States' capital budgets: Spending, classification can be variable exercise

States have begun to put serious money in their capital budgets but how much of that money is new and where does the spending go? India Ratings & Research data shows for FY24 nine major state governments plan to spend close to 26 per cent more than what they spent in FY23. As absolute numbers, these are big sums and bear examination. 

An analysis of the state budgets by Business Standard shows a large part of those capex numbers in key states are meant for construction of buildings. These are mostly for hospitals, schools or training institutions, particularly in eastern states. Hardly any state has made provisions that, say, mimic production-linked incentives schemes or subsidies for renewable power to attract private sector investments.

For the sake of comparison, we chose two states in eastern India, Odisha and West Bengal. By the estimates of most public finance economists and by those of successive Finance Commissions and the reports of the Comptroller and Auditor General, Odisha is one of the most fiscally responsible states. West Bengal lies at the other extreme. 

Most of the other major states, including Gujarat, Uttar Pradesh, Karnataka, Kerala, Rajasthan, Telangana and Haryana, hew close to either extreme.

This comparison could become difficult, however. Rajasthan has proposed to shift its accounts from treasury-based mode, where the rules are set by the Comptroller and Auditor General, to a pay and accounts mode. In the latter, the rules will be set by the state legislature. The incentive could rise as the capex purse expands. 

To understand how a state spends its money, budget speeches or the Budget at a Glance sections are of little use. State finance ministers (picking up from an earlier central government habit) spray expenditure numbers all over their speeches, using often dubious bases to compare. For instance, in FY23 West Bengal’s gross state domestic product (GSDP) (at constant prices) is estimated to grow at 8.4 per cent over the previous year when the national GDP is estimated to grow at 6.8 per cent (RBI estimate). With that cushion, the aggregate capital expenditure projections often look impressive. 

So how do states write their capital spending? To understand them, it is important to dive into the budget literature of each state, particularly the “demand for grants”. This document is voted upon by the state legislature. So it is supposed to show in meticulous detail where each rupee will be spent by the executive.

In this study we look at the demands for two comparable departments — health and family welfare of Odisha and West Bengal to understand how the capital budget shall be spent. 

The Odisha government’s demand for grants on this head expects to spend Rs 3,434 crore in FY24. This is an impressive 40 per cent rise over the budget estimate for FY23. Of this the state plans to spend 60 per cent from its own pocket, ie net of the central support. Most of this money will be spent on infrastructure development of health institutes. The redevelopment of the state’s Cuttack-based medical college and hospital will draw in Rs 1,400 crore or about 40 per cent of the capital budget for the medical sector. Since the state has spent Rs 890 crore in FY23, the 57 per cent additional spend seems a plausible estimate. 

A far cry from such clarity are the West Bengal numbers. The demand for grants for capital expenditure for the state includes both administrative expenditure and state development schemes. This is unusual as no other state includes administrative expenditure under this head. (It seems a throwback to how former Union Finance Minister Pranab Mukherjee drummed up a concept of effective revenue deficit. Under that head, expenditure even under revenue, but linked to capital formation, was subtracted from the revenue expenditure of the government to underplay the extent of the revenue deficit.) 

In West Bengal, of the total projected Rs 2,886 crore the state plans to spend as capital investment for health, almost 40 per cent will be spent on medical education, training and research, clearly a revenue expenditure. The rest of the money is to be spent on 11 so-called “state development schemes”, which beyond the bald statement offer no clarity on what they are. Since there are no names for them, but they have legislative approvals, they could work as purses which the state government can tap into whenever it needs.

For instance, there is a state development scheme under the general administration department, “direction and administration”. A sum of Rs 81 crore is sequestered there. Commenting on this trend from the audit report of FY21, the CAG audit of the state notes: “There were instances of misclassification of revenue transactions under capital section and non-accountal of other liabilities, which would have further increased the deficits”

Coming on top of the fact that the state for five years from FY16 to FY20 had underspent its capital outlay budget by 22 per cent, compared with the 17 per cent average for all states, the numbers do not inspire confidence at all.

The numbers for other states are better. In Uttar Pradesh, the government has divided the expenditure not only between the traditional capital and revenue, it has gone ahead and split both into new and extension of old schemes. 

Again in health, the state has asked for legislative approval to spend Rs 32 crore for reconstructing anganwadi and maternity centres. 

But Uttar Pradesh faces a risk of a different sort. It has set for itself stiff targets on capital spend. For instance, in the sub-section family welfare, it spent Rs 8,912.44 crore in FY23. This was double the Rs 3,965.2 crore spent in FY22. The state has bumped up the number to Rs 10,069 crore in FY24. This is a massive 171 per cent rise over just two years, a trend in its capital budget for almost all heads. 

Spending so aggressively on family welfare, which means spending on mother and child care, through the state budget is prone to major leakages. A CAG audit report of FY21 contained a table of "instances where a substantial proportion (50 per cent or more of the total expenditure under the major head) of the expenditure was classified as other expenditure” by the state government. This implies that the state treasury was either rushing to balance the books and had no time or was not given any clear understanding by the spending department on how the money will be spent. Family welfare was one of those where a whopping half of the money was parked under other expenditure. 

It seems quite clear that unless a state decides to adopt some hard constraints for itself in setting budget goals that can be monitored, just shifting the goals of the budget to spend more on capital will not by itself improve the development outcomes.