Overall revenue of India’s top 17 states, which account for 85-90% of aggregate gross state domestic product, is likely to grow at a moderate pace of 7-9% this fiscal, after galloping ~25% last fiscal. Last fiscal growth was however on a flattish base of fiscal 2021, due to slowdown in the economy, caused by the pandemic.

Healthy tax buoyancy will support revenue growth, with Goods and Services Tax (GST) collections and devolutions from the Centre - together comprising 43-45% of the states’ revenue - expected to show robust double-digit growth this fiscal.

Growth from buoyant GST collections, will however, be somewhat moderated by flattish or low single digit growth in sales tax collections from petroleum products (8-9% of total revenue) and grants recommended by the Fifteenth Finance Commission (13-15%).

Says Anuj Sethi, Senior Director, Crisil Ratings, “The biggest impetus to revenue growth will come from aggregate state GST collections which had already rebounded ~29% on-year last fiscal. We expect this momentum to sustain and collections to further increase ~20% this fiscal, supported by better compliance levels, higher inflationary environment and steady economic growth.”

In addition, the share of states in central taxes is expected to grow further. While the proportions are determined by the Finance Commission, the overall kitty is linked with the central government’s gross tax collections. This pool, which expanded ~40% last fiscal¹, should further grow ~15% this fiscal.

On the other hand, fuel collections for states from sales tax on motor fuel are expected to remain almost range bound. That’s because the effects of an expected 25% on-year increase in crude price in the current fiscal and better sales volumes would be offset by the reduction in central excise on petrol and diesel in November 2021 and May 2022, followed by a reduction in sales tax rates by some states.

Also, various grants provided by the Centre, including grants towards Centrally Sponsored Schemes, Finance Commission grants and revenue deficit, are likely to see only marginal growth this fiscal, based on the budget calculations and Finance Commission stipulations².

Furthermore, on expected lines, GST compensation payments (7-9% of revenue in past two fiscals) will also end, with the expiration of the compensation period on July 1, 2022. When the GST was introduced, the Parliament passed the GST (Compensation to States) Act, 2017 to make good the shortfall in states’ GST collections³ (owing to the transition from the earlier structure) for a period of five years – which ended on June 30, 2022. The shortfall in the GSTcollections was proposed to be funded through GST cess collections.

Says Aditya Jhaver, Director, Crisil Ratings, “Fiscals 2021 and 2022 saw a significant shortfall in both GST and GST cess collections, due to the pandemic. This led the Centre to raise GST compensation loans⁴ in these two years, which was provided to states to help support their revenues. These revenue streams will not be available henceforth as per the Act’s provisions.”

Crisil Ratings’ calculations bake in a real gross domestic product growth forecast of 7.3% for this fiscal and no further material pandemic-related lockdowns. A slowdown in economic activity due to higher-than-expected inflationary pressures could negatively impact revenue. On the other hand, better-than-expected tax buoyancy or any extension in GST compensation payments could tip the scales in its favour. That said, it will also be imperative for states to focus on different avenues for revenues and better processes for higher collection efficiency which can support future revenue growth.

¹ Adjusted for Rs 0.43 lakh crore which was provided as one-time arrears pending for fiscals 1997 to 2018 to all states
² Includes revenue deficit grants provided by the Fifteenth Finance Commission, which will reduce from Rs 0.78 lakh crore in fiscal 2022 to Rs 0.50lakh crore in fiscal 2023
³ Shortfall is calculated as a subtraction of actual GST revenue from the protected revenue; protected revenue is calculated using 14% annualgrowth on the base year revenue of fiscal 2016
⁴ In fiscal 2022, the states analysed received GST cess payments of Rs 0.8 lakh crore and GST compensation loans of Rs 1.3 lakh crore