New Delhi: Facing a revenue shortfall due to falling fuel tax accruals and tepid economic growth, state governments guarded their capital expenditures more than their wasteful revenue expenditures in 2015-16, showing signs of more maturity in how they handle their finances in the backdrop of higher untied funds transferred to them due to the 14th Finance Commission recommendations.

A study of the finances of 18 states prepared by HSBC Global Research shows capital expenditure fell to 3.5% of gross state domestic product (GSDP) in 2015-16 against the budgeted 3.7% for the same fiscal, while revenue expenditure fell to 14.5% of GSDP in 2015-16 from the budgeted 14.8%.

“This is an important development. Last year, when the centre decided to give more untied funds to states, there was some fear that states would be reckless, frittering away precious funds on unproductive schemes. It is therefore heartening to see that India’s states, on aggregate, protected capex more than current spend," the report said.

The centre now transfers 42% of untied funds of net central taxes to state governments from 32% earlier, following the recommendations of the 14th Finance Commission. While this has not necessarily increased the net fund transfers to states, it has given them more freedom to implement schemes suited to local needs.

The deft fiscal management also led to only marginal rise in fiscal deficit to 2.7% of GSDP in 2015-16 from the budgeted 2.6% of GSDP. However, the report maintained that the burden of the 7th Pay Commission on state exchequers and implementation of the Ujwal Discom Assurance Yojana (UDAY) will lead to worsening of state finances in 2016-17 to 2.9% of GSDP.

Under UDAY approved by the cabinet on 5 November to rescue the ailing state power distribution firms, state governments willing to join the scheme can take over 50% of the debt this year and 25% in the next; state electricity boards will bear the balance; more than 10 states have signed up for the scheme.

As per the rules of the scheme, debt taken over will not be counted to calculate states’ fiscal deficit or their borrowing limits, but their actual deficit will double to 6% or more for states such as Haryana, Jharkhand, Punjab, Tamil Nadu and Madhya Pradesh.

“Around 1.8 trillion of UDAY bonds will be issued by 8 states over FY16 and FY17. While they will not be issued in the primary market, the state deficits will still have to finance their interest costs. Marrying likely bond placements with prevailing interest rates, we estimate that it is likely to cost states 0.1% of GDP in FY17 as interest pay-out," the report said.

On state-level pay hikes which come after the Centre implements the Pay Commission recommendations, HSBC said a third of the states it analysed (6 of 18) including Uttarakhand, Andhra Pradesh and Haryana. have already made space for these wage hikes in their fiscal accounts. “Of the remaining, we assume that a majority will incur these as under-budgeted costs through the year while the remaining will defer to FY18," it added. Thus, the once-in-a-decade pay hikes for state government employees could add 0.2 percentage points to the fiscal deficit in 2016-17, the report said.

The centre has partially factored in the impact of the recommendations of the 7th Pay Commission in the 2016-17 budget by allocating around 65,000-70,000 crore for pay hikes against over a 1 trillion funds needed. However, it has not yet announced implementation of the pay hikes and is waiting for the recommendations of a secretary-level committee.

Though ideally, higher state deficits will mean higher market borrowing, HSBC said looking holistically along with the central government borrowing which has stuck to its promise to cut fiscal deficit to 3.5% of GDP in 2016-17, combined borrowing will actually be slightly lower than in the previous fiscal at 6.3% of GDP in 2016-17 against 6.4% of GDP in 2015-16. “The message coming from consolidated government borrowing is much more heartening. As a percentage of GDP, gross borrowing is likely to soften, despite rising state bond issuance, as a result of the fiscal discipline the central government has exhibited," the report said.

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