Imagine the following scenario. Your annual income is down by 30% and you apply for a personal loan to just about cover the EMIs of your home loan for a year. Your Silicon Valley-based elder sister, who owes you money, pleads she is herself in a precarious situation. Why don’t you take a bigger loan, she suggests. The recent decision of the GST Council to not pay the compensation due to states, asking them instead to borrow and make up for the shortfall, has miffed many states.
Those that are not ruled by the Bharatiya Janata Party are making their displeasure amply known. The government of Punjab should be forgiven for feeling a bit like our imaginary protagonist. The state government has estimated that its revenue shortfall for the ongoing fiscal could be as high as 30% on account of the pandemic. In April, during the peak lockdown to curb the spread of the novel coronavirus, Pun- jab’s own receipts slipped by 80%. In the first quarter, the shortfall was Rs 5,576 crore, or 54% of its budgetary target.
And because of its earlier borrowings, partly by the previous regime led by the Shiromani Akali Dal, the state’s debt servicing obligation (Rs 67,003 crore) is now more than its budgeted borrow- ing for the year (Rs 64,998 crore). Borrowing more is, therefore, an unpalatable option for the state. “With all other revenue sources drying up, we were banking on receiving our constitutionally guaranteed GST compensation as, I am sure, were other states. But the Centre took a highly unreasonable and appalling decision unanimously, without consulting us,” says Punjab Chief Minister Amarinder Singh in an email interview to ET Magazine, referring to the GST Council’s decision.
For most states, the decision came as a bolt from the blue, throwing into disarray their finances, already severely weakened by the pandemic. In 2017, recalcitrant states were wooed into the ambit of the GST with an assurance that if collections fell short of a compound growth of 14% during the transition period between July 2017 and June 2022, the shortfall would be compensated for. With the pandemic eroding the revenue base of the states and the Centre withholding the compensation since April, the states are left with no option but to borrow more and survive.
Money Trail
The situation is trickier as most states are already massively indebted and, therefore, any borrowing over and above their regular loans will mean they will have to walk a tightrope. According to an estimate by the GST Council, the shortfall this fiscal will be about Rs 3 lakh crore, out of which Rs 65,000 crore is expected to be generated through cess. The question is where will the rest — Rs 2.35 lakh crore — come from? Though most states, including several BJP-ruled ones, initially insisted that the Centre should borrow the entire amount and disburse it to them, the central government in turn offered two options for the states to choose from. In both the options, the states have to borrow.
The first option, which Bihar, Karnataka and others have said they will adopt, recommends that the states borrow Rs 97,000 crore, an estimated shortfall arising out of the implementation of the GST but not covering the loss due to Covid-related hardship. The Centre on paper has described the pandemic as an “act of God”, arguing that the Parliament in 2017 could not have contemplated these extraordinary circumstances when the compensation mechanism was enacted. Act of god is the literal translation of the concept of force majeure — a clause that releases parties from their obligations in a contract due to circumstances beyond their control.
GST Collection
Pay Later
For its part, the Centre has made it clear that it would not dispute the fact that the states are entitled for compensation under Section 7 of the GST Act regardless of the cause of the shortfall, adding that the amount borrowed by the states will be paid back post-2022, when the states will no longer be eligible for receiving any compensation. Also, under option one, the states will be allowed to breach the borrowing limit stipulated by the Fiscal Responsibility and Budget Management (FRBM) Act.
Under option two, the states will be allowed to borrow the entire amount of the shortfall, estimated to be Rs 2.65 lakh crore, arising on account of faltering implementation as well as the wrath of the pandemic. But there is a caveat. In this case, there will be no relaxation on FRBM target, meaning the states following this route will have limited borrowing options otherwise. “Let’s not politicise GST compensation.
Had GST not been there and the VAT regime continued, then also, there would have been a revenue shortfall during this pandemic. Bihar will receive Rs 3,512 crore as GST compensation this fiscal. We will borrow the rest (Rs 6,539 crore) which will be compensated after 2022. That’s a fair deal,” says Sushil Kumar Modi, deputy chief minister of Bihar, who also holds the state’s finance portfolio. He also adds that the states can’t expect the Centre to borrow for them when the Centre itself is forced to enhance its borrowing limit for this fiscal from the previously budgeted Rs 7.8 lakh crore to Rs 12 lakh crore now.
No doubt, the Centre’s decision to defer the GST compensation has stirred up a hornet’s nest, with Mamata Banerjee and Pinarayi Vijay- an, chief ministers of West Bengal and Kerala, respectively, writing strongly worded letters to the prime minister to intervene in the matter.
GST Collection
But those supporting the Centre’s line of argument insist that several states chose to extend the lockdown on their own in addition to enforcing weekend shutdowns for months, knowing well their financial fallout and revenue loss. For the month of August, for which the GST data has just been released, the total collection slipped to Rs 86,449 crore from Rs 98,202 crore a year ago, even as it rose sharply from the April figure — Rs 32,172 crore. Only essential services were permitted in April. The states which dragged down the GST numbers of August include Goa, Kerala, Maharashtra, West Bengal and a few Northeast states whereas the collection in five states — Rajasthan, Chhattisgarh, Uttar Pradesh, Nagaland and Uttarakhand — was in the positive territory.
