Economy: State Finances: Capex surges & tax tides

4 Mar 2024 , 11:00 AM

Observations on State Finances 1) Led by capex, Fiscal Deficit (FD) expanded by 70 bps over 5y (FY19-24) to 3.1% just over FRBM limit of 3%. Largest 16 states have FD of 2.8% 2) Centre’s rising cess and surcharges have held down States’ share of taxes 3) No political preference seen in centre-to-state transfers – UP, Guj, Odisha & AP are better managed fiscally while Punj, MH & MP bring up the rear 4) Power subsidy hurting but T&D losses falling 5) 9mFY24 has seen central grants fall but revenue strength has kept state capex going.

• States’ FY24 fiscal deficit > FY19, driven by capex: All-States’ FY24 FD is up over 5y by 70bps to 3.1% of GDP (~FRBM level) driven by 1.4ppt exp. jump to 17.9% but only 60bps revenue increase to 14.5%. But revenue deficit flat implies entire increase is from capex (up from 15.6% to 18.1% of GDP). Individually, 19 States / UTs have busted FRBM limit.
• Revenue boost mainly from SGST (State GST): Over last 5y to FY24B, States’ own tax revenues have risen from 6.4% of GDP to 7.2% led by SGST excl. compensation cess (from 2.7% in FY19 to 3.1% in FY24B), which is now in line with pre-GST levels, despite avg. GST rate being 300bps below then proposed revenue neutral rate of 15.3%.
• Centre-state transfer capped by Cess & Surcharges: Grants & shareable taxes from centre have been stable at 6-6.5% of GDP since FY16. Shareable taxes have remained at around half of this despite States’ stipulated share being raised in 2015 from 30% to 40% as Centre has raised tax cesses & surcharges (not shared with states), compressing divisible taxes pool by 10ppt of gross tax rev. over 10y to 78.9% in FY22. Despite devolution criteria including difficult terrain, low income, high population etc., such states still higher FDs. Over the years, need-based / disability parameters have been promoted over efficiency parameters.
• Subsidised power weighs heavily but T&D losses decreasing: States spend 8-9% of revenue receipts/expenditure on subsidies, mainly on power (to farmers) – Kerala & TN are exceptions. Reforms have pulled down AT&C by 900bps in 4y to 13% in FY23 but still > global benchmarks (8%) for most States. Power related revenue/exp is a sorry sub-40%.
• Grants drop but revenue growth spurs capex FYTD: States’ strong growth in tax & non-tax revenues (14% & 19% YoY respectively), was offset by central grants falling -28%YoY partly due to compensation cess ending. On spending, strong growth in capex (36%YoY) is helped by subdued growth in revex (9%YoY) – even in non-BJP ruled states. 9mFY24 fiscal deficit < pre-Covid.
• State-wise fiscal health check: On measuring the progress made by the top 16 biggest states in terms of contribution to GDP over the last five years, analysts of IIFL Capital Services find that UP, Gujarat, Odisha and AP are chart toppers while Punjab, MH and MP bring up the rear. The parameters chosen are – fiscal deficit, debt, growth in own tax and non-tax revenues, and growth in revex and capex from FY19 to FY24B.
• Plenty of fiscal upside possibilities, but political will? RBI’s estimates on fiscal impact include the following items 1) Reverting from New Pension Scheme (NPS) to Old (OPS) in all states, would cause fiscal burden could be up 4.5x and, additional annual hit 0.9% of GDP by 2060 2) Some States (Rajasthan, Punjab, to name a few) have FY24 FD & Debt >4% & 35% vs all-India avg. of 3.1% & 27% respectively. These will incrementally need to be thrifty rather than profligate 3) Mining is an important source of non-tax revenue for the mineral-rich states. A robust mechanism to prevent, detect and curb illegal mining activities is needed. 4) Lastly that raising tariffs for electricity and public service plus improving ailing PSUs will help with non-tax revenue and overall FD.