Prime Minister Narendra Modi’s plan to increase capital spending to help India regain title as the fastest growing large economy is at risk of being derailed by cash-strapped states, which are cutting capital spending .
The country’s 28 states, which account for around 60% of total government spending on infrastructure and asset creation, are hampered by declining tax revenues and the cost of tackling the Covid-19 pandemic. In addition, unlike the central government, states do not have the flexibility to borrow more to maintain spending, as this would cause the budget deficit to explode.
“While central spending growth has accelerated dramatically over the past three months, states continue to cut spending to keep budgets balanced,” said Samiran Chakraborty, economist at Citigroup Inc. “This could slow down the overall growth. “
Modi’s government this month proposed to increase capital spending by 26 percent to 5.54 trillion rupees ($ 76 billion) for the next fiscal year starting in April, hoping that the multiplier effect of that spending will translate into double-digit global expansion for the economy which shrinks sharply this year.
The Reserve Bank of India estimates that every rupee spent by the federal government will lead to an increase in gross domestic product of Rs 3.14, while similar spending by states will increase output by Rs 2. But states are not spending enough, according to an analysis by Yuvika Singhal, research economist at QuantEco.
Capital spending in 17 key states contracted 23.5% in the nine months to December compared to a year ago, which could lead to a shortfall of Rs 1.8 trillion in the current year spending target, Singhal said.
This gap can cost economic output 3.6 trillion rupees. While, the additional federal government spending during the current year would add only Rs 84,800 crore despite a higher multiplier effect.
State reduction may “soften” some of the effects of federal stimulus measures and “act as a drag on stimulus investment and overall growth,” the RBI said in a report in December.
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