The states are financially squeezed
The Centre’s budget arithmetic, delays in fund transfers are pushing them towards a fiscal crisis
Missing in the analysis of the Union Budget has been any serious debate on the impact of the Government of India’s precarious fiscal math on state finances. Yet, when it comes to government expenditure, India’s states and their fiscal health matter a great deal. Taken together, state expenditure as a share of GDP is today in the range of about 17%, while the Union government’s share of expenditure is about 13.2% of GDP (2019-20 estimates). While state governments are big spenders, they depend significantly on New Delhi for revenue receipts. Between 2015 and 2020 (the period of the 14th finance commission), 47% of state’s revenue receipts came from central transfers. Thus, changes in the fiscal math in the Union Budget have an inevitable impact on state finances.
The headline figure that most post-budget analysis has focused on has been the inevitable shortfall in tax devolution, amounting to 0.75% of GDP to states when compared with the July 2020 budget, and a consequent overall fall of 0.5% GDP of total central transfers to states from 2018-19. This was perhaps inevitable, given the unrealistic revenue targets in the July budget, and the expected shortfalls in revenue receipts due to cuts in corporate taxes. But it is worth noting that in our fiscal federal architecture, critical taxation decisions like corporate tax cuts, which inevitably impact state finances given their dependence on central tax transfers, can be taken with minimal consultation with state governments. In the absence of effective consultation mechanisms, topped up by poor budget arithmetic and unrealistic revenue targets, and, let’s not forget, lower than expected Goods and Services Tax compensation, effective budget management becomes near impossible. How can states plan and spend if there is uncertainty over nearly half their total revenue receipts?
But beyond headline figures, the full impact of the Union government’s precarious fiscal math on State spending is only revealed through a closer look at the actual process of fund transfers and payments made through the financial year. Central transfers to state governments are made up of a combination of different fiscal transfers instruments — tax devolution, finance commission grants and central schemes. Of these, the central schemes are significant, amounting to nearly 2% of GDP in the current financial year. All the flagship schemes that readers would be familiar with — Swachh Bharat, Ayushman Bharat, Pm-kisan and Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) — account for this 2% of GDP. State governments are expected to top up these transfers with an additional 40% contribution to scheme budgets. The real impact of the Centre’s expenditure compression is hidden in these transfers.
The full extent of expenditure compression is only revealed through an analysis of the actual release of funds from New Delhi to states. Data analysed by the Centre for Policy Research’s Accountability Initiative across flagship central schemes present a dismal picture for the current fiscal. The Centre has delayed moving money for most flagship schemes. Here are some examples — Samgra
Shiksha, released only 58% of its total allocation by November 2019. The funds released for Jal Jeevan Mission were at 51%, PM Kisan at 57%, Ayushman Bharat at 32%, and the Poshan Abiyan at 31% of the total allocations by November/december 2019. These delays inevitably mean that total schemes transfers would see a significant reduction in the revised estimates.
But here is where the picture gets murky. For most of these schemes, the revised estimates (with a few exceptions such as Ayushman Bharat and PM Kisan, whose budgets were reduced) are not very different from allocations made in July. So either New Delhi is expecting a revenue windfall that will be passed on to states, or states are likely to be squeezed even further. My guess is it will be the latter.
Delays in scheme transfers are not unique to this fiscal year or this government. However, the extent of delay this year is greater than the last two years. Anyone familiar with the Indian government’s public finance management system is well aware that it is notorious for delaying fund transfers and payments. This inevitably creates unpredictability in spending and delays in project implementation. These delays are a consequence of a combination of opaque and inefficient budgeting, complicated rules and bureaucratic red tape that make spending money difficult. But in times of sluggish revenue growth, and when tax devolution is lower than budgeted, these very problems become opportunities for clever budget jugglery that make the Union government look like they are managing their deficit targets and expenditure commitments even though the reality is far from it.
Economist Rathin Roy has long argued that the Union government is facing a fiscal crisis that is deepening every year. It now looks like the Centre may well be pushing states towards a crisis too. Of course, states too are notorious for poor fiscal math and bad budget management. This improved somewhat in recent years. But with growing uncertainties in central transfers, these gains may not last long.
Finally, the data highlighted here is a call for an urgent need to adopt 21st century public finance management systems and improve fiscal transparency. The finance minister, Nirmala Sitharaman, took an important step toward transparency by revealing the extent of off-budget borrowing in the 2020 budget. She must now turn her attention to and place much needed sunlight the fund transfer system.