Uttar Pradesh has, reportedly, pleaded with the Centre for a moratorium on annual debt servicing for a few years. This is bound to be picked up by other states. But can the Centre oblige? It borrows what it annually lends to the states: three fourths of the small savings and about a half of plan transfers. Moratorium will mean that the Centre will have to service the debt on account of UttarPradesh (and other states requiring a bail out). With its own fiscal deficit overshooting the target, the Centre has no room for manoeuvre. But if a moratorium is denied, the Centre will have to deduct the amount owed to it from its dues to a state on account of devolution and possibly also from plan transfers. Uttar Pradesh first, and other states soon enough, will come under a severe squeeze. They will face a crisis of unimaginable proportions.

A moratorium will necessarily require conditionalities. This is because post moratorium, debt servicing will stand enhanced. So, the state(s) will have to achieve agreed targets of additional tax revenue and expenditure reduction. Enforcement of conditionalities will, however, inevitably complicate relations between the Centre and the obligated state(s). There is no alternative to advance releases of central funds to the state(s); the debt servicing problem of the states is best left to the fiscal commission. The commission could recommend waiver of dues to theCentre, if it thinks there are special problems. What is worrisome is that the states, and the Centre, have yet to realise that it is not possible to live beyond means. The finance commission must devise a carrot and stick approach to ensure that the states optimise their tax revenues and rationalise expenditure. (Conditionalities by another name!) But the more fundamental problem is that the Centre resorts to public debt to fund its obligations to the states instead of shoring up tax collections.