RBI says next few years challenging for states; lists out ways how states should respond post-pandemic

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October 27, 2020 7:27 PM

RBI said that the state governments may have to face the difficult choice of putting investment projects on hold, but, low capital spending will inevitably entail growth losses.

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The Reserve Bank of India today said that the next few years are going to be challenging for the Indian states. They need to remain empowered with effective strategies to drive through these difficult times, RBI added. Sub-national fiscal policy has to be judicious and calibrated while across states, maintaining overall stability, quality of spending, and credibility of budgets may distinguish one state’s resilience from another, it further said in a report. Speaking about the way forward for Indian states, the report underlined that state governments may have to face the difficult choice of putting investment projects on hold, but, low capital spending will inevitably entail growth losses.

What could be the key elements of a virtuous post-pandemic fiscal response by states?

RBI said that the states should reprioritise expenditures towards more productive high multiplier capital projects, bringing them to the center-stage and insulating from being sacrificed repeatedly due to shortsighted fiscal arithmetic. The central bank added that investing in health care systems and social safety nets, and strengthening urban infrastructure have to be an integral part of the fiscal strategy. Expanding states’ spending on health towards achieving the universal health coverage goal of 2.5 per cent of GDP at the aggregate level must be brought forward in the agenda of fiscal priorities of states, it further said. 

It has also been advised that the improving revenue mobilisation has to be frontloaded to make up for the tax base and accruals lost in the pandemic. The Reserve Bank laid emphasis on digitalisation, citing it as a source of dual benefits. Among the other recommendations, linking higher borrowing with financing capital expenditure, and central transfers to bring in incentive-compatibility, and charting out a glide path back to fiscal rectitude are included.

Meanwhile, downside risks confronting the Indian economy due to a prolonged slowdown was further stimulated by the pandemic. The adverse effects led to the steepest contraction in Q1 GDP. With states at the forefront of the fight against the pandemic, their finances have taken a blow in the first half of 2020-21. RBI has projected that the state governments’ gross fiscal deficit may widen beyond 4 per cent of GDP in 2020-21.

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