The pandemic figures till mid-June show that Maharashtra, Tamil Nadu, Delhi, Gujarat and Uttar Pradesh are the five states with the largest number of confirmed COVID-19 cases in India. Together, these states also account for 42 per cent of India’s Gross Domestic Product. Thanks to the coronavirus outbreak and the ensuing lockdown, these states are likely to report losses amounting to a staggering Rs 14.4 lakh crore, or 48 per cent of the total losses states might incur in 2020-21, claims a report by a research team of the State Bank of India.
That is not to say the rest of India is faring much better. The report pegs the total loss of all states at Rs 30.3 lakh crore-or 13.5 per cent of their combined GSDP. Most Indian states are dealing with huge fiscal constraints as they fight the Covid pandemic. With lost livelihoods becoming as big an issue as the battle to save lives, states have had to step up humanitarian expenditure in the form of cash handouts and free/ subsidised food. The return of migrant workers compounded the problem, with transport, quarantine and rehabilitation adding to the spend. And now that they have to find ways to stimulate the economy, costs are expected to balloon.
The combined fiscal deficit of all states, budgeted at 2.6 per cent of the GSDP for FY21, is now set to widen to 4.5 per cent, estimates a study by credit ratings agency India Ratings & Research. “The fiscal deficit will rise by that amount unless some measures are taken,” says M. Govinda Rao, member of the 14th Finance Commission and former director of NIPFP (the National Institute of Public Finance and Policy). By comparison, the fiscal impact of the government’s financial stimulus package of Rs 20.9 lakh crore (or 10 per cent of national GDP), announced during the lockdown, is a paltry 0.8 per cent of GDP, says a DBS Bank report. That estimate is widely corroborated by various experts.
Graphics by Tanmoy Chakraborty and Raj Verma
That’s the reason chief ministers have been asking for more resources from the Union government. Punjab chief minister Amarinder Singh has sought Rs 3,000 crore from the Centre as interim compensation to overcome revenue constraints. The Uttar Pradesh government also claims a decline of 70 per cent in revenue. Bihar deputy chief minister and finance minister Sushil Modi pegged the state’s revenue shortage at 84 per cent for April. Reporting a sharp decline of 85 per cent in tax collection, Delhi deputy chief minister Manish Sisodia wrote to Union finance minister Nirmala Sitharaman asking for a Rs 5,000 crore package for Delhi to pay salaries of government employees.
West Bengal finance minister Amit Mitra sought central intervention to repay loans because the state expected to lose Rs 15,000 crore in revenues during the lockdown. Rajasthan was expecting Rs 17,000 crore in revenue for March-April, but got only Rs 4,000 crore. The state has spent Rs 2,000 crore on the Corona crisis so far. “It is clear that states will have to take care of themselves. I have found ways to improve state finances in the past and will do it again now. It’s a challenging task, but it has to be done if the Centre is indifferent,” says Chief Minister Ashok Gehlot.
Where states get money from
States have seven major sources of revenue-goods and services tax (GST), VAT on petroleum products, excise (primarily on liquor), stamp duty and registration fees, taxes on vehicles, taxes and duties on electricity and non-tax revenue. While GST, accounting for 44 per cent of a state’s revenue, is collected by the Centre and then shared with them, VAT on petroleum (23 per cent) and excise duty on alcohol (13 per cent) are the two biggest sources of direct revenue. VAT on petroleum products contributed Rs 2.3 lakh crore to the states in 2018-19. In 2019-20, the states earned a monthly average of Rs 15,000 crore as excise duty on alcohol.
As the lockdown severely impacted the consumption of petroleum products and alcohol, revenue from these products saw a sharp fall. According to an estimate by India Ratings & Research, states with a higher share of own revenues, such as Telangana and Maharashtra, are likely to be worse hit. “Our state averages Rs 10,800 crore a month from GST, excise, stamp duty and registration and mining. For April, it was Rs 1,700 crore,” says Telangana finance minister T. Harish Rao. Maharashtra Chief Minister Uddhav Thackeray put the lockdown losses of his state at Rs 35,000 crore.
