The Reserve Bank of India (RBI) issues an indicative quarterly calendar of state governments’ market borrowings. However, the actual issuance of state development loans (SDL), which is the state governments’ predominant source of borrowing, has differed considerably from the auction calendar issued by the RBI in many of the recent quarters, perplexing bond market participants and confounding fiscal analysis alike.
For instance, SDL issuance was lower than indicated in 10 out of the 16 quarters during FY2019-22. For the full year, the actual issuance was lower than indicated in FY2019 by Rs 1.2 trillion (led by Maharashtra, Uttar Pradesh and Tamil Nadu) and by a relatively modest Rs 254 billion in FY2021 (led by Maharashtra and Haryana). This gap widened to a sharp Rs 1.9 trillion in FY2022, led mainly by lower than indicated issuance by Uttar Pradesh, Punjab and Maharashtra. In contrast, issuance had exceeded the indicative amount by a mild Rs 58 billion in FY2020.
The magnified variation in FY2022 seems to have been impacted by higher-than-expected transfers by the Government of India (GoI) to the states, especially in Q4 FY2022, which eased the cash-flow position of the latter. The auction calendar had projected the SDL issuance at Rs 3.24 trillion for Q4 FY2022. However, the actual gross SDL issuance was limited at Rs 2.35 trillion in Q4 FY2022, a significant `887 billion lower than the indicated amount.
When the auction calendar for Q4 FY2022 would have been prepared by the states, presumably in December 2021, the Budget Estimate (BE) for central tax devolution from the GoI to the state governments for FY2022 was Rs 6.7 trillion. Of this, Rs 4.5 trillion was released between April and December 2021, leaving an estimated balance of Rs 2.2 trillion for Q4 FY2022, relative to the BE.
Eventually, a massive Rs 4.3 trillion was released to the states in that quarter, including some arrears for earlier periods, nearly rivalling the amount released in the previous nine months. Accordingly, the total devolution exceeded the original FY2022 BE by around Rs 2.2 trillion, following a better-than-estimated tax revenue out-turn for the GoI.
It’s no surprise then that the states’ borrowings fell short of what they had estimated by a considerable Rs 0.9 trillion. We are curious to see whether the rest of the unexpected windfall translated into higher capex. Provisional unaudited data available for several states for January-February 2022 does not suggest the same. Possibly, the extra tax devolution received in Q4 FY2022 may end up moderating the states’ fiscal deficit for FY2022 instead of spurring growth-enhancing capex, which is a not an ideal outcome in the current context of an uneven and tentative growth recovery.
The total tax devolution of Rs 8.8 trillion made in FY2022 included the normal adjustment for FY2021 as well as a prior period adjustment for FY1997 to FY2018. Setting these two aside, we estimate the devolution for FY2022 itself at `8.1 trillion. This is merely 2.8% lower than the Rs 8.2 trillion included in the FY2023 BE. The latter appears to be rather conservative, as does the GoI’s FY2023 BE for its overall tax revenues.
It is unclear to us what level of quarterly tax devolution the states built in while projecting their Q1 FY2023 SDL calendar at Rs 1.9 trillion, a YoY rise of 32%. The actual amount of devolution released in Q1 FY2023 may alter the size of the actual SDL issuance relative to the indicated amount.
This brings us to what is a reasonable annual and monthly devolution amount for FY2023 that the states should assume going ahead, both to estimate their borrowings and plan their capital spending.
Prior to FY2020, the monthly formula/methodology used for devolving taxes by the GoI to the states appeared largely stable (approximately 7.1% of the BE in the first 10-11 months of each fiscal, with the balance amount released in February-March based on the Revised Estimates or RE figures), which imparted predictability to the cash flows of the state governments. However, following the adverse impact of the pandemic on the GoI’s tax revenues, this monthly pattern of devolution underwent some changes in FY2021 and in the initial months of FY2022.
If the GoI reverts to the earlier practice of releasing 7.1% of the budgeted tax devolution (Rs 8.2 trillion) to the states in the early months, it would entail a monthly release of around `580 billion in Q1 FY2023.
However, we expect the GoI’s tax revenues and devolution to sharply exceed the FY2023 BE.
If we simply assume that tax devolution will grow at the same pace as nominal GDP (our forecast of which is 14%), then the states may be entitled to as much as Rs 9.3 trillion in FY2023. This entails an upside of Rs 1.1 trillion, which is modestly larger than the size of the special assistance loan for capital investment from the GoI to the state governments for FY2023.
If the GoI sticks to the earlier formula of calculating monthly devolution, then the upside of Rs 1.1 trillion may end up getting deferred to Q4 FY2023. Given the lead time required to plan and execute projects, that may be too late to convince the state governments to spend aggressively on capex, which is urgently required to boost economic growth amid the geopolitical uncertainties.
The writer is chief economist, Icra
