No GST compensation: Will the Centre find another way to give states money?

At the end of July, the Centre will have paid the final instalment of the GST compensation that is due to the states. With that, the compensation covenant will end, leaving the states without this substantial source of revenue.

By looking at their finances, it is clear that a few are under great fiscal stress already, which will be significantly exacerbated once the GST compensation transfers end.

Over the five years of GST, the Centre would have transferred more than Rs 8 trillion to the states as GST compensation. The cessation of this payout will affect all the states, but some much more than others.

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There are several ways to measure states' fiscal health, but in the context of the stoppage of a major revenue stream, some indicators assume greater importance.

The North-Eastern and other hill states like Himachal Pradesh can be left out of this analysis. Their finances are in a mess, almost without exception, and they will remain dependent on the Centre for the foreseeable future. Let’s instead look at the rest of the states and, amongst them, those spending well above their means.

According to RBI data, there are eight remaining states that have a fiscal deficit more than 0.5 percentage points higher than the combined states’ average of 2.6 per cent— Goa (6.6 per cent), Tamil Nadu (4.8 per cent), Uttar Pradesh (4.7 per cent), Chhattisgarh (4.6 per cent), Madhya Pradesh (4.6 per cent), Punjab (4.6 per cent), Haryana (4.3 per cent), and West Bengal (4.2 per cent).

It is also important to see which states can finance a reasonable portion of their regular expenditure with their own revenue. In other words, how dependent they are on transfers from the Centre and other external sources.

Six of the non-NE and hill states have a revenue-to-revenue expenditure ratio of less than 50 per cent—Bihar (22.9 per cent), Uttarakhand (36.4 per cent), West Bengal (37.5 per cent), Punjab (43.5 per cent), Madhya Pradesh (44.3 per cent), and Jharkhand (48.5 per cent). These states can’t even cover half their regular expenditure such as salaries, pension, and other overheads from their revenue.

Now, look at the borrowing pattern of these states. All states (taken together) have total outstanding liabilities amounting to 31.2 per cent of their combined gross domestic products. There are eight for whom this proportion is higher than the national average, some much more than others.

Punjab stands out, with outstanding liabilities at 53.3 per cent of its GSDP. The others are in a relatively more manageable position. However, their liabilities are still high—West Bengal (38.8 per cent), Kerala (38.3 per cent), Andhra Pradesh (37.6 per cent), Haryana (35.3 per cent), Uttar Pradesh (34.2 per cent), Bihar (34 per cent), and Jharkhand (32.6 per cent).

These states are borrowing well above what they should be, meaning an increasing share of their future revenues will be tied up in repaying loans.

Finally, there is the quality of a state’s expenditure; that is, how much of what it spends goes into subsidies. Two states stand out with subsidies as a percentage of total expenditure coming in the double digits—Chhattisgarh (26.4 per cent) and Punjab (10.7 per cent).

Punjab is in the worst position, with a high fiscal deficit, low ability to independently finance its expenditure, high liabilities, and high subsidy burden. Apart from the subsidy burden, West Bengal is also in the same boat.

The real question is whether the Centre will impose a hard budget constraint. Given how politics works in our country and the past record, these states may not have much to worry about, especially Punjab, a border state.