With lockdown regulations eased, revenue collections from petroleum and alcohol have begun to slowly improve. A number of states have raised excise duty on alcohol and VAT on petrol and diesel. Yet, public finance experts don’t see these measures dramatically improving the fiscal health of states. States like Gujarat and Bihar, which have prohibition in place, anyway do not earn excise revenue from alcohol.
Other states too may not gain as much; bar and liquor vend owners say they are expecting a 25 per cent drop in sales this year. As for VAT on fuel, Govinda Rao feels it can only be hiked so much. “Although international crude oil prices have declined, the Centre has continued to keep the prices of distillates high besides raising central excise duty to garner revenue, leaving very little taxing space for the states,” he says.
Even before COVID-19 hit their finances, state governments had faced severe revenue constraints through the second half of FY20. Tax revenues of around a dozen states grew less than 2 per cent till February, against nearly 15 per cent a year ago. GST collections in February-a month before the lockdown started-was the lowest in five months. What makes fiscal management more difficult for the states is the delay in the release of GST compensation by the Centre.
After GST was implemented in July 2017, states had complained of revenue losses. The GST (Compensation to States) Act, 2017, assures compensation to states for the revenue shortfall for the first five years (till 2022) and guarantees a 14 per cent annual growth rate in state GST revenues. This assumption of 14 per cent growth has now come back to haunt the Centre as state GST is likely to grow at a much lower rate in 2020-21.
Compensation to states comes from the GST Compensation Fund, which is made up of a cess levied by the Centre on coal, tobacco, pan masala, automobiles and aerated drinks. The cess collections have seen a drop as the sale of many of these goods declined in the past couple of years. In FY20, the Centre faced a shortfall of Rs 55,945 crore in cess collection, but utilised the Rs 47,271 crore surplus cess (from 2017-18 and 2018-19) to pay the states Rs 151,496 crore as GST compensation from April 2019 to February 2020.
On average, the GST compensation grants accounted for 4.4 per cent of the revenue of the states in the past three years (but in 2020-21, states like Gujarat, Punjab and Delhi expect 14-15 per cent of their revenue to come from it). The GST Council can recommend other funding mechanisms for the compensation fund.
A meeting in July will discuss market borrowing by the council itself as a way to raise money and compensate states for GST revenue losses. Economists feel the Centre’s options are limited as the pandemic has not spared its own revenue sources. “The Centre’s tax resources have dried up. For two years now, FY19 and FY20, there has been a contraction in tax revenues. This means lower devolution of taxes to the states,” says D.K. Srivastava, chief policy advisor, EY India.
But even with the massive shortfall in its own tax revenues, the Centre says it has continued to transfer the states’ share in central taxes and duties. Of the Rs 7.84 lakh crore tax allocated to states for 2020-21, the Union government has released Rs 92,076 crore in two equal instalments in April and May. “In April, the transfer to the states was 110 per cent of the Centre’s net revenues in the month,” says Union expenditure secretary T.V. Somanathan.
The 15th Finance Commission had allocated 41 per cent of central taxes to the states and Union territories and 1 per cent to the territories of Jammu & Kashmir and Ladakh. These were the first two instalments of the tax devolution recommended by the Finance Commission. However, the states are upset over the Centre’s allocation of the revenue-deficit grant for FY21. These grants cover the revenue deficit some states face after devolution of their share of the taxes collected by the Centre. The 15th Finance Commission estimated that 14 states would need Rs 74,340 crore as revenue-deficit grants in 2020-21. However, Sitharaman’s budget for 2020-21 allocated only 40 per cent of the amount. The Centre has released two instalments of Rs 6,195 crore each in April and May.
What the states can do
On the face of it, states have two options to keep the economy moving-cut budgeted expenditure or increase borrowings. “States can generate funds from donations, cuts in salaries of government servants, non-essential government expenditure and involvement of private sector through PPP mode,” says Ulaganathan Sankar, honorary professor at the Madras School of Economics.
Since there is relatively less scope to reduce committed expenditure such as payment of interest, salaries and pensions, capital expenditure could see a massive drop in many states. In the absence of strong private support, public capital expenditure has been a strong component of economic growth in the past few years. With private consumption and investment expected to slip further, reduction in government expenditure could lead to a further decline in GSDP.
