GS-2:Functions and responsibilities of the Union and the States; issues and challenges pertaining to the federal structure, devolution of powers and finances and challenges therein

GS-3:Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment; Government Budgeting; Infrastructure: Energy, Ports, Roads, Airports, Railways etc.

Keywords: Capital Expenditure, Multiplier effect, Frontloading, economic growth, fiscal federalism, State’s balance sheet.

Why in News?

To bring about a behavioural change among States and get them to spend on capex throughout the year, the Finance Ministry recently fixed quarterly targets and incentivised those that achieved it to borrow more. 

Keypoints:

States in general spend more on Capital expenditure, but they traditionally do so in a manner that is not entirely efficient.

• The money is not uniformly spent through the year but is bunched up and spent in the last quarter of the fiscal.
• This is because Capex is a discretionary expenditure unlike salaries, pension and subsidies which have to be necessarily spent.
• Unsure of the revenue flow States prioritise revenue expenditure and asset creation happens towards the end of the fiscal. 

In this light Finance Ministry, recently fixed quarterly targets for States and incentivised those that achieved it to borrow more:

• In the first quarter the States were supposed to spend 15 per cent of the budgeted capex.
• By Q2 the spend is 45 per cent,
• 70 per cent by Q3 and
• 100 per cent by Q4.

Need for such a move:

• Capital expenditure has the maximum multiplier effect, something the economy needs to accelerate its pace of growth. 
  • According to a study by the National Institute of Public Finance and Policy, every rupee spent as a revenue expenditure has a multiplier effect of ₹0.98.
  • At the same time a rupee of capex delivers a multiplier effect of ₹2.25 in the year it is incurred and it is ₹4.80 during the course of the entire expenditure.
• Apart from the higher multiplier effect, government capex catalyses private investment, increases production capacity thereby speeding up economic growth which in turn creates a lot more jobs.
• The States cumulatively spend more on capex than the Centre.
  • In FY21, they spent ₹4.46 lakh crore while the Centre’s spend was ₹4.12 lakh crore.
  • States spending more on capex helps as it has better multiplier effect than by the Centre, as Centre’s capex includes defence capital spending (roughly about ₹1 lakh crore) which predominantly consists of imports which provide little impetus to the Indian economy.

Issues/Concerns:

• In Q1 FY22, Only 11 States achieved the target set by the Finance Ministry and they qualified for additional borrowings.
  • Most of the high GDP States like Maharashtra, Tamil Nadu, Gujarat and Rajasthan failed to meet the target.
  • In Q2, even fewer States, only 7, met the target (of spending 40 per cent of Budgeted capex)
• Many states argued that such a move is an impingement on fiscal federalism. The States had the right to spend the money they get from devolution the way they want. 
• Uncertainties in revenue generation in wake of Pandemic: Even though GST collections have risen sharply, it is not clear if it is due to pent-up demand or a sustained recovery.
• Also, it is too early to say if the Coronavirus has been vanquished. A new Omicron variant has again created fears of economic disruptions.
• For many States the additional borrowing is not an incentive. They are already heavily leveraged and would not want to add to the debt. They have no incentive to front-load capex given the uncertainties.
• Issues with State’s Balance Sheets: Tamil Nadu, Andhra Pradesh, Sikkim and Manipur, have negative cash balance as of end-October. Front-loading of devolution will certainly help ease their cash flow but it is unclear if they will use it on capex or prefer to clear their pending revenue expenses.
• It needs to be ensured that focus is on the quality of capex. Spending on roads, power plants, ports and airports generate better multiplier effect than investing in buildings. 
  Related Scheme: National Infrastructure Pipeline
• NIP has outlined plans to invest more than ₹102 lakh crore on infrastructure projects by 2024-25
• Infrastructure projects under NIP will receive an equal share of contribution in terms of capital expenditure from the Centre and States of 39% each while Private Sector share being 22%.
• Roads, Urban and Housing, Railways, Power (Conventional and Unconventional) and Irrigation will receive the most from NIP amounting to almost 80% of the funds.

Conclusion:

• An attempt to bring about a behavioural change on how capex is spent is a welcome move. The policy may meet with limited success in short term due to the pandemic and the uncertainties it has created in terms of revenue visibility. But better results will come as the economy recovers.
• These changes are necessary if India has to escape its current moderate pace of economic expansion and post strong double digit GDP growth in a sustained manner in the future.

Source: The Hindu BL

Prelims Question:

Q. Consider the following statements with respect to Capital Expenditure:

1. It is the expenditure incurred by the government on operational expenses.
2. Capital Expenditure by States combined is more than that by Union.

Which of the statement/s given above is/are correct?

A.Only 1

B.Only 2

C.Both 1 and 2

D.Neither 1 or 2

Ans:B

Mains Question:

Q. To sustain the economic recovery post the Covid pandemic, there is a need to focus on capital expenditure, especially by states. Examine.