Weighed down by sharp fall in revenue collections and central grants amidst rising expenditure to fight the coronavirus pandemic, states' fiscal deficit in the current financial year is expected to breach 4 per cent of the gross domestic product (GDP) target, the Reserve Bank of India (RBI) said in its annual report on state finances.
States have budgeted their consolidated gross fiscal deficit (GFD), gap between the total expenditure and receipts, at 2.8 per cent of GDP in 2020-21; however, the coronavirus pandemic may alter budget estimates significantly, eroding the gains of consolidation secured in the preceding three years, the RBI said in its report titled State Finances: A Study of Budgets of 2020-21.
"With states at the forefront of the fight against the pandemic, their finances have taken a body blow in the first half of 2020-21. State governments' gross fiscal deficit is projected to widen in 2020-21 beyond 4 per cent of GDP in the baseline scenario," said the report released on Tuesday.
Going forward, the increase in indebtedness, coupled with persisting losses of power distribution companies (DISCOMs) and rising guarantees, slants risks to state finances to the downside, it said.
The RBI report warned that COVID-19 pandemic may also leave lasting scars on federalism in India. It will have a bearing on inter-generational transfers, with lower discretionary spending or higher taxation in future. "States' indebtedness is set to rise, and if it is not accompanied by an acceleration in growth, fiscal sustainability will become the casualty, overwhelming the modest gains of the prudence in recent years," it said.
The report noted that the quality of spending and the credibility of state budgets will assume critical importance in the recovery from coronavirus-led economic crisis. The next few years are going to be challenging for the states as they have played an important role in the frontline of the defence against the pandemic.
Given that there is direct linkage between growth and tax revenues and considering the fact that tax collections fall faster than GDP when growth is negative, tax revenues are likely to be reduced for the next few years. Pandemic related spending, particularly on health and other support measures for households and firms, are likely to keep these expenditures high; prolonging the 'scissor effect'. In addition, states' fiscal position is likely to be affected by a surge in contingent liabilities (guarantees), the report noted.
"In this situation, state governments may have to face the difficult choice of putting investment projects on hold, but, given the multiplier associated with capital spending, this will inevitably entail growth losses in a vicious circle feeding itself," it said.
"Going forward, they need to remain empowered to provide growth impulses to the Indian economy and build resilience against future pandemics as well. It is in this context that this Report's spatial lens provides content and value to the theme "COVID-19 and its Spatial Dimensions in India", it added.
Recently, India Ratings and Research (Ind-Ra) raised its projection for states' aggregate fiscal deficit to 4.5 per cent of GDP for FY21 from its earlier estimate of 3 per cent. It has also revised upward its estimate of gross market borrowings of states to Rs 8.25 lakh crore in FY21 from its earlier estimate of Rs 6.09 lakh crore. This is because the agency expects states to resort to higher market borrowings to fund the fiscal deficit. The pressure on state governments to provide support to households and businesses through fiscal stimulus measures is set to increase.