States' GST compensation requirement to swell to Rs 4.1 trn in FY21

This is equivalent to 2.1 per cent of the country's estimated GDP

With the Covid-19 pandemic crippling collections of states, their GST (Goods & Services Tax) requirement is projected to swell to Rs 4.1 trillion in this fiscal, equivalent to 2.1 per cent of the country’s estimated GDP.

The total GST compensation for FY20 was estimated at Rs 1.7 trillion or 0.8 per cent of the GDP in FY20. Of this, the Government of India (GoI) released Rs 1.2 trillion to the state governments in that year, leaving an unpaid balance of Rs 505 billion for FY20.

“Moreover, we estimate that the closing balance of the GST Compensation Fund was a modest Rs 255 billion at end-March 2020, which comprises the unreleased cess balance of the prior years. Accordingly, the gap between the resources that are likely to be available to the GoI in FY2021 (Rs 494 billion plus Rs 255 billion) for disbursing the pending GST compensation requirement for FY2020 (Rs 505 billion) and the substantial requirement for FY2021 (Rs 4.1 trillion) would enlarge to Rs 3.9 trillion or 1.9 per cent of ICRA’s estimate of India’s GDP for FY2021”, a report by ratings agency Icra said.

The Covid-19 pandemic is expected to have a lingering impact on the consumption of several non-essential goods and services, on which the state governments in India levy State Goods and Services Tax (SGST), which is a key source of their own tax revenues. Icra expects the SGST collections to contract by 30 per cent to Rs. 3.5 trillion in FY2021 from Rs five trillion in FY2020. This is less than half of Icra’s estimate of the aggregate protected revenues of the state governments of Rs 7.7 trillion.

According to the report, GST compensation cess, which is levied on some specific items including automobiles and coal, for compensating the states’ shortfall in their SGST collections relative to their protected SGST revenues, would halve to Rs 494 billion in FY2021 from Rs one trillion in FY2020. This mainly reflects the expectation of muted demand for discretionary items, including automobiles, in the light of the ongoing Covid-19 crisis.

While the Union government recently increased the net borrowing ceiling of the state governments to five per cent of Gross State Domestic Product (GSDP) in FY2021 from three per cent of GSDP, to address the expected shortfall in their revenues because of the Covid-19 crisis, the increase in unconditional borrowings is limited to 0.5 per cent of GSDP only.

“We estimate the additional unconditional net borrowing of the states for FY2021 at Rs one trillion, which would be adequate to offset only a fourth of the aforementioned gap of Rs. 3.9 trillion between the GST compensation required and available cess collections. We estimate the conditional borrowing of 1.5 per cent of GSDP permitted to the state governments for FY21 at Rs. 3.0 trillion”, the report by Icra noted.

However, this is linked to the achievement by the state governments of the targets related to four reform areas prescribed by the GoI in FY2021. If the states are unable to achieve these targets and therefore not eligible to borrow the additional 1.5 per cent of GSDP, any mismatches in the magnitude and timing of the release of the GST compensation by the GoI to the state governments will considerably exacerbate the fiscal and liquidity stress that the states are experiencing in the aftermath of the Covid-19 crisis.