Entire GST shortfall will be compensated, says govt ahead of Sept 10 meet

The finance ministry ruled out borrowing by the Centre as suggested by some states

The GST Council will meet on Thursday to take a call on the borrowing options given by the Centre to meet the compensation gap of states. Ahead of the special meeting, finance ministry sources reiterated that the shortfall in compensation to states - whether on account of GST implementation or the coronavirus (Covid-19 pandemic) - would be compensated.
 

The ministry also ruled out borrowing by the Centre as suggested by some states with sources saying that under the GST law, the compensation cess is a tax owned by the states and under Article 292 of the Constitution. The Centre can borrow on the security of its own taxes and resources which is the Consolidated Fund of India.
 

“It cannot borrow against the tax which it does not own,” the ministry said.
 

Moreover, it said that any borrowing by the Centre would crowd out the much-needed resources for private players and push up rates on the government paper which is a benchmark in the market.
 

The ministry estimated that there would be a compensation requirement of Rs 3 trillion for states and the compensation cess would be around Rs 65,000 crore for the current financial year, leaving a gap of Rs 2.35 trillion. Of this gap, Rs 97,000 crore is on account of GST structure and the remaining due to the lockdown imposed to arrest the spread of the Covid-19 pandemic.
 

“It has never been the stand of Union finance minister (Nirmala Sitharaman) that the loss of revenue due to Covid-19 would not be compensated. The Central government has, time and again, committed that the entitlement of the States would always be for full compensation,” a  key finance ministry source said. He said the entire compensation sum on account of shortfall would be paid and honoured.
 

The Union government offered two solutions to the state governments.
 

The first is that states take a Rs 97,000 crore window, to be worked out with the Reserve Bank of India, or borrow Rs 2.35 trillion from the markets to be facilitated by the central bank. The amounts will be paid by the compensation cess which will be extended beyond June 30, 2022.

However, states will have to bear the interest burden if they decide to borrow the entire Rs 2.35 trillion shortfall.

In case of the second option, the proposed extension of cess will be used for paying only  the principal amount and not the interest.
 

While in the first case, borrowing under the special window will not be treated as debt of states, in case of the second option, only the amount up to Rs 97000 crore, which is the shortfall arising due to GST implementation, will not be treated as debt.
 

The states were given time till Tuesday to send their feedback to the Centre, after which the GST Council meeting will be called to take up the matter.
 

Reaction to the offer from states has so far come on the party lines. While the Opposition-ruled states accused the Centre of reneging on their promise, some BJP-ruled states such as Bihar and Karnataka opted for the first option.
 

The ministry sources said borrowing for meeting the entire shortfall at a time when the private sector is struggling to get back on its feet could hurt them badly.  “If states go for option 1 and borrow Rs 97,000 crore, it does not mean they will have to forgo the remaining compensation. The remaining compensation will be paid to states after the above borrowing has been fully repaid. Therefore, where is the doubt about the center not meeting its commitment,” wondered a top official.
 

In fact, while giving the two options, the ministry had stated in the note that to the extent the shortfall is not made good, the states would still be eligible to get it in arrears after the transition period through extension of the cess, if so decided by the Council.
 

The sources cited above referred to the note.
 

They said working out the revenue shortfall on account of GST implementation is just a mechanism to assess how much of the shortfall should be met by borrowing and how much could be deferred.
 

According to an official, the compensation cess has to be transferred to the Compensation Fund and released to states in the form of compensation. It is not really a resource of the Central government on the strength of which it can borrow under Article 292 of the Constitution of India.
 

"Compensation cess is actually a resource dedicated to states and only states can borrow on the strength of future flows from cess which will eventually get credited to the consolidated Fund of States," the source said.

Also, partially meeting the resource gap through borrowing is not only beneficial for the market, but also for the States. “It will ensure that some resources in the form of compensation keep coming even after the end of the transition period which would allow future generations also to maintain healthy levels of public expenditure. States falling off a resource cliff after the transition period of five year would not be a prudent fiscal strategy," said the same source.
 

Finance ministry sources said that the Union government had already enhanced the borrowing limit from 3 per cent, which goes up to five per cent of the gross state domestic product (GSDP).
 

On an average, the states have so far borrowed only about 1.25 per cent of the GSDP. Only a few states have reached above 2 per cent of the GSDP.
 

Therefore, “enough headroom is available to the states to borrow according to their requirements and needs. In any case, they will get the full compensation shortfall and therefore it is win-win-win for all – states, the Centre, and economy” said the top official.
 

Sources said that if the Centre borrows, it would have a higher impact on the market and push the G-Sec rate which becomes the benchmark rate for other borrowings, including borrowing by the state governments.
 

Any borrowing by the Central government would crowd out borrowings by the private sector and would make borrowings costly for entrepreneurs. The deciding factor would, thus, be whose borrowings will have the least impact on the market rates, they said.
 

“It is unarguable that since rates on Central government securities work as one of the benchmarks for market rates, any additional borrowings by the Centre would have a higher impact on the market rates than that by States. If the benchmark rates increase on account of borrowing by the Center, the states too will get impacted because it will increase their cost of borrowing," said the source in the know of the matter.
 

Therefore, according to the top sources, in the current scenario, it may be a safer option for states to raise the additional resources to meet the resource gap due to non-availability of compensation.
 

“Since the repayment will come from the compensation cess, there is no reason why the rates would be different from each State. In fact, the debt window could be so packaged that it is State independent altogether," said the top sources.