For a while now, states have been clamouring with the Centre over delay in releasing their share of the Goods & Services Tax (GST) collection. The novel coronavirus, or COVID-19, outbreak will further complicate matters for states.
West Bengal Chief Minister Mamata Banerjee had written to Prime Minister Narendra Modi seeking a relief package of Rs 25,0000 crore. She also wrote that the Centre should clear dues over Rs 30,000 crore.
Banerjee pointed out that the COVID-19 outbreak would impact state’s finances. In the letter, she wrote: “State finances (of West Bengal), like that of other states, is in a dire situation with practically no revenue flows after the closure of almost all businesses. Even with the massive debt trap left behind by the previous government, we were able to service the debt so far, but the future remains uncertain.”
Banerjee isn't alone. Thomas Isaac, Kerala's Finance Minister, has been vocal in his criticism of Centre's handling of revenue sharing.
Before the COVID-19 outbreak, India was already in the middle of a slowdown, which was starting to take a toll of state's finances. A study by Reserve Bank of India (RBI) showed that states have budgeted a consolidated fiscal deficit target of 2.6 percent of gross domestic product (GDP) in the financial year ending March.
Though states have managed to keep their fiscal deficits within the mandated threshold of 3 percent of the gross domestic product (GDP) in the last two years, an economic slowdown and now a pandemic makes it a tall task for states.
"State's finances have always been a little precarious. Most of them have been struggling to reach the mandated mark," said Madan Sabnavis, Chief Economist, CARE Ratings.
In the last five years, states' outstanding debt rose to 25 percent of GDP, posing medium-term challenges to its sustainability, according to a Reserve Bank of India (RBI) study.
According to International Monetary Fund (IMF), total sovereign borrowing, including Centre and states, stands at 69 percent of GDP, higher than China’s 55.6 percent.
"The COVID-19 outbreak will affect all revenues. And it's not just GST collections. States collect taxes on commodities like fuel. Now fuel consumption is at its lowest with the lockdown and vehicle prices crashing. They'll have a problem in meeting their revenue targets," Sabnavis said.
In Modi's meeting with state chief ministers over video conferencing on April 2, most states have demanded that FRBM (Fiscal Responsibility and Budget Management Act, 2003) limit be raised for FY21. Some states suggested that fiscal deficit up to 5 percent of state GDP be allowed against the mandated 3 percent ceiling.
"Objective of the FRBM Act is to usher fiscal discipline in public finances. It sets targets and suggests means of reducing fiscal and revenue deficits. With the growth rate likely to be experience a southern trend, there will be an impact on tax revenues," Sanjay Kumar, Senior Director, Deloitte, said.
With revenue and expenditure moving in the opposite direction, it would widen the revenue deficit and fiscal deficit. "Certainly, in times like today, the targets agreed in FRBM and the Budget may be difficult to be adhered to. Probably, the government may soon develop a long-term fiscal plan as envisaged under FRBM," Kumar said.
Some states have been telling the Centre that they are so cash strapped that they have had to defer salary payments. What states collected as their own tax revenue from sales tax on petroleum products and stamp duty on real estate transactions have taken a hit after the real estate prices crashed.
GST compensation for states in FY20 fell short by Rs 30,000 crore. Additionally, the states’ own tax receipts like sales tax on petroleum products and stamp duty on real estate transactions has taken a big hit.
"Ind-Ra expects the aggregate fiscal deficit of states to come in close to 3 percent of GDP in FY21, higher than the budgeted 2.6 percent of GDP for FY20. Ind-Ra expects continuance of low GDP growth even in FY21. State government finances are likely to continue witnessing revenue pressure in FY21," credit rating agency Ind Ra had said in a report before the COVID-19 outbreak hit India.
The COVID-19 outbreak may not leave Centre with any option but to relax the FRBM targets. "There exists a conflicting need to kick start the economy once the lockdown ends, which in turn would require an injection of significant governmental funds. A relaxation of FRBM requirements may potentially be required," said Abhay Sharma, Partner, Shardul Amarchand Mangaldas and Company.