The Reserve Bank of India (RBI) recently released its annual report on the status of state finances, giving insight into the economic landscape in the wake of the Covid-19 pandemic. The report reveals a significant impact on state government finances, with key points covering the effects of the pandemic on fiscal deficits, capital spending, tax buoyancy, and GST revenue. In addition to detailing the projected overall impact on state indebtedness and fiscal sustainability.
COVID-19 Impact on State Finances
The COVID-19 pandemic has had a major impact on state finances due to a simultaneous collapse in revenue and escalation in health-related and other costs, thus creating what is commonly referred to as a scissor effect. This effect has in turn significantly affected the fiscal deficit of state governments.
Fiscal Deficit Scenario
Given that most state budgets were presented before the advent of the pandemic, these estimates don’t accurately capture the fiscal reality of the ongoing 2020-21 year. Pre-pandemic gross fiscal deficit to GSDP (Gross State Domestic Product) averages stand at 2.4%, while post-pandemic budget presentations show a rise to 4.6%. This indicates an impending doubling of gross fiscal deficit for states in the 2020-21 period. Fiscal Deficit represents the difference between the government’s total income and its total expenditure.
Capital Spending Status
Capital spending by states is expected to be significantly lower than initially budgeted for the year. This reduction can be attributed to lockdown restrictions in the first quarter and monsoons in the second quarter preventing the successful initiation of many projects. Over 60% of general government capital expenditure—money used to acquire assets like land, buildings, machinery, and investments in shares—comes from state-level capital spending.
Tax Buoyancy
Predicted tax buoyancy for 2020-21, in relation to the revised estimates of 2019-20, is higher than originally budgeted. This implies an expected increase in tax collection pace correlating with rises in income. Tax buoyancy is defined as the ratio of tax change and GSDP (Gross State Domestic Product).
Impact on GST Revenue
The largest impact will be on the States Goods and Services Tax (SGST), the GST component that goes directly to the states. SGST collection fell by 47.2% in the quarter from April-June in the 2020-21 fiscal year. This fall also affects state receipts due to a decrease in the divisible pool of the Centre’s tax revenue.
Overall Impact on State Finances
The report concludes that state indebtedness is projected to rise, a factor that could negatively affect fiscal sustainability if not countered by growth acceleration. The recent modest gains from financial prudence might be overwhelmed by this surge. Furthermore, there may be a need to put investment projects on hold due to an increase in contingent liabilities (guarantees). In response to these challenges, state governments are cutting various expenditures like deferments and deductions of salaries and allowances, and rationalising travel and establishment expenses, in efforts to stimulate aggregate demand.