Opinion Three developments that have brightened the outlook for capital expenditure by state governments

Aditi Nayar writes: Higher devolution, interest-free loans and easing of restrictions will ease stress on state finances

Aditi Nayar writes: Based on our projection, tax devolution will need to be as high as Rs 9.3 lakh crore this year, overshooting the budget estimates by more than Rs 1 lakh crore.

Aditi Nayar

September 8, 2022 08:30 AM IST First published on: Sep 8, 2022 at 03:45 AM IST

Three recent developments have brightened the outlook for capital expenditure by state governments. First, the Union government has stepped up tax devolution during July-August. Second, the interest-free capex loan scheme for states has seen a sharp pickup in off-take in July. Third, the norms for the adjustment of off-budget borrowings for the current fiscal have been eased. We believe all of these will reduce the stress on state finances and support higher capex in the coming months.

First, the Centre has stepped up the amount of tax devolution to states, releasing a double tranche in August. We believe this was warranted given the expected overshooting of its tax revenues relative to the budget estimates for 2022-23. We estimate that Rs 3.2 lakh crore has been devolved in the first five months of this year. This implies a growth of 49 per cent over the corresponding period last year. This should encourage the states to step up their capital spending in the post-GST compensation months.

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Based on our projection, tax devolution will need to be as high as Rs 9.3 lakh crore this year, overshooting the budget estimates by more than Rs 1 lakh crore. Therefore, the amount left to be disbursed to the states in the remainder of the year is quite substantial. Additional double tranches may be prudent every quarter after the advance tax inflows are received to ensure that there isn’t too much back-ending of the devolution in the fourth quarter as was the case last year.

The Centre could also consider sharing with states the likely amount of devolution prior to the start of each quarter. This revenue visibility would enable states to plan their capital spending, given the lead time required to plan and execute capital projects. It may also result in more accurate assessments of their quarterly market borrowings, which have been woefully off-the-mark in recent quarters.

Second, this year, the Centre massively stepped up interest-free loans to states, which are earmarked for capital spending. The scheme for special assistance to states for capital investment was launched in October 2020 as part of the measures to support economic activity which had been negatively impacted by the Covid-19 pandemic. In the Union budget 2022-23, the Centre had stepped up the allocation towards this scheme to Rs 1 lakh crore for the current fiscal from under Rs 15,000 crore in the previous two years. This amount will be given to the states as a loan, over and above the normal borrowing ceiling fixed. But, not all states had included the estimated inflows from the capex scheme in their respective budgets, although this does not prevent them from participating in the scheme.

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The guidelines for the usage of the funds under the Capex scheme permit the states to settle their pending bills for ongoing capital projects in addition to using them for new and ongoing capital projects that are duly approved by the Centre. The scheme is divided into seven parts. The bulk of the total or Rs 80,000 crore has been earmarked under part I of the scheme which does not have a sectoral end-use specified for the capital spending. Under this, 50 per cent of the approved amount will be released upfront after the list of projects is approved. The balance will be released after a utilisation certificate of at least 75 per cent of the first instalment is provided.

After a tepid start, capital expenditure amounting to Rs 31,500 crore was approved for 10 states in July 2022. Execution of capital projects typically witnesses a slowdown during the monsoon months. Accordingly, the second instalments are likely to be released in the second half of the year. Given the rising interest rates scenario, it makes economic sense for the states to avail the interest-free borrowing for fresh capital spending and/or clearing pending bills. However, the jury is still out on whether the capex loan will supplement the budgeted capex amount or simply fund the same. The answer may differ across state governments.

Lastly, the latest guidelines by the Centre indicate that states’ off-budget debt only for 2021-22 would be adjusted over a four-year period beginning 2022-23 and ending in 2025-26. This could provide relief to those states that had undertaken large off-budget borrowings in the previous two years, thereby creating the fiscal space for states to ramp up capital spending.

The writer is Chief Economist, ICRA