Shallowing Coffers: Of Shrinking Revenues and Fiscal Challenges

ON 17th of March 2020, when the Indian Finance Minister presented a Rs. 1.01 Lakh crore budget for the newly crafted union territory of Jammu and Kashmir, an optimistic nominal GSDP growth target of 11% for Financial Year (FY) 2020-21 was envisaged in the parliament. Unlike states with a thriving private sector and diversified economic drivers, government expenditure in J&K with a high multiplier factor, acts as a central axis around which the remaining fringes of the economy operate. Therefore, any change in the spending by the government has a direct, lasting and a spillover effect for the rest of the economy.

The Projection

Compared to a previous budget size of Rs. 84,571, this FY witnessed a sizeable projected growth of around 19.91%. This was almost entirely to be funded by 47% increase in the annual central grants. Another aspect of these budgeted estimates is that a major portion of the capital expenditure which is around 73% projected for the current FY, were funded by the revenue surplus. Therefore, the relevance of these budgeted estimates was pinned on the increase in the transfer of share in central taxes and grants, growth of J&K’s own tax and non-tax revenues, and importantly a revenue surplus of over Rs. 28,000 crore. However, on account of a lethal shock to the economy due to the ongoing pandemic, all the underlying assumptions started falling apart and this castle of fiscal math started collapsing in tatters.

The Shortfall

Besides thirteen months of dwindling household income and drying up cash flows of businesses, the revenues of GoJK too, due to the twin-shocks of Aug 5 2019 and Covid19 lockdown, are reaching at its wits end. As per a response by the Union Finance Minister in the Indian parliament, J&K has witnessed a contraction of 30.5 percent in the goods and services tax (GST) revenue during the April-August 2020 period compared to the corresponding period of the last FY. To add insult to the injury, the Central government through its recent GST council meeting in the last week of August 2020 has conveniently proposed to pass the entire buck of GST compensation to the already indebted State government balance sheets by offering two borrowing linked options. To put things into perspective, former union Finance Minister Mr. Arun Jaitley, while clinching a deal on an all-India GST to replace different central and state taxes, had guaranteed the states revenue growth of 14% per year for five years. This was enshrined in the GST Compensation Act. The compensation fund (funded by GST compensation cess) created for this purpose by the Union government, as on date, is absolutely empty. As a result, GST compensation for the April-July 2020 period stands already delayed and states have been told to opt for the borrowing route to address the shortfall. This brazen denial of GST compensation can lead to an unaffordable loss to J&K’s already choked revenue side. Pertinently, J&K had received Rs. 2279.29 crore under this head in the previous FY and this conduit has been a very essential element of J&K’s revenues since GST rollout in 2017.

Given the seemingly perpetual nature of this pandemic, the revenues for rest of the current financial year, at least, are also expected to show a contraction. This may be visible under all the heads like the state goods and services tax (SGST), state VAT (mainly petroleum products), state excise, stamps and registration fees, tax on vehicle as well as the tax and duty on electricity. These heads along with share in central taxes contribute over 30% to the revenue side of J&K’s budget. Moreover, the fact that Union government itself is walking a tight rope on account of a drastic drop in union budget revenues and rising fiscal deficit; the very essential component of central grants amounting to Rs. 54,594 crore which contribute around 60% to J&K’s total revenue income is expected to be under serious pressure.

The Ramifications

Since over 73% of the projected capital expenditure was based on revenue surplus funding, the first casualty therefore, on account of revenue contraction is going to be seen in the form of contractionary capital formation policies by the government of Jammu and Kashmir. In other words, the impact shall be witnessed in the form of a curtailed government investment in the already starving Infrastructure sector & Social sector. Administrative sector and Financial sector being too important, from security point of view, fall a little lower on the austerity list.

Pertinently, projected capital investment under these four sectors was pegged at Rs. 38764 cr for FY 2020-21. Given the central significance of government spending in J&K, any erosion in the budgeted amount is going to send tremors in rest of the already collapsing economic sectors — without a doubt. In addition to this, the fact that the current economic quagmire is rooted on the demand side of the equation, any contraction in government spending will further squeeze whatever demand is left in the system. This can be absolutely counterproductive and economically suicidal to say the least.

Global recession has killed exports, unemployment has devastated consumption and uncertainty has frozen investment. Therefore, the only engine left, among the four, which has some capacity to drag the economy out of this quagmire is expansionary government spending. That should not even be the last thing that policy makers should think of curtailing.

However, given the claustrophobic elbow room on account of shrinking revenues and expanding expenses, are there any viable options available?

The Options

First, is the shortest and the easiest one — Market borrowings. The route has also been marketed by the union finance minister herself. This was indicated in the last month’s GST council meeting by relaxing market borrowing limit by another 0.5% to 5.5% of the GSDP under the Fiscal Responsibility and Budget Management (FRBM) act and assuring soft interest rates linked with Central government securities.

However, when it comes to J&K, this route stands already abused. The cumulative pile of debt hovering over Rs. 80,000 cr has put the UT finances in a never ending and excruciatingly costly debt cycle. J&K has the highest debt to GSDP ratio in India and the amount of money that goes out from J&K’s coffers to service this huge pile of debt has more than doubled already for the current FY. Now, imagine a scenario where GoJK will go for another bout of borrowing to fund the current shortfalls. GoJK will end up sinking even deeper in the inflating ‘borrow new to pay old’ cycle.

Second, is to curtail spending, which stands already discussed. It can be counterproductive and an anti-demand measure bound to fail in all respects. One has to be crazy enough to slowdown the only available engine in the ship.

Third, would have been to fiddle with the tax policy and squeeze revenues from sectors which are doing comparatively better. However, this power too stands surrendered by the states to GST council in 2017.

There are three logical as well as morally relevant arguments as to why the solution for the states’ fiscal arithmetic might not be available within but should be sought from outside — from the union government. Firstly, the fact that the 70 day national lockdown was imposed by the central government, which has sent all the sectors of the economy crashing down. New Delhi, logically as well as morally, is responsible for making good the losses incurred by the state governments. Secondly, the fact that the State governments across India, yielded their statutory powers of taxing goods and services in 2017; not rescuing their revenue shortfalls during prevailing crisis will be in contradiction to the very essence of federal financial structure of the GST. Thirdly, unlike almost no revenue garnering choices left with the State governments — the Central government has an arsenal of options like debt monetization, currency printing, wide borrowing options domestically as well as overseas and above all the power to introduce new taxes and tax rates. Despite all these luxuries, leaving economically injured State governments to their own devices is surely not justified.

The nature of the crisis is global and without a doubt much bigger than what we normally define as a national disaster. The required response, therefore, is beyond the financial capacity as well as appetite of the states. The same needs to be crafted with Central government’s funds and implemented through the State government machinery. The only viable option left with the states is to invoke the federal financial guarantee from the Union of India and seek solutions from the north block rather than trying to find costly and ineffective answers from within.

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Ejaz Ayoub

Ejaz Ayoub has been working in the BFSI industry in the field of Financial Risk Management, Strategy and Foreign Exchange. He can be reached at:[email protected]

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