States are ablehttps://indianexpress.com/article/opinion/columns/states-are-able/

States are able

They must also be willing to do the heavy lifting to kickstart the investment cycle.

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Will the states be able to spend the newfound resources on investment? The record of the states is better than that of the Centre.

Reviving investments is the biggest challenge facing the Indian economy today. The corporate sector is shy of sinking in more money because of unutilised capacities, high leverage and weak earnings. A recent Crisil survey of 192 listed, private- and public-sector companies shows that planned capital expenditure by the private companies is likely to decline this fiscal. While the refrain is that the onus is on the Union government to kickstart the investment cycle, in terms of financial resources, it is actually the states that can do the heavy lifting.

The states have been playing an increasingly bigger role in investment cycles than the Central government. In 2000-01, for instance, the capital expenditure of the states was 1.6 times that of the Centre. In 2013-14, it was 2.2 times. Increased devolution as a result of the 14th Finance Commission award, along with the revenue stream from coal auctions, have enhanced the financial capability of the states to invest.

While the Centre has some fiscal headroom because of the lower subsidy bill (lower oil prices) and increased excise collections on petrol and diesel, its ability to increase public spending remains limited as it follows the path of fiscal consolidation. Past trends also suggest that governments typically cut down on capex to meet fiscal deficit goals. For instance, to meet its fiscal deficit target of 4.1 per cent of the GDP for 2014-15, capex was brought down to 1.5 per cent from the budgeted 1.8 per cent.

Today, the states have much healthier balance sheets compared to the Centre. At the aggregate level, they run a revenue surplus. For the decade 2004-05 to 2013-14, while the Central government ran a revenue deficit of 3.2 per cent of the GDP, the states were in mild surplus (0.03 per cent of the GDP). During the same period, the fiscal deficit of the Centre was 4.6 per cent — twice the 2.3 per cent of the states.

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The revenue surplus of the states means all their borrowings go into investment spending. The Centre has not been able to achieve this and is unlikely to do so in the near future. The transition of the states from being revenue-deficit to revenue-surplus took place over the last few years. This is largely the result of the enactment of the Fiscal Responsibility and Budget Management (FRBM) Act by the states, which led to compression in expenditure relative to the GDP. This was also a period of high GDP growth, which helped the states increase their aggregate revenue receipts. An increase in revenue after the adoption of value-added tax also helped.

The Centre has now raised the states’ share of the total divisible pool of tax revenues to 42 per cent from 32 per cent, as per the recommendations of the 14th Finance Commission. This is the biggest-ever increase in vertical tax devolution. The states’ share of taxes and grants combined would constitute over 75 per cent of total transfers in 2015-16, compared with around 60 per cent in 2014-15. Plan grants, on the other hand, would come down from about 40 per cent to 24 per cent. The states will receive an additional Rs 2,144 billion over 2014-15. This not only increases the pool of resources available to them but also the flexibility to design, implement and finance programmes according to their specific needs. In addition, money from coal auctions will add substantially to the revenue of some states. As pointed out in the RBI’s latest study on state finances, taxing the fast-growing e-commerce market would also help improve the states’ revenue stream, provided there is clarity around rules governing such inter-state trade. The proposed GST structure should take care of this.

To keep its fiscal space intact, the Centre has reduced the resources it transfers to the states in the form of Central assistance for state plans (including Centrally sponsored schemes) by Rs 750 billion — from Rs 2,717 billion in 2014-15 (revised estimate) to Rs 1,967 billion in 2015-16. While this may disturb the budgetary funding of some states and they may end up losing out on a net basis, at an aggregate level, the increase in “Finance Commission” transfers is a good move as it enhances the autonomy of the states. This year’s Economic Survey notes that the “Central assistance to states” transfers are much less progressive compared to per capita “Finance Commission” transfers — that is, the latter does a better job of equalising income and fiscal disparities between major states.

But not all states benefit in equal measure. The new norms on fiscal transfers will benefit some states more than others. And the coal auctions will benefit only the states with coal mines.

Fiscally healthy states include Madhya Pradesh, Gujarat, Jharkhand, Chhattisgarh, Rajasthan and Tamil Nadu, which account for almost 32 per cent of the total capex by the states. These states run a revenue surplus, have fiscal deficits of less than 3 per cent of the GSDP, and debt under 25 per cent of the GSDP. Of these, MP, Chhattisgarh and Jharkhand stand to gain relatively more from the higher Central devolution and coal auctions. The additional annual income from coal to these three states will be about Rs 50 billion, which accounts for around 22 per cent of their non-tax revenues. These states, which are among the poorer ones, will be more financially able than others to utilise this increased flexibility to pursue their developmental goals.

Will the states be able to spend the new-found resources on investment? The record of the states is better than that of the Centre. While the Centre has been cutting capex by huge amounts to meet its fiscal deficit targets, the situation is more optimistic for the states. For instance, they spent Rs 3,791 billion on capex in 2013-14 against a budgeted Rs 3,854 billion. For the six states with better fiscal health, the actual capex, at Rs 1,209 billion, was comparable to the budgeted Rs 1,223 billion.

The ability of the states to handle increased flexibility in spending is yet to be tested. Whether they do the heavy lifting on investments or squander the opportunity remains to be seen.

Co-written by Adhish Verma.

Joshi is chief economist and Verma is junior economist at Crisil Limited.