Lower tax collections, increasing expenses: COVID-19 may bring states to their knees

HYDERABAD: Indian states are seeing their most unlucky moment in 2020. Finances are already under the weather thanks to lower GST and own tax collections.

With the COVID-19 pandemic, just like households, states appear ill-prepared for the new reality of falling income and rising expenses. And most irksome, perhaps, is the pressure to perform.

Analysts expect higher debt and strained balance sheets given that the only way out of the pandemic is for local governments to spend on free food, cash transfers and maybe even loan waivers if the pandemic worsens.

Low revenue leaves states with the only option to borrow more. In lockstep, the government on March 23 gave a free hand for states to raise up to Rs3.2 lakh crore from the open market, an unusually high amount compared to the states’ current quarter borrowing calendar of Rs1.4 lakh crore. RBI, too, raised limits for managing temporary cash flows by 30% for states besides increasing overdraft facility to 21 days from 14.
India already has the highest sub-national debt among BRICS nations and states’ borrowing limits have touched the brim owing to Uday bond issuances and high expenditure due to farm loan waivers and 7th Pay Commission payout. Though market borrowings have always been a critical component, their reliance has been dangerously rising. For instance, if states financed 53% of their gross fiscal deficit from borrowings between FY02 and FY17, it shot up to 88% in FY20.

If more states borrow, bond yields might come under pressure

As more states resort to market borrowings, Gupta said, demand may contract or/and pressure bond yields. On Tuesday, the market saw it in real-time.  Nineteen states planned to raise Rs 37,500 crore on Tuesday but mopped up only Rs32,560 crore. In contrast, just a week ago, 16 states raised Rs 26,160 crore, higher than the notified Rs25,757 crore. RBI-monitored auction for state government bonds, or borrowing, happens every Tuesday.

The pressure on bond yields too was telling. Typically, interest spreads are 60-70 bps higher than Central government securities. But Tuesday saw it cross over 150-200 bps.

Citing bleak revenue outlook, ICRA estimates 25-30 per cent in net state borrowings to Rs 6.2-6.4 lakh crore in FY21 from about Rs 5 lakh crore in FY20.

The spike is largely due to COVID-19 squeezing government revenue. Until now, states were resorting to expenditure compression to maintain the headline fiscal deficit, but clearly that option is off-limits this fiscal.

“The risk of fiscal slippage is expected to be higher for states, which have a larger number of COVID-19 patients, as they may have to significantly ramp up spending on health-related services. Moreover, states that have seen the return of a considerable number of migrant labourers, and those who have a sizeable number of daily wage earners, could see a sharp rise in their revenue expenditure in FY21, if they choose to extend food and/or income support to such people,” said Jayanta Roy, group head (corporate sector rating), ICRA.