Deep Dive

States’ deficits matter, too

NARAYANAN V Chennai | Updated on January 17, 2021

Finance Minister Nirmala Sitharaman

Sharp dip in tax/non-tax revenue and Covid-led expenses, among others, have overstretched State finances

Even as the Finance Minister gets ready to present the Union Budget for FY22, it is well known that the stress on the Centre’s finances due to the pandemic has widened the fiscal deficit considerably in FY21. But looking at the Centre’s books alone does not give the full picture as a large part of the revenue and expenditure of the country is captured in the dispersed State Budgets.

How have the States fared in the Covid times and how will the combined fiscal deficit of Centre and States be?

States’ numbers

State finances are in dire straits. A sharp decline in the tax and non-tax revenue, coupled with pandemic-led additional expenditures and borrowings has overstretched the State finances pushing their gross fiscal deficit much higher.

Data compiled from the Comptroller & Auditor General (C&AG) show, the fiscal deficit of large States, in the first eight months of FY21, is already about 70 per cent of their annual budget. Against a fiscal deficit budget of ₹5.66 lakh crore for the whole of FY21, the actual deficit of these States has already touched ₹3.89 lakh crore.

States such as Karnataka, Andhra Pradesh, Rajasthan and Kerala have overshot their annual fiscal deficit target by a wide margin. States like West Bengal, Telangana and Chhattisgarh are also closing in. (Chart 1)



In its latest report on State finances, the Reserve Bank of India said the gross fiscal deficit of State governments is projected to widen beyond 4 per cent of the GDP in 2020-21 compared with the budgeted 2.8 per cent. The central bank also said the Covid-19 pandemic may alter Budget estimates significantly, eroding the gains of consolidation secured in the preceding three years.

“The average gross fiscal deficit (GFD) for States that presented their Budgets before the outbreak of Covid-19 is 2.4 per cent of GSDP, while the average for budgets presented post-lockdown is 4.6 per cent,” the RBI said.


Over the last few years, States such as Haryana, Kerala, Telangana and West Bengal were showing improvement in their GFD as a percentage of gross state domestic product (GSDP). (Chart 2) However, the budgeted GFD-GSDP ratio of these States as well as others is expected to go completely off-track owing to the pandemic-led spike in expenditure and drop in tax and non-tax revenue.

State-wise GFD, based on FY21 Budget estimates, shows 10 out 31 States have already breached the fiscal responsibility laws (FRL)-imposed threshold on fiscal deficits while several other States are on the borderline. (Chart 3)


Loss of revenue due to demand slowdown, coupled with pandemic-related spending, particularly on health and other support measures for households and firms, are likely to keep these expenditures high, prolonging the ‘scissor effect’— loss of revenue accompanied with higher expenditure, the RBI said.

According to Madan Sabnavis, Chief Economist at CARE Ratings, the GST compensation of ₹1.1 lakh crore on account of CGST and IGST loss for States and ₹72,000-crore slippages on State GST will be the overall deficit for all States from the GST point of view.

“So, we can assume that ₹1.8 lakh crore will be the overall deficit for all the States just on account of CGST and IGST portion. The fall in own revenue is estimated to be around ₹70,000 crore,” he added.

Cutting down expenses

States are cutting down on various expenditures besides looking for additional revenue sources to bridge their fiscal deficit. While some have increased taxes on alcohol and petroleum products others are cutting down capital expenditures and deferring pension and subsidy payments, freezing dearness allowance (DA) and suspending leave encashment, among other measures.

Though States will have other compensations in the form of higher sales taxes, VAT collection on petroleum products etc, there will be slippages on the whole, Sabnavis said.

What will be the combined fiscal deficit number?

Prior to the onset of the Covid-19 pandemic, the Centre had budgeted a fiscal deficit of ₹7.96 lakh crore or 3.5 per cent of India's GDP estimate for FY21. For States and Union Territories (UTs), the fiscal deficit was budgeted at ₹6.26 lakh crore, which is 2.8 per cent of the country's GDP. But the pandemic has made all those estimates irrelevant. According to SBI's latest Ecowrap report, revenue shortfall and enhanced government expenditure will take the Centre's fiscal deficit to ₹14.46 lakh crore or 7.4 per cent of new revised nominal GDP estimate for FY21.


States are also required to expand spending on healthcare to focus on vaccine delivery and to achieve the universal health coverage goal of 2.5 per cent of GDP at the aggregate level. Accordingly, a conservative estimate of ₹2.75 lakh crore expenditure outflow will take the State's fiscal deficit to over ₹9 lakh crore or 4 per cent of India's GDP. Consequently, the combined fiscal deficit of Centre and States is estimated at 11.4 per cent for 2020-21. (Chart 4) SBI's report puts the combined fiscal deficit at 12.1 per cent.

Borrowing expands

The expanding deficit of the States results in increased borrowing. About 90 per cent of States’ fiscal deficit are financed through borrowings.

For FY21, the States had budgeted a gross borrowing of ₹7 lakh crore. Under the Aatmanirbhar package, States were allowed to increase their borrowing limits from 3 per cent to 5 per cent for 2020- 21, which was expected to provide extra resources of ₹4.28 lakh crore.

However, despite higher borrowing limits, States may be able to utilise only half of the additional borrowing given to them considering the terms and conditions they’ll have to meet to be eligible for the increased limits.

“Under Aatmanirbhar programme, different scales were given to different States to get additional fiscal space. Later, some of those conditions were also removed for certain States to enable them to borrow more. So, overall, we expect the slippages at 4 per cent for all States put together,” said Sabnavis.

According to SBI's Ecowrap, the net market borrowing of the Centre will be around ₹8.8 lakh crore and with repayments of ₹2.7 lakh crore, gross borrowing is expected to be ₹11.5 lakh crore. With States’ gross borrowing at around ₹9.4 lakh crore, the total gross market borrowing would be around ₹20.9 lakh crore, but could have a clear downward bias.

Debt burden

The increase in borrowing is likely to further the debt burden of the States as it entails huge outflow of interest expenditure. The ratio of outstanding liabilities of States has steadily increased from 22 per cent of the GDP at the end of March 2015 to 26.3 per cent as of March 2020. In value terms, the outstanding liabilities of States and UTs is estimated to touch ₹53.43 lakh crore as of March 2020, from ₹27.43 lakh crore in March 2015 (Chart 5).


For FY21, the outstanding liabilities are estimated to be ₹59.89 lakh crore or even higher due to the pandemic-led expenditure and fall in revenue collection.

“Outstanding debt continued to grow in double digits, albeit lower than in the years of Ujwal DISCOM Assurance Yojana (UDAY) implementation. State-wise data reveal that the debt-GSDP ratio is expected to increase for 13 States. For 19 States, this ratio is expected to exceed 25 per cent in 2020-21 which may force curtailment of capital expenditure,” the RBI said.


Published on January 17, 2021

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