The state of fiscal deficits

Ambitious receipt estimates of States pose a risk to meeting deficit targets this year

Although market participants carefully analyse every minute detail of the Union Budget, State Budgets don’t receive due attention, notwithstanding that State spending is about one-and-a-half times the Centre’s. The pain involved in compiling State Budgets from the respective Finance Departments, some of which are in regional languages, partly explains the resistance.

States as prudent as Centre

The Centre goes through immense scrutiny for its fiscal deficit Budget estimates (BEs). Not surprisingly, the Centre has overshot its deficit BEs only thrice — FY-09, FY-12 and FY-18 — during the past 15 years, while it over-achieved the BEs 10 times. Only twice — FY2015 and FY2017 — has the Centre exactly met its BEs.

The general perception is that the lack of scrutiny allows States to disregard their deficit BEs.

Data, however, show that States have been at least as fiscally prudent, in terms of managing its headline deficit, as the Centre.

Since FY-04, States, on an aggregate basis, too, have overshot their deficit BEs in only three years — FY-09, FY-15 and FY-18 RE, while over-achieved the BEs nine times.

More interestingly, while the average miss by the Centre during the three years was as high as 1.7 percentage points of GDP, it was only 0.4 percentage points for States.

The average over-achievement, however, was similar at 0.5 and 0.4 percentage points for the Centre and States, respectively.

Historical data, thus, confirm that States’ deficit BEs are as credible as that of the Centre. It doesn’t, however, imply that all States are as credible.

For instance, Maharashtra has never overshot its deficit targets during the past decade except in FY-18, for which actual data has not yet been published. On the contrary, Bihar has missed it in three of the past four years.

Risks to meeting FY19 target

For FY-19, our analysis (extrapolated from data of 20 major States) suggests that States have budgeted for a deficit of 2.5 per cent of GDP, down from 2.8 per cent in FY-18 RE.

Can we then assume that States, on an aggregate basis, will be able to meet their FY-19 deficit targets?

There are two important arguments. One, our analysis suggests that States’ FY-19 receipt estimates are over-ambitious because of unrealistic revised estimates for FY-18.

Interestingly, they have kept FY-18 RE receipts broadly unchanged, implying record high growth of 22.3 per cent YoY, followed by 13.6 per cent growth in FY-19. Actual data available for up to February 2018 for 20 major States confirm that total receipts were 73.5 per cent of BEs, the lowest at least in the past eight years.

Assuming States achieve 14 per cent year-on-year growth in receipts in FY-18, it implies about 22 per cent growth for FY-19, which is what makes it overambitious. Nevertheless, even if taxes miss estimates, States can always adjust spending to meet their fiscal deficit targets. The outcome of slower growth, however, will be inevitable. Two, as many as 10 states — accounting for about 40 per cent of the national GDP — are slated for elections in 2019. This certainly increases upward risks for spending and thus, deficit targets.

An analysis of the major States scheduled for elections in 2019 — Andhra Pradesh, Haryana, Madhya Pradesh, Maharashtra, Odisha and Rajasthan — however, doesn’t support such fears.

The core revenue spending (excluding interest payments), which is more relevant from an election perspective, in three States — AP, Maharashtra and Odisha — was lower-than-budgeted during all the past three election years (FY-04, FY-09 and FY-14).

It was lower-than-budgeted in two out of three years for the remaining three States. Similarly, fiscal deficit (as a per cent of GDP) in Odisha and AP were lower-than-budgeted in all the past three election years, while it was lower-than-budgeted twice in Haryana and MP. Rajasthan, however, had higher-than-budgeted deficit in the past two election years.

Finally, almost all States have implemented the Seventh Pay Commission and most of the States going in for elections have already introduced farm-loan waivers. Not that there can’t be more populist spending; however, that will be a worry probably for FY-20 than FY-19.

Overall, the risks for FY-19 deficit targets, I believe, are evenly balanced.

The writer is Economist at Motilal Oswal Institutional Research.

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