Shrinking budgets of states to worsen slowdown effect

RBI’s annual study of state finances released on Monday shows a reduction in the size of the states’ budget from 2017-19. Mint explains how this, along with a growth slowdown, may have worsened the economic situation and the implications for states’ debt sustainability.

What is the states’ fiscal position?

States consolidated their fiscal positions in FY18 and reverted to the pre-UDAY (Ujwal Discom Assurance Yojna) path with fiscal deficit-to-GDP ratio within the fiscal responsibility legislation’s targets. States have budgeted for a consolidated gross fiscal deficit of 2.6% of GDP for FY20, as against the revised estimate of 2.9% in FY19 and 2.4% in FY18 (actual). The revised estimates for FY19 show the fiscal deficit of states was 34 basis points higher than the budget estimates. This was primarily because of lower-than-budgeted receipts and higher expenditure on farm loan waivers and income support schemes.

Where has the states’ money gone?

The above-the-line rectitude achieved has been accompanied by an increase in the indebtedness of states and a sharp cut-back in development expenditure. The quality of expenditure has been compromised. Debt has risen persistently since FY16, led by schemes such as UDAY. Non-development expenditure rose sharply during FY18, in a break from the past, led by committed expenditures such as salaries, pension, and interest payments. Debt liabilities rose through 2016-19 and are likely to remain at around 25% of GDP in FY20, making sustainability of debt the main fiscal challenge.

What are the states’ fiscal challenges?

The debt position of states is showing signs of unsustainability. The slowdown poses fiscal challenges as lower revenue raising capacity and inherent difficulty in cutting expenditures can force an increase in borrowings. Reforming the goods and services tax and increasing compliance can help. A turnaround in the power distribution sector is crucial.

How will state finances impact the slowdown?

States reduced capital expenditure in FY18, in growth terms and as a percentage of GDP, so as to adhere to fiscal discipline targets. The cuts will have adverse implications for the pace and quality of development. States employ five times more people and spend around one-and-a-half times more than the Centre. Compared with central government expenditure, states’ public spend has a higher multiplier—its impact on the quality and quantity of the economy’s physical and social capital infrastructure is greater.

What is the revenue position of the states?

Growth in revenue receipts is expected to decelerate in FY20 on lower tax devolution and grants. State GST mop-up has risen from 29% of the own revenue receipts of states in FY17 to 35% in FY20 (budget estimate). As these revenues have proved inadequate relative to the rising spend, states shifted to other sources of taxes. Despite a fall in petroleum excise duty in 2018, it accounted for over 11% of own tax revenues of states.

*Puja Mehra is a Delhi-based journalist and the author of The Lost Decade (2008-18).