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State governments are running out of resources to sustain the fight against covid-19 and to fund relief efforts.

The ongoing lockdown has precipitated a fiscal crisis by crimping revenue sources for state governments even as they continue to spend on health and relief efforts. The states have limited tools to deal with the fiscal crisis and can’t borrow as freely as the Centre. Further, most states will not be able to increase spending by much as the Fiscal Responsibility and Budget Management (FRBM) Act bars them from exceeding the 3% fiscal deficit threshold and even the escape clause allows for an additional spending of only 0.5% of gross state domestic product during a crisis (See chart 1).


State goods and services tax (SGST) collections, which constitute almost 45% of own tax revenue of states, have collapsed because of the freeze in economic activity. Poorer states are hit harder as GST is a consumption-based tax and poor states tend to be net consumers. For instance, in Bihar, SGST constitutes almost 56% of own tax revenue, much higher than the national average.

What about other sources of revenue for states? Taxes on alcohol, petroleum products, and property account for 15% of revenues on average. The ban on liquor, the sharp fall in mobility, which has hit fuel stations hard, and the slump in the property market have dealt a body blow to this revenue stream. The other big source of revenue is the states’ share of tax devolution from the Centre. This is also likely to be much lower than budget estimates.

As relatively poorer states get a larger share of tax devolutions, they will face a relatively greater budget crunch because of the devolution shortfall.

On the expenditure side, there is little scope of reduction as almost a third of state budgets are spent on salaries, pensions, and interest payments.

States will have to continue these payments as well as the capital expenditures they have committed to, a significant part of which is the matching grant for centrally sponsored schemes. Any cutback would mean fewer resources from the Centre for those schemes. States will also have to boost health expenditure to fight the pandemic.

What about the flow of resources from the Centre? Centrally sponsored schemes account for a large share of development expenditure in states and also attract a large share of resources from states themselves. The poorest five states, Chhattisgarh, Jharkhand, Bihar, Odisha, and Madhya Pradesh, spend more than 10% of their total development expenditure on the top five Centrally sponsored schemes, the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS), the Pradhan Mantri Gram Sadak Yojana, the Swachh Bharat Abhiyan, the Mid-Day Meal Scheme, and the Sarva Shiksha Abhiyan. The lockdown has rendered these schemes non-functional for almost a month, resulting in significant welfare loss, especially for people from poorer states. State governments might need to step up spending on these schemes to provide a safety net to people.


The analysis suggests that states need immediate policy interventions to supplement revenue streams. There are some options on the table for the Centre to help states tide over the current crisis. First, As against the nearly 75,000 crore of revenue deficit grants proposed by the 15th Finance Commission, the Centre has released only 6,000 crore. The remaining money needs to be released as early as possible. Revenue deficit grants cover the gap between the revenue and expenditure of states.

Second, the Centre should relax fiscal responsibility limits on states to open up additional market borrowing to tide over revenue loss in the short run.

Third, the Ways and Means Advances (WMA) limit, which has been relaxed by 30% for the first half of the fiscal, should be further relaxed by the Reserve Bank of India (RBI). WMA is an advance given by RBI to state governments to help them tide over temporary mismatches in receipts and payments.

The Centre should also consider untying constraints on funds for centrally sponsored schemes and allow states to spend them as they deem fit. Covid-19 has affected different states differently and hence their requirements will be different. Having more untied resources will allow each state to fund the scheme that needs the maximum support. For some states, the food distribution system may be top priority. For others, it may be MGNREGS.

States have a lot to worry about amid the ongoing efforts to contain covid-19. Finance must not be allowed to become a bottleneck in this fight.

The authors are graduate students at the Harvard Kennedy School, US.

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