Finance

Cost of GST compensation

Later this week, the GST Council will meet to discuss the issue of GST compensation to states.  The central government is required to compensate states for any loss of revenue they incur due to GST.  The Centre must pay this compensation on a bi-monthly basis, but over the past one year these payments have been delayed by several months due to lack of funds.  The COVID-19 pandemic and the consequent lockdown have amplified the issue manifold, with both centre and states facing a revenue shortfall, limiting the ability of the Centre to meet states’ compensation needs.

Why is the Centre required to compensate states for GST?

With GST implementation in 2017, the principle of indirect taxation for many goods and services changed from origin-based to destination-based.  This means that the ability to tax goods and services and raise revenue shifted from origin states (where the good or service is produced) to destination states (where it is consumed).  This change posed a risk of revenue uncertainty for some states.  This concern of states was addressed through constitutional amendments, requiring Parliament to make a law to provide for compensation to states for five years to avoid any revenue loss due to GST.

For this purpose, the GST (Compensation to States) Act was enacted in 2017 on the recommendation of the GST Council.  The Act guarantees all states an annual growth rate of 14% in their GST revenue during the period July 2017-June 2022.   If a state’s GST revenue grows slower than 14%, such ‘loss of revenue’ will be taken care of by the Centre by providing GST compensation grants to the state.  To provide these grants, the Centre levies a GST compensation cess on certain luxury and sin goods such as cigarettes and tobacco products, pan masala, caffeinated beverages, coal, and certain passenger vehicles.  The Act requires the Centre to credit this cess revenue into a separate Compensation Fund and all compensation grants to states are required to be paid out of the money available in this Fund.

How much compensation is provided to states?

For 2018-19, Centre gave Rs 81,141 crore to states as GST compensation.  However, for the year 2019-20, the compensation requirement of states nearly doubled to Rs 1.65 lakh crore.  A huge increase in requirement implies that states’ GST revenue grew at a slower rate during 2019-20.   This can be attributed to the economic slowdown seen last year, which resulted in a nominal GDP growth of 7.2%.   This was significantly lower than the 12% GDP growth forecast in the 2019-20 union budget (Figure 1).

Figure 1:  GDP growth rate (2017-21)

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Sources:  Union Budget Documents; MOSPI; PRS.

In 2019-20, the gross GST revenue (Centre+states) increased by just 4% over the previous year.  Despite this, due to the compensation guarantee, all states could achieve the growth rate of 14% in their GST revenue – much higher than the overall growth in GST revenue.  However, there was a delay in payment of compensation from Centre.   More than Rs 64,000 crore of the compensation requirement of states for 2019-20 was met in the financial year 2020-21.

What led to a delay in payment of compensation to states?

In 2019-20, the delay in payment was observed due to insufficient funds with Centre for providing compensation to states.  These funds are raised by levying a compensation cess on the sale of certain goods, some of which were affected by the economic slowdown.  For instance, in 2019-20, sales of passenger vehicles declined by almost 18% and coal offtake from domestic coal companies reduced by nearly 5%, over the previous year.  As a result, cess collections registered a growth of just 0.4% in 2019-20 (Figure 2), against the 104% increase seen in the compensation requirement of states.  This resulted in a shortfall of funds of nearly Rs 70,000 crore.

Figure 2:  Cess collections insufficient for providing compensation

image

 

 

 

 

 

 

 

 

Note:  In 2017-18, GST was implemented for only nine months.  Compensation amount shown may not match with the amount released in that financial year because of delay in releases.

Sources:  Union Budget Documents; Ministry of Finance; GST Council; Lok Sabha Questions; PRS.

How can compensation be paid to states if cess collections are insufficient?

The shortfall in collections for 2019-20 was met through: (i) surplus cess collections from previous years, (ii) partial cess collections of 2020-21, and (iii) a transfer of Rs 33,412 crore of unsettled GST funds from the Centre to the Compensation Fund.   These unsettled funds are GST collections, generated in 2017-18 from inter-state and foreign trade, that have not yet been settled between centre and states.

In the 2020-21 budget, the Centre has estimated a 10% growth in nominal GDP.  However, due to the impact of COVID-19 and the lockdown, the actual growth in 2020-21 is likely to be much lower.  In such a scenario, states’ GST revenue would also be much lower than expected, thus leading to a higher compensation requirement.  However, the ability of Centre to pay compensation depends on the cess collections, which are also getting impacted this year.  For instance, cess collections during the period Apr-Jun 2020 have been 41% lower in comparison to the same period last year.  Moreover, of the Rs 14,482 crore collections made during this period, Rs 8,680 crore has been likely used up for paying compensation for 2019-20.

Note that under the GST (Compensation to States) Act, 2017, Centre can provide compensation to states only through the money available in the Compensation Fund.   The Union Finance Minister, in her budget speech in February 2020, clarified that transfers to the Fund would be limited only to collections of the GST compensation cess.  Despite a shortfall of money in the Compensation Fund, the Centre is constitutionally obligated to meet states’ compensation requirement for a period of five years.

