Fiscal concerns cloud likely uptick in Capex

By increasing states' share in the divisible tax pool to 42%, the 14th Finance Commission has ushered in a monumental change in the country's fiscal architecture. States now have the flexibility to pr

A review of the budgets of 17 states throws up three broad trends. First, states expect their own revenue to grow 16 per cent in 2016-17, higher than the Centre's transfers, which are projected to grow at 14 per cent. Second, a conservative estimate puts capital outlay by states at three per cent of gross domestic product (GDP) in 2016-17, higher than the Centre's capital outlay. Third, despite projecting an improvement, states are likely to see their fiscal deficit worsen to 2.9 per cent of GDP in 2016-17, from 2.7 per cent in 2015-16, on account of UDAY, the power distribution reform scheme, and Seventh Pay Commission hikes. (FINANCE COMMISSION  TRANSFERS TO STATES)

Where does the money come from?
After being overly optimistic about the growth prospects of their own revenue in 2015-16, states have been more realistic in 2016-17. At the aggregate level, 17 states see modest revenue growth of 16 per cent in 2016-17. Total revenue receipts are now budgeted at 14.6 per cent of the gross state domestic product (GSDP) in 2016-17.

Compare this to 2015-16, when states had budgeted revenue receipts at 15.2 per cent of GSDP but ended up collecting only 14.6 per cent, largely due to shortfalls in their own revenue.

Despite greater tax devolution, a majority of the states are more reliant on their own revenue than transfers from the Centre. Of the 18 state budgets analysed by CARE, 11 are relying on their own revenues to a greater extent than transfers from the Centre. For these 11 states, their own revenue is expected to be 67 per cent of total revenue receipts in 2016-17, with the balance coming from the Centre.

Digging a bit deeper, one finds it is largely the low income states of Bihar, Odisha, Jharkhand and Madhya Pradesh that are more reliant on transfers from the Centre, roughly 60 per cent of their revenue receipts in 2016-17.

In 2015-16, many states had prepared their budgets before the Centre accepted the recommendations of the 14th Finance Commission. As a result, states had underestimated the quantum of transfers. This can be seen from the fact that there was a sharp increase in the states' share of central taxes between the budget estimates (5.9 per cent of GDP) and the revised estimates (6.1 per cent of GDP). The upside of this was that the unexpected increase in transfers helped states overcome the shortfall in their own revenues.

The flip side was that most states had ended up over-budgeting the Centre's contribution to Centrally Sponsored Schemes. With the Centre transferring a lower amount and the lack of clarity over its contribution, work on some of these schemes suffered in 2015-16. The confusion continued till the sharing formula between the Centre and the states was finalised.

Where does the money go?
Despite concerns that states were institutionally unprepared to deal with the increase in transfers from the Centre, data suggest that, on aggregate, states have been able to focus on productive and developmental spending.

According to CARE, capital outlay is budgeted to grow 18 per cent, in 2016-17, from Rs 3,46,939 crore in 2015-16 to Rs 4,09,225 crore. Though HSBC estimates states' capex growth to be flat in 2016-17, on aggregate, states capex is budgeted to outstrip the Centre's considerably.

With the Centre reorienting its priorities to stimulate rural growth, the burden of reviving the investment cycle seems to rest more on states and public sector undertakings (PSUs). HSBC estimates the combined and PSU capex to rise to 5.6 per cent of GDP in 2016-17, from 5.4 per cent in 2015-16. The Centre's capex is budgeted at 0.9 per cent in 2016-17.

The emphasis on capex at the state level can be seen from the fact that when in 2015-16 states' own revenues fell short of projections, most of them sharply reduced their current expenditure. As a result, capital spending saw a relatively lower cut. There were exceptions. Some states, such as Bihar did take advantage of the flexibility offered by way of an increase in untied funds to boost social sector expenditure in the run-up to the Assembly elections.

Worrying outlook for fiscal deficit
Despite higher devolution from the Centre, the fiscal position of states is expected to deteriorate. While the aggregate fiscal deficit for 2016-17 is budgeted at 2.6 per cent of GSDP, down from 2.7 per cent in 2015-16, HSBC estimates it would worsen to 2.9 per cent.

By comparison, the Centre has reaffirmed its commitment to fiscal consolidation, projecting to bring it down from 3.9 per cent of GDP in 2015-16 to 3.5 per cent in 2016-17. The fiscal slippage at the state level is largely on account of the interest that states will have to pay on UDAY bonds and implementation of Pay Commission recommendations for their employees.

HSBC estimates eight states to issue Rs 1.8 trillion in UDAY bonds by the end of the current financial year. The interest burden on these bonds alone is likely to amount to 0.1 per cent of GDP in 2016-17, putting pressure on the fiscal health of the sates.

Abhimanyu, finance minister of Haryana, said, "The 2016-17 budgetary estimates have been substantially impacted by this singular decision. The state government has decided to take over (discom) debt of Rs 25,950 crore in two tranches in 2015-16 and 2016-17 under UDAY."

The other factor is likely to have a bearing on the deficit is states' pay commission. If the states' pay commission wage burden roughly equals the Centre's, it could cost around 0.4 per cent of GDP, according to HSBC.

But, according to Nomura, states have not budgeted for pay commission hikes this year, presumably on account of the added burden of UDAY bonds. While some might announce the hikes during the course of the year, as these are likely to be implemented in a staggered manner, the full impact of the wage bill will be felt over the coming years.

In 2015-16, as in the past, states saw a slippage from the budgeted fiscal deficit target. As opposed to a budgeted target of 2.6 per cent, states on aggregate clocked 2.7 per cent. This was largely because of lower-than-expected revenue collection at the state level, attributed to the sharp fall in oil prices and lacklustre growth of Value Added Tax collections.

According to Nomura, data from the Petroleum Planning and Analysis Cell show the petroleum sector contributed only Rs 79,000 crore to state exchequers in the first half of 2015-16, declining 1.3 per cent from the previous year.

But, there is a reason to cheer for those who are worried that higher state deficits would cause bond yields to rise. The increase in states' borrowings is likely to be offset by a decline in the Centre's borrowings. As the Centre has committed to staying on the path of fiscal consolidation, the consolidated government borrowings, Centre plus states, as a percentage of GDP is likely to soften in 2016-17.

Based on research reports by CARE and HSBC Global Research

VOICES

"Some far-reaching changes unilaterally introduced by the Centre have adversely impacted state finances. Subsequent to the acceptance of the recommendations of the 14th Finance Commission, the central government unilaterally restructured CSS"

Amit Mitra, Finance minister, West Bengal

"The 2016-17 budgetary estimates have been substantially impacted by this singular decision. The state government has decided to take over debt of Rs 25,950 crore in two tranches in 2015-16 and 2016-17 under UDAY"

Abhimanyu, Finance minister, Haryana

"In the initial budgets, we had tried to fulfil the pre-poll promises made by the Samajwadi Party (SP) and we have been successful. Now, our focus is on farmers, rural population and giving employment to the youth"

Akhilesh Yadav, Chief Minister, Uttar Pradesh, (holds finance portfolio)

"With the aim of the state government to develop Bhubaneswar as a world-class city, a provision of Rs 333 crore under the Smart City Mission was announced"
Pradip Kumar Amat, Finance minister, Odisha