State Governments’ Finances

Why in news?

The Reserve Bank of India has studied the state governments’ finances.

Where are the GFDs of states headed?

• Due to the Covvid-19 pandemic, the gross fiscal deficits (GFDs) of state governments may double in 2020-21.
• In 2020-21, about half of the states have budgeted the GFD to gross state domestic product (GSDP) ratio at or above the 3% threshold.
• But most of these budgets were presented prior to the onset of Covid-19.
• The direction of possible revision is evident from the fact that,
  1. The average for states presenting their budget before the outbreak of the pandemic is 2.4%.
  2. But the average for the balance number of states that made post-outbreak budget presentation is 4.6% of GSDP.
• Thus, states are grappling with the pandemic with constrained fiscal space.
• In terms of primary balances, states are in an unfavourable position.

Will the stress on states continue?

• The crisis literature focuses on the operation of the scissor effects: revenue loss due to demand slowdown, coupled with higher expenditure associated with the pandemic.
• The duration of stress on state finances will be contingent upon factors like tenure of lockdown and risks of renewed waves of infections.
• All of this makes traditional backward-looking tax buoyancy forecasting models unreliable, according to the RBI study on state finances.
• The quality of spending and the credibility of the state budgets will assume critical importance.
• The next few years are going to be challenging for the states.

What will be the impact on states?

• As tax revenues fall faster than GDP when growth is negative, tax revenues may be reduced for the next few years.
• Pandemic related spending, particularly on health and other support measures for households and firms may keep these expenditures high.
• This may prolong the ‘scissor effect’.
• In addition, states’ fiscal position is to be affected by a surge in contingent liabilities (guarantees).
• In this environment, 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.
• If the rising States’ indebtedness is not accompanied by acceleration in growth, fiscal sustainability will become the casualty.

What happened during earlier pandemics?

• An event study analysis was done using four pandemic outbreaks in India: 1896 plague, 1918 Spanish flu, 1957 Asian flu and 1974 smallpox.
• This study shows that all episodes were associated with a contraction in GDP, with the 1918 flu registering the sharpest downturn of about 13%.
• Interestingly, the recovery pattern is quite similar.
• There was a sharp rebound in the immediate subsequent year because of favourable base effects.
• This was followed by contraction again, with the GDP growth rate finally subsiding back to pre-pandemic years in about 3-4 years.
• These severe disease outbreaks have also depressed per capita economic output in the economy, albeit with varied magnitudes.
• However, the recovery observed was swift and complete within two years of the outbreak.

What the RBI says about the Kerala model?

• The presence of empowered local governance institutions and community participation helped Kerala in effectively reaching out to affected people.
• With the resurgence in new cases, Kerala is actively roping in the services of local self-governments (LSGs) in its fight against the pandemic.
• LSGs have emerged as frontline institutions in containing the disease and in alleviating the distress caused to the vulnerable.
• The state managed to contain the spread of the pandemic in the first wave of infections.
• However, it witnessed a second wave of infections with the arrival of non-resident Keralites and with the easing of restrictions.

What does the RBI say about the Dharavi model?

• Public-private partnership and community participation played a crucial role in combating Covid-19 in Dharavi, Asia’s largest slum.
• The government tied up with doctors, hospitals, NGOs, private volunteers and elected representatives and civil society organisations.
• A rapid action plan of testing, screening, early detection, contact tracing, timely isolation and putting high-risk contacts in institutional quarantine facilities was followed.
• Community participation, community kitchens and collective solidarity were the key features that helped to contain the spread of the virus.
• Enforcing a strict lockdown and blocking the movement of residents except for essential services controlled the contagion.
• Dharavi has flattened the curve and is worthy of emulation worldwide.

Source: The Indian Express