Dear

1. The Twelfth Finance Commission will be constituted in due course. We expect the Commission would submit its final report by September,2004, six months before the commencement of the period of operation of the Commission s recommendations(2005-2010).

2. While the decade of the eighties and more so of the nineties has seen a step up in rates of growth of the economy, there have been certain areas that have been a cause of concern for both the Centre and States. Some of these concerns are:

• Fiscal situation of both the Centre and States has not been satisfactory. The combined fiscal deficit of the Centre and States has increased from 6.5% to 9.1% of GDP between 1995-96 and 2000-2001 (RE). Similarly, combined revenue deficit as a percentage of GDP has steadily increased from 3.2% to 5.9% between 1995-96 and 2000-2001 (RE).
• A related issue is the ever-growing borrowing need of both the Centre and States to bridge the deficit. It has become increasingly difficult for the Reserve Bank of India to ensure full subscription to some State loans, especially in respect of those States whose credibility in honouring guarantees and interest payments is low. These concerns have been brought out in the Ninth Conference of States  Finance Secretaries held on 28 November, 2001 in Mumbai. Raising of funds from the market through Special Purpose Vehicles similarly introduces a non-transparent fiscal burden on States.
• Another area that needs to be addressed is the steady growth of government guarantees. As per a Reserve Bank paper, the outstanding State Government guarantees amounted to Rs.124,813 crore. Unsustainable guarantees pose a serious fiscal risk and defaults may cause avoidable loss of credibility and resultant financial instability.

3. The Government of India has accepted the recommendations made by the Eleventh Finance Commission in its Supplementary Report that disbursements from the Incentive Fund as well as utilisation of grants recommended by the EFC will be subject to review by the 12th Finance Commission. These issues will indeed be referred to the next Finance Commission.

4. The Eleventh Finance Commission has made several recommendations on State Finance Commissions and also on Local Bodies on which steps are to be taken by the State Governments. I would take this opportunity to request you to review action that is being taken/needs to be taken at your end with regard to these issues.

5. In the background of the above, I would request you to convey the comments/suggestions of your State Government regarding the Terms of Reference for the Twelfth Finance Commission. A response by 31st January, 2002 will be appreciated.
With regards,

Yours sincerely,
Sd/-
28.12.2001
( D.Swarup )

Pr. Secretary(Fin.)
All State Governments