Various measures have been suggested to address the issue of shortfall in the Fund, either by reducing the compensation payable to states (which would require Parliament to amend the Act following GST Council’s recommendation) or by supplementing the funds available with Centre for providing compensation to states.   The Act allows the GST Council to recommend other funding mechanisms/ amounts for credit into the Compensation Fund.  For example, one of the measures proposed for meeting the shortfall involves Centre using market borrowings to pay compensation to states, with the idea that these borrowings will be repaid with the help of future cess collections.  To enable this, the GST Council may recommend to Centre that the compensation cess be levied for a period beyond five years, i.e. post June 2022.

Impact on states post 2022

In 2019-20, except for a few north-eastern states, most states saw their compensation requirements increase multifold by 2-3 times, over the previous year’s figures.  Table 1 shows the compensation requirement of states for the years 2018-19 and 2019-20.  Six states (Delhi, Gujarat, Karnataka, Maharashtra, Punjab, and Tamil Nadu) accounted for 52% of the total requirement of compensation for 2019-20.  Further, in some states such as Punjab and Delhi, compensation grants form a significant share of the overall revenue receipts (20% and 16% resepctively).  

Note that states have been guaranteed compensation only for a period of five years.  After June 2022, states dependent on compensation will observe a revenue gap due to a cut in these grants coming from Centre.  States have roughly two years to bridge this gap with other tax and non-tax sources to avoid a potential loss of revenue, and a consequent fall in the size of their state budget, which could adversely affect the economy.  To what extent will such concerns be alleviated remains to be seen based on the course of action decided by the GST Council.

Table 1:  GST compensation requirement of states for 2018-19 and 2019-20 (in Rs crore)

State

2018-19

2019-20

% increase in compensation requirement

Amount

As a % of revenue

Amount

As a % of revenue*

Andhra Pradesh

0

-

3,028

3%

-

Assam

455

1%

1,284

1%

182%

Bihar

2,798

2%

5,464

4%

95%

Chhattisgarh

2,592

4%

4,521

7%

74%

Delhi

5,185

12%

8,424

16%

62%

Goa

502

5%

1,093

9%

118%

Gujarat

7,227

5%

14,801

10%

105%

Haryana

3,916

6%

6,617

10%

69%

Himachal Pradesh

1,935

6%

2,477

8%

28%

Jammu and Kashmir

1,667

3%

3,281

5%

97%

Jharkhand

1,098

2%

2,219

4%

102%

Karnataka

12,465

8%

18,628

11%

49%

Kerala

3,532

4%

8,111

9%

130%

Madhya Pradesh

3,302

3%

6,538

4%

98%

Maharashtra

9,363

3%

19,233

7%

105%

Meghalaya

66

1%

157

2%

138%

Odisha

3,785

4%

5,122

5%

35%

Punjab

8,239

13%

12,187

20%

48%

Rajasthan

2,280

2%

6,710

5%

194%

Tamil Nadu

4,824

3%

12,305

7%

155%

Telangana

0

-

3,054

3%

-

Tripura

172

1%

293

3%

70%

Uttar Pradesh

0

-

9,123

3%

-

Uttarakhand

2,442

8%

3,375

11%

38%

West Bengal

2,615

2%

6,200

4%

137%

Note:   Arunachal Pradesh, Manipur, Mizoram, Nagaland, and Sikkim did not require any compensation in 2018-19 and 2019-20.

*Revenue for the year 2019-20 does not takes into account those GST compensation grants which were payable to states in 2019-20 but were released by Centre in the year 2020-21. The percentage figures would be slightly lower if such grants are included in 2019-20 revenue.

Sources:  State Budget Documents; Ministry of Finance; Lok Sabha Questions; CAG; PRS.

Impact of Lockdown on Government Revenue

To mitigate the spread of coronavirus in India, the central government imposed a nation-wide lockdown on March 25, 2020.  The lockdown necessitated the suspension of all economic activities, except the ones classified as ‘essential’ from time to time, and the ones that can be carried out from home.  As a result, all economic activities which require persons to travel or work outside home, such as manufacturing of non-essential goods and construction, have stopped since then.  While this has resulted in a loss of income for many individuals and businesses, the ongoing 40-day lockdown is also going to severely impact the revenue of the central and state governments, primarily the tax revenue that they would have generated from all such economic activities.  

This note discusses the possible effect of the lockdown on the revenue of the central and state governments in 2020-21.  At this stage, the effect of the pandemic and the lockdown are difficult to estimate.  We do not know whether there will be partial restrictions when the current lockdown ends on 3rd May or the possibility of further action during the year.  Therefore, this note can be used as a first estimate to compute the impact under various scenarios.  For example, a reader who believes that the effect on GDP growth would be different than the IMF’s estimate used below can extrapolate the numbers to fit his assumptions.

The central government and most of the state governments passed their budget for the financial year 2020-21 during February-March 2020, before the lockdown.  The central government estimated a 10% growth in the country’s nominal GDP in 2020-21, and more than half of the states estimate their nominal GSDP growth rate in the range of 8%-13%.  Due to the unforeseen impact of the lockdown on the economy, the 2020-21 GDP growth rates are expected to be lower than these estimates.  As a result, the tax revenue that the central and state governments will be able to generate are expected to be much lower than the budgeted estimates, during the period of lockdown.

