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Subdued private consumption and services activities are concerns for Indian economy

Indebtedness of states may hit a decade-high 36 per cent this fiscal

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Subdued private consumption and services activities are still causes of concern as India enters a technical recession. Conservative fiscal stance had led to a sharp contraction in government consumption during the quarter ending September 2020.

It is expected that though this will have a salutary effect on containing the fiscal deficit, the implications for economic recovery can be negative. As per a report by Anand Rathi, due to the cautious removal of lockdown restrictions and flattening of the infection curve, the outlook for H2 FY21 looks promising. The report says that while earlier it was expected that India's full year real growth will contract by close to 10 per cent, the economy will now shrink by 9 percent during FY21.

The report points out that while easy monetary policy is expected to continue, fiscal stance remains uncertain. The report observes that unexpected hardening of retail inflation has compelled the RBI to hold back cut in policy rates. Inflation has been mainly driven by high food prices. It is expected that retail inflation will start softening and the RBI may resume rate cut during Q4 FY21.

As per a report by Emkay Global Financial Services, the Q2 FY21 expectedly staged a sharp sequential recovery and the GDP growth contraction moderated to -7.5 per cent after a 24 per cent contraction in Q1 FY21. The report points out that agriculture remained a bright spot, while manufacturing reverted to mild recovery as firms saw a sharp surge in operating profits amid lower expenses. The services sector however continued to under perform. Manufacturing growth was back in the positive and private sector momentum also recovered.

The report observes that the contraction in services was led by trade, hotels, transport and communication while finance and real estate sector contraction worsened to -8.1 per cent. It was also observed that the government spending fell by 12.2 per cent led by a sequential contraction in the centre and states’ revenue expenditure.

As we are already in a technical recession, a report by CRISIL has pointed out that the indebtedness of states may hit a decade-high 36 per cent this fiscal. The pandemic-induced lockdown and consequent slump in economic activity is expected to increase the states’ indebtedness to at least 36 per cent this fiscal which will be the highest in a decade. This has been mainly attributable to falling goods and services tax (GST) collections and sticky revenue expenditure of states. As per CRISIL’s study of the top 18 states, two which account for 90 per cent of the aggregate gross state domestic product (GSDP), indicates as much. CRISIL points out that the states’ overall revenues are estimated to decline almost 15 per cent on year this fiscal in line with a shrinking economy.

It is also expected that all the revenue sources of the states will take a hit, with almost 65 per cent of the decline attributable to a fall in state GST collections, GST compensation payments, and tax devolutions to the states from the centre’s own tax pool, which together forms nearly 50 per cent of states’ revenue receipts.

“Amid falling revenue receipts, states’ revenue expenditures would remain largely sticky due to the high committed expenditures (related to salaries, pension and interest costs) and essential developmental expenditures (such as grants in aid, medical and labour welfare related expenses). These cumulatively contribute to about 75-80 percent of the total revenue expenditure and will be difficult to cut down,” said Manish Gupta, Senior Director, CRISIL Ratings.

It is expected that given the stretch in revenue account, states may moderate their capital expenditures (capex) by around 30 per cent, largely to remain within fiscal borrowing limits. Despite the moderation in capex, states’ gross fiscal deficit is likely to expand by around 65 per cent on-year this fiscal and will increase states’ borrowing needs substantially.

CRISIL also expects that the overall debt of states, including guarantees and loans provided by the centre to partly compensate for states’ GST shortfall, will increase sharply by around Rs 10 lakh crore this year to Rs 68 trillion by the end of this fiscal. This will expand states’ indebtedness to at least 36 per cent.

There is also a likely shrinkage of two-four percent in states' nominal GDP this fiscal. This will remain sensitive to the containment of the pandemic and states’ policies towards unlocking the economy. A substantial recovery in revenue collections to pre-pandemic levels is expected next fiscal.

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