Centre must step up cash flow to states

Aditi Nayar writes: By increasing tax devolution, Centre can help states tide over another uncertain year and make spending comfortable for them

Every Tuesday, the RBI auctions state development loans (SDLs) or bonds which are the predominant source for state governments to raise money to finance their fiscal deficit. In 2020-21, the gross amount raised through this source had jumped to Rs 8 trillion, up from Rs 6.3 trillion in the previous year — an expected, albeit unhealthy fallout of the Covid-19 pandemic on state finances.

So how have states fared so far this year? In the first quarter of the current financial year, gross issuances of bonds stood at Rs 1.4 trillion. This amount is 14 per cent lower than the bonds issued last year (Rs 1.7 trillion) when state governments’ cash flows had undergone a sharp disruption during the nationwide lockdown. This is also around 20 per cent lower than what states had initially indicated they would borrow (Rs 1.8 trillion) through the indicative calendar of market borrowings released by the RBI. As a result, state bond issuances have undershot expectations in the first quarter, despite the negative impact of state-level restrictions, amidst the second Covid wave, on economic activity.

In our view, lower state borrowings were a consequence of three major factors which boosted state governments’ cash inflows.

First, an additional tax devolution of Rs 450 billion from the Centre in late March. This amount was in excess of the Rs 5.5 trillion tax devolution that had been included in the revised estimates for 2020-21 presented during the budget in February.

Second, record-high GST collections in April. Expectedly though, growing restrictions tempered GST E-way bills in month-on-month terms in April and May, which dampened collections in May and June. Nevertheless, the amount that the states received through state GST and their upfront share of integrated GST doubled to Rs 1.3 trillion in the first quarter of this year, up from Rs 0.6 trillion in the same period last year.

Third, receipt of substantial grants from the Centre adding up to Rs 436 billion in April-May related to the recommendations of the Fifteenth Finance Commission.

Thus, in aggregate, gross bond issuances in April-May 2021 were Rs 476 billion lower than indicated. However, the situation reversed in June 2021, with the issuances being 20 per cent higher than the indicated amount. This uptick may reflect some emerging stress in the states’ revenue collections in June as widening state-level restrictions in May curtailed economic activity.

Now, for the ongoing second quarter, the indicative calendar released by the RBI pegs states market borrowing at Rs 1.7 trillion, or 9 per cent lower than the amount raised over the same period last year. This implies that overall borrowings by states will be lower in the first half of this year as compared to last year. However, this trend will not sustain as redemption pressures will push up borrowings in the second half of the year.

There are some other critical factors as well that can lead to state-wise differences in the magnitude of borrowing, and change the timing of issuance over the next three quarters.

First, the varying pace of unlocking and the consequent economic revival in states from June onwards may crucially affect state borrowings in the second quarter. A faster ramp-up of vaccine administration may help some states to protect themselves against a potential third wave, leading to relatively lower economic disruption, reducing the need to borrow.

Second, the eventual calendar for raising back-to-back loans by the GoI to compensate states for the loss in their GST revenues could also result in a change in the states’ borrowing schedule.

Third, the quantum, and timing of tax devolution will also play a role. Central tax devolution forms a quarter of states’ combined revenue receipts. This revenue stream has contracted by 15 per cent in the first two months of the year, falling to Rs 392 billion each in April-May this year, from Rs 460 billion last year. If the Centre continues to devolve to states this amount till February 2022, then a massive Rs 2.4 trillion (36 per cent of the budgeted amount) will be left for devolution in March 2022 — assuming that the devolution for the full year is not revised below the budgeted level. From the states’ point of view, this would be rather inefficient from a cash flow perspective.

An early step-up in tax devolution by the central government may provide comfort to the states to accelerate expenditure during another uncertain year, without borrowings being pushed up in the next two quarters.

This column first appeared in the print edition on July 8, 2021 under the title ‘States of uncertainty. The writer is chief economist, ICRA

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