States should be allowed to issue ‘pandemic relief’ bonds, with the central bank being allowed to buy these bonds by printing money and monetising their debt.
By Sharmadha Srinivasan & Prakhar Misra
The Covid-19 pandemic has made two things clear: The economy will take a huge hit by the time the crisis is over, and the crisis is not ending anytime soon. While some economic recovery will take place in the next 6-8 months, governments will have to move mountains to return to pre-Covid levels of economic growth. State governments will have to raise finances through innovative mechanisms to tide over this crisis. This will require additional measures—from relaxation of the Fiscal Responsibility and Budget Management (FRBM) Act norms and buying of state bonds by RBI to the possibility of introducing a state cess for tackling Covid-19.
Even before the pandemic hit the economy, state budgets weren’t in the best of shape. This was due to both recent policy measures such as shocks from the Goods and Services Tax Act (GST), and structural issues such as poor fiscal marksmanship. This pandemic is only adding to existing worries. Consider Maharashtra—the largest state in India by Gross Domestic Product (GDP)—which had some of the best fiscal indicators in 2019. It had the second-lowest ratio of outstanding liabilities, at 16.6% of GDP, and the fiscal deficit was well within the specified limit at 2.1%. However, the budget presented on March 6—before the pandemic became this deadly—showed an increase in revenue expenditure and falling revenue receipts. Revenue expenditure on salaries, pension and interest, which accounts for more than 80% of the state’s total expenditure, was revised upward by 1.9% against the budget estimates. Revenue receipts on the other hand, were revised to Rs 3,87,102 crore—a 1.8% drop. Thus, the revenue deficit too witnessed a significant revision: a 55% increase against budgeted estimates. It now accounts for 1.09% of the SGDP. This gap in revenue is set to drastically widen in this Covid-19 hit year.
Even though within limits, these numbers indicate that Maharashtra is not prepared to deal with the sharp drop in economic performance that Covid-19 has brought about. And, this is the dire situation of one of the best-performing states. States’ revenues are more susceptible to the crisis, as these are usually taxes on fuel, stamp duty, and liquor. For instance, stamp duty collections have already plummeted by over 40% in Mumbai during the lockdown period.
Thus, the struggle for states such as Maharashtra is real—and that is not all. The Centre is yet to completely compensate states on tax revenue from GST; it hasn’t done so due to shortfall in tax collections. Further, the allocations under the State Disaster Relief Funds are too meagre to make up for the additional spending that states are undertaking during this crisis. For Maharashtra, an additional 1% of revenue expenditure would amount to Rs 33,500 crore, while the allocation under State Disaster Relief Funds is only Rs 4,300 crore. Improving the fiscal firepower of the states will be key to fighting Covid-19.
A few measures could be undertaken as stopgap remedies to improve the situation. The first would be the relaxation of the FRBM Act norm for states for having their deficit at 3% of their SGDP, given that this is a crisis year. The FRBM Act does not specify a well-defined escape clause for the states as it does for the Centre. The escape clause is basically conditions under which the government is permitted to deviate to a certain extent from its fiscal target. In the absence of this, any deviation for the states would, at the very least, require the approval of the Centre.
For Maharashtra, a relaxation of 1% of SGDP would alone allow Rs 32,000 crore to be brought to the table. Second, while states such as Kerala have resorted to raising additional borrowing on the capital market and started issuing bonds, the interest rate charged has been exorbitantly high. Kerala raised money on the capital markets, effectively paying 9% interest for a Rs 6,000-crore state development loan of a fifteen year period. The outstanding liabilities to SGDP ratio, on an average, is 27.7% across states in India—and will only rise on the back of such high interest rate loans. This pile-up in debt will be a major obstacle for future governments to handle.
Third, in times of such a crisis, central banks are resorting to extraordinary measures. The Federal Reserve has stepped in to buy highly-rated corporate bonds, and the European Central Bank has scrapped its bond-buying limit as part of its Covid-19 response. In India too, states should be allowed to issue ‘pandemic relief’ bonds, with the central bank being allowed to buy these bonds by printing money and monetising their debt. Further, the Ways and Means Advances facility to the states is extended only for a period of three months. State finances will ultimately need additional long-term measures to cushion their budget, and RBI must consider increasing the duration to six months or even one year.
Left to their own, states would tinker with the taxes under their purview after the lockdown ends and consumer spending picks up. Levying a surcharge on postponed transactions and on consumer spending—from property and stamp duty to state excise taxes on vehicles, fuel and alcohol—is one of the few options states could go towards. But, this would mean that when oil prices are down globally, Indians pay more on fuel as states look to make up in tax collection. Second, the state GST rate could also be increased to garner more revenues—either by increasing the number of goods taxed, or by increasing the rate itself. These are indirect taxes, and will affect the poorer strata disproportionately. The only direct tax that states can look towards is in the agricultural sector. However, while this is notionally a good reform, targeting only a small minority of rich farmers, it is politically verboten—especially at a time such as this.
While the fight against Covid-19 requires states to have more resources at their disposal, it is also an opportunity for advancing the cause of cooperative federalism. The coming days will witness the action moving to individual states as the national lockdown slowly starts phasing out. Even the best-performing states, some of which have shown the way in successfully containing the spread of the virus, will require the necessary fiscal power to provide cover for the damage done to the economy.