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GST compensation requirements of states are increasing at faster rates than the compensation cess collections which finance them. This could lead to a scenario in the future when cess collections may not be sufficient to provide compensation to states. In 2019-20, cess collections have so far seen a growth of 1.5% during the seven-month period April to October 2019, which is much lower than the 21% growth budgeted for the year. Also, states have been guaranteed compensation only for a period of five years, which will end in 2022. After 2022, states receiving compensation will have a revenue gap as they will not get these funds. States have roughly 2.5 years to bridge this gap with other sources to avoid any potential loss in revenue.

15th Finance Commission: The 15th Finance Commission’s Terms of Reference were amended in July 2019 to require it to examine whether a separate funding mechanism for defence and internal security should be set up, and if so, how it can be operationalised.

In 2019-20, the central government has estimated Rs 5,11,610 crore of expenditure on defence and internal security (18% of its budget). If the 14th Finance Commission had recommended the funding of this entire expenditure out of the divisible pool, devolution to states would have been lower by 7% of their 2019-20 revenue. Note that the 15th Finance Commission has not yet made any recommendation in this regard.

States cutting their capital outlays: States face a shortfall in their receipts (9% during the 2015- 18 period), due to which they cut back their budgeted expenditure (as borrowing is also limited).

Capital outlay by states sees higher underspending (14%) as compared to revenue expenditure (7%). Note that states’ share in governmental capital outlay is significantly higher than the centre. In 2019-20, capital outlay by states on aggregate is estimated to be 2.8% of GDP (Rs 5.7 lakh crore), much higher than that by the centre (1.8% of GDP or Rs 3.8 lakh crore).

States increasingly adopting Income Support Schemes: Between 2018-19 and 2019-20, six states have announced income support schemes which involve direct cash transfer to targeted beneficiaries. While most of these schemes are targeted towards farmers, certain schemes also cover other sectors such as education, social welfare, and transport (page 6).

Farm loan waivers have increased debt burden: Farm distress has led to declaration of farm loan waivers by 10 states, amounting to Rs 2,63,260 crore. The loan waivers have increased debt burden on these states. States are implementing them over several years to limit the impact on fiscal deficit. As of 2019-20, Rs 1,08,843 crore is still to be disbursed for the waivers (page 7).

Taking over discoms’ losses under UDAY may impact states: Under UDAY, 15 states took over debt of about Rs 2.1 lakh crore from their discoms in 2015-17. UDAY also requires states to progressively fund greater share in losses of discoms (10% in 2018-19, 25% in 2019-20, and 50% in 2020-21). If discoms are not able to cut their losses, it could significantly impact states in the near future (page 8).