Chennai: With the West Asia crisis and El Niño looming, revenue receipts of states may shrink to 88-90 per cent of their budget estimates this year, resulting in a revenue shortfall of ₹5-6 lakh crore across 18 major states. Fiscal deficits may also rise to 3.1-3.3 per cent of GSDP, according to Aditi Nayar, Chief Economist at ICRA.
ICRA has analysed the finances of 18 major states, excluding the North-Eastern states, Goa and Jharkhand, and found that many are unlikely to achieve their budgeted revenue targets.
ICRA has studied the revenue situation of 18 major states and found that many may not achieve their budgeted revenue receipts in FY27. Why do you expect this shortfall?
This is not a new phenomenon. Most years, there is a gap between what states project in their budget estimates and what they actually achieve, both on the receipts and expenditure sides. More often than not, the actual numbers are lower.
When states prepare their budget estimates, they first revise the previous year’s numbers and then assume a certain growth rate. If the revised estimates themselves are overstated, then achieving the next year’s budget targets becomes extremely challenging. This is something we see repeatedly across most states.
This year, the challenge is compounded by the West Asia crisis, which may affect consumption, and the possibility of an El Niño event, the severity of which remains uncertain. Both factors could create additional stress in achieving revenue targets.
Overall, how much shortfall are you expecting in revenue receipts across these 18 states?
The extent of the shortfall will vary from state to state. Overall, we expect revenue receipts to be around 88-90 per cent of the budget estimates. This implies a shortfall of approximately ₹5-6 lakh crore. A large part of this gap is likely to arise from an overestimation of grants.
What were the budget assumptions for states’ own tax revenues, and how much do you expect them to be impacted?
As a group, states have budgeted for their own tax revenue to grow by around 22 per cent in FY27 over the provisional actuals for FY26. Major categories of state own tax revenue were projected to grow between 19 and 25 per cent.
Compare this with our expectation of nominal GDP growth of around 12 per cent. The implied tax buoyancy is simply too high. Moreover, state’s own tax revenues have grown only about 7-8 per cent annually over the past three years. Therefore, the expectations embedded in the budgets appear unrealistic.
How do you see SGST, sales tax, stamp duty and registration revenues performing this year?
The budgeted growth rates for these categories range from 19-25 per cent. However, we expect actual collections to be closer to 85-90 per cent of the budget estimates for state own tax revenue as a whole.
SGST collections are closely linked to consumption. Petrol, diesel and LPG prices have increased. To the extent that higher fuel prices reduce disposable income, consumption may be affected, particularly in higher-taxed categories.
As far as stamp duty and registration revenues are concerned, some micro-markets could be affected by the fallout of the West Asia crisis, remittance trends and stress in IT sector employment. These factors could dampen property market activity and collections.
The Finance Commission has retained the 41 per cent vertical devolution to states, although the formula for horizontal devolution has changed. How do you see tax devolution shaping up this year?
The devolution formula itself is fixed. What matters is the size of the Centre’s shareable tax pool.
After accounting for cesses and surcharges, which are not shared with states, the remaining shareable taxes are distributed according to the prescribed formula. Therefore, the key question is how the broader macroeconomic environment affects tax collections.
Changes in excise duties and customs duties, along with potential moderation in corporate tax collections, could affect the size of the tax pool. Corporate taxes from oil marketing companies may be lower if their profits decline.
At this stage, we expect only a mild shortfall in actual tax devolution compared to the Union Budget estimates. It is not a major risk factor yet, but it is something worth monitoring.
What do the GST trends so far indicate for FY27?
We currently have GST collection data for April and May, which reflect economic activity from March and April due to the reporting lag.
These figures do not yet capture the impact of recent fuel price increases. We need data for May and June collections before drawing meaningful conclusions about how consumption patterns have been affected. At this point, the available data is insufficient for more accurate forecasts.
Many states have budgeted for a sharp increase in grants from the Centre despite grants declining in recent years. Why is that?
Overestimation of grants is a chronic trend among states. We see it year after year.
This year, grants were budgeted to grow by more than 75 per cent over the provisional actuals of the previous year. This is an extremely large increase and is likely to account for a major portion of the expected revenue shortfall.
There are different types of grants. Some are formula-based, some are specified in the Union Budget, while others depend on utilisation levels. States have to estimate how much they will receive, and these estimates often prove optimistic.
Why do states continue to overestimate grants despite repeated shortfalls?
I don’t really have an answer for that.
What was the growth in grants assumed in FY27 budgets, and what do you expect the actual realisation to be?
States budgeted for grant growth of around 78 per cent.
We believe only around 60-65 per cent of the budgeted amount is likely to be realised. In addition, the 16th Finance Commission has discontinued revenue deficit grants, although these grants had already been tapering off in previous Finance Commission periods.
How will lower-than-expected revenue receipts affect state spending?
States operate within a fiscal framework that limits their fiscal deficit to around 3 per cent of GSDP. In addition, they receive allocations under the Centre’s 50-year interest-free capex loan scheme.
If revenue receipts fall short by ₹5-6 lakh crore, expenditure will also need to be reduced. Whether the adjustment comes through lower revenue expenditure, lower capital expenditure, or a combination of both will vary across states.
Many revenue expenditures, such as salaries, pensions and interest payments, are sticky and difficult to reduce. Certain subsidies are also not easy to curtail abruptly. Therefore, the burden often falls on expenditure linked to overestimated grants and, in some cases, on capital expenditure.
What is your fiscal deficit estimate for these 18 states?
States had budgeted for a slight improvement in their fiscal deficits. We think that is unlikely.
We expect the combined fiscal deficit of these states to be in the range of ₹12-20.8 lakh crore, compared to the budgeted ₹11.7 lakh crore. This implies an increase of roughly ₹30,000 crore to ₹1.1 lakh crore over budget estimates.
As a share of GSDP, fiscal deficits are likely to be around 3.1-3.3 per cent.
Does that mean state borrowings will exceed the prescribed targets?
No. States cannot simply exceed their borrowing limits.
The borrowing ceiling is linked to the fiscal deficit target of 3 per cent of GSDP, along with the additional borrowing permitted under the Centre’s interest-free capex loan scheme. The fiscal framework acts as a soft constraint on deficits.
What actions can states take to minimise the impact of revenue shortfalls?
This year presents a unique set of challenges. We do not know how long the West Asia conflict will continue, and we will have to closely monitor the monsoon and El Niño developments over the next few months.
Governments need to remain vigilant and continuously assess how these factors are affecting revenues. If necessary, they may have to trim expenditures that are considered less productive and have a relatively limited impact on economic growth.
At the same time, sharp expenditure cuts are not desirable because they could hurt growth. The next two to three months will be critical in determining how governments respond.
Are there specific areas where spending can be cut without affecting productivity?
Each state will have to assess its own expenditure profile.
One word of caution is that cutting welfare spending can reduce disposable incomes at a time when households may already be under pressure. Therefore, there is no simple answer.
Every state will need to carefully evaluate where spending reductions are possible. Ideally, capital expenditure should not bear the entire burden of adjustment.
So there is no single formula that can be applied across all states?
Exactly. Each state will need to examine its own mix of capital expenditure and revenue expenditure before deciding how best to respond to the emerging challenges.
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