Indian States Are Going Under. What Does This Mean For Us?

M. Govinda Rao and Arjun Srinivas each examine the precarious financial situation of Indian states and the implications of this.

Here are key takeaways from two pieces, by M. Govinda Rao and Arjun Srinivas, that tell you what Indian states are going through financially and what this means for us as a country and people. 

- The Covid 19 Pandemic and resulting lockdown in April led to a large and sudden shortage of revenue inflow for State Governments. Economic slowdown prior to the lockdown was already challenging the fiscal capacity of states, and some, like Delhi, have experienced a pullback of upto 92% compared to their revenue of April 2019. 

- As a consequence, state expenditure has been threatened, with grave consequences for citizens. This expenditure is what creates infrastructure and jobs and stimulates businesses and provides critical social services to vulnerable citizens. 

- The solution to these problems is not an easy one. As of now it appears the states have two options: cut down on public expenditure or increase the amount they borrow. 

- There exists a sharing of revenue between the centre and the states. In the budget for the 2020-21 financial year, 52.5% of the states’ total revenue were to be generated on their own, while 47.5% came via central transfers (aggregated across all states).

- A sizable 10% of state revenue comes from levies on land transactions which have completely stalled and 85% comes from various taxes, under which the main tax head is the State GST. This is determined by the GST council and thus cannot be revised by states. 

- The most that states have been able to do to raise revenue is to raise sales tax and excise, primarily on liquor and petrol. They have hoped to take advantage of pent up demand. Delhi for instance, had imposed a 70% tax on liquor called Corona fee (this has now been withdrawn). Such strategies are not always effective however. Sales fell in Karnataka after an initial surge and it fell short of its monthly excise target of Rs 19 billion by Rs 4 billion. Some states have resorted to more unconventional, ad hoc measures, such as Karnataka’s attempted sale of corner plots - within Bangalore Development Authority jurisdiction - to raise Rs 150 billion. 

- Further complicating this issue is the fact that the states’ ability to raise revenue for themselves is far from uniform. More prosperous ones like Delhi were projected to raise as much as 86.5% of its own revenue, while Nagaland was thought to be able to raise only 8.4%. 

- There will be a loss in state grants issued by the center as a result of its own loss of revenue. For instance, a promised annual 14% increase in GST revenue for states will most likely not be met. This will especially affect states dependent on the centre for their revenue. 

- Ideally, states are encouraged to keep taxes and fiscal deficits (between revenue and expenditure) within stipulated limits in order to attract private investment. They had difficulty in doing this even in the pre-covid financial year of 2018-19, as only 12 of 36 states and Union Territories restricted their deficit to within 3% of their gross state domestic product (GSDP). With both increased pressure to curtail expenditure and an overall increase in the same in the fight against Covid, it is likely that the situation will only worsen.

- To deal with these issues, the borrowing limit for states has increased by 2% of their GDSP (Gross Domestic State Product: a monetary value of all the final goods and services produced in a state in a specific time period). However, 1.5% would require them to undertake reforms in various spheres, including the public distribution system of foodgrains, ease of doing business, the power sector and urban local bodies. It is fairly likely that states would be unable to meet these stipulated conditions, which would discourage such borrowing practices (in order to avail of an extra 1.5%) and instead induce them to reduce expenditure. Additionally, though reforms are desirable, the unprecedented presence of these conditions for borrowing has troubling implications for the financial autonomy of states. 

- In curtailing expenditure, states appear to focus on reducing capital expenditure (eg acquisition and creation of assets) because they aren’t really able to cut back on revenue expenditure (eg payments towards interest, salaries, pensions). This is bad for the economy because capital expenditure by states accounts for 2.8% of India’s GDP, and is also channelled into crucial sectors like transport, irrigation, energy and rural development. 

- Although clear solutions to this problem are not easy to find, institutional mechanisms that enable inter-government bargaining, cooperation, conflict resolution, and non-predatory competition among states for Center grants would go a long way in terms of managing the crisis. 

You can read M. Govinda Rao’s piece here:

And Arjun Srinivas’ piece here:

Also, here are related articles for you to read on IPC:

Indian Federalism in the time of Modi’s BJP

Questions for the 15th Finance Commission to Answer

Indian States Need Cash

A Brave New Design for Centre-State Coordination

M. Govinda Rao was a member of the Fourteenth Finance Commission and former Director, National Institute of Public Finance and Policy; Arjun Srinivas is with 'How India Lives', which is a database and search engine for public data.

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