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On GST compensation, the way out requires states to come forward to work with Centre

Sushil Kumar Modi writes: It is heartening to note that the Centre has not reneged on its promise to find ways to compensate the states for loss of revenue. I think the states should come forward and work with the Centre in the true spirit of cooperative federalism that the Council has come to be known for these past few years.

Written by Sushil Kumar Modi |
Updated: September 11, 2020 10:03:02 am
GST, Centre vs State on GST, gst compensation payments, covid impact on gst compensation, coronavirus gst compensation payments, nirmala sitharaman, Sushil Modi writes, Indian express opinionOf the two options presented by the Centre, option-1 seems to be superior in all respects. (File)

The global pandemic has played havoc with the economy. Revenue streams of the government, the private sector and individuals have been severely impacted while the expenditure, particularly of the government, is shooting up with a rise in commitments.

One significant area of loss of revenue to both the Centre and the states is GST. While the states have the comfort of assured 14 per cent growth through the compensation mechanism, the Centre has no such guarantee. The Compensation Act mandates compensating the states for revenue loss on GST implementation from the Compensation Fund.

The course of action to be adopted in the event of the amount in the Fund falling short of requirements was discussed at length in the GST Council. The late Arun Jaitley, then chairman, had, in the 8th meeting, assured that “… in case the amount in the GST Compensation Fund fell short of the compensation payable, the GST Council shall decide the mode of raising additional resources including borrowing from the market which could be repaid by collection of cess in the sixth year or further subsequent years”; the Council had agreed to this suggestion. Quite clearly, the sense of the house and, consequently, the decision of the Council, was that it is the Council (and not the Government of India) that shall decide the mode of raising additional resources in the event of a shortfall and this is reflected in Section 10(1) of the Compensation Act.

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Additional resources could be raised by increasing the tax or the cess but in the present difficult times it would not be advisable to raise the burden of either the tax or the cess; if anything, it is the time to mitigate the burden on the common man. Hence, the only way out of this difficult situation is borrowings. The question that has been in the public domain is: Who should borrow — the Centre or the states?

It is being argued by some that since borrowings by the Centre or by the states make no difference in the context of fiscal discipline, the Centre should borrow in view of its higher borrowing and debt-servicing capacity and its ability to borrow at lower rates. Under normal circumstances, this might have been true but we are in an unprecedentedly abnormal situation. Even otherwise, it would be difficult for all if the Centre were to borrow.

Article 292 (1) mandates that the Centre can borrow on the security of the Consolidated Fund of India (CFI). It may be recalled that since the idea of providing compensation to the states from the Consolidated Fund of India was not agreed to in the Council, it is difficult to agree with the suggestion that GoI borrow on the basis of the said CFI.

Explained Ideas: Why states borrowing money to make up for gap in GST revenues is the right way forward

It is also financially imprudent for the Centre to borrow since large borrowings by the Centre would push up the bond yield rates, which in turn would push up the bond yield of the states setting off a spiral leading to hike in the interest rates for businesses and individuals. The states’ borrowing would become costlier if the Centre were to borrow for this purpose.

It is also not correct to contend that the Centre should borrow to honour its commitment to fully compensating the states; the Council had agreed that the means of financing the shortfall are to be decided by the Council and not by the Government of India.

The borrowing capacity of the states, too, is not very inferior. The RBI study of state finances shows that the debt receipts of all the states as a percentage of GDP has hovered between 2.4 per cent and 3.6 per cent during the last four years and an average level of 2.9 per cent; the states have on the average borrowed just about 1.25 per cent of the GSDP thus far.

The point being made here is that the states are consistently borrowing less than they can borrow (legally and financially), which makes sound financial sense but which can be utilised in times like this. Further, the cost of state borrowings for this purpose can be considerably lowered if arranged through a special window.

The Centre has already breached the budgeted borrowing limits for the current year in the first four months itself and, with revenues taking a battering, it is anybody’s guess that the Central borrowings will exceed the revised target of Rs 12 lakh crore against the originally budgeted Rs 7.96 lakh crore.

Thus it makes sense for the states to borrow. The two options presented in this context involve borrowing by the states. In one option, the entire shortfall can be borrowed in one go while only the shortfall attributable to GST implementation is to be borrowed in the other option with the remaining shortfall to be made good from the Cess Fund post the transition period. In both the options, the principal amount will be serviced from the Cess Fund.

Of the two options presented by the Centre, option-1 seems to be superior in all respects. Borrowing the entire shortfall, as envisaged in option-2, will hurt both the markets and the private sector, pushing up the interest rate. On the other hand, the single window under option-1 being arranged by the Centre and the entire debt being serviced from future cess receipts will ensure that the cost remains close to the G-sec rate. Moreover, there will be no variation in the interest rate as between the states.

There will be considerable flexibility in borrowings for the states in these stressed times as certain conditionalities have been relaxed for option-1, besides retaining the roll-over option for borrowing limits. Most significantly, the 14 per cent assured growth has been maintained; only a part of it has been deferred.

It is heartening to note that the Centre has not reneged on its promise to find ways to compensate the states for loss of revenue. I think the states should come forward and work with the Centre in the true spirit of cooperative federalism that the Council has come to be known for these past few years.

This article first appeared in the print edition on September 11 under the title “Not Centre vs States.” The writer is Deputy Chief Minister, Bihar.

Editorial: Burdening the states

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