An insight into the steady decline of states' spending from FY17 to FY20

In FY20, the difference between the Budgeted provision and actual amount spent rose to Rs 4 trillion, about 13 per cent of total expenditure of states

Indian states became central to the discussion on public spending in India from 2015-16, when the then new Bharatiya Janata Party government accepted 14th Finance Commission’s recommendation to increase states’ share in central taxes from 32 per cent to 42 per cent. Major taxes such as income tax, Goods and Services Tax, excise duties, are collected by the Centre, but belong to both the Centre and the states. States made a lot from this deal, their revenues rose, and so did their spending: both on social schemes and on capital assets such as roads and health infrastructure. 

But the previous year, 2019-20, clearly breaks from this path. 

The year when India’s economic growth slipped to 4.2 per cent, the lowest in more than a decade, Indian states cut their spending by a massive Rs 4.16 trillion, a recently released report by the Reserve Bank of India shows. As against a Budgeted revenue expenditure of Rs 31.4 trillion, the provisional accounts (PA) put it at Rs 28.4 trillion. The revised estimates still put it at Rs 31.8 trillion, 12 per cent higher than the provisional number. 

Similarly, provisional actual capex stands at Rs 4.55 trillion against the Budgeted Rs 5.81 trillion. The RE still pegs it at Rs 5.31 trillion, 17 per cent higher than provisional data. 

In terms of revenue receipts, there is a gap of Rs 1.77 trillion between the RE and PA of 2019-10, meaning that the revised estimates grossly overestimate the revenues of states. 

This massive gap in expenditure between the RE and provisional estimates is more than two per cent of India’s GDP, and shows the extent to which states cut their spending to maintain fiscal balance. Indeed, states’ fiscal deficit actually reduced from 3.2 per cent in the RE stage, to 2.6 per cent in the PA stage, courtesy the expenditure cut that followed poor revenue realisation.

The cut in capex was such that it reversed the ongoing trend in two ways. States had gradually taken a strong lead, by increasing their share in combined capital spending from half to 60 per cent in six years to 2018. In 2019-20, it came down to 57 per cent. In this analysis, capex means capital outlay mentioned in states budgets. 

Why is capex important? 

Spending on capital assets creates more jobs than revenue spending, encourages more private investment in the economy. Imagine a situation in which the government spends on constructing a highway connecting one city to another. Private companies then find the newly connected town as a potential for new investments. Thus, despite having a small share (combined capex Rs 8 trillion for FY20) in overall investments in the economy (Rs 54 trillion), governmental capex is key to catalysing investments in the economy as a whole. 

“State governments may have to face the difficult choice of putting investment projects on hold, but, given the multiplier associated with capital spending, this will inevitably entail growth losses in a vicious circle feeding itself,” the state finances report notes. 

Then, apart from states’ falling share, the share of capex in overall spending by states had improved from 13.7 per cent in 2011-12 to 15.8 per cent in 2016-17. It has gradually come down to 13.8 per cent in 2019-20, going by the provisional accounts data. For the Centre, too, it declined from 14.4 per cent in 2016-17, to 12.5 per cent in 2019-20.

Incidentally, India’s gross domestic product growth declined from 8.1 per cent in the last quarter of 2017-18, to 3.1 per cent in the last quarter of 2019-20, according to official data. 

But then, falling capex would mean that revenue spending is rising, which, however, is not the case. The share of expenditure identified as social sector expenditure is too falling. 

In the 14th FC period (2015-16 to 2019-20), the share of social spending in overall disbursements rose in initial years, from less than 40 per cent, to  nearly 42 per cent in 2016-17. In the latest known accurate estimate, 2018-19, it has fallen to 40 per cent back again. Though the share looks higher in 2019-20 and 2020-21, they are revised and Budget estimates, respectively, likely to undergo final revision downwards.

“Since 2015, discretionary spending has risen in response to exogenous fiscal shocks in the form of UDAY (scheme that bailed out power distribution companies temporarily), farm loan waivers and income support schemes,” the state finances report said. 

There are a few markers that are giving states the opportunity to spend on populist schemes like these.

“Primary factors pushing up states’ discretionary spending are debt and GSDP growth,” the report notes. This effectively means that states are putting proceeds from higher debt into discretionary spending, made possible by higher GSDP growth in recent years. 

The RBI data also shows that the pool available for this discretionary spending is being depleted due to a higher requirement to spend on non-development items such as interest payments, administrative expenses and pensions. 

The share of development spending in total expenditure declined from 67.6 per cent in 2016-17 to 62.9 per cent in 2018-19, while that of non-development items rose by two percentage points in the same period. 

“Reprioritising spending towards more productive capital projects has to be made centre-stage and insulated from being sacrificed repeatedly at the altar of the expediency of shortsighted fiscal arithmetic,” the report said. 

Investing in public health systems and social safety nets taking into account the states’ demographic and epidemiological profiles, and strengthening urban infrastructure should become primary in designing fiscal strategy, it added.

“Linking higher borrowing with financing capital expenditure, and central transfers to transparent fiscal would bring in incentive-compatibility,” it noted.