The expenditure incurred by the government is classified under capital expenditure and revenue expenditure. Capital expenditure (capex) is the money spent by the government towards the creation or acquisition of physical or financial assets or to reduce financial liabilities, such as land, building, roads, bridges, pipelines, machinery, equipment, health facilities, education, investment in shares, repayment of loan, etc. Revenue expenditure by the government is meant for meeting operational expenses and liabilities, such as salaries, wages, pensions, subsidies, interest on loans, etc.

While capital expenditure creates long term assets in the economy, revenue expenditure is recurring and unproductive in nature.

Importance of Capital Expenditure

Higher capital expenditure in the economy implies creation of infrastructure and allied assets. These aid the production capacity and boost operational efficiency in the economy and help in revenue generation and capacity creation in the long-run, crucial for rapid economic growth.

Capital expenditure has a high multiplier effect (a mechanism through which increase in spending leads to more than proportionate increase in income generation in the economy) in the economy. This multiplier effect works through expansion of ancillary industries (those industries which manufacture parts and components to be used by larger industries as inputs), ancillary services and employment generation on the demand side. On the supply side also, it can facilitate labour productivity and boost purchasing power. According to a study by the National Institute of Public Finance and Policy (NIPFP), in case of capital expenditure, for every rupee spent in, the addition to the economy is Rs 2.25 within the same year and Rs 4.80 over the course of the entire capital expenditure.

Capital expenditure by government has the ability to crowd-in private investment in the economy which augments production capacity of the economy leading to higher economic growth and employment generation.

Case for Increasing Capex by States

Public capital expenditure (the Centre and states combined) is highly decentralised in India as capital expenditure undertaken by the states accounts for more than 60 per cent of the general government capital expenditure, according to the Reserve Bank of India (RBI) Annual Report on State Finances: 2020-21. Moreover, capital expenditure by states has higher potential to contribute to growth than that of the centre as states are closer to the local community. As per data from the Comptroller and Auditor General (CAG), most states have recorded an increase in their capex in the first quarter (Q1) of the financial year (FY) 2021–22 as compared to their pre-pandemic levels in 2020–21. A bulk of this increase went into the social sector, which includes spending on healthcare facilities and education, as states had to ramp up hospitals and emergency facilities to manage the COVID crisis.

According to Shaktikanta Das, current RBI Governor, the state finances and expenditures by states have an important role to play in the growth of the country’s gross domestic product (GDP), especially in current times when India is gradually recovering from the pandemic. With economic growth still nascent and private capex gradually recovering, government capex has to take the lead to spur economic growth.

As per an RBI study on state finances, it was found that, in the period between 2000–01 and 2019–20, states failed to meet the budgeted target of capex in 17 out of 20 years. In order to meet fiscal deficit targets, states have resorted to cutting back on capital expenditure as political compulsions prevent them from reducing revenue expenditure. State governments should aim to cut down on inefficient revenue expenditure.

The union government has adopted a ‘carrot and stick approach’ to make states increase spending on capex. The Centre has allowed enhanced ceilings for market borrowings by states subject to implementation of state level reforms. Going ahead, capex on health care, education, and skill development needs to be increased significantly. With increasing automation in jobs, low-skilled workers need to be reskilled so that they can continue in the job market. Increasing capital expenditure will help in achieving long-term targets of economic growth and employment. According to a working paper hosted by the Institute of Economic Growth, it is the difference in the quality of growth-enabling factors such as roads, railways, telecom, banking network, etc. across states in India that account for differences in the growth performances of ‘rich’ and ‘poor’ states.

Incentivising Capex by States

The central government has budgeted Rs 5,54,236 lakh crore for the FY 2021–22, an increase of 29 per cent over FY 2020–21, and would like states to do likewise. The union government has been incentivising states to increase their capex through enhanced ceilings for borrowings by states and interest-free loans. Under the ‘Atma Nirbhar Bharat Package’ announced in 2020, states were offered 50-year Rs 12,000 crore interest-free capex loan to be spent on new or ongoing capital projects by March 31, 2021. In April, 2021, in continuation with the previous package, the central government announced that an additional amount of up to Rs 15,000 crore would be provided to states as interest-free 50-year loan for spending on capital projects. An additional amount of Rs 5,000 crore is to be provided if states undertake asset monetisation and disinvestment of their public sector enterprises.

Areas for Improvement

Increase in spending by states needs to be accompanied by the following:

  1. Focus on the quality of expenditures States need to give a greater focus on the quality of expenditures. For assessing the quality of expenditure, there is the need to develop measurable parameters.
  2. Need to review the existing schemes It is time for states to review all their existing schemes to assess their utility. Schemes which have outlived their utility need to be discontinued. Also, a sunset date must be set for schemes which must be closed once their need is over.
  3. Prudence in public expenditure (fiscal prudence) Given the competing demands for government funds for different schemes amid limited resources, there is need for judicious use of funds for different schemes of the state governments. Government programmes/schemes should be chosen on the basis of what kind of multiplier effect a scheme will have or the scheme’s ability to impact the lives of the people.
  4. Improve the mechanism of the state finance commissions Unlike the Union Finance Commission, the mechanism of state finance commissions has not worked efficiently. Although the constitutional provisions for both the finance commissions (union and states) are the same, the states have not been setting up their finance commissions every five years as mandated by the 73rd Constitutional Amendment Act. Reports of state finance commissions have lacked in quality and analytical ability, when compared to union finance commission reports.

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