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Tuesday, May 17, 2022

The bad news from state budgets

States have spent less in this year, may focus on fiscal consolidation in the year to come. This belies hopes of a public-spending-led recovery.

Written by Ishan Bakshi |
Updated: March 18, 2021 9:15:10 am
The broad state-level budget trends highlighted in this article are based on 11 states that account for a little over 60 per cent of India’s GDP.

Over the past few weeks, several state governments have presented their budgets for the financial year 2021-22. These budgets shed light not only on how state finances have fared during the current year (2020-21) but equally critically, detail the expenditure stance of these governments during these tumultuous years (2020-22). Considering that the states, put together, account for a larger share of general government spending than the Centre, their spending stance is pivotal to the hopes of a government spending-led economic recovery.

The broad state-level budget trends highlighted in this article are based on 11 states that account for a little over 60 per cent of India’s GDP. While more concrete trends will emerge once all states present their budgets, this does provide a sense of what transpired in the year almost gone by, and what to expect in the coming financial year.

Five broad trends emerge.

First, the collapse in states’ revenues and transfers from the Centre, coupled with a “reluctance” among some states to borrow more to spend, has meant that at the aggregate level spending by these states in 2020-21 will end up being lower than what they had budgeted for before the onset of the pandemic. The revised estimates peg their total expenditure to decline by around 6 per cent in 2020-21 from their budget estimates.

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If these trends were to hold for the other states as well, then it would imply that the “additional” spending by the central government, over and above its budget estimate (which was around Rs 2 lakh crore if one discounts allocations meant for clearing past dues as that does not amount to a demand stimulus), is likely to be offset by the decline in spending by states. In effect, the total general government spending may end up being around or even lower than what was budgeted for before the onset of the pandemic.

Second, this year, states which typically run revenue surpluses will run revenue deficits. This was expected. The collapse in revenues meant that states that usually borrow to finance capital expenditure have had to borrow to finance their recurring expenditure as well. As a consequence, capital spending by states, which was budgeted to be around 50 per cent more than that of the Centre in 2020-21, has been cut sharply.

But the spending cuts don’t end there. With their borrowings curtailed, and the collapse in revenue so severe, states have had to cut back even on the sticky components of revenue expenditure. Data on state budgets collated by PRS shows that most of these states have cut back on allocations for pensions. Some have even slashed allocations for salaries this year.

States, though, expect the situation to reverse in the coming fiscal year, with most projecting a return to revenue surpluses even as the Centre will continue to run revenue deficits. This anomaly is unlikely to be resolved unless the root cause of the situation — the nature of the fiscal compact between the Centre and the states — is addressed.

Third, oddly enough, some of these states did have the leeway to ramp up spending by borrowing more. The Centre had raised the ceiling on their market borrowings from 3 to 5 per cent of GSDP. Of this 2 percentage point increase in the borrowing limit, part was unconditional while the remaining was subject to fulfilling Centre-mandated reforms. Several states did qualify to undertake the conditional borrowings. As per ICRA’s estimate, 17 states qualified based on the One Nation One Ration Card reforms, 15 qualified based on the ease of doing business reforms, seven partially completed power sector reforms, while six had completed the urban local body reforms.

But, it is only the low-income states of Bihar, Rajasthan and Madhya Pradesh with already stretched finances — their budgeted fiscal deficit for 2020-21 was pegged at 3 per cent or above before the pandemic — that seem to have availed the additional borrowing space and were thus able to either maintain or exceed their budgeted expenditure levels. In comparison, the high-income states of Gujarat, Maharashtra and Karnataka, all of whom had greater fiscal headroom going to the crisis, and were better placed to borrow more and spend, have not done so.

It is true that the economic hit from the pandemic is uneven — the growth projections accompanying these budgets, though to be taken with a pinch of salt, suggest that some states expect to do better than others. But, considering the breadth and depth of this crisis, there is a case for far greater spending than what is visible in these budgets.

Fourth, as is the case with the Centre, states have, remarkably, budgeted for aggressive fiscal consolidation next year. The average fiscal deficit across these states is expected to fall by more than 1 percentage point of GSDP, more than twice the decline recommended by the 15th finance commission.

Fifth, this aggressive consolidation next year is expected to be achieved not by expenditure compression, as is the case with the Centre, but by significant revenue enhancement. However, some revenue assumptions are quite ambitious, to say the least — some states have pegged their GST and VAT collections to grow far in excess of 30 per cent in 2021-22. A deterioration in fiscal marksmanship will mean that expenditure in the coming fiscal year will also end up being lower than what has been budgeted for. But this is not an anomaly. In the past too, there has been a considerable gap between the “aspirational” budget estimates and actuality.

Subdued general government spending during these tumultuous years heightens the risks to economic recovery. Considering the possibility of the economy exiting from this period with lower medium-term growth prospects, there is a strong case for greater government spending during these years. Mistaking a rebound in economic activities and that too in the formal part of the economy for a broad-based recovery in the larger economy could prove to be a costly error.

This column first appeared in the print edition on March 18, 2021 under the title ‘Don’t be tight-fisted’.

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