Why states should find newer resources rather than cut back on spending

For states staying within the fiscal deficit targets is important, but not by cutting back on expenditure

The latest report on state budgets, brought out by the Reserve Bank of India (RBI), has shown how most states have curtailed their expenditure to stay within the fiscal deficit limits set by them under the law. The combined fiscal deficit of all states and Union Territories with their own legislature was in 2019-20 contained within their budget target of 2.6 per cent of gross domestic product (GDP), even though their revised estimates had shown a significant slippage at 3.2 per cent. And they achieved this fiscal correction not by increasing revenue collections, but by sharply cutting back on both revenue and capital expenditure.

Even as their revenues according to the provisional accounts fell by 6 per cent, compared to the revised estimates, the spending squeeze was by a margin of 11 per cent for revenue expenditure and by 14 per cent for capital expenditure. Experts will be debating for long the implications of such expenditure contraction by states for the Indian economy and whether this had indeed “negated the fiscal impulse from central finances in that year to counter the cyclical slowdown.”

But an equally disturbing trend the RBI report brings out is the steady deterioration in the state budgets’ discipline of preparing realistic estimates and adhering to them as strictly as is desirable. In the last couple of years, this discipline has been flagrantly violated by the Union finance ministry. It would now appear that the states are no longer free from this disease of projecting unrealistic estimates.

 In the last two years, in particular, the Centre’s actual revenue receipts were much lower than even the revised estimates that were put out almost a year after the budgets were presented. In 2018-19, the actuals for revenue receipts were 10 per cent lower than the revised estimates. And in 2019-20, the provisional actuals for revenue receipts were over 9 per cent lower than those presented in the revised estimates.

 On the expenditure side, such slippages were quite pronounced in 2018-19. Revenue expenditure was lower by over 6 per cent, largely achieved through transferring the burden of some spending to state-owned enterprises, and capital expenditure was down by 2.53 per cent. Such a ploy helped the Centre show the actual fiscal deficit number at 3.4 per cent of GDP, no different from what was given in the revised estimates.

 In 2019-20, the finance ministry did not seek recourse to such expenditure management. Thus, the provisional actuals for fiscal deficit soared to 4.6 per cent of GDP, compared to 3.8 per cent claimed in the revised estimates. To be fair, there would be variations before 2019 as well in the actuals for revenue and expenditure, but those would be relatively small and never so large as to require a change in the fiscal deficit number.

 A similar lack of discipline in state budgets has been exposed by the RBI report now.  In 2018-19, the states’ actual revenue receipts were lower by 8.4 per cent compared to the revised estimates. The slippage in non-debt capital receipts was higher at 19 per cent. But a squeeze on expenditure saved the day for the states. Their revenue expenditure was down by over 6 per cent and capital expenditure was lower by a higher margin of 18 per cent. The result: The combined fiscal deficit of the states was down to 2.4 per cent, compared to 2.9 per cent shown in the revised estimates.

 The actuals for the states’ combined revenue receipts in 2019-20 were also lower by 6 per cent, compared to the revised estimates. Even their non-debt capital receipts were lower by 25 per cent. But the states pressed the pause button on their expenditure, as a result of which their revenue spend was down by 11 per cent, and worse, their capital spend was lower by 14 per cent. The result: The actual fiscal deficit for states in 2019-20 was cut to 2.6 per cent, from the revised estimates figure of 3.2 per cent of GDP.

 It would appear that like the Centre, the states too are indulging in presentation of unrealistic revenue numbers, on the basis of which expenditure programmes for the next year are rolled out. But once the revenue growth assumptions are proved wrong, there is a squeeze on expenditure to somehow keep to the fiscal deficit target. This is an example of poor fiscal planning.

 There are two other trends that become apparent from a closer study of the RBI report on state budgets. One, the size of the state budgets is growing at a slower pace than that of the Union budgets. The combined size of the state budgets at Rs 12.85 trillion in 2011-12 was smaller than the Union budget size of Rs 13 trillion that year. However, from the following year, the state budgets began growing at a rapid pace showing double-digit annual growth ranging between 11 and 19 per cent till 2016-17.

Illustration: Binay Sinha

In contrast, the Union budget size grew at a smaller rate in this period with annual increases ranging between 6 per cent and 10 per cent. But since 2017-18, the state budgets have begun to grow at a reduced pace, partly because of the slower than expected revenue growth in the years after the launch of the goods and services tax (GST) and the consequent expenditure squeeze. Union budgets, on the other hand, have continued to grow at a higher rate of 8 to 16 per cent.

 In 2019-20, the size of the state budgets was only 24 per cent more than the size of the Union budget. This was a significant change from 2016-17, when the state budgets were more than 33 per cent of the Union budget. This trend is likely to continue, given the way states have been curtailing their expenditure in the last two years.

 States are in the forefront of undertaking expenditure in critical areas in the economy such as healthcare, infrastructure and  skilling as well as education. Outlays for such areas will suffer, if the states’ budget expenditure sees a slowdown, causing concern for the country’s overall growth. Additionally, if the Centre’s budgets see a healthy rise in its size, much more than the state budgets, it could also signal a new direction towards increasing centralisation in public expenditure, with attendant implications for the pattern of development and governance in the country.

 The other significant trend change is the manner in which the states’ revenues have been witnessing slower growth than those of the Centre. Between 2011-12 and 2018-19, the states’ own tax revenues grew at less than 7 per cent in each of these years. But the Centre’s gross tax revenue recorded double-digit growth in most of the years during the same period. Similarly, while the Centre’s tax revenues fell by over 3 per cent in 2019-20, the states are likely to have suffered a steeper decline. 

The states’ failure to improve their revenue flows will have an impact on the their financial strength and fiscal autonomy. At a time, when the central transfers to the states are under squeeze for a variety of factors, the states must explore newer avenues of raising resources to keep their expenditure plans intact. Staying within the fiscal deficit targets is important, but not by cutting back on expenditure. Instead, the way out should be to raise more resources, perhaps through non-tax revenues.