The fiscal crisis stemming from the disruption in economic activity due to the coronavirus is now beginning to show. Concerned over the impact on their revenues, several state governments planned cuts in salaries of government employees. While they have softened their stance subsequently — salaries will be paid in a staggered manner — the situation nonetheless underlines the severity of the cash crunch being faced by state governments. The stress to state finances stems from multiple sources. First, as economic growth falters, their own income streams, for instance, revenues from petroleum products, real estate transactions, will slow down further, as will GST collections, and the amount collected through the compensation cess will not be enough to meet budgeted expectations. Second, as the Centre’s own revenues also slow down, transfers to states will take a hit. It is quite likely that tax devolution to states, which has been budgeted at Rs 7.8 lakh crore in 2020-21, will not materialise. As, collectively, state expenditure far outstrips that by the Centre, with revenues falling short, any cut backs in their spending, at a time when there is a need for a bold fiscal expansion, will further aggravate the economic stress. Thus, states, which are at the frontline of fighting the public health crisis, need to be assured of adequate resources.
On Tuesday, the Reserve Bank of India decided to increase the ways and means advances (WMA) limit by 30 per cent for state governments. The WMA is a temporary liquidity arrangement with the RBI which helps governments tide over their short-term liquidity woes. While states have been averse to opting for this facility in the past, and the new WMA limits may need to be revised further if the mismatch rises, this is a short-term measure, and does not address the underlying issue of significant revenue slippages. Under the existing fiscal deficit constraint, the collapse in revenues will force states to cut back on spending, imparting a contractionary impulse to the economy.
Thus, the Centre must take several steps to ensure adequate flow of resources to states. First, it must immediately clear all its pending dues to state governments. Second, while it is cheaper for the Centre to borrow and transfer to states, even though the spreads between state and central government bonds have now widened, making state borrowing more costly, states must be allowed to borrow more. As some state chief ministers have suggested, the fiscal deficit limits imposed on states must be relaxed.
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