SBI Ecowrap - The good and bad of state finances

18 Apr 2022 , 09:05 AM

A collateral casualty of pandemic seems to be the fiscal situation of states, as our comprehensive analysis of finances of 18 states demonstrates that the average fiscal deficit (as % of GSDP) has been revised upwards by 50 bps to 4.0% for FY22, with six states slithering towards the red line, reporting fiscal deficit more than 4% of GSDP. Fiscal deficit of seven states exceeded their budgeted target though 11 states have been able to keep their fiscal deficit equal to or lower than their budgeted numbers during FY22. Notably, Bihar (8.3% of GSDP or Rs54,327 crore over its BE) and Assam (4.5% of GSDP or Rs21,935 crore over its BE) exceeded their fiscal deficit significantly as per RE FY22, while Arunachal Pradesh, Jharkhand, Kerala, Maharashtra and Rajasthan too join the club of states having higher fiscal deficit than their BE. For FY23, states have budgeted lower fiscal deficit of 3.4% with combined fiscal deficit for these 18 states projected at Rs7.2 lakh crore, though the group numbers seem shrouded in uncertainty given the constraints in receipts, adherence to fiscal discipline and hyper adventurism embraced by a select few. 

An interesting anecdote in India is that if we apply a bottom up approach to estimating India’s GDP by aggregating GSDP across states, the figures have significantly widened in FY21, to the extent of at least 5.7% of GDP. The dichotomy of growth numbers by the Centre and States brings forth interesting divergences in geographical aspirations, and ensuing imbalances going forward as states like Andhra Pradesh, Assam, Gujarat, Haryana, Maharashtra, Rajasthan, Telangana and West Bengal show their real GSDP growth much higher than the overall GDP growth of the country even while overall growth for 17 states (estimated by States in their budgets) is slightly lower than India’s real GDP growth! There has always been a gap between India’s GDP and GSDP given by the States and UTs.  

States’ capex in FY22 grew by a whopping 36.2% in response to the need to upscale heath infrastructure in the face of the multi-year nature of pandemic. Capex outlays have also been increased for urban development, water supply and sanitation, irrigation and transport. States’ total expenditure is budgeted to increase moderately in FY23, likely to be driven by a significant slowdown in capex (average growth of 21 states is 13.8%), while revenue spending should remain compressed (average: 8.5%).

Committed expenditure of a state typically consisting of expenditure on payment of salaries, pensions, and interest is steadily on the rise in the last three years with its share in the revenue receipts now standing at 56% in FY23 budgeted figures. Incidentally, a larger proportion of the budget allocated for committed expenditure items limits the state’s flexibility to decide on other expenditure priorities such as developmental schemes and capital outlay. It has increased by 6% in FY23 budgeted figures; salaries component up 6.8%, interest payments up 8.7% and pension payment up 12.2%.

At the time of GST’s introduction, States’ revenue subsumed under GST was legislatively protected for the transition period of five years (July 2017 to June 2022) with the assumption of a constant growth of 14% per annum. Any shortfall was to be funded through additional taxation (compensation cess) on sin/luxury goods. The slowdown in economic activity ensured a shortfall in cess collection in FY20 which increased further in FY21. In Oct’20, the Union Government decided to borrow Rs1.10 lakh crore from the market in lieu of compensation cess for shortfall in their revenue in FY21. Apart from Rs1.10 lakh crore compensation, the Centre had also provided Rs0.91 lakh crore to States out of the GST compensation fund in FY21.

Most states want the Union Government to pay the GST compensation for an additional five years (post Jun’22). As for some of the states, the GST compensation as % of state’s tax revenue is more than 20%. However, many states are offering freebies like farm loan waiver, restoring old pension system, etc., which are economically unsustainable given the financially bad shape of many states. For example, Telangana has committed 35% of revenue receipts of the state to finance several populist schemes. States like Rajasthan, Chhattisgarh, Andhra Pradesh, Bihar, Jharkhand, West Bengal and Kerala have all committed to spend 5-19% of their revenue receipts on such schemes. In terms of percentage of state own tax revenue, this is as much as 63% for some of the states. Clearly, states seem to be currently living beyond their means and it is imperative that states rationalize their spending priorities in accordance with revenue receipts.

In FY23, the net borrowings of states are pegged at Rs6.6 lakh crore, while gross borrowings are expected to come around Rs9 lakh crore after taking a repayment of around Rs2.4 lakh crore. Thus, total gross borrowing of the Centre and States for FY23 comes to 24 lakh crore while net borrowing stands at Rs18.4 lakh crore.

The author of this article is Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India.

The views and opinions expressed are not of IIFL Capital Services, indiainfoline.com