Upside Risks To States' Fiscal Deficit Increase Amidst A Rise In Welfare Spending

In the past week, Manju has received a tab, mixer and hard cash from her MLA in Bandra West, Mumbai. The state is set for elections in a month and the battle will likely be closely fought between the reigning Mahayuti and the Maha Vikas Aghadi alliances.

While some states such as Maharashtra and Jharkhand are lining up for elections, some such as Jammu and Kashmir have recently completed polls. The slew of state elections, especially post an unexpected verdict in the general elections held earlier this year, has meant some populist spending and a spate of welfare schemes that require further monitoring, amidst upside risks to federal finances.

States’ aggregate fiscal deficit as a share of the GDP is set to widen to 3% in FY25 from 2.8% in the last fiscal. However, fiscal and borrowing data available for FY25 so far has not been too disturbing, said Madhavi Arora, lead economist at Emkay. "However, we see reasonable risks of slippage in the second half of the fiscal, vs the last three years, and see the quality of fiscal mix worsening with revenue deficit widening further to 0.5% vs FY24 provisional estimates at 0.3%," she stated.

We do see periods where welfare spending by states is prioritised over capex, especially ahead of elections, said Aditi Nayar, chief economist at ICRA. However, it might be too early to discuss the net impact of these expenses and chances of overshooting fiscal deficit targets, said Nayar, given low state capex along with the need for states to balance books.

Still, ICRA does forecast a modest slippage in the combined revenue and fiscal deficits of 13 major states in FY25 to Rs 2.2 lakh crore and Rs 8.8 lakh crore, respectively, from Rs 1.9 lakh crore and Rs 8.5 lakh crore, respectively, in the budget estimate.

Combined capex by states is projected to rise by 13% to Rs 6.5 lakh crore in FY25, as per ICRA's estimates, lower than the budget estimate of Rs 7.2 lakh crore. States' revenue growth is likely to trail budget estimates with state GST, excise duty and stamp duty and registration collections likely to expand by 11-13%, along with sales tax growth moderating to 5.5% in FY25.

Lower-than-budgeted revenues would warrant some trimming in revenue spending, Nayar said, adding that within committed spending, funding of pension liabilities is a key concern, along with likely doubling of combined power subsidies in FY25 from pre-Covid levels.

Meanwhile, the centre has trimmed its fiscal deficit target to 4.9% of the GDP in the ongoing fiscal after having undershot its target of 5.8% last fiscal. There are two main reasons behind this divergence, continuing from FY24, Arora explained. States’ budgeted expenditure growth, especially revenue expenditure, is much higher than the centre at about 19% over FY24, along with higher budgeted revenue growth that seems optimistic at about 19%, she said.