Although every minute detail of the Union Budget is deciphered by the markets, state budgets do not receive their due share of attention. At the beginning of 21st century, states' spending was similar to that of the central government. But this has increased tremendously over the past few years, as states now receive a larger share of central taxes and are guaranteed by the Centre for any GST shortfall. Consequently, states' spending was about 135 per cent of the Union Budget in 2018/19, and their net market borrowings are budgeted to be higher than those of the Centre for the first time ever in 2019/20. A combined analysis of the states and the Centre, thus, is required to understand the fiscal policy of the economy.
Our analysis of 2019/20 budgets of 20 states (which together account for about 95 per cent of total spending by all states, about 94 per cent of total receipts and approximately 97 per cent of total state development loans, or SDLs issued), when combined with the Union Budget, suggests five key implications for the economy.
State budgets are the most comprehensive source - and the only source in some cases - to learn about the true actual spending that happened two years ago, in 2017/18 in our case. According to official estimates published by the Central Statistics Organization (CSO), fiscal (real) spending grew at 14.4 per cent YoY in 2017/18, almost the double of 7.5 per cent growth in the past three years. Actual data for 2017/18 (from Budget documents), however, suggest that fiscal (real) spending grew only 6 per cent YoY in that year. If so, it has a direct and adverse impact on real GDP growth. Lower fiscal spending growth implies a downward revision to the extent of more than one percentage point to the 2017/18 real GDP growth.
Based on actual data for the first 11 months for 19 states and the central government, we believe fiscal (real) spending grew faster by 9.2 per cent in 2018/19, supporting real GDP growth of about 7 per cent in that year. If so, the narrative will change from weakening growth to recovery that year. Further, our calculations suggest that if the government decides to achieve its 2019/20 fiscal deficit targets, fiscal real spending growth would be about 6 per cent again, implying real GDP growth of about 6.8 per cent this year.
Second, the actual fiscal deficit of states was only 2.3 per cent of GDP in 2017/18, as against 3.1 per cent projected in the 2017/18 revised estimate. This is in stark contrast to the market perception that states are running higher deficit - their deficit was actually the lowest in four years.
Nevertheless, the consolidated fiscal deficit of the public sector (Centre + states + Central Public Sector Enterprises or CPSEs) stood at a six-year high of 8.4 per cent of GDP. Although fiscal spending grew faster in 2018/19, the states' fiscal deficit was lower-than-estimated again, due to which aggregate public sector deficit was broadly unchanged at 8.2 per cent of GDP. It is budgeted to fall to 7.7 per cent this year, primarily due to lower borrowings by CPSEs.
Third, such high borrowings by the public sector have the potential to crowd out private spending, if the latter continues to remain strong. Interest rates, in that case, would start ticking up irrespective of what the RBI does. But if private sector demand weakens, which is suggested by the unfolding of various events in the financial markets, then even such elevated public sector borrowings would not only not-crowd out, but would actually be desirable to support the economic activity. The balancing required between the private and the public sector, however, is very delicate.
Fourth, while GST has hurt the central government finances, states have gained immensely. After rising from 19.5 per cent in 2014/15 to 20.5 per cent of GDP in 2016/17, total receipts of the general government are estimated to have stayed unchanged at 20.4 per cent of GDP in 2018/19. The share of states in total receipts, however, has risen from about 54 per cent in 2016/17 to 56.6 per cent in 2018/19. States' receipts in 2018/19 were at an all-time high of 11.5 per cent, while it was at of 8.8 per cent of GDP - the lowest in the post-liberalisation period. States could continue to gain in 2019/20 as well, as their share could rise further to 57.6 per cent this year.
A combined analysis of the Centre and states budgets suggests that the general government has budgeted for 16.6 per cent YoY growth in GST receipts for 2019/20, which appears highly ambitious. Total GST collections in 2018/19 stood at Rs 1.18 lakh crore and the governments have expected GST receipts to rise to Rs 1.37 lakh crore in 2019/20 - implying an increase in the monthly run-rate from Rs 9,810 crore last year to Rs 1.14 lakh crore this year. What's more, the Centre has budgeted to receive 55 per cent of GST expectations in 2019/20 (50 per cent in 2018/19).
Finally, after posting a 12-year slowest growth of 8.5 per cent in 2017/18, the general government's total spending is estimated to have grown 12.3 per cent YoY in 2018/19, lower than the about 18 per cent growth suggested by the 2018/19 revised estimate. So, total spending rose from 26.1 per cent to 26.2 per cent of GDP in 2018/19. While government spending on capital account grew faster than revenue spending between 2014/15 and 2016/17, capital spending declined marginally in 2017/18 and grew only slowly (about 9 per cent) in 2018/19. Consequently, the share of revenue spending has increased from 83.3 per cent in 2016/17 to about 85 per cent in 2018/19.
This will have an impact on the rural sector, where the focus has increased tremendously. While total spending of the general government is expected to grow 10.2 per cent in 2019/20, rural spending is budgeted to grow 15.4 per cent, supported by 33.5 per cent growth in the Centre's spending. Rural spending, thus, now accounts for 15.5 per cent of the total (budgeted) spending - the second-highest level since late 1990s. Rural wages, however, have remained weak over the past few years. Whether direct income support to farmers changes fortunes remains to be seen.
Overall, the dynamics of fiscal math has changed massively in the past couple of years. The Centre is feeling the heat because of lower receipts; the government is finding it difficult to increase spending, especially because it is too focussed on fiscal deficit targets. States are also turning extremely cautious on deficit numbers, leading to constrained spending growth. Hence, CPSEs are bearing more responsibilities. But with the public sector's total deficit remaining above 8 per cent, there are genuine limits to their ability to support feeble economic activity.
Nikhil Gupta is Chief Economist at Motilal Oswal Financial Services