States improve fiscal position, but local bodies still suffer: RBI report

Covid worsened finances of local govts in 2020-21 and 2021-22; local authorities would lose 15-25% of their revenues in 2021, which may make maintenance of current level of service delivery difficult

States have budgeted to bring down their deficits by a full percentage point from last year, as revenue improved in sync with lift in pandemic-related restrictions, but the local bodies have been badly hit by the pandemic and must be allowed functional autonomy, said a report by the Reserve Bank of India (RBI) on Tuesday.

For 2021-22, the states have budgeted their consolidated gross fiscal deficit (GFD) to gross domestic product (GDP) ratio at 3.7 per cent, “a marked improvement from the level of 4.7 per cent in the revised estimates for 2020-21, the year of the first wave of the pandemic,” stated the State Finance Report of the RBI.

However, the local governments, such as urban local bodies, have “come under severe strain, forcing them to cut down expenditures and mobilise funding from various sources.”

Terming the local bodies as ‘third-tier governments’, the RBI report said much of the pandemic management fell upon these bodies, as municipalities, and gram panchayats, implemented containment strategies, healthcare, quarantining and testing facilities, organised vaccination camps and had to maintain the supply of essential goods and services.

The pandemic worsened the finances of local governments in India substantially in 2020-21 and 2021-22. As various estimates cited by the RBI report, the local authorities would lose around 15-25 per cent of their revenues in 2021, which may make the maintenance of the current level of service delivery difficult. Gram Panchayats struggled for funds during the pandemic in rural areas. Urban local bodies also faced similar difficulties, as per a survey by RBI of 141 municipal corporations across the country.

Of the 141 surveyed, 98 per cent of respondents reported an increase in expenditure, decline in revenue collection, and “lack (or delayed release) of funds from the state governments during the second wave of the pandemic.” Several municipal corporations cut down on expenditure in other areas to fund the covid response.

In the survey, 22 per cent of the respondents reported revenue loss of over 50 per cent during the second wave of the pandemic, as against 16 per cent in the first wave.

The RBI report suggested that “increasing the functional autonomy of the civic bodies, strengthening their governance structure and empowering them financially via higher resource availability, including through own resource generation and transfers, are critical for their effective interventions at the grass-root level.”

Interestingly, in 2020-21, the shortfall in states’ revenue collections did not result in a concomitant fall in their capital outlay because of the “Special Assistance to States for Capital Expenditure” scheme announced by the

Centre on October 12, 2020 as part of the Atma Nirbhar Bharat Abhiyan , as well as reallocation and re-prioritisation of expenditure by the states themselves.

For states, the ratio of revenue spending to capital outlay (RECO) is budgeted to decline to 5.5 in 2021-22 from 6.7 in 2020-21, the RBI report noted.

“Within capital outlay, it is important for the states to channelise expenditure to sectors that crowd in private investments and optimise multiplier effects and inter-temporal and inter-sectoral linkages that boost output, employment and productivity,” it said.

RBI governor Shaktikanta Das had recently said that states that can afford to do so must shore up capital expenditure so that it triggers overall growth through a multiplier effect.

The RBI, in its report, said as the impact of the second wave wanes, states must take “credible steps to address debt sustainability concerns.” The combined debt to GDP ratio of states at 31 per cent at end-March 2021, which is expected to remain at the same level by end-March 2022, “is worryingly higher than the target of 20 per cent to be achieved by 2022-23.”

The 15th Finance Commission expects the debt-GDP ratio to peak at 33.3 per cent in 2022-23 ratio to peak at 33.3 per cent in 2022-23, and gradually decline thereafter to reach 32.5 per cent by 2025-26.

Therefore, the decline in the gross fiscal deficit by states of 3.7 per cent of GDP for the year 2021-22 - lower than the 4 per cent level as recommended by the Finance Commission – “reflect the State governments’ intent towards fiscal consolidation,” the report noted.

As noted by the 15th Finance Commission, there should be reforms in the power sector, mending of the health of power distribution companies, while functional autonomy of the civic bodies should improve.

“Overall, sub-national fiscal positions are at an inflection point. Empowerment of the third-tier government presents an opportunity that can result in better and more effective pandemic crusaders in the future,” the RBI report said.