Till February, around a dozen states had yet to spend nearly 40 per cent of their capital expenditure target. The trend will continue. For instance, Maharashtra has issued a government resolution directing all departments to cut developmental expenditure by 67 per cent. Sources in the MP finance department told india today that the lockdown will ensure a reduction of Rs 25,000 crore in public schemes and development works. Bihar is on a similar course.
Some states have tried to tinker with committed expenditure as well. The Uttar Pradesh government has frozen dearness allowance to employees till the end of June and ordered a 30 per cent cut in salaries and allowances paid to ministers, to save up to Rs 13,550 crore. Telangana chief minister K. Chandrashekar Rao has suggested deferring loan instalments payable by the states.
However, public finance experts caution against such measures as these could adversely impact an economic revival. “If the path to fiscal consolidation is through public expenditure compression rather than an increase in tax buoyancy, it will affect economic growth. Fiscal austerity measures such as salary cuts and retrenchment will also be detrimental to economic revival,” says Lekha Chakraborty, professor at NIPFP.
The other option for states is to increase market borrowings. In March 2020, the states borrowed a total of Rs 1.16 lakh crore through the state development loan auctions, compared with Rs 62,297 crore in March 2019. Some have used up more than 90 per cent of the first quarter borrowing window, disregarding interest costs. Many states have also floated additional bonds at higher interest rates. “Interest rates have gone up by 100 basis points between end-March and end-April. The amount floated was not even fully subscribed. The states should ideally agree with the RBI on a borrowing calender, and follow it to float bonds. They should distribute the borrowing over the year and try to defer borrowings to the latter part,” says Srivastava.
Higher borrowings mean a wider fiscal deficit. Under the Fiscal Responsibility and Budget Management (FRBM) Act, states have to limit their fiscal deficit to 3 per cent of GSDP. To increase their ability to borrow more, they had demanded that the FRBM limit be increased to 4-5 per cent. On May 17, finance minister Sitharaman hiked the limit to 5 per cent-allowing states an additional borrowing of Rs 4.28 lakh crore, in addition to the current ceiling of Rs 6.41 lakh crore. But she also imposed four conditions for borrowings beyond the 3.5 per cent limit-universalisation of ration cards, improvement in ease of doing business, reforms to make state-owned power distribution companies more profitable and shoring up urban local body revenues.
States are upset over these conditions and allege unfair treatment by the Centre, which has jacked up its own borrowings by Rs 4.2 lakh crore to Rs 12 lakh crore-54 per cent over the budget estimate! In her counter, Sitharaman counters that states have so far utilised only 14 per cent of their approved limits. Her argument is validated by N.R. Bhanumurthy, professor at NIPFP. “More than half the states are running revenue surpluses. They are not getting into deficit on the revenue account,” he says. Others point out that a 0.5 percentage point of the extra borrowing window will be available to all states unconditionally and the fiscal deficit is unlikely to rise beyond 3.5 per cent in most states.
Govinda Rao agrees states should meet these reform conditions to enhance their borrowing space. “In most states, the implicit and explicit subsidy on electricity is large. Besides improving operational efficiency, they could rationalise tariffs to levels where prices are equated to average cost. This will get them additional borrowing space of 50 basis points,” he says.
While these could be long-term measures, for now states want the central bank to step in and cushion it against the possibility of rising interest rates in open-market borrowings. “The RBI can purchase the loans of the states. Without the RBI shield, institutions like NABARD or other banks could raise interest in the backdrop of too many claimants for loans,” says Sushil Modi. His views find support from Sugata Marjit of the Indian Institute of Foreign Trade (IIFT), who is also project director, Centre for Training and Research in Public Finance and Policy. “The best way is to allow the states to borrow directly from the RBI just as the Centre does-equivalent to the states accessing newly printed money,” says Marjit.
