Putting the spotlight on state budgets

The news cycle of the last few weeks has been saturated with analysis, praise and criticism of the 2022 Union Budget. From the thrust on capital expenditure to the announcement of a digital rupee, the Budget has packed in enough and more punches to receive extensive scrutiny. And while this news cycle will soon make way for election coverage, a critical indicator of India’s economic health–state budgets–will be announced and passed without much commentary.

Why are state budgets important?

The skewed focus on the Union Budget in comparison to state budgets is puzzling because much of what directly affects citizens’ lives is dependent on the contours of the state budget. At ₹39.73 lakh crore (FY 2020-21), the quantum of all state budgets is cumulatively larger than the Union Budget, ₹30.42 lakh crore, thereby having a higher impact on India’s GDP. While this has always been the case, the suffering caused by the pandemic in the last two years necessitates a deeper analysis of state finances and the support states need.

Impact of pandemic on state finances

In 2020 and 2021, both the Centre and most states presented their budgets before the peak of Covid waves in the respective years. Therefore, the budgets of both years couldn't have accurately accounted for the economic devastation caused by the forthcoming year. Andhra Pradesh is an illustrative example where by October 2021 the actual revenue deficit touched an unprecedented 816.56% of the budget estimates for the 2021-22 financial year.

The onset of Covid-19 and the second wave pushed state and local governments to make significant expenditures on healthcare, setting up makeshift hospitals, preventive measures, testing, providing free rations to the poor, implementing restrictions and enforcing Covid-appropriate behaviour, and maintaining supply of essentials. Sustained spending over the last two years has resulted in an increase in revenue expenditure, even as state revenues continue to decrease. Delayed transfer of GST compensation from Centre to states coupled with a contraction in economic activity, has meant that states are hard-pressed for revenue.

The result is states borrowing to fund their revenue expenditure thereby worsening the debt to GDP ratio of several states. 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". As per a PRS Analysis of State of State Finances: 2020-21, “Kerala, Punjab, and West Bengal were expected to eliminate revenue deficit by the end of 13th Finance Commission period (2014-15), and all other states were expected to eliminate their revenue deficit by 2011-12 or earlier.” Potentially most states would have gotten closer to this target by 2019-20. However, as things stand, 12 states including Kerala, Punjab, West Bengal are estimated to declare a revenue deficit in 2021-22. This means states are likely to cut back on capital expenditure and redirect their revenue receipts to payment of debt and interest in the coming years as well. This needs to change.

Priority sectors

While central government incentives to boost capex by states has been a much needed shot in the arm, the path to recovery is slow and complex. The Union government has done well by proposing an infrastructure spend of ~ ₹10 lakh crore with an increase in capex of over 35%. This is likely to give a boost to sectors like road transport, telecom, technology. Similarly the asset monetization plan launched last year and the support from the 50-year interest free loans announced in this budget under the Gati Shakti Plan will also be centred around infrastructure. And while these are necessary, states have to augment this with investments in priority sectors like health, education and skilling. An overburdened health system which has borne the brunt of Covid, a fragile education system which has to mitigate the severe learning losses accrued by children over the last two years, and a fragmented skilling system which needs to realize the promise of our demographic dividend, all require significant investments from states. If this was necessary before Covid, it is imperative now.

Given the strong support being provided by the central government on infrastructure, it is now incumbent on states to divert their tax revenues towards capital expenditure in these priority sectors. States also need to go beyond making an annual budget to create a realistic long-term recovery plan which not only helps them get their books in order but also mitigates the impact of Covid. Failing this we are unlikely to see a sustainable economic recovery.

(Gaurav Goel is founder & CEO of Samagra, a mission-driven governance consulting firm)