Centre’s revenue

Table 1 shows the revenue expected by the central government from various sources in 2020-21.  73% of the revenue (Rs 16.36 lakh crore) is expected to come through taxes.   Because of the impact of lockdown, the actual tax revenue realised at the end of the year could be much lower, depending on how much the nominal GDP growth in 2020-21 gets affected.  To estimate the impact on tax revenue, we assume that the tax-GDP ratio (i.e. an estimate of the tax generated out of each unit of economic activity) in 2020-21 will remain the same as the budget estimate.   This may be a conservative estimate of loss of revenue due to lockdown as many permitted activities such as agriculture, government services and essential services have zero or lower-than-average taxes.

Based on this assumption, a 1%-point fall in the nominal GDP growth rate could decrease centre’s net tax revenue by about Rs 15,000 crore in 2020-21, i.e. 0.7% of its total revenue.  The IMF has projected GDP growth for 2020-21 at 1.9%; given the inflation target of 4%, nominal GDP growth could be about 6%.  In that scenario where the nominal GDP growth falls by 4% point from 10% to 6% in 2020-21, net tax revenue loss could be about Rs 60,000 crore (2.7% of total revenue).  As mentioned above, the tax-GDP ratio would likely be lower than the budget estimate because of the type of activities permitted during the lockdown.   This would increase the adverse impact on tax revenue.

There is a further assumption being made above regarding tax-GDP.  While GST tends to move with overall GDP, direct taxes would depend on income growth of individuals and profit growth of companies.  In a lower GDP growth environment, the effect on these two items may be higher than the deceleration of nominal GDP, bringing down the tax-GDP ratio.  Further, customs duties depend on the value of imports, which may have a lower growth.   This would, to some extent, be mitigated by the increase in the rate of excise duty on petroleum products.

These computations have been made considering the 2019-20 revised estimate as the base and the 2020-21 budget estimate as being realistic when it was made.  However, these numbers may also be lower.  For instance, if we extrapolate the net tax revenue growth rate of April 2019 to February 2020 (as released by the Controller General of Accounts) to March 2020, the shortfall is of the order of Rs 1,62,000 crore or 11% of the revised estimate.  Thus, the shortfall in tax collections in 2020-21 may be significantly higher.

Table 1:  Central government's revenue in 2020-21 (Rs crore)

Source

Revenue

Share in Total Revenue

Net Tax Revenue

16,35,909

73%

Non-Tax Revenue

3,85,017

17%

Dividends and Profits

1,55,395

6.9%

Capital Receipts

2,24,967

10%

Disinvestment

2,10,000

9.4%

Total Revenue

22,45,893

-

Note:   Capital receipts and total revenue do not include borrowings.
Sources:  Union Budget Documents; PRS.

Other than taxes, the centre’s receipts consist of non-tax revenue and capital receipts.  A significant part of non-tax revenue is from dividends and profits of public sector enterprises (PSEs) and the RBI (Rs 1.55 lakh crore).  If profitability gets impacted, then there could be an adverse impact in these figures.  The major chunk of capital receipts is budgeted from disinvestment of PSEs (Rs 2.1 lakh crore).  Equity markets have declined sharply over the last month.  If equity markets remain volatile, the disinvestment process and consequently the disinvestment receipts could get affected.  Note that disinvestment receipts were targeted at Rs 2,10,000 crore, significantly higher than the Rs 50,299 crore raised in 2019-20.

Devolution to States

Like the centre, states also rely on taxes for most of their revenue.  As per their 2020-21 budget, on an average, nearly 70% of their revenue is estimated to come from taxes (45% from their own taxes and 25% from their share of centre’s taxes).  Lower collections in centre’s taxes because of the lockdown will also impact states’ share in them (also known as devolution).  Table 2 shows the share of states in centre’s tax revenue and how they could get impacted by a lower economic growth rate due to the lockdown.

Table 2:  Impact of lower economic growth during the lockdown on devolution in 2020-21 (Rs crore)

State/ UT

Share in divisible pool (%)

