States can borrow to fund GST compensation, Centre not obliged to pay: AG

K K Venugopal does not recommend borrowings by GST council; experts dislike the idea of burdening states with more debt

Attorney general K K Venugopal has given a way out to the Centre to wriggle out of the compensation mess under the goods and services tax (GST) system, even as he did not recommend borrowings by the GST Council.

He suggested that the Council can recommend to the Centre to allow the states to borrow on the strength of the future receipts from the compensation fund, sources said. 

He also said that there is no obligation on the Centre to pay the GST compensation shortfall, according to sources. Experts, however, did not like the idea of burdening the states with further debts.

Pronab Sen, country director at International Growth Centre (IGC), said at the end of the day, the responsibility is not of the states to compensate themselves.

“If The GST Council says that the states can borrow over and above what the Centre permits, you will be pushing the states into further indebtedness,” the former chief statistician said.

More importantly, there will be an excessive supply of state government bonds, which effectively means the yields on these papers will rise, he said, adding this will leave a permanent effect on the states expenditure because interest burden in the future will go up.

He suggested that the Council recommend to the Centre that the latter could borrow and transfer the funds to the states as grants.

“This borrowing could then be adjusted against the GST cess collections in future," Sen prescribed, adding otherwise you will leave states with a permanent scar.

When told that the yields on the union government papers will also go up if the Centre increases its borrowings, Sen said the rise will be much less than in a situation in which states borrow more.

There is already a 100-150 basis points difference between the yields on Central and state government bonds, he said.

The states can usually borrow up to the point that their fiscal deficit reaches three per cent of their respective gross state domestic product (GSDP). However, they are allowed to borrow two percentage point of GSDP more on various conditions under the Atmanirbhar package.

As the situation of compensation cess collections started deteriorating, the GST Council deliberated for a while on the idea of going for market borrowings at its meeting in March.

Finance minister Nirmala Sitharaman had said she would have to get opinions on various legal issues, such as who would guarantee the borrowing, how it would be repaid, the impact on the Fiscal Responsibility and Budget Management (FRBM) Act, and such like.

The Council again discussed the matter in its June meeting but deferred it to the next meeting.

But can the GST Council borrow?

Pradeep Kumar Jain, managing partner, Singhania & Co LLP, said though the GST Council is a constitutional body, its function is to make recommendations to the union and state governments on issues related to GST.

"Unlike other statutory bodies (such as Sebi, electricity regulatory authority etc), it cannot hold property or exercise borrowing powers, so it can't borrow," he said.

Kapil Rana, founder and chairman of HostBooks Ltd, also said the Council is not an organisation that can borrow money and distribute the compensation deficits to states.

Alternatively, Jain said the Council can recommend monetising future revenue just like reverse mortgage or lease rent discounting. "Here, States can borrow on the basis of their GST collection which can be paid later from revenue," he said.

The Centre can also borrow or guarantee the borrowing. A better option is for states to borrow on the Centre's guarantee, he said.

But what happens if the states default? The liability would devolve on to the Centre. To this query, Jain said, "Certainly it will be the responsibility of the respective states to repay. Since it is discounting its future revenue, there is a lower chance for default. An agreement can be executed between the stakeholders," he said.

Rana said the Centre can establish an SPV or can use GSTNewtork. "Using GSTN as an agency to monitor the distribution of deficit will help in many ways like curtailment or extension of the GST compensation collection," he said.

He said the Centre has better avenues to borrow money and has a bigger revenue budget to manage the deficit in the overall balance sheet than states.

States are not going to like the idea of putting the burden on them to borrow more.

Earlier, Kerala finance minister Thomas Isaac told Business Standard that his state had proposed in the June 12 meeting that the GST Council be allowed to borrow and extend the compensation cess by another year or two and repay.

He said while Bihar deputy chief minister Sushil Kumar Modi was forthcoming about it, Bharatiya Janata Party-ruled states were mostly lukewarm to the proposal and pressed for a legal opinion on the matter.

He said the BJP-ruled states wanted to understand the legality. "Some raised the issue that the GST Council was not a sovereign body, and cannot provide guarantee. But then, the Centre will guarantee, so what is the problem," he said.

At the recent meeting of the standing committee on finance, the finance ministry expressed its inability to compensate states fully under the present circumstances. Isaac termed this as “brazen betrayal of trust”.

The Centre and states could collect Rs 14,591 crore as compensation cess in the first three months of the current financial year, 40 per cent lower than Rs 24,613 crore in the corresponding period of the previous year. On the other hand, the target was to collect 16 per cent higher cess at Rs 1.10 trillion for FY21 against Rs 95,551 crore in the previous year. 

Other than borrowing, the option before the GST Council is to raise the tax rates or compensation cess. However, raising the compensation cess will dampen the already beleaguered sector of automobiles among other sectors.

Sen did not like the idea of raising the tax rates or cess. “In a situation where there is very strong contraction happening in the economy, increasing tax rates is just a bad idea because you are adding contraction to contraction,’ he said.

The GST Council meeting was to be held this month to discuss the mechanism of compensating states. Isaac demanded that the meeting be held immediately as promised.

The Centre had to dip in past excess funds in the compensation cess and unallocated integrated GST to compensate states in 2019-20. It was evident from the fact that the Centre released Rs 1.65 trillion as the compensation to states for the year while the cess collection stood at Rs of Rs 95,551 crore. 

Under GST law, states were guaranteed to be paid for any loss of revenue in the first five years of the GST implementation from July 1, 2017. The shortfall is calculated assuming a 14 per cent annual growth in GST collections by states over the base year of 2015-16.