PremiumThe covid-19 pandemic disrupted the finances of India’s states in the ongoing fiscal year. Expense needs grew and public debt swelled, while revenues shrank. While most states could return to pre-pandemic output levels next year, their fiscal indicators are likely to remain strained for much longer, projections by the 15th Finance Commission (15-FC) show.
States’ combined fiscal deficit is likely to have risen to 4.5% of their total gross state domestic product (GSDP) in 2020-21, from 2.5% in 2018-19, the panel said. The commission’s fiscal roadmap puts the figure at 3% by 2025-26. Debts by that year could still be 32.5% of the total GSDP, against 27.3% in FY20, the estimates show.
The sharp jump in these ratios in FY21 came both due to elevated spending during the pandemic and sharp decline in economic output. Nine states are likely to have lost over 5% of their GSDP in the year ending March—none as bad as two of the biggest state economies, Gujarat and Maharashtra. Both states likely shrank more than 10%, the panel estimated.
The pandemic has toned down in India since the 15-FC submitted the report to the Centre in November. But the report, made public on 1 February, has used these estimates to make key recommendations on revenue-sharing between the Centre and states in the next five years. Finance commissions lay out such roadmaps every five years, but the exercise holds additional significance this time, given the context.
State finances were under strain even before covid-19—tax-GDP ratio was declining and non-tax revenues were in “virtual stagnation", the report said. The lockdown saw the twin challenges of rising expenses and eroding revenue, a phenomenon described as the “scissors effect" by the central bank and the 15-FC.
Moreover, this was the first time a Finance Commission used 2011 population data instead of 1971 data to determine states’ share in central taxes. The move had worried southern states, who feared that their success in controlling population growth could reduce their share.
To set the country on a recovery path, the 15-FC suggested keeping borrowing limits elevated for states, which the Centre has accepted in principle. But central grants have been computed assuming wiser spending patterns than the past—with the aim of “ensuring austerity in establishment-related expenses and eliminating profligacy and leakages in the administration of subsidies and public spending". The commission also accounted for administrative reforms to improve tax collections, estimating states’ tax revenue to rise from 6.2% of GSDP in 2020-21 to 6.9% in five years.
This means that if states falter, their finances will get even worse than projected, and central transfers won’t be enough. The recommended tax transfers, which the Centre has accepted, are much the same as in the 14th FC period (2014-15 to 2019-20): states will get 41% of the divisible pool of the Centre’s taxes, down from 42%.
The drop is because Jammu and Kashmir is no longer a state. This means most states will get a marginally larger chunk of shareable central taxes now on. Two exceptions, Karnataka and Kerala, lost some share even though the commission awarded weightage to states’ ability to control population growth.
Along with making recommendations on devolution of taxes and other grants, the commission has predicted the varied recovery paths for each state based on their expenditure needs and fiscal health.
After the contraction in FY21, states’ economic output is expected to grow 11-15% in FY22 in nominal terms, getting back to FY20 levels, the estimates show. This is mainly due to low base effect, and growth rates will return to normal thereafter. While states such as Goa, Kerala and Haryana are projected to grow 13% a year between FY22 and FY26, the rate could be 9% for Chhattisgarh, Odisha, Madhya Pradesh and West Bengal.
Kerala is likely to do well on the debt front as well, with the biggest projected decline in the debt-to-GSDP ratio between FY21 and FY26. Chhattisgarh, Madhya Pradesh and Odisha could fare badly here as well, with debt likely to rise.
The Finance Commission made its projections at a time when the pandemic had not yet weakened and vaccine approvals were weeks away. States may make fresh estimates in their upcoming budgets. But for now, the FC’s projections give us enough hints of how long fiscal recovery could take—provided that states spend wisely and boost tax mop-ups. Without much-needed reforms on that front, recovery could take even longer.
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