The Pre- and Post-COVID Outlook of State Finances
Imagination is an interesting thing. If one imagines the state of Uttar Pradesh as a separate nation, it would rank fifth in the list of most populous nations. In fact, when one assumes all the states of India as separate nations, with their GSDP (Gross State Domestic Product) acting as their GDP (Gross Domestic Product), 13 of them find a place in the top 50 countries, ranked by GDP (PPP)! The role of state governments in developing the growth story of our nation cannot be emphasised more. Under the framework of fiscal federalism, states are as important a stakeholder, if not more, as the Centre. After all, states spend as much as one and half times more and employ five times more employees than the Centre.
It is hence instructive to look at the framework of a typical state’s finances. The revenue from states’ own resources make up only 52.5% of its total receipts, leaving them at the centre’s mercy for their share from the tax pool and grants-in-aid. The importance of the states’ ability to enhance their self-sufficiency is clear from the following fact. The states play a bigger role in the nation’s capital expenditure (capital outlay of the states was 2.8% of GDP, in 2019–20) than the centre (1.8% of GDP). That being said, the financial health of the states in the recent past appears to be a mixed bag.
Pre-COVID Trends
Even before COVID-19 acted as a bolt out of the blue for states, certain trends in the financial health of states were observed. In 2015, the UDAY scheme was brought in, which mandated the takeover of 75% of their respective power distribution companies’ liabilities. This resulted in a slight deviation from the fiscal consolidation pathway of the states under the Fiscal Responsibility and Budget Management (FRBM) Act and the respective Fiscal Responsibility Legislations (FRLs). Though the Gross fiscal deficit (GFD) was reined in later, to 2.6% of GDP in 2019–20, the flip side of it was that the expenditure, especially capital expenditure took a hit. Given that the revenue expenditure such as salaries, pensions and interest payments are largely committed, the states underspent on their capital expenditure, to the extent of 14%, as opposed to the 7% decline in revenue expenditure.
The advent of farm loan waivers didn’t make things better. While this is not a novel idea to alleviate the distress in the agriculture sector, the recent announcements are much bigger in scale, at least on paper. 10 states have announced waivers amounting to Rs. 2,63,260 crores up to 2019–20, which would certainly impact states which don’t have the fiscal headroom for the same. Supplementing this is the foray of income support schemes such as Andhra’s Rythu Barosa, Telangana’s Rythu Bandhu and Odisha’s KALIA Scheme. While the amount, eligibility criteria and efficacy of the schemes are subject to debate, these are crowding out investment in the agricultural infrastructure, say for cold storage or irrigation, of the states (KALIA makes up 43% of Odisha’s agricultural budget).
A critical aspect of the low revenue-reduced spending-increased borrowing cycle is the burgeoning debt levels of the states. The sub-national debt level of India is among the highest viz a viz comparable economies. The debt to GDP ratio of the states is at 24.6%, higher than the 20% threshold recommended by the N.K.Singh committee. A handy statistical tool to indicate debt sustainability is the ratio of interest payments to the revenue receipts of the state, which should ideally be under 10. However, 14 states have breached this in 2019–20.
Taking into account the pre-existing constraints such as restrictions on the states’ borrowing capacity under Article 293 of the constitution (requiring centre’s approval for borrowing), dependence on the centre for GST compensations and the delays therein, the persisting gap between the cost of supply and revenue realised by power utilities (0.38/unit as of December 2019), overestimated revenue projections in budgets leading to underspending (see image below), not to mention the nosediving GDP growth rate since Q1 2018–19, the pressure points on the states’ finances become abundantly clear.
COVID Concerns
The struggle with a novel coronavirus by the whole mankind reminds one, of the quote, “All history is current” by Alice Walker, and the states were no exception. The extent to which the revenue-expenditure equation of the states was completely disrupted has no precedents in the recent past. An estimate by India Ratings and Research indicates that 21 major states lost over 97000 crores in revenue in April 2020. For example, Tamil Nadu, a state that generates over 60% of its receipts from SOTR (state’s own tax resources), realised just Rs.5,218 crores in SOTR from April and May, as against the anticipated amount of Rs.22,555 crores. The major components of SOTR include SGST, state excise duty, sales tax on alcohol and petroleum products, stamp duty from property sales and vehicle registration charges. Given that the lockdown has severely impacted the sale of properties, vehicles (apart from the pre-COVID demand slump in the automotive sector), and the complications in selling alcohol due to physical distancing norms, the states were up against a wall in finding viable funds for the myriad expenditure needs such as ramping up medical infrastructure, procurement of PPE kits, ventilators, testing kits, provisioning for migrant labourers etc.
It is only natural that the states look up to the centre when their own resources have dried up. The Centre did step up with its contributions via monthly instalments of tax devolution, grants-in-aid and revenue deficit grants. The Centre also enhanced the borrowing limits of the states from 3% of their GSDP to 5%, subject to reforms in areas like urban governance and ease of doing business. The RBI pitched in by increasing the WMA (ways and means advances) limits of the states by a total of 60% to tide over short term liquidity crunch.
However, a closer look reveals that the outlay for the extant financial year for post-devolution revenue deficit grants is actually 40% less than what was recommended by the 15th FC. The states have cried foul over other issues as well. In a recent interview, the Chief Minister of Madhya Pradesh rued the fact that the Atmanirbhar package was devoid of any specific stimulus for the states. While the contributions to the PM CARES fund could be considered as CSR expenditure for tax exemption, inflow into the states’ relief funds is, quite inexplicably, not to be treated so. When the GST council on June 12, it sounded uncertain about the means to meet the compensation requirements of states in the future, including exploration of borrowing as an option.
On and Ahead
Despite the numerous challenges, the states have been quick learners. While Kerala plans to cut the salaries of its employees for six days per month for the next five months, freeing up 2500 crores, Tamil Nadu has increased the retirement age by a year, putting off 5000 crores. Several states like Delhi have imposed a ‘Corona tax’ by hiking the price of alcohol. Given that these are short term breathers, there is ample room for the states to up their game in public finance management. For the immediate future, states can seek the help of multilateral institutions like the World Bank to build their ammunition against COVID-19. The centre, for its part, should consider simplifying the legal minutiae around the states’ relief funds and their CSR status to encourage more contributions, apart from being punctual with its transfers and GST compensation arrears.
In the medium to long term, states must ensure that their tax buoyancy is enhanced by cutting down populist expenditure, reduce their dependence on the Centre by attracting investment, respect the break-even cost of power utilities as the states are mandated to take over their losses up to 2021 under UDAY and contain their debt to serviceable levels. A report by Comptroller and Auditor General of India flagged the issue of non-disclosure of credit guarantees to state public sector enterprises, which obscures the real credit profile of states. A Financial Express article made a telling argument about how states must publish their monthly inflow and outgo figures, akin to Controller General of Accounts’ monthly accounts for the centre, for greater public scrutiny. An open and data-centric approach for the states’ finances is in order. Furthermore, since the states are central in undertaking development expenditure, it is essential to avoid what the RBI calls “the vicious spiral of austerity” wherein low revenues, high levels of borrowing, higher interest payments, low CapEx and a further downfall in revenues succeed each other.
