The state of southern states’ finances: All you need to know

The state of southern states’ finances: All you need to know
On February 1, the Union government presented the Budget for the upcoming financial year (FY) 2021-22 in the Parliament. Soon, between February and April, individual state governments will present their respective Budgets in their state legislatures. Among the southern states, Kerala has already presented its budget in January, and Tamil Nadu is expected to present its budget on February 23 with the other states to follow in March. Importance of State Budgets The Constitution provides for the distribution of financial powers between the Union government and states. Consequently, revenues are largely collected by the Centre and then proportionally shared with the states. However, both the Union government and states undertake expenditures towards realising various public policy obligations. And in recent times, the states have been collectively spending more than the Union government, by over 60%. For example, states undertake most of the expenditure on essential and economic services, including schools, health, agriculture, roads, electricity, and public safety. This implies that much of what affects citizens on a regular basis is decided at the level of the state. The Budgetary Process In the upcoming Budgets, for the FY 2021-22, state governments will present the estimates of: (i) How much money will be earned from different sources, and (ii) The money they expect to spend through various ministries. Based on these Budget Estimates (BEs), each ministry will prepare a detailed Demand for Grants (DFGs), i.e., a break-up of expenditure to be incurred. The DFGs will then be discussed and approved by the legislature to enable the government to spend that money. Legislatures simultaneously also have a responsibility to hold the government accountable. Thus, elected members (MLAs) play a central role in enforcing accountability, by examining these DFGs, and whether such spending would lead to desirable outcomes. While there are Parliamentary standing committees that scrutinise DFGs of the central ministries, some states like Goa, Mizoram, and Arunachal Pradesh have a Budget Committee to examine budget proposals. However, among the southern states, only the Kerala Assembly has constituted ministry-wise Subject Committees to scrutinise DFGs. In the other four states, the overall budget and the Grants are simply discussed on the floor of the House and are approved without much scrutiny by the legislature. Budgetary Trends – Revenue States earn revenue from their own sources, and through transfers from the Union government. Own sources consist of tax revenue (includes SGST, Sales tax, Excise duty) and non-tax revenues (such as, lottery sales and royalty). Central transfers include states’ share in central taxes (as recommended by the Finance Commission) and Grants-in-aid. During 2015-21, as seen in Figure 1, trends in revenue receipts show that southern states are largely reliant on their own sources of revenue. They generate on an average, 65% of their revenue from their own sources, thus indicating self-sufficiency to a great extent. Sources: State Budget Documents However, between 2015 and 2019, states, on average, have raised 9% lesser revenue than what they estimated in their budgets. The southern states (except Karnataka) in particular, have witnessed even larger shortfalls in their revenues, as seen in Figure 2. Across states, among the four broad categories of revenue receipts, the highest shortfall (by 23%) is seen in the Grants-in-aid (from the Union government) component. And, as seen in Figure 3, all the southern states (except Karnataka) have observed exceedingly high shortfalls in the Grants-in-aid (from the Union government) component. Sources: State Budget Documents Thus, a shortfall in estimated revenues will lead to either: (i) Reduction in expenditure during the year, or (ii) Additional borrowing to meet expenditures. Budgetary Trends – Expenditure State budgets also estimate the expenditures that will be incurred in a particular year. Government expenditure is of two types: (i) Revenue expenditure, which is recurring in nature, such as on salaries, pensions, and subsidies, and (ii) Capital expenditure, which creates assets or reduces liabilities, such as the creation of schools, hospitals, roads or repayment of loans. Revenue expenditure forms over 80% of the incurred expenditure for the southern states (the national average is 85%), with Kerala, in particular, spending around 90% on revenue expenditure. This implies that only a relatively smaller portion of the budget remains available for capital expenditure. In terms of sectoral spending in budgets, between 2015-19 (as seen in Figure 4), the southern states have spent on average: (i) 22% on human development (includes education, health, and water supply and sanitation), (ii) 26% on economic sectors (includes agriculture, urban and rural development, housing, energy, and roads and bridges), and (iii) 5% on administration and security (including public works, and police services). Sources: State Budget Documents However, these states also regularly underspend their budgets, often an outcome of the revenue shortfalls seen earlier, that forces them to revise/cut their spending targets. Between 2015-19, Telangana, has underspent its budget by 19% which is the highest among southern states. Karnataka, has been the only southern state that had no revenue shortfall and has managed to spend the money it had budgeted for. Underspending also impacts expenditure on capital outlay (which leads to the creation of assets), with Telangana having massively underspent by 37%, and Karnataka having spent 1% over and above its budgeted figures.  Such underspending adversely impacts government-led capital investment in the country, since a higher share of capital outlay is borne by the states. Sources: State Budget Documents Budgetary Trends – Borrowing and Debt States invariably have to borrow money to meet their expenditure targets. Each state has enacted a Fiscal Responsibility and Budget Management (FRBM) Act that specifies the revenue deficit (excess of revenue expenditure over revenue receipts) and fiscal deficit (excess of expenditure over receipts) levels to be adhered to while preparing the budget. A high revenue deficit implies states have to borrow even for regular expenditure, while a high fiscal deficit implies higher overall borrowing requirements in a financial year. The Finance Commission (FC), while providing revenue deficit grants, previously recommended that states should achieve zero-revenue deficit, by 2019-20. However, as seen in Figure 6, states like Andhra Pradesh (AP) and Kerala continue to show large revenue deficits. For the 2021-26 period, all southern states, except Telangana, are slated to receive revenue deficit grants, with AP and Kerala set to receive grants over Rs 30,000 crore. Similarly, the FC also recommended that states maintain fiscal deficits up to 3% of their GSDP, with some conditional and performance-linked relaxations for certain states. However, as seen in Figure 7, on average, Andhra Pradesh and Kerala have had higher fiscal deficits. This results in accumulation of long-term debt and a higher obligation to repay loans in the coming years, further constraining states’ expenditure priorities. Sources: State Budget Documents The economic slowdown of 2019-20, and the COVID-19 pandemic of 2020-21 have hugely impacted revenue collection and expenditure patterns among states. But, with economic activity slowly picking up in 2021, and with the Finance Commission also providing a fiscal roadmap for the next five years, it will be crucial to see how soon state finances recover to the pre-pandemic levels. Anoop Ramakrishnan is a programme officer with PRS India, responsible for citizen engagement platforms and outreach to state legislators. Views expressed are the author's own.

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