The RBI has raised the ways and means advance (WMA) limits for state governments by 60 per cent over and above their existing limits for 2019-20 to help them borrow more from the market. The overdraft period too has been extended, allowing the states to mop up a maximum Rs 3.2 lakh crore in the April-September period. “The states should utilise the WMA and the enhanced draft limit to make committed payments,” says Srivastava.
With little scope for whining, the BJP-ruled states are exploring ways to increase their resources. UP chief minister Yogi Adityanath has set up a committee headed by additional chief secretary Sanjiv Mittal to study the financial impact of the lockdown and suggest measures to mobilise resources. “There could be multiple modes of financing, such as floating Covid bonds and monetising the deficit-money financing of the fiscal programme,” says NIPFP’s Chakraborty.
Govinda Rao believes states should use the crisis as an opportunity to carry out reforms such as identifying urban land in big cities and auctioning them through development agencies, selling off commercial non-strategic public enterprises and their large holdings of land, regularising unauthorised constructions in cities in lieu of high fees, auctioning/ increasing prices of minor minerals under state control, increasing fees for services provided and rationalising tariffs on road transport. Rajasthan, in fact, has been considering some of these measures.
The state can get Rs 10,000 crore by monetising hotels, motels, old forts and heritage buildings, says one officer in the government. EY’s Srivastava says such moves should be timed for good returns. “This is not the right time to monetise land or sell assets. That should be done when the situation improves and land prices begin to rise. At this point, they should allocate land to attract industry,” he says.
What the Centre can do
Several state governments have urged the Centre to set up a separate fund to help them tide over the economic crisis. Delhi’s Sisodia, for example, has asked for a disaster fund from the Centre to fight the coronavirus outbreak in the capital. Some chief ministers have proposed available legal measures to bail out states. For instance, Kerala chief minister Pinarayi Vijayan has sought the help of the Employees’ State Insurance Corporation (ESIC), which has powers to pay salaries under ‘special circumstances’. Pinarayi has requested the Centre to include COVID-19 in that list.
Many economists believe the Centre should support the states in making up the revenue losses, especially in terms of tax devolution from the Centre. Govinda Rao suggests the central government give an additional year to the 15th Finance Commission to recommend COVID-19 grants to offset the estimated revenue loss from tax devolution. “A COVID-19 grant to states and local bodies is imminent,” says NIPFP’s Chakraborty.
Besides rolling out the Rs 15,000 crore package to help states with their COVID-19 preparedness, the Centre has also taken steps to release funds pending under other heads. On May 20, the finance ministry made advance payments of Rs 5,005 crore as the first instalment of untied basic grants to urban local bodies in ‘non-million-plus’ cities (less than one million population) in 28 states. On April 3, the Union government released Rs 17,287 crore under the State Disaster Risk Management Fund (SDRMF) to all states. Sisodia has claimed that Delhi has not received any financial assistance under the SDRMF.
However, the Centre has signalled that the states need to focus more on fiscal discipline. On May 4, in a letter addressed to secretaries of all central ministries, Somanathan said the ministries should first check if states and Union territories have the capacity to actually spend the balance from previous years and funds released during the current year. The letter also directs ministries and departments to release funds to states only on a “need basis”.
Somanathan also claimed that substantial amounts of surplus cash available with several states was parked in treasury bills, on which states were earning interest. “This means that while, on the one hand, the Union pays interest on the borrowings released to the state, on the other, for lack of utilisation, states park these funds in treasury bills, earning interest,” he says.
On their part, states claim the Centre has created unwarranted provisions to deprive them of additional revenue. For instance, the PM-CARES fund, set up by Prime Minister Modi to fight COVID-19, is now eligible to receive CSR (corporate social responsibility) spends by corporates. But the provision has not been extended to the chief minister’s relief funds. Bengal’s Amit Mitra wrote to Sitharaman about how this was “jeopardising” the state’s efforts.
Practically impossible as it sounds to put politics aside, both the Centre and states must rise above this blame game and work toward a common strategy on the best utilisation of available resources. The country faces a never-before crisis on both the health and economic fronts, nothing short of a concerted effort will do.
-with Amitabh Srivastava, Amarnath K. Menon, Rahul Noronha, Romita Datta, Rohit Parihar and Shwweta Punj