Devolution

Impact of 1% point drop in national nominal GDP growth rate on Devolution

Revenue impact as a percentage of state’s revenue receipts

Andhra Pradesh

4.11

32,238*

293

NA

Arunachal Pradesh

1.76

13,802

125

0.61%

Assam

3.13

26,776

243

0.26%

Bihar

10.06

91,181

829

0.45%

Chhattisgarh

3.42

26,803

244

0.29%

Delhi

-

-

-

-

Goa

0.39

3,027

28

0.21%

Gujarat

3.4

26,646

242

0.15%

Haryana

1.08

8,485

77

0.09%

Himachal Pradesh

0.8

6,266

57

0.15%

Jammu and Kashmir

-

15,200

138

0.16%

Jharkhand

3.31

25,980

236

0.31%

Karnataka

3.65

28,591

260

0.14%

Kerala

1.94

20,935

190

0.17%

Madhya Pradesh

7.89

61,841* 

562

NA

Maharashtra

6.14

48,109

437

0.13%

Manipur

0.72

5,630

51

0.28%

Meghalaya

0.77

5,999*

55

NA

Mizoram

0.51

3,968

36

0.37%

Nagaland

0.57

4,493

41

0.28%

Odisha

4.63

36,300

330

0.27%

Punjab

1.79

14,021

127

0.14%

Rajasthan

5.98

46,886

426

0.25%

Sikkim

0.39

3,043

28

0.35%

Tamil Nadu

4.19

32,849

299

0.14%

Telangana

2.13

16,727

152

0.11%

Tripura

0.71

5,560

51

0.30%

Uttar Pradesh

17.93

1,52,863

1,389

0.33%

Uttarakhand

1.1

8,657

79

0.19%

West Bengal

7.52

65,835

598

0.33%

Total 

100

8,38,710

7,624

0.22%

Note:  *Andhra Pradesh, Madhya Pradesh, and Meghalaya passed a vote on account, so their devolution data has been computed as the total devolution to states provided in the union budget multiplied by their share.  The devolution data for all other states has been taken from the state budget documents, which may not match with the union budget data in case of a few states.  Revenue receipts data not available for Andhra Pradesh, Madhya Pradesh, and Meghalaya.   The total for revenue receipt share has been computed excluding these three states.
Sources:  Union and State Budget Documents; 15th Finance Commission Report for 2020-21; PRS.

State GST

Out of the 45% revenue coming from state’s own taxes, 35% revenue is estimated to come from three taxes – state GST (19%), sales tax/ VAT (10%), and state excise (6%).  State GST is levied on the consumption of most goods and services within the state.  While state GST is the largest component of states’ own tax revenue, states do not have the autonomy to change tax rates on their own as the rates are decided by the GST Council.  Thus, due to lower GST revenue during the lockdown period, if a state wishes to increase GST rates for the remaining part of the year, it cannot do this on its own.

Table 3 shows the possible impact of a 1%-point decrease in the growth rates of nominal GSDP (GDP of the state) and its impact on state GST revenue in the year 2020-21.  These estimates are based on the assumption that the tax-GSDP ratio during the lockdown remains same as estimated for the 2020-21 budget.  However, as discussed earlier, the tax-GDP ratio for taxes such as GST is likely to decline.  The analysis estimates the minimum impact on states’ GST revenue and does not captures its full extent.

 Table 3:  Impact of lower GSDP growth during the lockdown on state GST revenue in 2020-21 (Rs crore) 

State/ UT

State GST revenue

Impact of 1% point drop in nominal GSDP growth rate on State GST revenue

Revenue impact as a percentage of state’s revenue receipts

Andhra Pradesh

NA 

NA

NA

Arunachal Pradesh

324

3

0.01%

Assam

13,935

128

0.14%

Bihar

20,800

187

0.10%

Chhattisgarh

10,701

97

0.12%

Delhi

23,800

215

0.39%

Goa

2,772

26

0.19%

Gujarat

33,050

292

0.18%

Haryana

22,350

198

0.22%

Himachal Pradesh

3,855

35

0.09%

Jammu and Kashmir

6,065

55

0.06%

Jharkhand

9,450

85

0.11%

Karnataka

47,319

445

0.25%

Kerala

32,388

289

0.25%

Madhya Pradesh

 NA

NA

NA

Maharashtra

1,07,146

957

0.28%

Manipur

914

8

0.05%

Meghalaya

NA

NA

NA

Mizoram

504

4

0.04%

Nagaland

541

5

0.04%

Odisha

15,469

139

0.11%

Punjab

15,859

141

0.16%

Rajasthan

28,250

255

0.15%

Sikkim

650

5

0.07%

Tamil Nadu

46,196

410

0.19%

Telangana

27,600

242

0.17%

Tripura

1,311

12

0.07%

Uttar Pradesh

55,673

525

0.12%

Uttarakhand

5,386

49

0.12%

West Bengal

33,153

298

0.17%

Total 

5,65,461

5,104

0.17%

Note:  Andhra Pradesh, Madhya Pradesh, and Meghalaya passed a vote on account, so data not available.  2020-21 GSDP data for Delhi was not available, so the GSDP growth rate in 2020-21 has been assumed to be the same as the growth rate in 2019-20 (10.5%).
Sources:  State Budget Documents; PRS.

Sales tax/ VAT and State Excise

These two taxes have been major sources of revenue for states, estimated to contribute 16% of states’ revenue in 2020-21.  With implementation of GST, states can now levy sales tax only on petroleum products (petrol, diesel, crude oil, natural gas, and aviation turbine fuel) and alcohol for human consumption.  However, the lockdown has severely impacted the consumption, and thus sale, of all of these goods as most of the transportation is prohibited and businesses selling alcohol are also shut.  As a result, the revenue coming from these taxes is likely to see a much larger impact as compared to the other taxes. 

In addition, alcohol is also subject to state excise.   Table 4 shows the average monthly impact of the lockdown on revenue from state excise.  That is, this estimates the loss of revenue for each month of lockdown, with the assumption that there is no production of alcohol for human consumption during such periods.

