More capex for states

Higher Central funds for states' capital outlay are welcome, but these should lead to additionality

A key feature of Finance Minister Nirmala Sitharaman’s Budgets has been the steady rise in the government’s capital expenditure. From about 1.67 per cent in 2019-20, the share of the government’s capital expenditure in gross domestic product, or GDP, rose steadily in the following years — to 2.15 per cent of GDP in 2020-21, 2.53 per cent in 2021-22, and to 2.67 per cent in 2022-23. In the current financial year, it is budgeted to rise to 3.3 per cent of GDP. The last time the government’s capital expenditure had crossed the level of 3 per cent of GDP was almost two decades ago in 2004-05.

This was creditable, not least because a smaller increase in the government’s capital expenditure could have given the finance minister the leeway to present a lower fiscal deficit number. The fact that she decided to give up that obvious advantage is testimony to her greater commitment to the idea of the government raising its capital expenditure to not only upgrade the country’s infrastructure, but also to help crowd in private sector investment, whose growth so far has been muted. Along with introducing accounting transparency to the way the government meets its subsidy burden, Ms Sitharaman’s five Budgets would be remembered for the sharpest rise in government capex in any five-year period in the past many years.

But there is yet another significant change. This pertains to the composition of the capital expenditure budget during the post-pandemic years. In 2021-22, the capex allocation of Rs 5.93 trillion included a small portion of Rs 10,000 crore to be disbursed to the states by way of 50-year interest-free loan for capex, subject to the fulfilment of certain economic policy reforms by the state governments. In the following year, the states were allocated Rs 1 trillion by way of capex support to them. Thus, a little over 13 per cent of the total Central capex of Rs 7.5 trillion went to the states. This share has been maintained in 2023-24, when out of Rs 10 trillion, the states have been allocated Rs 1.3 trillion for their capex projects under the same window.

Did the increased capex allocations result in higher capital expenditure by the states? Remember that even when the Centre had given only Rs 10,000 crore to the states during 2021-22, the capital expenditure by most states had risen significantly. Official data shows that capital expenditure by 28 states and the Union Territory of Delhi rose by about 32 per cent from Rs 4 trillion in 2020-21 to Rs 5.31 trillion in 2021-22, as governments began to spend more in the wake of the Covid pandemic. What also became evident was the fact that the states had begun spending more on capital expenditure even with only a small amount of support from the Centre. Only three states — Andhra Pradesh, Mizoram and Sikkim — saw a decline in their capital outlay, ranging between 10 and 13 per cent in 2021-22.

There was, however, a surprise in store. In 2022-23, when the pandemic was on the wane, the capital expenditure by these 28 states and the Union Territory of Delhi increased by only 12 per cent to Rs 5.97 trillion. And this, when the Centre had offered Rs 1 trillion to the states by way of capex support.

What happened? In spite of an additional support of Rs 1 trillion from the Centre, the states’ capex went up by only Rs 66,000 crore. What’s more, as many as eight states saw their capital outlay shrink by huge margins — Andhra Pradesh by 55 per cent, Punjab and Rajasthan by 17 per cent each, Telangana by 38 per cent, Assam by 20 per cent and Nagaland by 18 per cent.

In contrast, many large states stepped up their capital outlay in 2022-23 by substantial margins —Bihar by 29 per cent, Chhattisgarh and Gujarat by 27 per cent each, Haryana by 17 per cent, Jharkhand by 49 per cent, Kerala by 13 per cent, Maharashtra by 32 per cent, Odisha by 45 per cent, Tripura by 48 per cent, Uttar Pradesh by 31 per cent, and West Bengal by 26 per cent. Tamil Nadu and Uttarakhand were exceptions as their growth in capital outlay was in single digits — 7 per cent and 9 per cent, respectively.

There are four likely explanations. One, with the Covid pandemic gradually going away, the states are no longer that keen on spending more on capital projects to create jobs. Two, it is also possible that the few states that saw a decline in their capital outlay suffered either from a shortage of executable projects or from their inability to absorb any increased flow of funds. The third possibility is that many states used the Central support of Rs 1 trillion to their advantage and stepped up their outlay. And the fourth reason, which is slightly disconcerting, could be that many of these states used the Central support to divert the resources originally earmarked for capital projects to fund other schemes under revenue expenditure.

Whatever be the reasons, the slow capex growth for states in 2021-22, despite the sharp jump in Central support, is likely to result in serious rethinking on the nature of assistance or policy steps needed to sustain the rise in their capital expenditure. In their Budgets for 2023-24, these states have projected over 37 per cent growth in their capital outlay, perhaps enthused by an increased Central capex support of about Rs 1.3 trillion. But given what happened in 2022-23, there are now serious doubts if the projected increase in capex by these states will be achieved.

The states’ absorptive capacity to implement capital projects is certainly a cause for concern and there are no quick solutions to enhancing that administrative ability to implement projects at a decent pace. But the bigger concern is if some states are using Central funds to indulge in avoidable financial jugglery. It would be tempting for the states to use Central funds to meet their capex targets and divert their own resources for other populist schemes. The Union finance ministry would do well to ensure that all Central funds released to the states for capital expenditure effectively lead to additionality and do not substitute the outlays for their existing capital projects.