GST UNCERTAINTY CONTINUES

The Goods and Services Tax (GST) Council, chaired by Union Finance Minister Nirmala Sitharaman, met on Thursday with a single-point agenda to resolve the issue of compensation to the states owing to a shortfall in revenue collection. The states have not been compensated so far in the current financial year, because the Centre has not been able to bridge the revenue gap owing to the inadequate collection of the compensation cess. Overall GST collection has declined significantly in the current year, largely because of the Covid-induced lockdown. The state governments were assured compensation for five years in case GST collection fell short, assuming an annual growth rate of 14 per cent. But the Centre has made it clear that the shortfall cannot be bridged by the Consolidated Fund of India.

According to the Centre’s calculation, the shortfall in the current year, adjusting for compensation cess collection, is likely to be ~2.35 trillion. It has been argued that the entire shortfall is not because of the implementation of GST, but also due to Covid-related factors as the lockdown imposed to contain the pandemic resulted in a momentous fall in economic activity and consumption. The Centre has thus given two options to the states: First, a special window can be provided, in consultation with the Reserve Bank of India (RBI), for borrowing of ~97,000 crore at a “reasonable interest rate”. The amount can be repaid after five years (of GST implementation) ending 2022 from cess collection. The second option before the states is to borrow the entire ~2.35 trillion shortfall under the special window. The loan can be repaid out of the compensation cess from the sixth year onwards and the states will not have to use other resources. The proposed arrangement is only for the current year. The states had rejected the idea of borrowing from the market and suggested the Centre borrow and distribute. The Union government has also given an additional relaxation of 0.5 per cent of gross domestic product in the borrowing limit of states under the Fiscal Responsibility and Budget Management Act.

The states, being at the forefront of fighting the pandemic, are facing financial difficulties and some are reported to be delaying salaries of their employees, including health care workers. While the proposed plan may look reasonable on paper in that the states will not have to bear the burden, it would create a fair amount of uncertainty. For instance, how will the funding mechanism work if the states are not expected to approach the market? If they borrow from the market, how will the RBI manage yields? The Centre is expected to share the details in the coming days, which will allow the states to pick their option. More broadly, the extension of the compensation cess beyond five years will create uncertainty for businesses. It is not clear at this stage as to how long the cess will be in place to cover the current year’s shortfall. Though the proposed arrangement is only for the current year, revenue could be under pressure in the next fiscal year as well. The overall uncertainty and delays will create more stress in Centre-state relations at a time when they are required to work closely to implement reforms and revive growth.