Table 4:  Average monthly impact of the lockdown on state excise revenue in 2020-21 (Rs crore)

State/ UT

State excise revenue

Average monthly impact on state excise revenue

Monthly revenue impact as a percentage of state’s revenue receipts

Andhra Pradesh

NA 

NA

NA

Arunachal Pradesh

157

13

0.06%

Assam

1,750

146

0.16%

Bihar

0

0

0.00%

Chhattisgarh

5,200

433

0.52%

Delhi

6,300

525

0.95%

Goa

548

46

0.34%

Gujarat

144

12

0.01%

Haryana

7,500

625

0.69%

Himachal Pradesh

1,788

149

0.39%

Jammu and Kashmir

1,450

121

0.14%

Jharkhand

2,301

192

0.25%

Karnataka

22,700

1,892

1.05%

Kerala

2,801

233

0.20%

Madhya Pradesh

 NA

NA

NA

Maharashtra

19,225

1,602

0.46%

Manipur

15

1

0.01%

Meghalaya

NA

NA

NA

Mizoram

1

0

0.00%

Nagaland

6

0

0.00%

Odisha

5,250

438

0.35%

Punjab

6,250

521

0.59%

Rajasthan

12,500

1,042

0.60%

Sikkim

248

21

0.26%

Tamil Nadu

8,134

678

0.31%

Telangana

16,000

1,333

0.93%

Tripura

266

22

0.13%

Uttar Pradesh

37,500

3,125

0.74%

Uttarakhand

3,400

283

0.67%

West Bengal

12,732

1,061

0.59%

Total 

1,74,164

14,514

0.48%

Note:  Andhra Pradesh, Madhya Pradesh, and Meghalaya passed a vote on account, so data not available.
Sources:  State Budget Documents; PRS.

Sales tax/VAT is collected from sale of alcohol and petroleum products.  We do not have any data on the reduction of sale of these items -- news reports indicating sale of alcohol in some states while petroleum products would be used by providers of essential services.  For estimating the impact on sales tax/ VAT revenue, we have assumed the following three scenarios: (i) 40% shortfall in tax collections, (ii) 60% shortfall in tax collections, and (iii) 80% shortfall in tax collections in any month of lockdown.   Table 5 shows the average monthly impact of the lockdown on sales tax/ VAT revenue under the three scenarios.  

Table 5:  Impact of lockdown on sales tax/ VAT revenue in 2020-21 (Rs crore)

State/ UT

Loss of sales tax/ VAT revenue per lockdown month

As a percentage of state’s revenue receipts

40% shortfall

60% shortfall

80% shortfall

40% shortfall

60% shortfall

80% shortfall

Andhra Pradesh

NA

NA

NA

NA

NA

NA

Arunachal Pradesh

9

14

18

0.04%

0.07%

0.09%

Assam

178

267

356

0.19%

0.29%

0.39%

Bihar

194

292

389

0.11%

0.16%

0.21%

Chhattisgarh

138

207

276

0.16%

0.25%

0.33%

Delhi

207

310

413

0.37%

0.56%

0.75%

Goa

41

62

83

0.31%

0.47%

0.62%

Gujarat

774

1,162

1,549

0.48%

0.72%

0.95%

Haryana

357

535

713

0.40%

0.59%

0.79%

Himachal Pradesh

56

84

112

0.15%

0.22%

0.29%

Jammu and Kashmir

50

75

100

0.06%

0.09%

0.11%

Jharkhand

195

293

391

0.26%

0.39%

0.52%

Karnataka

593

889

1,186

0.33%

0.49%

0.66%

Kerala

775

1,163

1,551

0.68%

1.01%

1.35%

Madhya Pradesh

NA

NA

NA

NA

NA

NA

Maharashtra

1,333

2,000

2,667

0.38%

0.58%

0.77%

Manipur

9

14

18

0.05%

0.08%

0.10%

Meghalaya

NA

NA

NA

NA

NA

NA

Mizoram

3

4

5

0.03%

0.04%

0.06%

Nagaland

9

13

18

0.06%

0.09%

0.12%

Odisha

292

438

583

0.23%

0.35%

0.47%

Punjab

186

279

372

0.21%

0.32%

0.42%

Rajasthan

700

1,050

1,400

0.40%

0.61%

0.81%

Sikkim

7

11

15

0.09%

0.14%

0.18%

Tamil Nadu

1,868

2,802

3,736

0.85%

1.28%

1.70%

Telangana

880

1,320

1,760

0.61%

0.92%

1.23%

Tripura

15

22

30

0.09%

0.13%

0.17%

Uttar Pradesh

943

1,414

1,886

0.22%

0.33%

0.45%

Uttarakhand

66

98

131

0.15%

0.23%

0.31%

West Bengal

251

377

503

0.14%

0.21%

0.28%

Total 

10,130

15,195

20,260

0.34%

0.51%

0.67%

Note:   Andhra Pradesh, Madhya Pradesh, and Meghalaya passed a vote on account, so data not available.
Sources:  State Budget Documents; PRS.

How much can GST compensation help?

The shortfall in state GST revenue could get offset by the GST compensation provided to states by the central government.   The GST (Compensation to States) Act, 2017, requires the central government to provide compensation to states for loss of revenue arising due to GST implementation until 2022.  For this purpose, the Act guarantees a 14% annual growth rate in state GST revenue, which is much higher than the growth likely in the year 2020-21.  As a result, the central government would be required to provide states a compensation equivalent to the shortfall in growth in their state GST revenue, in comparison to the 14% growth.

However, it is likely that there may not be sufficient funds to provide compensation to states in 2020-21.  Compensation to states is given out of the GST Compensation Fund, which consists of collections of a cess levied specifically to generate funds for this purpose.  The cess is levied on coal, tobacco and its products, pan masala, automobiles, and aerated drinks.  The cess collections may see a shortfall as the sale of many of these goods is likely to be affected this year.  Note that domestic automobile sales declined 18% in 2019-20 over the previous year while coal production stayed constant.

