Centre must step up cash flow to states

Note4Students

From UPSC perspective, the following things are important :

Prelims level : State Development Loans

Mains level : Paper 3- Centre needs to help states to tide over the uncertain year

Context

The states are borrowing less than expected in the first quarter of FY 2021-22 despite the negative impact of state-level restrictions, amidst the second Covid wave, on economic activity.

An overview of borrowing by States

  • In 2020-21, the gross amount raised through state development loans (SDLs) or bonds had jumped to Rs 8 trillion, up from Rs 6.3 trillion in the previous year.
  • The increase was a fallout of the Covid-19 pandemic on state finances.
  • In the first quarter of the current financial year i.e. 2021-22, gross issuances of bonds stood at Rs 1.4 trillion.
  • This amount is 14 per cent lower than the bonds issued last year (Rs 1.7 trillion).
  • This is also around 20 per cent lower than what states had initially indicated they would borrow (Rs 1.8 trillion) through the indicative calendar of market borrowings released by the RBI.
  • As a result, state bond issuances have undershot expectations in the first quarter.

Factor’s responsible for lower state borrowing

  •  Lower state borrowings were a consequence of three major factors.
  • First, an additional tax devolution of Rs 450 billion from the Centre in late March.
  • This amount was in excess of the Rs 5.5 trillion tax devolution that had been included in the revised estimates for 2020-21.
  • Second, record-high GST collections in April which doubled to Rs 1.3 trillion in the first quarter of this year, up from Rs 0.6 trillion in the same period last year.
  • Third, receipt of substantial grants from the Centre adding up to Rs 436 billion in April-May related to the recommendations of the Fifteenth Finance Commission.

Factors that could influence the borrowing pattern in the next three quarters

  • First, the varying pace of unlocking and the consequent economic revival in states from June onwards may crucially affect state borrowings in the second quarter.
  • A faster ramp-up of vaccine administration may help some states, reducing the need to borrow.
  • Second, the eventual calendar for raising back-to-back loans by the GoI to compensate states for the loss in their GST revenues could also result in a change in the states’ borrowing schedule.
  • Third, the quantum, and timing of tax devolution will also play a role.

Why timing of the Central tax devolution matters for States

  • Central tax devolution forms a quarter of states’ combined revenue receipts.
  • This revenue stream has contracted by 15 per cent in the first two months of the year, falling to Rs 392 billion each in April-May this year, from Rs 460 billion last year.
  • If the Centre continues to devolve to states this amount till February 2022, then a massive Rs 2.4 trillion (36 per cent of the budgeted amount) will be left for devolution in March 2022 — assuming that the devolution for the full year is not revised below the budgeted level.
  • From the states’ point of view, this would be rather inefficient from a cash flow perspective.

Conclusion

An early step-up in tax devolution by the central government may provide comfort to the states to accelerate expenditure during another uncertain year, without borrowings being pushed up in the next two quarters.

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