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Photo: PTI
Photo: PTI

In centre-state GST tussle, growth will be casualty

Increasing strain on state finances will hurt capital spending, posing a risk to India’s growth revival

The tussle between the centre and the states over the Goods and Service Tax (GST) imperils not just state finances but also the prospects of India’s rapid economic recovery. State governments have been the leading driver of investments over the past few years. With the GST compensation on hold, and their own tax revenues under a cloud, states are likely to cut back sharply on capex this year, hurting growth.

As a share of India’s GDP, states’ combined capex was 2.9% in 2019-20, nearly twice that of the centre (1.6%). This means that about two-thirds of the total public capex in the economy came from states.

With massive contractions in states' tax collections, they will be staring at huge shortfalls in revenues. The limited resources of states are likely to be augmented by higher borrowing but will still not be enough to cover all budgeted expenses. Most of the funds are likely to flow towards current expenditure. State capex will be hit hard.

“Post the crisis, the states are simply not in a position to incur capital expenditure," said Indira Rajaraman, economist and member of the 13th finance commission.

In fact, many states have already postponed tendering for new infrastructure projects, while several ongoing projects are facing delays.

Data from the Centre for Monitoring Indian Economy's (CMIE's) capex-tracker shows that new projects by state governments fell sharply in the June-ended quarter, contributing to the collapse in overall capex numbers.

The drop in state capex will derail the investment cycle completely, and make it extremely difficult to get India’s economy back on track quickly. Slower economic recovery will mean slower rise in tax revenues. This will in turn worsen debt metrics, and put public finances under greater strain in the years to come.

The strain on state finances is especially high for states which spend a higher share of revenue receipts on committed expenditures --- such as payment of salaries, pensions, and interest payments. Punjab spends the highest on committed expenditure (82%), followed by Uttarakhand (71%), Tripura and Kerala (70% each).

The centre has allowed some headroom to states to borrow more--0.5% of the GDP unconditionally and an additional 2% if they meet certain performance goals. But states which already face precarious debt positions may not want to take on added debt. They will opt to trim their discretionary spending.

To be sure, the additional borrowing on account of shortfall in GST compensation will not be treated as states’ liability. If the states’ choose to borrow the entire shortfall of 2.35 trillion, which includes the revenue lost from GST implementation and the pandemic-induced lockdown, the principal will be paid back to states from future sin taxes. States will, however, have to pay the interest. Or states could collectively borrow 97,000 crore, the revenue shortfall from GST implementation according to the centre, and the centre will pay both the principal and interest. However, the centre has not specified what happens if the cess collections again fall short of requirement next year.

“There can easily be a shortfall of around 2 trillion next year also", said A Prasanna of ICICI securities Primary Dealership. “They will again extend the cess but next year someone will have to pay the interest".

This is the time when states need a stability in flow of funds, to be able to plan their expenditure, said Lekha Chakraborty, Professor at National Institute of Public Finance and Policy. “Now states are also exposed directly to marco-economic uncertainty, not just the centre," said Chakraborty.

For the economy to revive, public investment will have to fill up a larger gap in aggregate demand than it does now, but if state finances continue to remain stretched, public capex is unlikely to recover.

“The centre has taken the initiative to drive infrastructure investments but it remains to be seen if they can fully compensate for the states’ capex contribution," said Rajaraman.

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