The Union government has travelled a long way since it announced in the Budget speech of 2020-21 that hereafter “the transfers to the fund would be limited only to collection by way of GST compensation cess”. This was a negation of the repeated assurances that were given to the states in the Empowered Committee of state finance ministers, GST Council and even Parliament.
The understanding was that if there was a shortfall in the collection of GST Cess Fund, it would be made good by way of Central government borrowing, to be recouped by extending the compensation cess beyond the stipulated five years. After nine months of acrimonious wrangling, it has now agreed to borrow at least part of the fund requirement.
Even before Covid, it was clear, given the lacklustre performance of the economy and maladministration of GST, that the revenue growth would be far below the 14% envisaged in the compensation law. The Chairman of the Finance Commission even made a suggestion in the 37th GST Council that the states should revisit the compensation formula which, of course, no state was willing to do. With the outbreak of Covid, the anxieties of the states grew manifold.
The total shortfall in the GST revenue from the legally protected one in 2020-21 was expected to be Rs 3 lakh crore. The only solution was to borrow to meet the short-fall and repay it by extending the cess collection. There were two key issues: Who should borrow? How much should they borrow? In the 41st GST Council meeting, we discussed them for eight hours, and 15 states suggested that the Centre should borrow and that full compensation should be paid. But at the fag end of the meeting, without any reference to the discussions so far, the Central government placed two options before the states to choose.
Option 1 introduced a new concept of dividing the revenue losses ‘‘on account of implementation of GST” and “due to the pandemic”. The compensation for the latter would be deferred to post-2022. Events like recessions, pandemics, demonetisation, etc., were never in consideration when the compensation formula was devised. The Compensation Law clearly defines how it is to be calculated and it has no reference whatsoever to any conditions, whether it be an act of nature, god or man.
In the second option, the entire shortfall was to be borrowed by states and the interest burden was to be paid from their consolidated fund. No state wanted even to consider this option. The Centre also argued that the Attorney General had opined that it is not legally bound to compensate the states from the Consolidated Fund of India. Given the history of the discussions and the consensus reached by the states and Centre regarding compensation, bringing up these types of arguments to coerce the states to accept one of the two options is the lowest point in the Centre-state fiscal relations.
In the 42nd GST Council meeting, it was announced that 21 states had already opted for option 1. Nine states rejected both the options. There are three cardinal principles that dissenting states have raised.
1) There can be no bifurcation of revenue shortfall for compensation purposes as due to pandemic and due to implementation of GST. The entire shortfall needs to be compensated.
2) The Centre should borrow given its better capacity, ability to gain better terms and administrative ease of borrowing.
3) Compensation cannot be linked to normal borrowing or additional borrowing limits allowed to states. Both the options infringed upon the above principles and were unacceptable to us.
It was clear from the AG’s opinion that a decision of the Council was necessary to extend the cess collection and also for deferment of compensation payment beyond five years. The Council decided to extend the cess collection but no such decision was made with respect to deferment of compensation payment.
The demand for a formal decision in the Council was not heeded in the name of consensus. Had such a decision been made, it would have been binding on the states that did not accept option one or two, though we would have continued to press the issue through grievance redressal mechanisms or other means. Instead of adopting such a democratic procedure, the meeting was concluded without any decision, ostensibly for lack of consensus. Then an announcement was made in the press conference.
States that argued for a third option were threatened that choosing none of the options would mean no compensation. It would appear that better sense has prevailed; the Centre has now expressed its willingness to borrow through a special window and provide back-to-back loans to states in lieu of compensation. All the dissenting states have welcomed the move. At least it has met the demand that the Central government should borrow.
Now we have to discuss and reach a consensus on how much to borrow. The dissenting states have made it clear that the entire compensation should be borrowed and paid in the current year itself. Such borrowing is not going to affect the Centre’s fiscal deficit and its fears of crowding out private investment is totally misplaced. Not only consumption demand, but investment demand has also collapsed. In Covid times, the last thing the Centre should do is to squeeze state government expenditure.
It seems the Central government is not agreeable to the above suggestion. Nevertheless, it is possible to negotiate to reach an amicable agreement as in the case of the first question. It will be an irreparable damage to the functioning of the GST Council if the Centre insists on its first option and enforces it without the consensus of the Council. The best option would be to extend to all states 0.5% more unconditional borrowing to the 2% additional borrowing already permitted. I am certain it would provide sufficient fiscal staying power to states to discuss and reach a consensus on how much to borrow.
T M Thomas Isaac
Finance Minister of Kerala