Why States Should Utilise Fiscal Room to Ramp up Capital Spending

Why in news?

• As many as 13 major states have a massive fiscal space of Rs 7.4 lakh crore for capital spending in the current fiscal, 81 per cent higher than the last fiscal, as per study by ratings firm ICRA.
• These could also be eligible for Centre's 50 year interest free loan for investing in capacity expansion in their respective states.

 

ICRA observations

• GDP share: These 13 major state governments namely Andhra Pradesh, Gujarat, Haryana, Karnataka, Kerala, Madhya Pradesh, Maharashtra, Punjab, Rajasthan, Tamil Nadu, Telangana, Uttar Pradesh and West Bengal account for 85 per cent of India’s GDP in 2020-21.
• Estimated capital spending: These 13 states had made a capital expenditure of Rs 4.1 trillion last fiscal and their Budget estimates for capex spending this fiscal is Rs 5.8 trillion, the rating agency added.
• Fiscal space meaning: It refers to the flexibility in a government's budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy
• ICRA concerns: While the availability of funds doesn't appear to be a constraint in FY2023, the actual outgo incurred by these state governments in the early months of this fiscal has been rather muted.
  • ICRA estimates the combined revenue deficit of these 13 states will be at Rs 2.1 lakh crore, higher than the Rs 1.8 lakh crore budgeted.
  • ICRA noted that while tax devolution as well as GST compensation grants are likely to exceed the amount budgeted by the states in the sample in FY2023, but this will not fully offset the estimated shortfall in other revenues and the projected higher-than-budgeted revenue expenditure in this fiscal.
• Assessment: Based on this, ICRA has made assessment that these states will have adequate resources to fully fund and/or exceed their budgeted capex this year, but has expressed apprehensions about whether these state’s capex will exceed the budgeted level, despite ample fiscal space to do so.

 

About Capital expenditure (Capex)

• Description: It is the money spent by the government on the development of machinery, equipment, building, health facilities, education, etc.
  • It also includes the expenditure incurred on acquiring fixed assets like land and investment by the government that gives profits or dividends in future.
  • Along with the creation of assets, repayment of loan is also capital expenditure, as it reduces liability.
• Significance: Capital spending is associated with investment or development spending, where expenditure has benefits extending years into the future, hence acting as multiplier.
  • It also increases labour participation, takes stock of the economy and raises its capacity to produce more in future.
• Different from Revenue Expenditure: Unlike capital expenditure, which creates assets for the future, revenue expenditure is one that neither creates assets nor reduces any liability of the government.
  • Examples: Salaries of employees, interest payment on past debt, subsidies, pension, etc. fall under the category of revenue expenditure. It is recurring in nature.

 

Resource flows to fund fiscal deficit

• In order to estimate the capital outlay and net lending of these states, the resources that is likely to be available to them for funding their fiscal deficit need to be calculated first. This includes the following:
  • The unconditional market borrowings of 3.5 per cent of their gross state domestic product (GSDP),
  • The additional borrowing linked to the completion of power sector reforms (0.5 per cent of GSDP) and
  • The interest-free capex loan provided by the Centre
• Calibrating debt: The estimated resource flows from these channels are then reduced by their off-budget debt which is to be adjusted in 2022-23, and the projected revenue deficit for the year.
• Enhanced tax devolution: To encourage early capital spending, the Centre has also front-loaded tax devolution to states.
  • It released two instalments of tax devolution to states amounting to ₹1.17 trillion in August 2022, against the normal monthly devolution of ₹58,333 crore.

 

About interest-free capex loan

• Launch: It was first launched by the Centre in October 2020-21 as part of the measures to support economic activity.
• Enhanced funding: However, the government stepped up scheme allocation in 2022-23 to Rs 1 trillion from around Rs 150 billion in the previous two years.
• Owing to slow capital growth: The pick-up in the sanctioned amount comes amid a slow capex off-take by states in the initial months, with 21 states on an average achieving only 15% of the budgeted target till July 2022.
• Financing projects: ₹1 trillion was allocated as interest-free 50-year capital expenditure loans for states over and above their normal borrowing ceiling to be spent on new or ongoing projects.

 

About off-budget borrowings

• Description: It refers to the loans taken by state entities, special purpose vehicles, etc., which are expected to be serviced through the state government’s own budget, instead of the cash flows or revenues generated by the borrowing entity.
• Recent developments: The Union government has recently clarified that henceforth, off-budget borrowings would be considered as borrowing of the state government and would be subject to the provisions of Article 293(3) of the Constitution of India.
  • The Centre hence, would be adjusting the incremental off-budget borrowings raised by the state governments in 2021-22 from their net borrowing ceiling over a one to four-year period, beginning in 2022-23 and ending in 2025-26.
  • Article 293(3): A State may not without the consent of the Government of India raise any loan if there is still outstanding any part of a loan which has been made to the State by the Government of India or by its predecessor Government, or in respect of which a guarantee has been given by the Government of India or by its predecessor Government.

 

Conclusion

• From a fiscal point of view, state governments are in a strong position to emerge as key drivers of economic growth this year but its ability to ramp up capital expenditure and take advantage of the fiscal space that they have, will be a key determinant of the aggregate fiscal impulse to the economy.
• Also how effectively states ramp up their spending will have a critical bearing on the pace the Indian economy grows in near future.

 

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Source: Why States Should Utilise Fiscal Room to Ramp up Capital Spending