Context: The Reserve Bank of India’s study on state governments’ finances indicates that gross fiscal deficits (GFDs) of state governments are set to double in 2020-21. 

The gross fiscal deficit (GFD) 

  • It is the excess of total expenditure including loans net of recovery over revenue receipts (including external grants) and non-debt capital receipts. 
  • Generally fiscal deficit takes place either due to revenue deficit or a major hike in capital expenditure. 

Gross Fiscal Deficit = (Total Expenditure + Loans Servicing) – (Revenue Receipts + Non Debt Capital Receipts)

  • Capital expenditure is incurred to create long-term assets such as factories, buildings and other development.
  • A deficit is usually financed through borrowing from either the central bank of the country or raising money from capital markets by issuing different instruments like treasury bills and bonds.

Key takeaways of the RBI study:

  • GFD-to-GSDP ratio: In 2020-21, about half the states have budgeted the GFD-to-GSDP (gross state domestic product) ratio at or above 3%.
    • The average for states’ budget before the outbreak of the pandemic is 2.4% of GSDP, while it is 4.6% for the remaining states that made their budget after the outbreak. 
  • Primary deficits: Most states are incurring primary deficits in 2019-20, as against primary surpluses at the onset of the global financial crisis.
    • Primary Deficit is the difference between the current year's fiscal deficit and the interest paid on the borrowings of the previous year. 
    • Primary Deficit indicates the borrowing requirements of the government, excluding interest.
  • Operation of ‘scissor effects’: It is the loss of revenues due to demand slowdown, coupled with higher expenditure associated with the pandemic. 
  • The duration of stress on state finances will likely be contingent upon factors such as 
    • The lockdown tenure  
    • The risk of new waves of infection
    • These factors make traditional backward-looking tax buoyancy forecasting models unreliable.
    • The quality of spending and the credibility of state budgets will assume critical importance. 
  • Covid-19 impact on states
    • Revenue fall: Considering the fact that tax revenues fall faster than GDP when growth is negative, tax revenues are likely to be reduced for the next few years.
    • Pandemic-related spending, particularly on health and other support measures, are likely to keep states’ expenditures high, prolonging the ‘scissor effects’. 
    • A surge in contingent liabilities (guarantees) will affect states’ finances. 
    • Tough choice of putting investment projects on hold, will inevitably entail growth losses in a vicious cycle due to multiplier effect. 
    • States’ indebtedness is set to rise, and if it is not accompanied by an acceleration in growth, fiscal sustainability will become the casualty.
  • Pandemic response in specific states
    • KERALA MODEL: With the resurgence in new cases, Kerala is actively roping in the services of empowered local self-governments (LSGs) in its fight against the pandemic. 
    • DHARAVI MODEL: The RBI said public-private partnership and community participation played a crucial role in combating Covid-19 in Dharavi. 
      • The government tied up with local private doctors, hospitals, NGOs, volunteers and elected representatives and civil society organisations for accessible testing, proactive screening, early detection, contact tracing, timely isolation.
      • Community participation, community kitchens and collective solidarity were the key features that helped contain the spread. 
      • Dharavi has flattened the curve and is worthy of emulation worldwide (WHO).

Lessons from previous pandemics

  • Previous four pandemics in India — the 1896 plague, the 1918 Spanish flu, the 1957 Asian flu and the 1974 smallpox — were associated with a contraction/deceleration in GDP.
  • These outbreaks have also depressed per capita economic output, with varied magnitudes. 
  • Similar recovery pattern: It followed a sharp rebound in the immediate subsequent year because of favourable base effects, followed by contraction again, and the GDP growth rate finally returning to pre-pandemic levels in 3-4 years.
Image Source: ET