States are able

Will the states be able to spend the newfound resources on investment? The
record of the states is better than that of the Centre .

Reviving investments is the biggest challenge facing the Indian economy

today. The corporate sector is shy of sinking in more money because of
unutilised capacities, high leverage and weak earnings. A recent Crisil
survey of 192 listed, private- and public-sector companies shows that
planned capital expenditure by the private companies is likely to decline
this fiscal. While the refrain is that the onus is on the Union government to
kickstart the investment cycle, in terms of financial resources, it is actually
the states that can do the heavy lifting.
The states have been playing an increasingly bigger role in investment
cycles than the Central government. In 2000-01, for instance, the capital
expenditure of the states was 1.6 times that of the Centre. In 2013-14, it
was 2.2 times. Increased devolution as a result of the 14th Finance

Commission award, along with the revenue stream from coal auctions,
have enhanced the financial capability of the states to invest.
While the Centre has some fiscal headroom because of the lower subsidy
bill (lower oil prices) and increased excise collections on petrol and diesel,
its ability to increase public spending remains limited as it follows the path
of fiscal consolidation. Past trends also suggest that governments typically
cut down on capex to meet fiscal deficit goals. For instance, to meet its
fiscal deficit target of 4.1 per cent of the GDP for 2014-15, capex was
brought down to 1.5 per cent from the budgeted 1.8 per cent.
Today, the states have much healthier balance sheets compared to the
Centre. At the aggregate level, they run a revenue surplus. For the decade
2004-05 to 2013-14, while the Central government ran a revenue deficit of
3.2 per cent of the GDP, the states were in mild surplus (0.03 per cent of
the GDP). During the same period, the fiscal deficit of the Centre was 4.6
per cent twice the 2.3 per cent of the states.
The revenue surplus of the states means all their borrowings go into
investment spending. The Centre has not been able to achieve this and is
unlikely to do so in the near future. The transition of the states from being
revenue-deficit to revenue-surplus took place over the last few years. This
is largely the result of the enactment of the Fiscal Responsibility
and Budget Management (FRBM) Act by the states, which led to
compression in expenditure relative to the GDP. This was also a period of
high GDP growth, which helped the states increase their aggregate
revenue receipts. An increase in revenue after the adoption of valueadded tax also helped.
The Centre has now raised the states share of the total divisible pool of
tax revenues to 42 per cent from 32 per cent, as per the
recommendations of the 14th Finance Commission. This is the biggestever increase in vertical tax devolution. The states share of taxes and
grants combined would constitute over 75 per cent of total transfers in
2015-16, compared with around 60 per cent in 2014-15. Plan grants, on
the other hand, would come down from about 40 per cent to 24 per cent.
The states will receive an additional Rs 2,144 billion over 2014-15. This
not only increases the pool of resources available to them but also the
flexibility to design, implement and finance programmes according to
their specific needs. In addition, money from coal auctions will add
substantially to the revenue of some states. As pointed out in the RBIs
latest study on state finances, taxing the fast-growing e-commerce market
would also help improve the states revenue stream, provided there is

clarity around rules governing such inter-state trade. The proposed GST
structure should take care of this.
To keep its fiscal space intact, the Centre has reduced the resources it
transfers to the states in the form of Central assistance for state plans
(including Centrally sponsored schemes) by Rs 750 billion from Rs
2,717 billion in 2014-15 (revised estimate) to Rs 1,967 billion in 2015-16.
While this may disturb the budgetary funding of some states and they
may end up losing out on a net basis, at an aggregate level, the increase
in Finance Commission transfers is a good move as it enhances the
autonomy of the states. This years Economic Survey notes that the
Central assistance to states transfers are much less progressive
compared to per capita Finance Commission transfers that is, the
latter does a better job of equalising income and fiscal disparities between
major states.
But not all states benefit in equal measure. The new norms on fiscal
transfers will benefit some states more than others. And the coal auctions
will benefit only the states with coal mines.
Fiscally healthy states include Madhya Pradesh, Gujarat, Jharkhand,
Chhattisgarh, Rajasthan and Tamil Nadu, which account for almost 32 per
cent of the total capex by the states. These states run a revenue surplus,
have fiscal deficits of less than 3 per cent of the GSDP, and debt under 25
per cent of the GSDP. Of these, MP, Chhattisgarh and Jharkhand stand to
gain relatively more from the higher Central devolution and coal auctions.
The additional annual income from coal to these three states will be about
Rs 50 billion, which accounts for around 22 per cent of their non-tax
revenues. These states, which are among the poorer ones, will be more
financially able than others to utilise this increased flexibility to pursue
their developmental goals.
Will the states be able to spend the new-found resources on investment?
The record of the states is better than that of the Centre. While the Centre
has been cutting capex by huge amounts to meet its fiscal deficit targets,
the situation is more optimistic for the states. For instance, they spent Rs
3,791 billion on capex in 2013-14 against a budgeted Rs 3,854 billion. For
the six states with better fiscal health, the actual capex, at Rs 1,209
billion, was comparable to the budgeted Rs 1,223 billion.
The ability of the states to handle increased flexibility in spending is yet to
be tested. Whether they do the heavy lifting on investments or squander
the opportunity remains to be seen.
Co-written by Adhish Verma.

Joshi is chief economist and Verma is junior economist at Crisil Limited.