Economy - Centre and State Finances Stretched :: Edelweiss, link

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Centre’s tax revenue collections, as highlighted by us, have been quite underwhelming so far and could potentially fall short ~0.4-0.5% of GDP compared to the budgeted. Though the crude price plunge will lighten the oil subsidy burden, its full benefit will accrue only in FY16 and beyond. In fact, in the interim, the impact of fall in petro-product prices (accounting for ~17-18% of states’ own taxes) will be adverse on states’ revenues. Moreover, Centre’s devolution of taxes to states will also fall (as Centre itself faces shortfall), compounding the strain on latter’s finances. In a nutshell, the only alternative at the disposal of Centre and states to meet their fiscal targets is to compress expenditure ~0.7-0.8% of GDP. This, we believe, could be a near-term drag on economic activity given that private sector recovery is still nascent.

Centre’s fiscal position stretched; expenditure cuts likely

Weak economy is taking a toll on government’s fiscal position. Tax collections have disappointed-growing a mere 6-7% during April-October compared to budgeted projection of ~20%; indirect taxes have been particularly underwhelming. Our estimates indicate that even if the government meets its disinvestment target (~INR630bn), the revenue shortfall could be of 0.4-0.5% of GDP. The decline in oil price will definitely ease subsidy burden, but its full benefits will accrue only in FY16. Thus, the government will be compelled to scale back expenditure (close to 0.4% of GDP: our estimate) to meet its fiscal target of 4.1% of GDP. Notably, this will be the third year running that the government will have to squeeze expenditure to meet fiscal target.

Crude fall could strain states’ finances

State finances are under pressure from at least 2 channels. First, weakness in Centre’s tax collections means devolution of taxes to states will be lower than projected (states receive ~30% of gross taxes collected by Centre under Finance Commission’s guidelines). In our view, states may face a shortfall of ~0.2% of GDP on this front. Second, the dip in commodity prices, especially petrol and diesel, will dent states’ sales tax collections (sales tax on petroleum products accounts for a substantial 17-18% of states’ tax collections). As per our rough-cut calculations, shortfall on this account could be around 0.2% of GDP. This implies that in order to meet fiscal targets, states will have to squeeze expenditure to the tune of ~0.3-0.4% of GDP.

Fiscal policy a near-term drag as private sector recovery still nascent

In a nutshell, if the Centre and state governments aim to meet fiscal targets they will have to compress expenditure by 0.7-0.8% of GDP. This will be a near-term drag on economic activity as private sector recovery is still nascent and monetary policy is yet to turn growth supportive. Therefore, over the next few months, economic indicators may continue to remain mixed. Thereafter, we expect this adverse policy mix to start unwinding as the monetary cycle reverses and private consumption picks up aided by improving real incomes.

LINK

https://www.edelweiss.in/research/Economy--Centre-and-State-Finances-Stretched/27814.html