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Even as governments across the world opened up their purse strings last year to deal with the fallout of the covid-19 pandemic, the Indian government practiced austerity. On 1 February this year, the Union government finally shifted its stance, announcing an expansionary budget, with a focus on raising capex spend in the last quarter of fiscal 2021. The spending plan for fiscal 2022 represents only a modest hike over the previous fiscal year but the plan still involves an ambitious borrowing program that will push the fiscal deficit levels much beyond earlier thresholds.

In contrast to the expansionary stance of the Union government, state governments seem to have taken a more conservative approach in planning their budgets this year. A Mint analysis of the budget numbers of 19 major states show that state government borrowing is expected to be relatively muted compared to central borrowing. The severe strain on state finances over the past year seems to have led state governments to be much more cautious than the centre in budgeting additional spending.

When the pandemic first struck, it was assumed that state finances would be hit hard largely because of a shortfall in their own tax revenues. But state governments seemed to have suffered more because of a shortfall in their share of central taxes. While the centre could impose additional cesses during the pandemic to add to its kitty, such cesses and surcharges were not shared with the states as they are not part of the divisible pool.

Loans Limited

The experience of the past year could be limiting state governments’ appetite for greater spending. Besides, the sharp rise in central government borrowings limits states’ ability to borrow since additional borrowing through bonds tends to push up yields. As state government bonds are priced below central government bonds (meaning yields are higher), any rise in central borrowing ultimately raises borrowing costs for states. In the past fiscal, state governments borrowed slightly less than planned and faced higher costs of borrowing, a recent report from Care Ratings Ltd noted.

State borrowing could rise as the year progresses, said Abshishek Updadhyay, economist, fixed income strategy, at ICICI Securities Primary Dealership.

“States have budgeted high GST compensation figures," said Upadhyay. “But we saw last year, with GST collections falling short, the compensation could also suffer.... So, borrowing numbers could be higher."

Capex Question

Markets expect higher borrowing from states in the second half but if the Reserve Bank of India (RBI) starts normalizing monetary policy by then, this could push up bond yields, and raise borrowing costs for states. The RBI has indicated that it will do whatever it takes to keep yields low, at least for the first half of the fiscal year, when the central government is the major borrower. But it is not clear if that policy will continue in the second half, when state governments typically borrow more. If the economic recovery picks up pace, RBI may well shift its stance by then.

The ability of states to borrow will in turn determine their ability to raise capex spending, which had been hit by the pandemic last year. Most states have budgeted for relatively higher capex spends this year but shortfall in GST collections and higher borrowing costs could lead many states to cut back on capex, as they did last year.

Funding Growth

Given that state governments have been the primary driver of public investments in the pre-covid era, their ability to fund capex will be key to determine India’s medium term growth trajectory. But over the long term, states’ ability to fund essential social infrastructure projects will matter equally.

Thanks to the pandemic, health spending has got its due, our analysis shows. Disconcertingly, education spending is projected to fall at a time when students and teachers both need greater resources to recover from the pandemic shock. The loss in learning for disadvantaged school children could dent lifetime earnings and widen inequality, research suggests.

Most states have allocated less for education than in the pre-covid era. This includes states with poor learning outcomes, such as Odisha and Uttar Pradesh.

Unless there is a correction in education spending, both growth and equity will suffer in the years to come.


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