Bridge the gap

Centre's decision to borrow doesn't fully address the GST issue

The Union government’s decision to borrow and on-lend to the states to cover the shortfall in goods and services tax (GST) collection should be welcomed. Contrary to its earlier position, the Centre will now borrow Rs 1.1 trillion and pass it on to the states. The debt will be repaid by extending the levy of cess beyond five years. In the given context, this is certainly a more efficient way of borrowing than forcing individual states to approach the market. This would also make things easier for the government’s debt manager (Reserve Bank of India), and the states would get a better and uniform rate. However, this borrowing will not be reflected in the Centre’s accounts and will be the liability of states. Thus, it will not affect the deficit and debt of the Union government.

While the Centre’s move will definitely help states in the near term as it will ease the cash crunch, it is unlikely to end the disagreement between the Centre and the states, because it still leaves a large gap. The expected shortfall in the states’ share of GST collection in the current year is likely to be Rs 3 trillion. The cess collected to compensate the states for the revenue loss is projected to be about Rs 65,000 crore. The Union government has also allowed the states to borrow an additional sum worth 0.5 per cent of gross state domestic product, which would help cover the shortfall. Predictably, some states are not happy with the arrangement and want the Centre to borrow the entire sum and distribute it to the states, which can be serviced by extending the compensation cess. The additional borrowing by the states will increase debt, which will need to be serviced by their own resources.

To be sure, servicing the entire borrowing to cover the GST shortfall by extending the compensation cess could increase uncertainty and affect the overall business environment. But the appropriate decision should have been taken in the GST Council. It is for the Council to decide how resources would be raised, including borrowing from the market, in case the compensation fund falls short. But this is not how the issue has been addressed. In fact, the way the compensation issue has been handled raises an important question as to where it leaves the GST Council. The Centre had proposed two options to cover the shortfall in GST collection without adequate consultation with the states. The first option included borrowing Rs 1.1 trillion, which would be repaid by extending the compensation cess. Under the second option, the states could borrow the entire shortfall of Rs 2.35 trillion but were expected to bear the interest cost.

The last meeting of the GST Council ended without a consensus, but the Centre went ahead and allowed the states that accepted the first option to borrow from the market. It then decided to do the borrowing itself and on-lend to states. It is not clear how the concerns raised by some of the states would now be addressed. Ideally, all these decisions should have been taken by the GST Council. The handling of the compensation issue, which is not yet fully settled, has certainly damaged the standing of the GST Council and is bound to affect Centre-state relations at a critical juncture.