Grant-in-aid, tax devolution from Centre to States will moderate at 4.5% from 15.3% last fiscal: NSE

State Governments are expected to face tighter finances in FY25, as grants-in-aid from the Centre are projected to decline by 6.3 per cent, highlighted a report by NSE.

The report noted that this is a significant change compared to the 13.9 per cent growth in these grants seen in FY24. This drop in grants, which are a crucial part of non-tax revenues for many States, could place financial pressure on those heavily dependent on central support.

"The States have budgeted grants-in-aid from the Centre to drop by 6.3 per cent in FY25BE as against a growth of 13.9 per cent in FY24RE" the report said.

The reduction in grants is particularly concerning for States that rely heavily on this source of income. States in eastern and northeastern regions — such as Meghalaya, Mizoram, Himachal Pradesh, and Assam —are among the most affected.

The report highlighted that these States receive a significant portion of their revenue from grants-in-aid, with such grants constituting between 25 per cent and 40 per cent of their total revenue receipts.

In FY25, these states are expected to see a 26 per cent decline in grants from the Centre, which could severely impact their financial health.

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"This is particularly true for eastern and northeastern States (Meghalaya, Mizoram, Himachal Pradesh, Assam) who have about 25 per cent to 40 per cent of their revenue receipts coming from the grants-in-aid from the Centre" the report added.

Alongside the drop in grants, the growth in devolution, which refers to the transfer of taxes from the Centre to the States, is also expected to slow. Devolution is set to rise by just 11 per cent in FY25, down from 16.2 per cent in FY24. The report said "Further, growth in devolution is also expected to moderate to 11 per cent in FY25BE from 16.2 per cent in the previous year (FY24RE), translating into a modest 4.5 per cent growth in overall transfers from the Centre (devolution+ grants-in-aid) vs. 15.3 per cent in FY24RE".

Overall, the combined transfers from the Centre, which include both devolution and grants-in-aid, are expected to grow by a modest 4.5 per cent, a sharp drop from the 15.3 per cent increase witnessed in FY24. This slowdown in central transfers could make it harder for states to balance their budgets and fund key projects.During the pandemic in FY21, the share of grants-in-aid from the Centre in overall non-tax revenues for many states surged to 77 per cent. However, this has been declining since then and is expected to fall to 61 per cent in FY25. For states that depend on these transfers, any contraction in grants will force them to either cut spending or find alternative revenue sources, which could be difficult task.

This overall reduction in central assistance, combined with other financial pressures, means states may need to adopt more stringent financial management strategies to ensure they can meet their expenditure needs while maintaining fiscal stability.