Risk to state govt finances

Debt at the subnational level is high

Goods and services tax (GST) collection in September slipped to a 19-month low of Rs 91,916 crore. A lower GST collection along with slower growth in direct taxes and a reduction in corporation tax rates could affect the finances of not only the Union government but also of the state governments. States spend about one and a half times more than the Centre and account for about two-thirds of the general government capital expenditure. Therefore, the state of state government finances has a significant bearing on macroeconomic outcomes. In this context, the annual study of state finances by the Reserve Bank of India serves an important purpose by filling a critical information gap. The latest edition, released this week, highlights several issues that could affect the broader economy in the medium term.

For one, at the aggregate level, states have budgeted for a fiscal deficit of 2.6 per cent of gross domestic product (GDP) in the current fiscal year, compared to the revised estimate of 2.9 per cent last year. While states at the aggregate level have maintained the fiscal deficit below the 3 per cent mark, the quality of expenditure has deteriorated in recent years with a rise in revenue expenditure. In 2018-19, for instance, states witnessed a slippage of 34 basis points in their revised estimates for fiscal deficit, compared to the budget estimates, largely because of lower receipts and higher expenditure on account of farm loan waiver and income support schemes. This restricted the flow to capital expenditure, which would affect growth in the medium term and, in turn, hamper revenue mobilisation.

Second, GST collection has fluctuated and the targets for most states have remained elusive. While the states are compensated for any shortfall in GST collection, the arrangement is not permanent. Therefore, all outstanding issues in the GST system should be resolved at the earliest. It is also important to examine what needs to be done with regard to the introduction of the invoice matching system, which so far has posed a major challenge before the tax administration. The other problem for states is that the revenues from sources such as stamp duty and sales tax have become more volatile in recent years, which affects predictability of receipts. Also, states generally tend to overestimate revenues, which could be undermining the quality of expenditure.

Third, debt at the state level has increased over the last few years and is at about 25 per cent of GDP. The report shows that India has the highest debt-to-GDP ratio at the subnational level among its peers. It further highlights that at the aggregate level, debt is sustainable in the medium term, but if outstanding guarantees are taken into account, state government debt would become unsustainable. State governments provide guarantees to borrowings by state public sector enterprises, which have gone up in recent years. Deterioration in the financial conditions of power distribution companies could also put pressure on the state governments’ finances. As things stand today, bringing down the state debt to 20 per cent of GDP  by 2024-25— as recommended by the committee that reviewed the Fiscal Responsibility and Budget Management Act — would require an increase of 14 per cent in receipts every year.   

Overall, while states have adhered to fiscal discipline, there are potential risks to their finances. A prolonged slowdown can dent state government finances and result in a vicious cycle of lower expenditure and lower growth. Therefore, it would be advisable that the Centre and states work together to push up economic activity, improve tax compliance and prioritise capital expenditure to maximise returns.