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Fiscal Space To Increase Capital Spending

Context

According to a study by ratings firm ICRA, 13 major states have a massive fiscal space of Rs 7.4 lakh crore for capital spending in the current fiscal, which is 81% higher than the previous fiscal. These may also be eligible for the Centre’s interest-free loan for 50 years to invest in capacity expansion in their respective states.

Relevance

General Studies-I & 2: Governance, Constitution, Polity, Social Justice and International relations.

Mains Question

How have the recommendations of the 14th Finance Commission of India enabled the states to improve their fiscal position? (150 Words)


Observations of the ICRA

  • GDP share: In 2020-21, Andhra Pradesh, Gujarat, Haryana, Karnataka, Kerala, Madhya Pradesh, Maharashtra, Punjab, Rajasthan, Tamil Nadu, Telangana, Uttar Pradesh, and West Bengal will account for 85% of India’s GDP.
  • Estimated capital spending: These 13 states spent Rs 4.1 trillion on capital expenditure last fiscal year, and their budget estimates for capex spending this fiscal year are Rs 5.8 trillion, according to the rating agency.
  • Fiscal space is defined as the flexibility in a government’s budget that allows it to provide resources for a desired purpose without jeopardising the sustainability of its financial position or the economic stability.
  • ICRA concerns: While funds appear to be available in FY2023, the actual outlay incurred by these state governments in the first months of this fiscal year has been rather muted.
    • According to ICRA, the combined revenue deficit of these 13 states will be Rs 2.1 lakh crore, which is higher than the budgeted Rs 1.8 lakh crore.
    • According to ICRA, while tax devolution and GST compensation grants are likely to exceed the amounts budgeted by the sample states in FY2023, this will not fully offset the estimated shortfall in other revenues and the projected higher-than-budgeted revenue expenditure in this fiscal.
  • Assessment: Based on this, ICRA has determined that these states will have sufficient resources to fully fund and/or exceed their budgeted capex this year, but has expressed concerns about whether these states’ capex will exceed the budgeted level, despite having ample fiscal space to do so.

Capital expenditure (Capex)

  • Capital expenditure (Capex) is money spent by the government on the development of machinery, equipment, buildings, health facilities, education, and so on.
    • It also includes government spending on fixed assets such as land and investments that will yield profits or dividends in the future.
    • Loan repayment, like asset creation, is capital expenditure because it reduces liability.
  • Significance: Capital spending is associated with investment or development spending, where expenditure has long-term benefits, acting as a multiplier.
    • It also increases labour participation, assesses the economy, and improves its capacity to produce more in the future.
  • Distinct from Expenditure on Revenue: Unlike capital expenditure, which creates assets for the future, revenue expenditure neither creates nor reduces the government’s liabilities.
  • Employee salaries, interest payments on past debt, subsidies, pensions, and so on are examples of revenue expenditure. It occurs frequently in nature.

Flows of resources to finance the fiscal deficit

  • In order to estimate these states’ capital outlay and net lending, the resources that are likely to be available to them for funding their fiscal deficit must first be calculated. These are some examples:
    • The unconditional market borrowings of 3.5% of their GSDP, o The additional borrowing linked to the completion of power sector reforms (0.5% of GSDP), and o The interest-free capex loan provided by the Centre
  • Debt calibration: The estimated resource flows from these channels are then reduced by their off-budget debt, which will be adjusted in 2022-23, and the year’s projected revenue deficit.
  • Increased tax devolution: To encourage early capital spending, the Centre has increased tax devolution to states.
    • In August 2022, it released two instalments of tax devolution to states totaling 1.17 trillion, compared to the normal monthly devolution of 58,333 crore.

Concerning the interest-free capex loan

  • Launch: The Centre first announced it in October 2020-21 as part of the measures to support economic activity.
  • Increased funding: However, the government increased scheme allocation to Rs 1 trillion in 2022-23 from around Rs 150 billion in the previous two years.
  • Slow capital growth: The increase in sanctioned funds comes amid slow capex off-take by states in the early months, with 21 states achieving only 15% of the budgeted target by July 2022.
  • Project financing: $1 trillion has been allocated as interest-free 50-year capital expenditure loans for states that exceed their normal borrowing limit to be spent on new or ongoing projects.

Concerning off-budget borrowings

  • Definition: Loans taken by state entities, special purpose vehicles, and so on that are expected to be serviced through the state government’s own budget rather than the borrowing entity’s cash flows or revenues.
  • Recent developments: The Union government has recently clarified that henceforth, off-budget borrowings would be considered as borrowing of the state government and would be subject to the provisions of Article 293(3) of the Constitution of India.
    • As a result, the Centre will adjust the state governments’ incremental off-budget borrowings in 2021-22 from their net borrowing ceiling over a one to four-year period beginning in 2022-23 and ending in 2025-26.
    • Article 293(3): A State may not raise any loan without the consent of the Government of India if any part of a loan made to the State by the Government of India or its predecessor Government remains outstanding, or in respect of which a guarantee has been given by the Government of India or its predecessor Government.

Conclusion

  • From a fiscal standpoint, state governments are well-positioned to emerge as key drivers of economic growth this year, but their ability to ramp up capital spending and capitalise on the fiscal space that they have will be a key determinant of the aggregate fiscal impulse to the economy.
  • Also, how effectively states increase their spending will have a significant impact on the rate at which the Indian economy grows in the near future.

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