With the lockdown hitting the economy hard, revenues of the Central and State governments are falling rapidly while money is needed to keep households and businesses afloat. The mid- and long-term impact is yet unknown, but some fiscal implications are becoming clear.
A global issue
The global worry around defaults of entire countries has sparked discussions about global relief mechanisms. One such mechanism suggested by eminent academics is a Global Solidarity Fund to bridge the estimated $2.5 trillion gap.
The Indian scenario
Looking at India, State governments are ringing the alarm bell. Kerala’s finance minister Thomas Isaac has pointed out in a livemint interview that he had to front-load all borrowings to April-May, a situation that is hardly sustainable.
What is the size of Bihar’s budget and how much is spent on education?
According to a PRS analysis of the State budget, Bihar had planned to have a total expenditure in this FY of Rs 2,11,761 crore out of which Rs 27,609 crore should come from borrowings. Rs 39,351 crore were planned to be spent on education (not only school education).
However, Bihar would require far more resources in order to provide a sufficient number of classrooms and teachers. With disposable incomes shrinking, school fees become unaffordable for more and more parents, potentially leading to more children attending government schools. This might not necessarily reflect in increasing enrolment numbers as many children visiting unlicensed private schools are simultaneously enrolled in government schools.
Reliable estimates put the additional requirement for Bihar at 7.9% of GSDP equal to almost trippling the spending per student in elementary school. This would mean an increase from Rs 5,929 per student annual spending to Rs 18,770. Overcrowded classrooms and a lack of WASH infrastructure mean additional problems for Bihar when it comes to reopening schools.
With government schools already severely underfunded, the current pandemic and the implied fiscal crisis might cause major disruptions.
Short-term liquidity measures
As Thomas Isaac, Kerala's Finance Minister, stated in a livemint interview, States face severe trouble as the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, limits the fiscal deficit to 3% of GDP. In addition, borrowings for States under the RBI’s Statutory Liquidity Ratio bonds come with a substantial interest rate and are limited in their volume.
In the short run, the Centre’s Ministry of Finance has issued sanctions for the April instalment of the devolution of States’ share in Central taxes and duties, amounting to Rs 4631.96 crore for Bihar. However, as Rathin Roy, Director and CEO of the National Institute of Public Finance and Policy New Delhi, has pointed out on twitter, this is no extra money. It is merely meant to bridge the immediate revenue shortfall.
Mid-term impact on State revenues
The lockdown will have severe consequences on State and Central revenues as another PRS analysis indicates (the following paragraphs are based on this analysis).
Devolution from Center to State
Around 25% of State revenues come from their share in Central taxes. A 1% point drop in national nominal GDP would lower the devolution from the Center to Bihar in the current FY by Rs 829 crore or 0.45% of total State revenues.
In addition, States have their own revenue sources. They account for around 45% of revenue on average (this may vary from State to State). The biggest share comes from State GST (around 19%). A 1% point drop in nominal GSDP would lower Bihar’s revenues by Rs 187 crore or 0.1%. In addition, every month of the lockdown will cause a severe shortfall in sales tax/VAT revenues. A 40% shortfall might mean a revenue loss of Rs 194 crore (0.11%), a 80% shortfall Rs 389 crore (0.21%) per month.
Losses in revenue and the need for additional spending might escalate fiscal deficits. In 2019-20 (based on revised estimates), Bihar had a deficit of 9.5%. In 2020-21 it planned to maintain the 3%-boundary as mandated in the Bihar Fiscal Responsibility and Budget Management (FRBM) Act, 2006. This seems impossible now.
The way forward
If the education budget shall not shrink further, additional lending at lower interest rates, new ways of generating revenue, and putting existing funds to use must be explored.
Measures to keep interest rates low
Pronab Sen, Programme Director for the IGC India Programme, has suggested that the Centre should borrow from the market and lend the money to States 50 basis points above the market interest rate. This would significantly lower interest rates for States.
Measures to generate additional revenue
A wealth tax of 4% on India’s 953 richest families would generate a revenue of a little more than 1% of India’s GDP as suggested by eminent economist S Subramanian. Such a tax would have to be introduced by the Centre.
States have limited means to generate additional revenue. After the GST introduction, States can only levy sales tax on petroleum products and alcohol for human consumption. This levy is currently not used by the Government of Bihar. While increasing the tax burden for petroleum might hit the transport sector and farmers, an end to the prohibition policy could generate substantial revenue. In FY 2015-16, the State generated Rs 3,605 crore worth of revenue from liquor sales. This could amount to well above Rs 4,000 crore today.
Using existing funds
In addition, according to the Comptroller and Auditor General's Financial Audit for the year 2017-18 of the Accounts of the Union Government (No. 2 of 2019), Rs. 94,036 crore have been collected under the Secondary and Higher Education CESS (SHEC). Yet, the “Cess is being retained in the CFI, contrary to procedure, though a Fund (Madhyamik and Uchchtar Shiksha Kosh) for this purpose was created in August 2017, and has not been operationalised so far.” This money can now be used to pay for Secondary and Higher Education, allowing other resources to be channelled to elementary education.
To sum up: The situation is worrisome. States like Bihar need support by the Centre, e.g. through low-interest loans and additional devolutions financed through a wealth tax. Bihar’s own policy levers are limited. Giving up prohibition might generate substantial revenue that could make up for some of the shortfall but might be politically contested.