In the 2020-21 budget, the central government estimated to provide Rs 1,35,368 crore as compensation to states, which is close to the total compensation estimated by states in their budgets.  However, due to the lockdown, the cess collections financing these grants are estimated to decrease, whereas the compensation requirement of states is estimated to increase due to lower GST collections.   While there is a risk that any incremental requirement may not be met, states’ revenue can see a much larger impact if cess collections are not even sufficient to meet their existing amounts as per the 2020-21 budgets (Table 6).  States, on an average, depend on GST compensation grants for 4.4% of their revenue in 2020-21.  However, states such as Gujarat, Punjab, and Delhi expect almost 14-15% of their revenue in 2020-21 to come in the form of GST compensation grants.

Table 6:   GST compensation grants estimated by states in 2020-21 (Rs crore)

State/ UT

GST Compensation

GST compensation as a percentage of state’s revenue receipts

Andhra Pradesh

NA 

NA

Arunachal Pradesh

0

0.0%

Assam

1,000

1.1%

Bihar

3,500

1.9%

Chhattisgarh

2,938

3.5%

Delhi

7,800

14.1%

Goa

1,358

10.2%

Gujarat

22,510

13.9%

Haryana

7,000

7.8%

Himachal Pradesh

3,338

8.7%

Jammu and Kashmir

3,177

3.6%

Jharkhand

1,568

2.1%

Karnataka

16,116

9.0%

Kerala

0

0.0%

Madhya Pradesh

 NA

NA

Maharashtra

10,000

2.9%

Manipur

0

0.0%

Meghalaya

NA

NA

Mizoram

0

0.0%

Nagaland

0

0.0%

Odisha

6,200

5.0%

Punjab

12,975

14.7%

Rajasthan

4,800

2.8%

Sikkim

0

0.0%

Tamil Nadu

10,300

4.7%

Telangana

0

0.0%

Tripura

208

1.2%

Uttar Pradesh

7,608

1.8%

Uttarakhand

3,571

8.4%

West Bengal

4,928

2.7%

Total 

1,30,894

4.4%

Note:   Andhra Pradesh, Madhya Pradesh, and Meghalaya passed a vote on account, so data not available.
Sources:  State Budget Documents; PRS.

A similar scenario played out last year when due to the economic slowdown, the cess collections were not sufficient to meet states’ compensation requirements.  As a result, states have received the GST compensation only till November 2019.  Note that the GST (Compensation to States) Act, 2017 provides that the GST Council can recommend other funding mechanisms for the Compensation Fund.  For instance, this can be done when there is a shortfall of money in the Fund for providing compensation to states.

Impact on State Finances

In light of such severe stress on the revenue side, states will have to either cut their budgeted expenditure or increase their borrowings to meet the budget targets.  Note that because of the coronavirus pandemic and the lockdown, states are also making unforeseen expenditure in the health sector and for providing relief from the lockdown.  As a result, many states have already started working on the former by drawing up plans to defer or cut their planned expenditure, or divert funds for planned expenditure towards these immediate requirements.  With relatively less flexibility on the side of revenue expenditure, capital expenditure could see a larger cut in many states.  For instance, revenue expenditure includes expenditure committed towards payment of interest, salaries, and pension.  On average, this committed expenditure uses up 50% of states’ revenue.  However, some states have already gone ahead and deferred or cut the expenditure towards payment of salaries.  Also, with private consumption and investment expected to remain sluggish, reduction of government expenditure could lead to a further decline in GDP.

The other option for states is to increase their borrowings.  However, states’ borrowings are limited by their FRBM laws at 3% of their GSDP (with a further 0.5% of GSDP if they fulfil some conditions).  States also need the consent of the central government to borrow money.  While most states had already budgeted their fiscal deficit for 2020-21 near the upper limit, it seems some states do have some fiscal space to borrow more (Table 7).   However, with GSDP expected to take a hit because of the lockdown, fiscal deficit as a percentage of GSDP for all states could be higher than budgeted targets, even if they do not make any additional borrowings.

Table 7:  Fiscal deficit estimates for 2020-21 as a percentage of GSDP

State/ UT

2019-20 (Revised)

2020-21 (Budgeted)

Andhra Pradesh

NA 

NA

Arunachal Pradesh

3.1%

2.4%

Assam

5.7%

2.3%

Bihar

9.5%

3.0%

Chhattisgarh

6.4%

3.2%

Delhi

-0.1%

0.5%

Goa

4.7%

5.0%

Gujarat

1.6%

1.8%

Haryana

2.8%

2.7%

Himachal Pradesh

6.4%

4.0%

Jammu and Kashmir

NA 

5.0%

Jharkhand

2.3%

2.1%

Karnataka

2.3%

2.6%

Kerala

3.0%

3.0%

Madhya Pradesh

NA 

NA

Maharashtra

2.7%

1.7%

Manipur

8.9%

4.1%

Meghalaya

 NA

 NA

Mizoram

8.3%

1.7%

Nagaland

9.0%

4.8%

Odisha

3.4%

3.0%

Punjab

3.0%

2.9%

Rajasthan

3.2%

3.0%

Sikkim

4.3%

3.0%

Tamil Nadu

3.0%

2.8%

Telangana

2.3%

3.0%

Tripura

6.2%

3.5%

Uttar Pradesh

3.0%

3.0%

Uttarakhand

2.5%

2.6%

West Bengal

2.6%

2.2%

Centre

3.8%

3.5%

Note:   Andhra Pradesh, Madhya Pradesh, and Meghalaya passed a vote on account, so data not available.
Sources:  Union and State Budget Documents; PRS.

