In view of the massive disruption to economic activity due to Covid-19 impact and likely huge shortfall in revenues, the council felt that fiscal response to the crisis should be much more nuanced.
Even though many hard-pressed state governments have asked the Centre to raise their fiscal deficit limit to 5% of GSDP from 3% now, 15th Finance Commission chairman NK Singh said such a change would be time-consuming as it will require a new law at state level and central government consent.
An expeditious option, Singh said, would be for states to invoke an “escape clause” to breach their FRBM mandated fiscal deficit target by half a percentage point, giving them flexibility to respond to economic shocks similar to the option available to the Centre.
“By the way, 5% fiscal deficit would be in disregard of the state FRBM Acts. So, that will require a new Act and the new Act will require approval from the Centre,” Singh said after the meeting of its advisory council here. Abandoning state level FRBM Acts might not be a solution as they are linked to various incentives, based on the Finance Commission recommendations, which all state governments want to avail.
While the combined fiscal deficit of states in FY20 is seen higher than 2.6% of GDP estimated, several states recently asked Prime Minister Narendra Modi for forbearance in FY21, for raising the deficit level to even 5%. Singh also doubted that even if fiscal deficit limit is enhanced, states would like to borrow from market due to upward pressure on interest rates and possibility of weak demand.
The advisory council members discussed the implications of the Covid-19 pandemic for GDP growth in FY21 and FY22 and uncertainty about macro variables over time. They also discussed possible assumptions for tax buoyancy and revenue in the current year and next year as well as what should be the public expenditure fillip to shore up the economy. The 15th FC has to submit its second report in October for 5-year period beginning FY22, with regard to devolution of central taxes and other incentives to states.
In view of the massive disruption to economic activity due to Covid-19 impact and likely huge shortfall in revenues, the council felt that fiscal response to the crisis should be much more nuanced. Members of the council were of the view that some mechanism has to be worked out to support cash-starved MSMEs.
In order to avoid bankruptcies and deepening of NPAs in the financial sector, measures should be appropriately designed. Measures like partial loan guarantee may help. The Reserve Bank of India will have a key role in ensuring that financial institutions are well-capitalised, they said.
The finances of the central and state governments need to be watched carefully. As of now, adequate provision for ways and means advances can largely help governments to manage cash-flow mismatches. “As we move ahead, we need to think of options for financing the additional deficit. It is important to ensure that the state governments get access to adequate funds to undertake their fight against the pandemic,” the Finance Commission said quoting council members.