In about 45 days from now, a milestone in the country’s fiscal history is quietly, but surely, going to take place. The Goods and Service Tax (GST), which was billed as independent India’s biggest reform initiative, will complete five years of rollout on July 1, 2022.
After nearly a decade of confabulations, GST kicked in at a grand midnight event in Parliament. The new indirect tax system held out the promise of dismantling fiscal barriers among states and turning India into a common national market for goods and services by consolidating a welter of local and central levies into a single tax.
One of the major concerns of the states was that GST would rob them of their fiscal powers, leaving them with very little fiscal elbow room to raise revenues. The big question, of course, was what if revenues for states fell short after GST came into force?
This was addressed by a safety net of sorts, with the Centre promising to compensate states for any revenue shortfall, calculated on a 14 percent annual growth rate.
For a GST revenue base of Rs 100 in a year, a state is guaranteed an annual revenue of Rs 114. If it is unable to generate Rs 114 from its own share of GST revenue, the Centre promised to bridge the gap.
This safety net, however, came with a sunset clause. It would end five years after GST came into force. This guarantee is ending in June 2022. For many states, the disproportionately high reliance on Centre’s compensation to fill the GST revenue gap could pose a serious fiscal risk in less than two months’ time.
According to a study by PRS Legislative Research, during 2018-21, most states have relied on compensation grants to achieve the guaranteed revenue. In 2018-19, states were able to achieve 88 per cent of the target on their own and relied on compensation for only 12 per cent. The revenue gap has only progressively increased with states, on an aggregate basis, depending on Centres’ GST compensation for 23 per cent of their guaranteed revenue in 2019-20 and 36 per cent in 2020-21.
The PRS Legislative Research Study points out that states such as Himachal Pradesh, Punjab, and Uttarakhand have a significantly higher reliance on compensation as compared to the other states.
For example, a significant part of Punjab’s guaranteed revenue was met using compensation (37 per cent in 2018-19, 47 per cent in 2019-20, and 56 per cent in 2020-21). This tap closes very soon, and the clock is ticking very fast.
Sample this. As per the Reserve Bank of India’s “State Finances: A Study of Budgets of 2021-22” report, the combined debt to GDP ratio of States which stood at 31 per cent at end-March 2021 and is expected to remain at that level by end-March 2022, is worryingly higher than the target of 20 per cent to be achieved by 2022-23, as per the recommendations of the FRBM Review Committee.
A recent RBI paper showed that state governments’ market borrowings have grown at a much faster pace since 2014-15 compared to the Centre. Gross market borrowings of state governments increased almost three-fold from Rs 2.4 lakh crore in 2014-15 to Rs 6.34 lakh crore in 2019-20. The state-wise position shows that the debt-GSDP ratio, on average, ranged from a low of 16.1 per cent for Telangana to a high of 48.7 per cent for Jammu and Kashmir.
A potentially lower GST revenue compensation this year (2022-23) could force states to borrow much more.
In public finance, as it is for households, borrowing in itself is not a bad idea, if the bulk of the loans are spent on asset creation. The expenditure pattern of states, however, shows some red flags. Revenue expenditure constitutes about 83 per cent of total expenditure. The share of capital outlay, which can help in improving growth prospects through building requisite infrastructure by states, was consistently below 15 per cent. States spend about 25 per cent of total expenditure towards committed expenditure including interest payments.
Add to that the health of power distribution companies (discoms) and the guarantees that many state governments have extended for loans that these discoms have taken to pay off generation and transmission companies. In 2020-21, such loans for 16 states stood at Rs 1.36 lakh crore, which have been guaranteed by state governments. Any default by discoms in repaying these loans will only add to the mountain of state governments’ debt as the liabilities will cascade through to them because of guarantees. The fiscal risk, therefore, for states, is very high.
In 2019, the RBI warned of the rising risks to fiscal consolidation of the states as their finances are saddled with farm loan waivers, income support schemes and the UDAY for their power discoms.
State finances require a long hard look, amid the prospect of many dangerously hurtling down a debt hole.
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