Indian States Need Cash

States have the bulk of the dual responsibility of containing and managing the spread of COVID-19 as well as providing for those in severe economic distress due to the lockdown. But do they have the financial means to be able to to do this?

Here is a breakdown of the financial challenges the states are up against -

1) Prima facie Indian states have limited means to raise revenues as compared with the central government. They have few independent sources of revenue, their collective budgetary expenses are about 37% more than the centre and a large part of what they earn is spent on unavoidable expenditure that they are committed to. They have limited access to emergency borrowings, and a modest sum of the disaster management funds at their disposal.

2) In this moment in time, there is an unanticipated increase in upfront expenditure and at the same time the revenue available to states is going down - this creates a double edged sword.

3) The fiscal deficit of any given state is the difference between its expenditure and its revenue. The central government mandates that the states maintain a fiscal deficit of less than 3%. Within that range, the fiscal deficit of some states is higher than those of others - for e.g. the projected fiscal deficit of large states such as Uttar Pradesh, Rajasthan, and Kerala is almost 3%, which means they have little to no room to accommodate emergency expenditures. Several states are demanding that the deficit limit be relaxed. It is imperative that the central government increases it to up to 4.5% at a time when financial consolidation is impossible for states. 

4) States have a large portion of their revenue already committed for fixed expenses every month, as mentioned above. Amongst these, interest payments, salaries, and pensions are the least flexible items of expenditure. Other than a few states such as Telangana and Maharashtra, most states have not cut salaries (it is a bad idea to cut salaries given that it will further reduce demand and negatively impact the economy). 

5) States such as Telangana, Tamil Nadu, and Kerala have the highest percentage of their revenue committed to fixed expenses and therefore have the least amount of elbow room to divert revenues towards the emergency expenditure needed at the moment.

6) Not only that, the revenues are also dwindling due to the lockdown as mentioned above. For most states, state goods and services tax, value added tax and sales tax, excise duties and stamp duties form the largest components of ‘own tax revenue’. Since many of the business activities through which states get their own revenues, such as real estate transactions, sales of petroleum products and alcohol, are at a near standstill, tax earnings for the states will also plunge.

7) To make matters worse, the centre's own revenue from taxes is also hit, impacting its ability to make tax transfers to the states. To understand the gravity of this problem, consider this figure - the central government still owes about Rs 30,000-34,000 crore to states as Goods and Services Tax compensation for December 2019 and January 2020.

8) The most important emergency fund available to states is the Disaster Management Fund. However, the total amount allocated to the states for disaster relief management is Rs 28,983 crore. Out of this, the central government’s share is Rs 22,184 crore. This total quantum works out to just about 0.1 percent of nominal GDP and is clearly inadequate in the current circumstances.

9) To cover the gap states can borrow from the market. However, given that states are set to borrow more than planned and that there is uncertainty about the revenues they might be able to collect in the near future, interest rates have shot up for them. 

10) A final means of borrowing for them is short term (90 day) loans from the central bank - the Reserve Bank of India. Until last year, Rs 32,225 crore was available to states via this window. This has been revised upwards by 60%, taking it to Rs 51,560 crore. The central bank has also allowed states a longer period of overdraft. 

11) This measure will bring some relief for cash strapped states but is by no means adequate to relieve them of the financial pressures they are under right now. For one, it is significantly lesser than what the centre is allowed to borrow under the same provisions. Secondly, states wanted this limit to be extended for up to a year but it is only valid until September. 

12) Therefore, it is critical that a financial package be announced to help states carry out the responsibilities that they are faced with. In addition, as mentioned above, the fiscal deficit limit must be relaxed. This of course is of little consequence if the states are not allowed to borrow freely from the RBI. They need the centre's clearance to do so and it must be issued alongside relaxation of the deficit limit. Finally, an accountability mechanism needs to be put into place to ensure states are spending the extra money on needs arising out of the pandemic and its fallouts.  

For more details refer to these two stories -


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