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States Have A Strong Cash Buffer As GST Compensation Period Ends

States' cash balances could provide a temporary buffer as GST compensation ends.

<div class="paragraphs"><p>The Shore temple at Mahabalipuram, Tamil Nadu. (Photo: BQ Prime)</p></div>
The Shore temple at Mahabalipuram, Tamil Nadu. (Photo: BQ Prime)

For five years after the Goods and Services Tax was implemented, states were assured compensation for loss of revenue as state levies were subsumed under the common national tax. A subsequent law mandated a 14% compounded growth in states’ GST revenue every year till 2022.

With that period ending in June, states are facing uncertainty in finances. However, cash balances held by these states could help tide over near-term volatility, economists said, even though longer term concerns persist.

Government cash balances increased to about Rs 3.4 lakh crore for the week ended June 17, 2022, compared to Rs 2.5 lakh crore in the week prior, according to Upasna Bhardwaj, senior economist at Kotak Mahindra Bank. Of this, Rs 2.8 lakh crore is cash balances held by states in the form of investments in short term government securities, she said.

Cash balances with states have ranged between Rs 2.5-3 lakh crore over the past few months, according to estimates by Kotak Mahindra Bank.
States Have A Strong Cash Buffer As GST Compensation Period Ends

The government has been releasing GST compensation to states in tranches. In May, the centre released Rs 86,912 crore as compensation to states, with compensation for June 2022 remaining. This, the government said, would be the last tranche of compensation due to states.

This would mean that an assured source of funds to states will now dry up.

Strong cash balances could help states tide over temporary mismatches, Devendra Pant, chief economist at India Ratings and Research said.

An indication of the relatively comfortable cash position of states comes through in their borrowings.

State development loans, or state government bonds, issued during the April-June 2022 quarter were below the indicated amount, said a research note by ICRA dated June 28, 2022. Eighteen state governments raised Rs 1.1 lakh crore in the first quarter of the fiscal, nearly 42% lower than the indicated Rs 1.9 lakh crore. Borrowings were 23.7% below a year ago, ICRA said.

This, in part, reflects a comfortable cash flow position of the state governments led by a highly back-ended release of the tax devolution to the states in FY22, the rating agency said. To be sure, borrowings also dropped due to a change in approval processes for states, it added.

Which States Have The Strongest Buffers

State governments with a surplus cash balance tend to invest in 14-day treasury bills or auction treasury bills for 91-days, 182-days and 364-days. While state-wise data for investments in 14-day t-bills is not available, the RBI publishes data for state investments in auction treasury bills with a two-month lag.

According to Bhardwaj's assessment:

  • Odisha and Karnataka hold the highest investments in auction treasury bills, indicating a strong cash balance.

  • Among major states, along with Karnataka, Tamil Nadu and Maharashtra are also placed favorably in terms of their cash balances.

  • Fiscally weak states like Punjab, West Bengal, Rajasthan, Kerala, Bihar and Uttar Pradesh could face headwinds in the medium term.

While tax revenues in Bihar, Karnataka, Rajasthan and Punjab tax revenues are buoyant, debt servicing is a concern in the medium term, she said.

Medium Term Uncertainty

While the high cash balances may help in the near-term, medium-term concerns persist.

A cash surplus is only a build-up of state borrowings and does not indicate fiscal health, said Pant. Even for states with significant investments in government securities, it remains to be seen if it will be enough to tide over the tapering of GST compensation, he added.

The impact of GST compensation will be different for different states, depending on what proportion of their revenue comes from GST, said Aditi Nayar, chief economist at ICRA. States with a relatively large share of GST compensation in their revenues, will have to squeeze expenditure or make adjustments to meet the shortfall, she said.

With Punjab's reliance on GST compensation as a share of its revenue, its fiscal position is particularly concerning, Bhardwaj said.

In June, research by the Reserve Bank of India had identified Punjab, Rajasthan, Kerala, West Bengal, Bihar as states with the weakest fiscal health based on the debt-gross state domestic product ratio.

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