States revenue loss from tax cuts on fuel to be lower than tax devolution in FY 22

However, it cautioned against the fiscal risk posed by a rise in guarantees extended by state governments to state-level entities, since contributions made by several states to their guarantee redemption funds have been low.

The central government cut the road and infrastructure cess (RIC) component of the Central excise duty levied on petrol and diesel by Rs 5 and Rs 10, respectively, effective November 4, in a bid to provide relief to consumers from rising crude oil prices. The RIC component is not shared with states, but since states levy VAT on an ad-valorem basis, the excise cut will lower their VAT inflows by Rs 9,000 crore, ICRA estimated.

“We tentatively estimate the revenue loss to all states and UTs from the VAT cuts on these fuels at Rs 350 billion (Rs 35,000 crore). Accordingly, their total revenue foregone is assessed at Rs 440 billion (Rs 44,000 crore) for FY2022, in line with the expected revenue loss of the GoI (Government of India),” said Aditi Nayar, chief economist at ICRA, during a webinar Thursday.

Factoring in the impact of the excise duty cut and expectations for mobility and the economic recovery with the rising Covid-19 vaccine coverage, ICRA forecasts the year-on-year rise in the consumption of petrol and diesel in the ongoing fiscal 2022 at 14% and 8%, respectively, on the low base of FY21.

Nayar said the fiscal loss or revenue foregone was warranted given the benefit it will have in terms of softening the inflation trajectory and boosting the overall confidence levels of households and other economic agents.

Upside from tax devolution

On the other hand, the ratings firm expects central tax devolution to exceed the government’s FY22 budget estimates of Rs 6.7 lakh crore by Rs 60,000 crore, and the FY21 provisional actuals by Rs 1.3 lakh crore.

Yet, tax devolution to states was nearly unchanged at Rs 2.6 lakh crore in the first half of FY21 and FY22. The devolution amount rose to Rs 47,500 crore in each month of the July-September quarter this year from Rs 39,200 crore each in the previous three months.

“Based on the expected upward revision in tax devolution to Rs 7.3 trillion (Rs 7.3 lakh crore) in FY22, the retention of the monthly amount of tax devolution at Rs 475 billion in October-February FY2022 will back-end the release of Rs 2.3 trillion to March 2022, which will be inefficient from the cash-flow perspective for the states,” Nayar said, backing the case for the government to increase the monthly devolution to states to avoid back-ended transfers.

“The revenue visibility will enhance confidence and allow them to expedite expenditure, especially growth-supportive capital spending,” she added.

ICRA expects most states to have a fiscal deficit at around 3.5% of their GDP in FY22, which will be quite manageable, and only a few states may need to borrow more than 10% of GDP. They will also have access to the back-to-back loans of over Rs 1.59 lakh crore by the Centre for GST compensation which will give them additional funds, besides the carried forward borrowings from last year.

“Only a few states are likely to be constrained beyond these sources of funding which are available in the current year,” Nayar said.

Issue of state development loans so far is 15% lower than last year, with only five states borrowing a higher amount than they had in the same period of FY21, she said.

State-level guarantees

States give guarantees to state-level entities that enable them to borrow funds from various sources. Each state decides its own guarantee ceiling. Unlike the annual borrowing limit for debt, which is set by the GoI, states have the flexibility to set and modify their guarantee ceilings. This allows them to extend fresh guarantees within a short period of time without any approvals or significant oversight from the GoI or the Reserve Bank of India.

ICRA noted that some states had already extended considerable guarantees before the pandemic started, and a few states’ stock of guarantees is expected to have risen sharply since then.

“Without the availability of adequate data, it is unclear how much of the recent rise in guarantees is related to non-revenue generating projects, which would eventually end up being serviced by the respective states, making them an actual and not a contingent liability. This poses a fiscal risk, particularly given the modest contributions made by several states to their guarantee redemption funds,” Nayar cautioned.