Opinion Going forward, much depends on states’ room for spending
In FY2021-FY2025, the combined capital expenditure and loans & advances of 28 states reported a healthy 18.5 per cent CAGR, doubling to Rs 8.4 trillion
We now keenly await the recommendations of the 16th Finance Commission. Two questions we have heard repeatedly in recent months are: How did some states incur a fiscal deficit higher than 3 per cent of GSDP in recent years, and have welfare schemes curtailed the space for state-led capital spending?
The answer to the first question is fairly straightforward. During FY2021-FY2025, states were permitted additional borrowings over and above their base borrowing limits, allowing them to incur a higher fiscal deficit. Their base borrowing limit was set between 3-4 per cent of the GSDP and an estimated additional borrowing of 0.5-1.1 per cent was allowed by the Union government and/or the 15th Finance Commission. This additional borrowing included loans by the Centre to the states (GST compensation loans and the 50-year interest-free capex loans) and reforms-linked additional borrowings.
During FY2021-FY2022, the Centre disbursed GST compensation loans of Rs 2.6 trillion to states. It also transferred Rs 3.7 trillion during FY2021-FY2025 under the 50-year interest-free capex loans. Such loans were availed by all except for a few states in some of the years. These loans are over and above the normal borrowing limit of the states. The surge in states’ capital spending in recent years benefited from the expansion in capex loans to around Rs 1.5 trillion in FY2025 from Rs 0.1 trillion in FY2021.
Alongside, several states had completed one or more reforms prescribed by the Centre in FY2021 and availed total additional borrowings of Rs 1.1 trillion. The 15th FC had recommended additional borrowing flexibility of 0.5 per cent of GSDP for power sector reforms. Some states including Andhra Pradesh, Himachal Pradesh, Kerala, Odisha, Rajasthan, Tamil Nadu, Uttar Pradesh and West Bengal completed the power sector-related reforms and availed a total of Rs 1.3 trillion between FY2022-FY2025.
Interestingly, the Government of India had allowed states to carry forward any unutilised borrowing from FY2021 to FY2022 to support growth amid fragile economic conditions due to the pandemic. The 15th FC had also given states the flexibility to carry forward any unutilised borrowings from previous years to the following years of the 15th FC’s award period (FY2022-FY2026). The carry-forward provision softened the fiscal deficit constraint of the states in recent years.
To the second question. Spending by state governments plays a vital role in the economic growth of the country. Their spending ability is influenced not only by their revenue position but the borrowing limit fixed by the Union government.
In recent years, several states have enhanced their social welfare spending, which includes items such as social security pensions, transfers to low-income households, cash transfers to women, etc. The combined cash transfers to women across 11 states added up to around Rs 1.5 trillion or a sizeable 0.8 per cent of GSDP in FY2026, up from Rs 120 billion or 0.1 per cent in FY2023.
But, despite this, their revenue deficit widened only slightly. An analysis of the components of their revenue spending reveals that to accommodate these cash transfers, some states are curtailing spending under other heads or trimming the outgo in older schemes to keep the total spending under limits. But it is possible that states with reasonable fiscal space available may opt not to squeeze spending under other heads.
It is encouraging that several states have also ramped up their capital expenditure during FY2021-FY2025. The combined capital expenditure and loans and advances of 28 states reported a healthy 18.5 per cent CAGR during this period, doubling to Rs 8.4 trillion.
We now keenly await the recommendations of the 16th Finance Commission. The recommendations, related to the sharing of resources during the commission’s award period, the base borrowing limits of states, additional borrowing limits and/or a continuation of carry-forward provisions, will be key to the spending space available to states in the coming years.
The writer is chief economist, head-Research & Outreach, ICRA
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