Did the Centre starve States of funds in FY16?

In its quest to prove fiscal marksmanship at the Central level, the Modi government seems to have shot its vaunted cooperative fiscal federalism in the foot. The Centre has been cutting back on essential transfers to States, made in the form of grants, to mitigate the effect of the higher share of States in the tax revenue.

The Centre initially budgeted transferring 6.3 per cent of GDP to the States for financial year 2015-16. The acceptance of the recommendations of the 14{+t}{+h} Finance Commission in February 2016, meant higher devolution of taxes to the States (42 per cent against 32 per cent earlier). This was to be for a five-year period, starting April 1, 2015. However, the actual transfer (which includes shareable taxes), which was 20 basis points less than the budgeted figures, came as a shocker to the States. While a transfer of 6.3 per cent of GDP was budgeted, revised estimates pointed to a lower figure of 6.1 per cent.

The transfers from the Centre to the State governments are of two types — tax devolution and grants-in-aid. While the former is untied, the latter could be tied to various conditions.

In 2015-16, the tax transfers were healthy; against the budgeted 3.4 per cent of GDP, the revised estimate was a higher 3.7 per cent. However, the Centre took away 8.1 per cent of tax revenues in 2015-16 (against 6.1 per cent in 2014-15) by way of surcharge and cess, which do not devolve to States.

But the transfers of grants-in-aid were sharply lower in the revised estimate. Against the budgeted 2.9 per cent, grants worked out to just 2.4 per cent of GDP in 2015-16. This, in turn, pulled down the overall figures for transfer in 2015-16 compared with the previous year.

The transfers to States in FY17 are expected to be even lower at 6 per cent of GDP.

While shareable taxes would continue to be 3.7 per cent of GDP, grants-in-aid would dip a further 10 basis points to 2.3 per cent of GDP.

Not the least, introduction of further cess and surcharges in 2016-17 would take away 9.1 per cent of tax revenues from the divisible pool

With higher tax devolution rates, it was expected that the Centre would cut grants, thereby allowing the States greater autonomy in financing and designing schemes.

“However, the quantum of cut in grants was slightly steeper than expected, especially against the backdrop of increase in borrowings of State governments,” says Indranil Pan, chief economist at IDFC Bank. In 2015-16, own-tax revenues of 16 States fell drastically, which was more than expected. Many of them hit the debt market as a desperate measure to meet their fund requirements.

Centrally-sponsored schemes and State Plans constitute bulk of the transfers made as grants to the States.

When the Modi government came to power in May 2014, one of the first things it did was to double the budgeted disbursements under both these heads.

However, after fixing higher tax devolution rates, it pulled the plug on eight Centrally-sponsored schemes — including national e-governance plan and that for setting up 6,000 model schools. In addition, it pruned the expenditure-sharing ratio with the States for its existing schemes to 60:40.

The Centre is also slightly tight-fisted in disbursing its share of money under the existing schemes. “The current government is finicky about fulfilling conditionalities set out by the Ministry of Finance or Union ministries before making further disbursements under various schemes,” says Vikram Srinivas, research associate with Accountability Initiative, a part of the Centre for Policy Research.

According to a Nomura report, State borrowings rose sharply in FY16 despite an increase in Central transfers. And, on an overall basis, there has been a slippage to the tune of 40 basis points in the fiscal deficit-to-GDP ratio of the 16 State governments as against their budgeted figures. “In the last two years the cash balances of State governments have fallen drastically,” said Sujoy Kumar Das, Head of Fixed Income at Invesco Mutual Fund.