#33-From my unlocked diaries: ‘Pehle Aap’ on borrowing for GST shortfall

The city of Lucknow in Uttar Pradesh, India is known for fine music and culture. Besides, it is also known for a very polished and polite Hindi (partly due to its Nawabi and Urdu influence and heritage). One such phrase that is often used in polite conversations – ‘Pehle Aap’; meaning – ‘after you’ or ‘you first’.

Well, last week’s Goods and Service Tax (GST) council meeting ended with a lot of – Pehle Aap! Unlike used in Lucknow, this Pehle Aap was for nothing pleasant. 

It was the Central Government (CG), represented by the Finance Minister (FM) and the State FMs asking each other to borrow from the market - to meet the GST shortfall!

Some background on how we got here?

GST was implemented by the CG (by current NDA government) during July 2017. One the most contentious issue, which then had become a serious road-block for GST go-live was about how the States would be compensated for their ‘perceived’ shortfall in their share of indirect tax collections. 

Remember, a lot of things changed for the States with the advent of GST regime. The right to tax Goods and Service was now administered by the CG. Unlike the legacy State VAT regimes, GST is a ‘destination’ based tax and not a ‘origin’ based tax. That explained the nervousness among the more industrial / producing States, as they had to let-go of significant revenue source.

A critical agreement was then reached by the then FM – Arun Jaitley. He used his navigation and statesman skills among many non-NDA ruled States to gain the needed consensus. Based on that agreement, CG would compensate the States for any GST shortfall for the first 5 years (till Year 2022), after assuming a 14% CAGR. It was also agreed that rather than burdening finances of CG or the States, it was decided to charge a GST Cess on consumption of certain ‘sin’ goods like cigarettes, tobacco, luxury cars and use this to fund any such tax deficits. 

Don’t laugh – it’s these smokers and pan-chewers, and those who splurge are the ones performing our ‘payback’!

And now the Pandemic hit to GST collections...

The impact of the pandemic, consequent lockdowns and its impact on business has steeply reduced GST collections, especially Cess on such sin goods as the consumers have turned cautious on discretionary spending.  

Current Proposal to fund the GST deficit to States

At the GST council last week, the Finance Minister (FM) presented 2 options to the States. As you will see below, the maximum shortfall is Covid induced - INR 2.35 lacs (~ USD 30 Bn) for the current fiscal.

And then the Pehle Aap…!

Both options have been well thought through and seem logical, no doubts about that. But what caught my eye - asking the States to borrow with Reserve Bank of India (RBI) and the CG ‘facilitating’ such borrowings?  

In my view States borrowing makes no sense - Here is why?

Let me state upfront - I am staying clear of constitutional or legal aspects of who should borrow. That is best left to the constitutional experts. 

In the current proposal all the 29 states will need to borrow. Following this approach will result in dispersed cost of borrowing, as the credit risk will be on each of the States. Given their current battered fiscal and financial position, the interest rate on such borrowings are expected to vary ranging from 6% to 12% (UP State bonds issued few months ago had a coupon of about 10.5%). This is like punishing the States (especially those States that need to borrow at higher rates) for no fault of theirs.

A more prudent approach will be for the CG to directly negotiate and borrow on behalf of the States. As in any case the repayment will come from the GST Cess, which is anyway monitored and allocated by the CG. 

Adopting this approach will mean that potential lenders (most likely Life Insurance Corporation of India - LIC, Employee Provident Fund – EPFO and other PSU and Non-PSU institutional lenders) will price the credit risk based on CG sovereign risk (perhaps further adding a premium for possible risk to GST growth estimates), as compared to pricing it based on each of the State’s financial position or fiscal risk. 

Keeping the current RBI REPO rate of 4% as a bench mark, and assuming risk premium ranging from of 1.5% to 2% for 5 years borrowing, CG can hope to raise money at a cost of 5.5% to 6%. This will achieve many benefits:

-       Reduce interest burden on all the States. A saving of about 4% (minimum) on borrowing cost over the next 5 to 7 years is going to be significant. This will help reduce the combined fiscal deficit of CG and the States 

-       Reduce burden on consumers of such sin goods (else GST council may be constrained to raise GST rates or Cess, or both should the GST revenues were to further fall, either this or subsequent fiscal years) 

-       Ensure GST Cess does not get extended for too many years beyond 2022

By doing Pehle Aap on each other, the States (including some BJP ruled) and the CG seem to be heading into another log-jam. We don’t need this tussle at this stage, do we? Our GDP has reduced by a whopping 24% during April to June - 2020, our virus count is peaking and Chinese PLA is taunting us on our borders.

The need of the hour is Statesmanship. Let us not forget - GST, one of our biggest indirect tax reforms got implemented because of the two great Statesmen and FMs – Pranab Da and Arun Jaitley.  

Many States are now facing near bankruptcy with very limited leg-room for incremental borrowing. Squabbling over who needs to borrow at this time seems silly. It seems like a missed opportunity to win the States over at this critical time in our fight against the Pandemic.

If not resolved, this is likely to be another political showdown, especially with the monsoon session of parliament coming up later in September. 

It is ironical. I write this on the day after Pranab Da passed away. It has been just about a year since Arun Jaitley passed away (Aug 24, 2019). Their ability to navigate such sticky issues is the need of the hour, and what we dearly miss. Not the Pehle Aap that is going on now.

I am still hoping that our FM or someone in the cabinet will show the much-needed statesmanship, rise above petty politics and use this as an opportunity to improve much needed Center – State relationship. 

Balu

September 1, 2020

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