Varying Dependence
The reliance on GST compensation or, for that matter, the dependence on the Centre, varies from state to state. Whereas states such as Bihar, Himachal Pradesh and those in the Northeast are heavily dependent on the Centre’s largesse, there are others with large consumer bases, such as Maharashtra, Delhi, Gujarat, Haryana, Tamil Nadu and Telangana, which in usual circumstances are capable of managing their finances without a helping hand from the Centre. For every state, revenues originate from three sources — its own resources, transfers from the central government and borrowings.
According to a report titled “State of State Finances”, published in December 2019 by the New Delhi-based think tank PRS Legislative Research, states’ own resources, at 53% of the total, are more than central transfers, including the share in central taxes plus grants in aid from the Centre. The report also explains how the states were expected to spend 64% more than the central government in 2019–20, a significant change from 46% in 2014–15, indicating the growing importance of state governments in the nation’s total government spending.
The states’ own tax revenue includes GST, sales tax, state excise, stamps and registration fees, taxes and duties on electricity, and land revenue. And non-tax revenue, which forms a tiny part of the state’s revenue, includes in- come from royalty, fees and fines, lottery and dividends from state public sector enterprises. The PRS report further explains how the states, during a five-year period of 2015– 20, had to resort to borrowing for financing 21% of their total expenditure. But the level of indebtedness varies from state to state. For example, Punjab (47%), Haryana (32%) and West Bengal (29%) rely heavily on borrowings as against Delhi, Mizoram and Arunachal Pradesh, for whom bor- rowing constitutes less than 10% of their total expenditure. And as high as 23% of the states’ revenue receipts is spent on debt servicing, with Punjab, Jammu and Kashmir, Nagaland and West Bengal spending a higher portion of their revenue for that purpose.
With more and more states adopting in- come support schemes, farm loan waivers and taking over discoms’ losses under a scheme called UDAY, the debt burden of states has exponentially risen in recent years. The farm loan waiver scheme adopted by 10 states, for example, drained Rs 2.6 lakh crore from the states’ ex- chequer, forcing them to borrow more. Even before the pandemic hit the nation, the budget of several states factored in huge borrowings for 2020–21. West Bengal, for example, had a borrowing provision of Rs 79,465 crore, or roughly 31% of the total expenditure, for the year.
Haryana, a state that does not need to depend too much on the Centre’s grant, estimated it would borrow Rs 44,439 crore, or 32% of its total expenditure target, this fiscal. Also, for several states, a major concern has been their debt servicing component. For example, Haryana is expected to spend Rs 40,729 crore in servicing its debt, of which Rs 18,138 crore would go towards interest payment. In West Bengal, the debt serving target for the year, as announced in its budget presented before the pandemic, is Rs 77,047 crore.
The state’s outstanding debt is about 33% of the GSDP, way higher than the 20% suggested by the FRBM review panel. Against this backdrop, the crisis triggered by the pandemic plus the Centre’s decision to defer the GST compensation have only exacerbated the financial health of the states. Though GST compensation alone would not have helped the states in tiding over this mammoth health-cum-financial crisis, its deferment would mean a body blow for them, at least temporarily. As Kerala CM Vijayan mentioned in his letter to the PM, the state’s dues on account of GST compensation stood at Rs 7,000 crore till August. The amount would not have had a magical effect on the state’s overall finances, but would have certainly eased the immediate financial mess.
Way Ahead
Former Union industry secretary, Ajay Dua, says it’s more a matter of principle to pay what was committed by a law enacted in Parliament. “GST compensation for five years is a legal entitlement for the states. The Centre can’t say ‘no’ midway. The Centre should borrow money from the RBI and fulfil its obligations instead of asking the states to borrow,” he adds.
The Centre, for its part, says the states should borrow the amount for the time being, which it will reimburse after 2022 by extending the tenure of the compensation cess. This is a specific GST cess and states are unlikely to object to its extension.
But states dislike the ever-increasing levies as cess and surcharges, a revenue mop- up method that the Centre does not need to share with the states under the divisible pool mechanism. All eyes are on the 15th Finance Commission, which is expected to submit its final report by the end of October, determining the roadmap on the sharing of taxes between the Centre and states for the next five years.
Its chairman, NK Singh, told ET Magazine that the pandemic has definitely made an impact on the commission’s thought process, adding that the commission, in a first, will have a separate chapter on the health sector, in which it will advise the states on how to prioritise health infrastructure. It may also recommend the need for states to scout for more revenues. Singh adds: “The governance of property tax needs a standardised template. The Finance Commission will give recommendations on property tax reforms which will have a positive impact on states’ finances.” Maybe a better template is also required for minimising potential fissures between the Centre and the states over financial matters.
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