Impact of COVID-19 on Railway’s finances

In light of the COVID-19 pandemic, all passenger trains were suspended till April 14, 2020.  However, goods services have been continuing with trains carrying essential commodities to various parts of the country.   Railways has also made railway parcel vans available for quick mass transportation for e-commerce entities and other customers including state governments to transport certain goods.   These include medical supplies, medical equipment, food, etc. in small parcel sizes.  Besides these, Railways has taken several other actions to provide help during the pandemic. 

Since the travel ban extends from March 23 till April 14, 2020 (and may extend further), it will impact Railways’ finances for both 2019-20 and 2020-21.  In this post, we discuss the situation of Railways’ finances, and what could be the potential impact of the travel ban on Railways’ revenues.  

Impact of the travel ban on Railways’ internal revenue

Railways generates internal revenue primarily from passenger and freight traffic.  In 2018-19 (latest actuals), freight and passenger traffic contributed to about 67% and 27% of the internal revenue respectively.  The remaining is earned from other miscellaneous sources such as parcel service, coaching receipts, and sale of platform tickets.  In 2020-21, Railways expects to earn 65% of its internal revenue from freight and 27% from passenger traffic.  

Passenger traffic:   In 2020-21, Railways expects to earn Rs 61,000 crore from passenger traffic, an increase of 9% over the revised estimates of 2019-20 (Rs 56,000 crore).  

As per numbers provided by the Ministry of Railways, up to February 2020, passenger revenue was approximately Rs 48,801 crore.  This is Rs 7,199 crore less than the 2019-20 revised estimates for passenger revenue, implying that this much amount will have to be generated in March 2020 to meet the revised estimate targets (13% of the year’s target).  However, the average passenger revenue in 2019-20 (for the 11 months) has been around Rs 4,432 crore.  Note that in March 2019 passenger revenue was Rs 4,440 crore.  With passenger travel completely banned since March 23, Railways will fall short of its target for passenger revenue in 2019-20.

As of now, it is unclear when travel across the country will resume to business as usual.  Some states have started extending the lockdown within their state.  In such a situation, the decline in passenger revenue could last longer than these three weeks of lockdown. 

Freight traffic:   In 2020-21, Railways expects to earn Rs 1,47,000 crore from goods traffic, an increase of 9% over the revised estimates of 2019-20 (Rs 1,34,733 crore).   

As per numbers provided by the Ministry of Railways, up to February 2020, freight revenue was approximately Rs 1,08,658 crore.  This is Rs 26,075 crore less than the 2019-20 revised estimates for freight revenue.  This implies that Rs 26,075 crore will have to be generated by freight traffic in March 2020 to meet the revised estimate targets (19% of the year’s target).   However, the average freight revenue in 2019-20 (for the 11 months) has been around Rs 10,029 crore.  Note that in March 2019, freight revenue was Rs 16,721 crore.  

While passenger traffic has been completely banned, freight traffic has been moving.  Transportation of essential goods, and operations of Railways for cargo movement, relief and evacuation and their related operational organisations has been allowed under the lockdown.  Several goods carried by Railways (coal, iron-ore, steel, petroleum products, foodgrains, fertilisers) have been declared to be essential goods.  Railways has also started operating special parcel trains (to carry essential goods, e-commerce goods, etc.) since the lockdown.  These activities will help continue the generation of freight revenue. 

However, some goods that Railways transports, such as cement which contributes to about 8% of Railways’ freight revenue, have not been classified as essential goods.  Railways has also relaxed certain charges levied on freight traffic.  It remains to be seen if Railways will be able to meet its targets for freight revenue.  

Figure 1: Share of freight volume and revenue in 2018-19 (in %)

image

Sources: Expenditure Profile, Union Budget 2020-21; PRS.  

Freight has been cross-subsidising passenger traffic; it may worsen this year

Railways ends up using profits from its freight business to provide for such losses in the passenger segment, and also to manage its overall financial situation.  Such cross-subsidisation has resulted in high freight tariffs.  With the ban on passenger travel and if the lockdown (in some form) were to continue, passenger operations will face more losses.  This may increase the cross-subsidy burden on freight.  Since Railways cannot increase freight charges any further, it is unclear how such cross-subsidisation would work. 

For example, in 2017-18, passenger and other coaching services incurred losses of Rs 37,937 crore, whereas freight operations made a profit of Rs 39,956 crore.   Almost 95% of profit earned from freight operations was utilised to compensate for the loss from passenger and other coaching services.  The total passenger revenue during this period was Rs 46,280 crore.  This implies that losses in the passenger business are about 82% of its revenue.  Therefore, in 2017-18, for every one rupee earned in its passenger business, Indian Railways ended up spending Rs 1.82.  

Railways expenditure 

While the travel ban has meant that Railways cannot run all its services, it still has to incur much of its operating expenditure.  Staff wages and pension have to be paid and these together comprise 66% of the Railways’ revenue expenditure.  Between 2015 and 2020 (budget estimate), Railways’ expenditure on salary has grown at an average annual rate of 13%.  

