State finances: Rising guarantees a source of potential state fiscal stress

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November 17, 2021 4:15 AM

It is unclear how much of the rise in guarantees in the current year is related to non-revenue generating projects, which would end up being serviced by respective state governments

petrol price, diesel price, excise duty, tax cuts on petrol,Tax cuts have come at an opportune time, with both the CPI and the WPI inflation in October 2021 having exceeded forecasts.

Tax cuts on petrol and diesel have brought succour to the inflation trajectory and household budgets, at the cost of revenue being foregone by the central and state governments. In this column, we argue that the fiscal cost of tax cuts is affordable, with central tax collections expected to substantively exceed the level budgeted for FY2022. However, we highlight that the rising guarantees of some state governments are likely to pose a potential fiscal risk over the medium term, especially where such guarantees have been extended towards debt taken for non-revenue generating projects. With the recent surge in crude oil prices feeding into record-high retail fuel prices and impinging on disposable incomes, the Government of India (GoI) announced a welcome cut in the road and infrastructure cess (RIC) component of central excise duty by Rs 5/litre on motor spirit (MS) or petrol, and Rs 10/litre on high-speed diesel oil (HSD) in November 2021.

We have factored in the impact of this excise duty cut and our expectations for mobility and the economic recovery into the fuel consumption estimates for the rest of the year. Accordingly, ICRA expects the consumption of petrol and diesel to record a year-on-year rise of 14% and 8%, respectively, in FY2022, on the shrunken base of FY2021. Based on the revised rates and assessed consumption, we project the gross and net revenue loss to the GoI from the excise cuts at Rs 440 billion each in FY2022, since RIC is not shared with the states. However, since most states levy value-added tax (VAT) on an ad valorem basis, the excise cut will lower their VAT inflows by about Rs 90 billion. Subsequently, varying VAT cuts on fuels have been announced so far by 25 states and Union territories (UTs), and others may well follow. We tentatively estimate the revenue loss to all states and UTs from the VAT cuts on these fuels at Rs 350 billion. Accordingly, their total revenue foregone is assessed at Rs 440 billion for FY2022, in line with the expected revenue loss of the GoI. However, this is not unaffordable for the Centre or states. Even after the excise cut, ICRA expects the net tax revenues of the GoI and the central tax devolution to states to exceed the GoI’s FY2022 budget estimates (BE) by a substantial about Rs 1 trillion and Rs 600 billion, respectively.

Moreover, tax cuts have come at an opportune time, with both the CPI and the WPI inflation in October 2021 having exceeded forecasts. The fiscal cost of the potential revenue foregone is outweighed in our view, by the expected prevention of early monetary policy normalisation. Interestingly, although the GoI’s tax collections and the devolution to states are expected to report a handsome growth in FY2022, the actual tax devolution to states was nearly unchanged at Rs 2.6 trillion in H1FY2021 and H1FY2022. In monthly terms, the devolution amount was stepped up to Rs 475 billion each in July-September 2021 from Rs 392 billion each in the previous three months. Based on our forecast of higher-than-budgeted tax devolution in FY2022, the retention of the monthly amount of tax devolution at Rs 475 billion in October-February FY2022 would have back-ended the release of Rs 2.3 trillion to March 2022. This would have been inefficient from the cash-flow perspective for states.

In a welcome step, the GoI has recently announced that it will transfer larger tax devolution to states for November 2021 (Rs 951 billion). This would mean a lower Rs 1.8 trillion tax devolution for March 2022, if the monthly amount of tax devolution is retained at Rs 475 billion for December-February FY2022. The upfront revenue will enhance confidence and allow states to expedite expenditure, especially growth-supportive capital spending through their budgetary resources. How else do states push expenditure other than through budgetary resources? They extend guarantees to state-level entities to enable them to borrow funds from various sources to undertake spending. The data on guarantees extended by states tends to be available with a long lag, lending opaqueness to this very important aspect of states’ fiscal profile.

Here’s what we do know: some states had extended considerable guarantees before the onset of the pandemic. The guarantees outstanding of Punjab, Chhattisgarh, Uttar Pradesh, Andhra Pradesh, Rajasthan and Telangana stood at 5-10% of their gross state domestic product (GSDP) as on March 31, 2020, much higher than the state average of 3.1% of GDP. Unlike the annual borrowing limit for debt, which is set by the GoI, states appear to have the flexibility to both set and modify their own guarantee ceilings. This allows them to extend fresh guarantees within a short period of time without any approvals or significant oversight from the GoI or RBI. The data on guarantees for FY2021 is available for only a few states in their FY2022 budgets. This reveals a sharp increase in the stock of guarantees of AP and Telangana from the year-ago level, led by guarantees extended to entities in irrigation and agriculture sectors, for projects that may well be non-revenue generating in nature. Additionally, Tamil Nadu, UP and Maharashtra are likely to have extended considerable guarantees in FY2021 to their power entities, related to the GoI’s liquidity scheme for the power sector.

There is also anecdotal evidence of a rise in guarantees of some states in FY2022, in a bit to hasten project implementation, amid pockets of liquidity stress at the state-level. Without the availability of adequate data, it is unclear how much of the rise in guarantees in the current year is related to non-revenue generating projects, which would eventually end up being serviced by the respective state governments, making them an actual and not a contingent liability. This poses a considerable fiscal risk, particularly given the modest contributions made by several states to their guarantee redemption funds.

The author is chief economist, ICRA.

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