State Finances status

Context:

The Reserve Bank of India’s study on state governments’ finances, released recently indicates that gross fiscal deficits (GFDs) of state governments are set to double in 2020-21. As per the report, COVID has led to the precarious position of state finances.

Concept:

Fiscal deficit:

The difference between total revenue and total expenditure of the government is termed as fiscal deficit. It is an indication of the total borrowings needed by the government.

Scissor Effect:

• The report focuses on the operation of ‘scissor effects’.
• It is the loss of revenues due to demand slowdown, coupled with higher expenditure associated with the pandemic.
• According to the report the duration of stress on state finances will likely be contingent upon factors such as the lockdown tenure and the risk of new waves of infection.
• The quality of spending and the credibility of state budgets will assume critical importance.

Increasing fiscal deficit:

• In 2020-21, about half the states have budgeted the GFD-to-GSDP (gross state domestic product) ratio at or above the 3% threshold.
• States are grappling with the pandemic with constrained fiscal space.
• In terms of primary balances, most states are incurring primary deficits in 2019-20, as against primary surpluses at the onset of the global financial crisis,

What will be the impact on states?

Reduced Tax revenues:

Tax revenue will decrease because of

1. Inter-linkages between growth and tax revenues
2. Tax revenues fall faster than GDP when growth is negative

• Pandemic-related spending (health) are likely to keep these expenditures high, prolonging the ‘scissor effects’.
• In this situation state governments may have to face the tough choice of putting investment projects on hold, but, given the multiplier associated with capital spending, this will inevitably entail growth losses in a vicious cycle.
• States’ debt is set to rise, and if it is not accompanied by an acceleration in growth, fiscal sustainability will become a big problem