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Saturday, April 04, 2020

Potemkin Budgets: The state of state finances

Be it raising revenues or spending money, there is wide gap between what states promise to do in any given year and what they actually do.

Written by Udit Misra , Nushaiba Iqbal , Harish Damodaran | New Delhi | Updated: March 19, 2020 5:19:15 am
State budget analysis, Indian Express research report, State budget India analysis, Bihar UP state budgets, India economy slowdown, economy slwodown india, indian express The problem of “Potemkin budgets” is, however, more serious when it comes to the state governments (Illustration: Suvajit Dey)

Not many believe budget numbers at the time of their presentation. Finance Ministers are always tempted to make optimistic revenue and disinvestment projections for the upcoming fiscal. When these don’t get realised, the axe inevitably falls on expenditures, with all departments being told to forgo allocations or restrict their spending, especially in the third and fourth quarters.

Thus, the 2019-20 Union Budget unveiled last July had forecast the Centre’s gross tax revenues at Rs 24.61 lakh crore and disinvestment receipts at Rs 1.05 lakh crore, whereas the revised estimate (RE), made when the 2020-21 budget was presented on February 1, revealed these to be short by Rs 2.98 lakh crore and Rs 40,000 crore, respectively.

READ | 17 state budgets, 1 story: Stressed fiscal, deep cuts in expenditure

The problem of “Potemkin budgets” is, however, more serious when it comes to the state governments. In their case, it isn’t simply about the RE numbers turning out different from the budget estimates (BE). The accompanying charts show that the gap in the states’ revenue receipts as well as total expenditures is not limited to just the REs over BEs. Instead, the real divergence is in respect of the “actual” numbers, which are far below the REs and BEs for both revenues and expenditures.

Thus, the aggregate revenue receipts of states for 2017-18 in the RE stood Rs 45,109 crore lower than the BE. But the shortfall in “actual” revenue receipts – which would have been known only when the 2019-20 budgets were presented — was even higher, at Rs 136,477 crore, vis-à-vis the RE. The discrepancy between “actuals” and RE was all the more, at Rs 252,808 crore, for expenditures. And this is a consistent pattern seen in all years.

A classic example here is Bihar. For 2019-20, its budget had assumed a fiscal deficit of Rs 16,101.05 crore, amounting to 2.81 per cent of the gross state domestic product (GSDP). But when Bihar finance minister Sushil Kumar Modi presented his budget for 2020-21 on February 25, the fiscal deficit in the RE for 2019-20 was reassessed at Rs 58,343.44 crore or 9.45 per cent of GSDP. That may appear to be a massive slippage, except that for 2018-19, too, the fiscal deficit in the RE was pegged at 4.62 per cent, as against the BE of 2.17 per cent. When the “actual” number for 2018-19 came out in the latest budget, the fiscal deficit was found to be only 2.68 per cent of GSDP.

“Every year, Bihar’s RE fiscal deficit is in the 5-9% range, but the final deficit is always below the 3% threshold,” a Credit Suisse Equity Research note of March 5 has pointed out.

A danger with “Potemkin budgets” that some economists highlight is the prospect of unrealistic revenue targets leading to aggressive pursuing of targets by tax authorities. There are reports of companies, for instance, being asked to pay advance tax based on projected incomes more aligned to the taxman’s punishing targets than the actual sales growth registered by them. The pressure to meet revenue demands, then, results in corporates becoming cautious and conserving liquidity that might otherwise have been deployed in their own businesses.

A second collateral damage is on government spending itself. When departments know that the budgeted revenues are unlikely to materialise, they wouldn’t go all out in implementing any scheme bound to suffer funding cuts in the latter part of the year. The same lack of enthusiasm will be shown by contractors who undertake irrigation, road and other public works. If payments are going to be delayed, or even not come, why would they bid at all in projects? Again, taking Bihar’s case, the state government’s total expenditures for 2018-19 was Rs 176,990.27 crore in the BE and Rs 190,918.72 crore in the RE. But the “actual” figure of spending turned out a mere Rs 154,655.14 crore!

The final casualty of not-so-credible budget numbers is, of course, interest costs. State governments today are borrowing at 7-7.2 per cent annually for 10 years, which is way above the core consumer price inflation of 4 per cent. High real interest rates, a result of the markets not believing revenue projections, will only add to their debt problems.

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Milking oil

States are likely to utilise the current crash in global crude prices to shore up their precarious finances

Since the start of this calendar year, benchmark Brent crude prices have fallen from $68 a barrel to below $30 a barrel. But that has come at an opportune time for states to hike value added tax/sales tax on petrol and diesel, thereby also partly insulating them from subpar GST revenue collections and uncertainties triggered by the novel coronavirus.

Karnataka and Maharashtra are the two states that have taken the lead in their latest budgets. The former has raised its sales tax from 32 per cent to 35 per cent on petrol and from 21 per cent to 24 per cent of petrol. The latter has imposed an additional Re 1 per litre VAT on both transport fuels, which, according to Maharashtra’s finance minister Ajit Pawar, will help garner an additional Rs 1,800 crore in the coming fiscal.

Between 2014-15 and 2017-18, Centre’s excise duty revenues from petro-products (which are outside the GST’s purview), rose to Rs 229,716 crore, exceeding the corresponding VAT/sales tax revenues of Rs 185,850 crore for states. This happened as the Centre took advantage of the then crash in global crude prices – the average cost of oil imported by Indian refiners fell from $ 105.52 per barrel in 2013-14 to $ 46.17 in 2015-16 to increase the specific excise duties on petrol and diesel. The states did not resort to similar hikes. Also, since their VAT/sales tax rates are mostly charged on an ad valorem basis — as a percentage of price, as against a fixed Rs per litre specific excise duty levied by the Centre — their revenues did not go up commensurately.

This time, though, the states may not want to miss out on the opportunity from the renewed collapse of oil prices to mobilise additional resources. A Re 1 per litre increase in the price of these two transport fuels can, thus, generate additional revenues totaling Rs 13,800 crore per year. That is a bonanza for both the Centre and the states, which will last as long as Brent crude rates remain at the existing lows.

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