42nd GST Council meet likely to be postponed to October 5 amid compensation row

"Around 19 of 31 states and union territories have replied to the Centre on their views about the options extended by the Centre to deal with the GST compensation shortfall. However, others are yet to reply," the source pointed out.

States in favour of option one are Bihar, Gujarat, Karnataka, Madhya Pradesh, Tripura, Assam and Goa and those in favour of the second option are Manipur and Sikkim.

States not in favour of either options are Delhi, Punjab, Rajasthan, Chhattisgarh, Tamil Nadu, Jharkhand, Telangana, Puducherry, Kerala and West Bengal.

In the 41st GST Council meeting held on August 27, the Centre had proposed two borrowing options for states to meet the GST shortfall. The first option proposed borrowing of Rs 97,000 crore by states with 0.5 percent FRBM relaxation, while the second option proposed borrowing of Rs 2.35 lakh crore to meet the full compensation in cess fund deficit.

Meanwhile, the message coming from the Centre is clear that it continues to stay committed to paying the entire shortfall of compensation to states, irrespective of whether it is on account of GST implementation or COVID pandemic.

With regards to the on-going GST row, government officials clarified that the GST Council is not looking to hike GST rates and no decision has been taken yet on moving a proposal to cut rates as well.

However, borrowing by the Centre would create pressure on yields and inch up the rates, sources said.

Under the first option, the protected revenue beyond Rs 97,000 crore will be given as and when the cess kitty has requisite funds. Most likely, the GST Council would extend the cess window to repay borrowings, officials said, adding that the Centre was open to relax another 0.5 percent under the FRBM window for states if they agree for the first option.

"Untill now (six months of the current fiscal), none of the states have been able to exhaust the entire 3 percent borrowing window and states are parking investments in T-bills," they opined.

"The government in its note on the borrowing option circulated to all states had said that it is committed to paying compensation. It has never been the stand of the finance minister that the loss of revenue due to COVID-19 would not be compensated. The entire compensation sum on account of shortfall in collections of GST will be paid and honoured," sources said.

If states go for option one and borrow Rs 97,000 crore, it does not mean they will have to forego the remaining compensation, is what the Centre conveyed.

"Working out revenue shortfall on account of GST implementation is just a mechanism to assess how much of the shortfall should be met by borrowing and how much could be deferred. Borrowing for meeting the entire shortfall when the private sector is struggling to stand back on its feet could hurt them badly. The remaining compensation will be paid to states after the above borrowing has been fully repaid," sources added.

Explaining the rationale behind the fact as to why the Centre cannot borrow to meet the GST compensation shortfall, people in the know said that under the GST law, the compensation cess is a tax owned by the states. Under Article 292 of the Constitution of India, "The Centre can borrow on the security of its taxes and resources which is the consolidated Fund of India. The Centre cannot borrow in the security of the tax which it does not own," sources explained.

Listing the benefits of state borrowings, sources in the Finance Ministry said, "It will ensure that some resources in the form of compensation keep coming even after the end of the transition period, which would allow future generations also to maintain healthy levels of public expenditure. States falling off a resource cliff after the transition period of five years would not a prudent fiscal strategy."

The Government of India has already increased the borrowing limit from 3 percent, which goes up to 5 percent of GSDP. On average the states have borrowed so far only about 1.25 percent of the GSDP. Only a few states have reached around above 2 percent of the GSDP.

"Enough headroom is available to states to borrow as per their requirements and needs. In any case, they will get full compensation shortfall and therefore it is a win-win-win for all – states, Centre, and economy," is the reasoning at North Block.

If the Centre borrows it would have a higher impact on the market and push the G-Sec rate, which becomes the benchmark rate for other borrowings, including borrowing by state governments. Any borrowing by the central government would crowd out borrowings by the private sector and would make borrowings costly for entrepreneurs. The deciding factor would, thus, be whose borrowings will have the least impact on the market rates.

"It is unarguable that since rates on Central government securities works as one of the benchmarks for market rates, any additional borrowings by Centre would have a higher impact on the market rates than that by states. If the benchmark rates increase on account of borrowing by the Centre, the states too will get impacted because it will increase their cost of borrowing," sources explained.

Therefore, in the current scenario, it may be a safer option for states to raise the additional resources to meet the resource gap due to non-availability of compensation. Since the repayment will come from the compensation cess, there is no reason why rates would be different from each state. The debt window could be packaged in a way that it is state-independent altogether.