per cent of the states' outstanding debt to the Centre.

Savings on interest as well as deferred capital repayments could be as much as Rs 98,000 crore (Rs 980 billion) over the residual maturity of the loans, the officials said.

Besides prodding the states to undertake tough reforms in the four areas of fiscal management, power, Budget and public sector undertakings (as outlined in the MTFRP), the Centre will have to look at the other issues if it is serious about improving state finances. A meagre Rs 10,607 crore (Rs 106.07 billion) fund is not incentive enough for the states to undertake big-ticket reforms.