If the Narendra Modi government is willing to treat the worst recession India faces in 85 years as a national financial emergency, it should readily accept the demand put forth by various state governments that the Centre borrow additional funds from the market at cheaper rates and handover the urgently needed resources to the states.
This may sound logical, but there is a continued stalemate over this issue between the Centre and states in the GST (Goods and Services tax) Council.
In the midst of such an unprecedented crisis, the Modi government cannot treat any part of this problem as a Centre versus State issue. Indeed, it must remember that after the 2008 financial markets meltdown, the US government, the Federal Reserve and states all worked together as one entity to do whatever was needed. The current economic crisis is much bigger than the 2008 financial meltdown. India’s economy is particularly affected more severely than many other peers because of a sharp structural decline in real economy parameters, like private investment and employment, even before COVID-19 struck.
At such a juncture, it is untenable for the Centre to quibble over who will borrow what amount to fund basic needs of the economy. One can concede that the states’ demand for full compensation based on an annual 14% growth in the economy may not be justified this fiscal.
But what is entirely justified and necessary is their contention that the Centre must borrow from either the market or RBI to make up for the revenue shortfalls necessary to meet basic welfare and other expenditures in the context of COVID-19. Even the Fiscal Responsibility and Budget Management (FRBM) Act mandates that if the overall GDP falls below -3%, then the Centre can borrow from RBI to meet the budget requirements. So some states are asking why the Centre is not invoking those provisions of FRBM Act. After all, the FRBM Act flows from the will of parliament and must reflect the will of the people.
Mistrust between the centre and states
In this backdrop, the Centre forcing states to borrow while imposing all kinds of conditionalities to borrowing beyond the limit of 3% of state GDP is most unfortunate and goes against the spirit of federal accommodation in our polity. The Centre must remember that the blame for the structural decline in growth, investment, employment and revenues largely rests with Modi’s unthinking and undemocratic experiments like demonetisation in which states were not consulted. This was followed by a badly implemented GST and a complete emasculation of the informal sector.
Even now, states are hardly consulted in big decisions like the farm reform Bills and changes in electricity laws which fall squarely in the state domain. There is little doubt that the Centre has mismanaged the economy badly over the past few years. After all this, if the Centre imposes onerous conditions on states’ additional borrowing requirement to meet the necessary expenditure against the background of COVID-19, it is nothing short of arrogance and a wilful disregard to the spirit of federalism. This is a health and financial emergency.
There is a massive tax revenue shortfall as India’s economy has shrunk 24% in the April-June quarter. Overall revenues are already 25-35% less than what was budgeted. This has thrown the expenditure budgets on health, education, sanitation, law & order – all managed by States – out of gear.
The Centre has conceded that there is a GST compensation shortfall of Rs 2.35 lakh crore which is due to states. And yes, it has agreed to extend the cess compensation beyond 2022. But to deal with the huge short-term funding requirement, the Centre cannot ask states to borrow it on their own strength from the market. As I said earlier, it does not really matter who borrows because it is a national crisis. Whoever can borrow more cheaply and efficiently must do so.
The state governments argue that the Centre is best placed to borrow cheaper from the market. The Centre has offered to help the states to borrow some of this money – over Rs 1 lakh crore – via a special window created by RBI. The Centre has offered to subsidise interest costs and even agreed to service states’ debt servicing via cess. Instead of getting into such complex arrangements, it is best that the Centre borrows directly and gives the money to states. But Modi appears quite reluctant to do so.
This stalemate continues and threatens to undo the spirit of federalism which brought the Centre and 31 states together in a grand bargain to implement the GST reforms. There is growing mistrust between the Centre and states over how to jointly tide over the current economic crisis.
Amicable resolution of issues required
The Centre has a greater responsibility to make things work as it had promised the states when GST was implemented in 2017.
At least 10 opposition states for the first time are threatening to put the current dispute—who will borrow the funds to meet the massive revenue shortfall—to vote in the GST Council.
The Centre which has the support of about 20 BJP-ruled states and union territories wants to avoid a vote because so far the GST Council has resolved disputes through discussion and by evolving a consensus. If put to vote, the Centre will need 75% of the votes to have its way. The Centre plus 20 states will have close to a 75% vote, but it could be touch and go. To keep up the spirit of federalism, it is imperative that the Centre avoid a vote because GST is barely 3 years old in India. It must seek to build a consensus and reach a compromise with the 10 opposition states and resolve all outstanding issues to mutual satisfaction.