Faster tax devolution may not affect states' borrowings, but will boost capex: Experts

Faster tax devolution payments are unlikely to affect states' market borrowing in fiscal 2024, but may encourage them to increase capital expenditure, said experts.

"Size rather than the pace of tax devolution impacts changes, if any, in annual SDL (state development loans) issuance," said economists from Standard Chartered in a note, contending that the faster pace of devolution for June 2023 would not reduce states' fiscal deficit and their borrowing, avoiding a repeat of FY22 and FY23.

The government said this month that it released the third instalment of tax devolution of ₹1.18 lakh crore to states. This comprised the regular monthly devolution of ₹59,140 crore due in June, plus an advance instalment, a finance ministry statement said June 12.


According to economists, the extra instalment is likely to encourage states to continue on the path of capital spending. Data for 18 states show that April's capital expenditure was 40% higher compared with last year.

"The aim for the advanced release of tax devolution is to encourage states to frontload their capex expenditure," said Gaura Sengupta, India economist at IDFC First Bank. "Even though the advanced devolution was done in FY23, around 29% of the capex expenditure for the year came in March 2023," Sengupta said, pointing out that April's numbers showed the current fiscal had started on a strong note.

"Frontloading has happened only after Covid when the government has been giving additional instalments. The whole intention is that you are doing it for the sake of capex," said Madan Sabnavis, chief economist, Bank of Baroda.

Limited upside

The extra instalment in June raised the cash surplus of states to ₹2.6 lakh crore from ₹1.6 lakh crore as of June 9. But this is still lower than the ₹3.5 lakh surplus that states started with in FY23. "We think a cash surplus above ₹2.5 lakh crore typically leads to the deployment of cash to finance states' fiscal deficit," wrote Standard Chartered economists.