State Capex: Glass one-third full

Meagre revenue growth appears to have compelled the states to restrain the rise in their revenue spending

The first eight months of the ongoing fiscal have been quite eventful, amid Assembly elections taking place in five states. With Parliamentary Elections coming up on the horizon, this is a good time to take stock of the state government finances.

The Comptroller and Auditor General (CAG) of India has released fiscal data for H1 FY2024 for 21 states, which throws up rather mixed trends. The combined revenue deficit of states widened modestly to Rs 0.7 trillion in H1 FY2024 from Rs 0.5 trillion in H1 FY2023 but was equivalent to a worrying 90 percent of the level budgeted for the full year. The root cause for this is a moderate pace of growth of their combined revenue receipts, at 8 percent in H1 FY2024, which is significantly below the 19 percent year-on-year (YoY) expansion forecast in the FY2024 Budget Estimates (BE).

Meagre revenue growth appears to have compelled the states to restrain the rise in their revenue spending to 10 percent in H1 FY2024, a far cry from the 18 percent increase that they had pencilled in at the time of the presentation of FY2024 budgets.

Meagre Revenue Growth

So why did revenues, a nominal metric, grow so languidly, when the Indian economy is estimated to have grown in excess of 7 percent in real terms in H1 FY2024? Dissecting the various components of the revenues of the states reveals that consumption-based taxes such as State GST and excise duty collections, actually reported a fairly healthy double-digit growth in H1 FY2024. However, a contraction in the sales tax collections and grants from the Centre in H1 FY2024 dragged the YoY increase in revenues of the states.

In the post-GST era, sales tax is largely imposed only on fuels, and in some states, on alcohol (over and above the excise duty). Several states in the sample had cut their VAT rates on petrol and diesel in November 2021, and have not revised them back to those levels until now. The negative impact of this has been exacerbated by the cut in cesses on fuels by the Government of India (GoI) in May 2022, which lowered the base price on which the VAT rates are levied by the states. Further, the sedate growth in the consumption of fuels has led to an estimated 3 percent contraction in the sales tax collections of the states in the first half of this fiscal.

Additionally, the grants from the Centre to the 21 states shrunk by a massive 27.2 percent in H1 FY2024, in stark contrast to the 25.3 percent expansion expected by them in FY2024 BE. This contraction was on account of the discontinuation of GST compensation grants with effect from June 2022 and the tapering of the Finance Commission recommended grants, both of which ideally should have been anticipated by the states, and built into their forecasts. In contrast, Central tax devolution has been front-loaded relative to last year, and recorded a handsome 21 percent expansion in H1 FY2024.

State Capital Expenditure

Nevertheless, the fiscal deficit of the sample widened considerably to Rs 3.5 trillion in H1 FY2024 from Rs 2.4 trillion in H1 FY2023 but stood at a relatively modest 40 percent of the FY2024 BE. The wider fiscal deficit followed from the welcome 50.3 percent expansion in the capital spending of the 21 states, exceeding the estimated 35 percent growth budgeted by them for FY2024. With this, the states achieved a third of their budgeted target for capital outlay for FY2024, higher than the trend recorded last year.

The jump in state capex benefitted from the front loading of the approval and disbursal of the interest-free capex loans by the GoI in FY2024 compared to FY2023. To recap, the GoI had presciently decided to enlarge the allocation of the capex loans to the states to Rs 1.3 trillion for FY2024 from the Rs 813 billion that was disbursed to them in FY2023. Till October 2023, the GoI had approved capex loans of Rs 962 billion and released a sizeable Rs 585 billion to the states. In FY2023, the entire Rs 813 billion had seen a back-ended release, getting disbursed nearly equally in Q3 and Q4 of FY2023.

To meet the target for FY2024, the capital outlay and net lending of the 21 states would have to expand by an estimated 28 percent YoY, or Rs 1.2 trillion, during the second half of the year. Although this is lower than the 50 percent increase in H1 FY2024 and in line with the growth in H2 FY2023, it appears challenging in the light of the Assembly elections in some states in Q3 FY2024 and possible imposition of the model code of conduct ahead of the parliamentary elections during Q4 FY2024. As a result, the fiscal deficits of some states may end up being lower than the budgeted level, although this would entail a less healthy quality of their fiscal deficit.

On a positive note, we now estimate the GoI’s gross tax revenues to exceed its FY2024 BE by Rs 0.5 trillion, of which around Rs 0.2 trillion would be devolved to the states. We expect this upside to be released to the states in Q4 FY2024, which could help to restrain the issuance of State Government Securities in that quarter, below our forecast of a sizeable Rs 3.4 trillion.

The writer is Chief Economist and Head - Research & Outreach, ICRA. Views are personal, and do not represent the stance of this publication.