Why Some Indian States Are Facing Temporary Cash Flow Mismatches

Is this a reflection of states managing their finances poorly? Maybe not.

Two thousand rupee banknotes are arranged for a photograph. (Photographer: Dhiraj Singh/Bloomberg News)
Two thousand rupee banknotes are arranged for a photograph. (Photographer: Dhiraj Singh/Bloomberg News)

Recent meetings of the GST Council have seen some states complaining about a shortfall in revenues. Some of these states have also indicated that they will borrow more from the market in the first three months of the financial year.

Is this a reflection of states managing their finances poorly? Maybe not. The blame, in this case, may lie more with the centre than the states. A change in the timeline for transferring the states’ share of direct taxes and the transition to the Goods and Services Tax appears to be at the centre of the short-term cash flow mismatches being faced by some states.

GST Woes

One part of the problem emerges from the new indirect tax system.

As per the GST agreement, states will be compensated for any revenue lost on account of items subsumed under GST for a period of five years. That compensation was to build in an expected increase of 14 percent in collections over a base year of 2015-16. Some states are reporting a shortfall of about 30-40 percent compared to this expected revenue, three government officials told BloombergQuint on condition of anonymity.

The problem seems to stem from the timeline of compensation.

States are compensated for the revenue loss once every two months. The compensation is received in the second or third week of the following month. For example, revenue losses incurred in March and April would be compensated for in the second or third week of May. During this period, states tend to see a shortfall, because of which they have to borrow money from the market to meet their expenses, explained two of the officials quoted above.

“The lag associated with the bi-monthly release of GST compensation may be partly contributing to the cash flow mismatches of state governments,” Aditi Nayar, economist at rating agency ICRA told BloombergQuint.

States facing a shortfall in revenue include:

  • Punjab
  • Chandigarh
  • Chhattisgarh
  • Bihar
  • Puducherry
  • Jammu and Kashmir
  • Uttarakhand
  • Himachal Pradesh

West Bengal seems to have a similar grouse.

“I also want to highlight the non-payment of fund release by the Centre. West Bengal has not received Rs 9,958 crores. We are forced to borrow from the market to keep our basic government initiatives running,” said West Bengal Amit Mitra in a statement on Monday. The comment was made in the context of terms of reference set for the 15th Finance Commission, which could limit the borrowing abilities of individual states.

The issue of cash flow mismatches was discussed at the last GST Council meeting held on May 4, the officials quoted above confirmed. States have been asked to come up with ways to boost their revenues and plug leakages in the current system, said one of the officials quoted above.

Another problem is the flow of states’ share in the integrated goods and services tax (IGST). States only get their due share of this tax kitty at the end of every month even though the tax collection happens sooner. For instance, IGST collected on imports, which constitutes a major chunk of tax collected under this head, is realized on the same day goods are imported. However, states get a share of this only by month end.

“This is a transitory issue and expected buoyancy in revenue would help in resolving it in future,” NR Bhanumurthy, a professor at National Institute of Public Finance and Policy told BloombergQuint.

Devolution Of Direct Taxes

To add to the states’ troubles, the center has made some changes to the timeline over which central taxes are shared with the states.

Earlier, the government used to transfer one-fourteenth of the budgeted central taxes to states on the first day of every month. Final adjustments were made in the last quarter.

This pattern has undergone a change in FY2019. It appears that starting April 2018, the states’ share of direct taxes is only being transferred once every quarter, Nayar had told BloombergQuint in an earlier.

The two factors taken together appear to be the reason for higher borrowings indicated by states in the April-June quarter, said ICRA in a note on Monday.

The increase in planned borrowings of the states is likely to be a consequence of the change in the states’ assessment of their cash flows, related to the modification in the timing of devolution of Central taxes from FY2019 onwards.
ICRA Report

Bhanumurthy of NIPFP adds that the borrowing burden has simply shifted from center to the state. “The central government was borrowing from the market, and used to fund states for their deficit. Now, the burden has been shifted from the centre to the states.”