The coronavirus pandemic has given the government’s finances a scissor cut. The economic output of the country has been dropping drastically making the government revenues shrink while on the other hand the government is forced to spend more and more sums of money to safeguard the lives and livelihoods.
The shrinkage in revenue does not have its effects limited to the widening deficit. The consequences are enormous for both the centre and state governments in terms of their ability to invest and lift the economy out of the current phase. The drop in revenue also hints at more borrowings by the governments. The debt servicing ability of the central government shall also be highly affected for worse as the states are dependent on the centre for a good part of the revenue stream.
In just the first half of the fiscal, that is from April to September, the total revenue collected by the centre, both tax and non-tax, stood at mere 27.3% of the budget for the full fiscal year, amounting to rupees 5.5 lakh crore. This comes in comparison to the 41.6 % off budgeted target collected in the first half of the previous fiscal year. Moreover, the revenue collected in the first half of the current year was down by 32.5% on year on year basis as against an average 15% growth over the same period in the last five fiscal years.
The currently available data is only for the first half of 11 large or so-called non-special category states. The revenue of the states has seen a decline of 21.5% year on year in comparison to the previous 5 years average of 10.4% growth. And once the centre’s transfers to these states are considered, the revenue decline drops to 16.5%. It is true that the shortfall in the revenue of States seems less than the shortfall in the revenue of the centre, but one thing to consider here is that the shortfall in the states’ revenue was partly mitigated by the transfers made by the central government.
How has this large fall in a new collection impacted the people and the government?
Very clearly the total expenditure by the centre has dropped by 0.6 % year-on-year during the current financial year’s first half. An 11.6% decline in the capital expenditure has been seen whereas revenue expenditure was mildly up by 1%.
The total expenditure and capital spending of the 11 States have declined by 1.5 % and 23.4 % respectively. However, a growth of 1.5 % has been seen in its revenue expenditures. In the committed nature of the revenue expenditure, allocations for pension and subsidies have declined by 10% and 20% respectively. Because of the fact that the states are at the forefront of the fight against the pandemic, their revenue expenditure has been arguably higher. Moreover, health is a state subject on which the state spends a little over two and a half times the expenditure done by the centre on medical and public health, making the states to shoulder an enormous part of the health expenditure burden put on on account of the virus.
The states, as well as the centre both, have done the best to fight the pandemic financially by cutting capital expenditure. But the states have faced a harder budget constraint and have also cut their capital expenditure more than the centre. This comes as a cause of worry because the state undertakes over 60% of the overall general government capital expenditure. In fact, States have curtailed capital expenditures over the last few years in order to align with the fiscal consolidation road maps. For example the capital expenditure by states stood at rupees 4.97 lakh crore in the year 2019 – 20, marking a drop of 20% from the budgeted target of rupees 6.22 lakh crore. During the same period, the revenue expenditure dropped only by 9%. All through this time, the actual capital expenditure by the centre was along budgeted lines.
To maintain the spending and keep the economy running, the centre has been forced to resort to the option of borrowing. Due to this, the borrowing by the centre as well as the states has increased by as much as 50% year on year so far. This also highlights the fact that the debt levels in the coming years are going to rise sharply. At the end of last year, the overall general government debt was 76.7 % of the gross domestic product (GDP), making it stand at a nine-year high. This could be divided as 26.3 per cent for the states and 50.4 per cent for the centre.
In recent years the debt and its servicing indicators have given market researchers a different outlook on the condition. The debt by the centre to the gross domestic product ratio has trended downwards whereas the state debt to GDP ratio has seen a jump since 2015 – 16. Another interesting fact here is that the ratio of interest payments to revenue receipts of the state governments has continued to go downwards. This ratio indicates the debt sustainability which generally moves in sync with the debt ratio. In other words, the two ratios which were earlier in sync, now seem to diverge. This has happened on account of the fixed path of interest outgo while there has been a continuous improvement in the revenue streams for the states. The ratio of states’ revenue to GDP jumped from 13.3% in 2015-16 to 14.5% in 2019- 20. The revenue of the states comprises their own revenue and the transfers received from the central government, both tax evolution and grants. If there had not been a growth in transfers from the centre, the debt sustainability ratio would have remained the same.
The share of transfers by the central government in States’ revenue jumped from nearly 42% in the year 2014-15 to approximately 47 % in the year 2019-20, majorly on account of a rise in the share of the divisible tax pool from 32% to 42% starting from 2015 -16. All the data stated above prove the financial dependency of the states on the centre and the vulnerability they face when they do not receive adequate and timely funds from the central government.
This throws at us another major point which is that with the slowdown in the revenue earned by both the central and the state government, the comfortable looking debt servicing for States is set to become troublesome and burdensome, which when combined with the rising debt levels would make the states unlikely to encourage their capital expenditure.
The recent publication by the Reserve Bank of India titled ” state finances: a study of budgets of 2020-21” shows that the capital spending by States is procyclical. In other words, this expenditure tends to be lower during a low growth phase and vice versa while the spending sensitivity to debt is greater with the debt ratio of more than 25%.
As of now, the debt to gross state domestic product (GSDP) ratio of 12 large States is over 25%. Out of these, 7 have a ratio greater than 30%, with Punjab leading the list with a ratio of 40%. It is expected that the situation will worsen and include more and more states in this list of having a debt to GSDP ratio of 25%.
And on the same note, the overall investments in this fiscal year could be badly hit. the government and the private sector are not in a condition to willingly invest even when the interest rates are low. With the continuation of demand uncertainty, the private sector is expected to remain wary of investing.