About 18% of the revenue expenditure is on fuel expenses, but that may see some decline due to a fall in oil prices.  Railways will also have to continue spending on maintenance, safety and depreciation as these are long-term costs that cannot be done away with.  In addition, regular maintenance of rail infrastructure will be necessary for freight operations.  

Revenue Surplus and Operating Ratio could further worsen

Railways’ surplus is calculated as the difference between its total internal revenue and its revenue expenditure (this includes working expenses and appropriation to pension and depreciation funds).  Operating Ratio is the ratio of the working expenditure (expenses arising from day-to-day operations of Railways) to the revenue earned from traffic.  Therefore, a higher ratio indicates a poorer ability to generate a surplus that can be used for capital investments such as laying new lines, or deploying more coaches.  A decline in revenue surplus affects Railways’ ability to invest in its infrastructure.  

In the last decade, Railways has struggled to generate a higher surplus.  Consequently, the Operating Ratio has consistently been higher than 90% (see Figure 2).  In 2018-19, the ratio worsened to 97.3% as compared to the estimated ratio of 92.8%.   The CAG (2019) had noted that if advances for 2018-19 were not included in receipts, the operating ratio for 2017-18 would have been 102.66%.

In 2020-21, Railways expects to generate a surplus of Rs 6,500 crore, and maintain the operating ratio at 96.2%.   With revenue generation getting affected due to the lockdown, this surplus may further decline, and the operating ratio may further worsen.  

Figure 2: Operating Ratio 

image

Note: RE – Revised Estimates, BE – Budget Estimates.
Sources:  Expenditure Profile, Union Budget 2020-21; PRS.  

Other sources of revenue

Besides its own internal resources, Railways has two other primary sources of financing: (i) budgetary support from the central government, and (ii) extra-budgetary resources (primarily borrowings but also includes institutional financing, public-private partnerships, and foreign direct investment).  

Budgetary support from central government:  The central government supports Railways to expand its network and invest in capital expenditure.  In 2020-21, the gross budgetary support from the central government is proposed at Rs 70,250 crore.  This is 3% higher than the revised estimates of 2019-20 (Rs 68,105 crore).  Note that with government revenue also getting affected due to the COVID pandemic, this amount may also change during the course of the year. 

Borrowings:  Railways mostly borrows funds through the Indian Railways Finance Corporation (IRFC).  IRFC borrows funds from the market (through taxable and tax-free bond issuances, term loans from banks and financial institutions), and then follows a leasing model to finance the rolling stock assets and project assets of Indian Railways.

In the past few years, Railways’ borrowings have increased sharply to bridge the gap between the available resources and expenditure.  Earlier, majority of the Railways’ capital expenditure used to be met from the budgetary support from central government.  In 2015-16, this trend changed with the majority of Railways’ capital expenditure being met through extra budgetary resources (EBR).   In 2020-21, Rs 83,292 crore is estimated to be raised through EBR, which is marginally higher than the revised estimates of 2019-20 (Rs 83,247 crore).  

Note that both these sources are primarily used to fund Railways’ capital expenditure.  Some part of the support from central government is used to reimburse Railways for the operating losses made on strategic lines, and for the operational cost of e-ticketing to IRCTC (Rs 2,216 crore as per budget estimates of 2020-21).  

If Railways’ revenue receipts decline this year, it may require additional support from the central government to finance its revenue expenditure, or finance it through its borrowings.  However, an increased reliance on borrowings could further exacerbate the financial situation of Railways.  In the last few years, there has been a decline in the growth of both rail-based freight and passenger traffic (see Figure 3) and this has affected Railways’ earnings from its core business.  A decline in growth of revenue will affect the transporter’s ability to pay off its debt in the future. 

Figure 3: Volume growth for freight and passenger (year-on-year)

 

Note: RE – Revised Estimates; BE – Budget Estimates. 
Sources:  Expenditure Profile, Union Budget 2020-21; PRS.  

Social service by Railways

Besides running freight trains, Railways has also been carrying out several other functions, to help deal with the pandemic.  For example, Railways’ manufacturing capacity is being harnessed to help deal with COVID-19.  Production facilities available with Railways are being used to manufacture items like PPE gear.  Railways has also been exploring how to use its existing manufacturing facilities to produce simple beds, medical trolleys, and ventilators.  Railways has also started providing bulk cooked food to needy people at places where IRCTC base kitchens are located.   The transporter also opened up its hospitals for COVID patients.  

As on April 6, 2,500 rail coaches had been converted as isolation coaches.  On average, 375 coaches are being converted in a day, across 133 locations in the country. 

Considering that railways functions as a commercial department under the central government, the question is whether Railways should bear these social costs.  The NITI Aayog (2016) had noted that there is a lack of clarity on the social and commercial objectives of Railways.  It may be argued that such services could be considered as a public good during a pandemic.  However, the question is who should bear the financial burden of providing such services?  Should it be Indian Railways, or should the central or state government provide this amount through an explicit subsidy?  

For details on the number of daily COVID cases in the country and across states, please see here.  For details on the major COVID related notifications released by the centre and the states, please see here.  For a detailed analysis of the Railways’ functioning and finances, please see here, and to understand this year’s Railways budget numbers, see here.