States got free money — in schemes like Uday — and did little reform, so the Centre’s conditions aren’t that unfair
Given that states are going to be woefully short on resources this year as tax collections dwindle, they will have to work that much extra to implement the reforms set out by the Centre to enable them to borrow more from the bond markets. The reason the additional borrowings—up to 2% of GSDP beyond the permitted FRBM limit of 3% of GSDP—are important is that, without this, states will be forced to axe capital expenditure. Several commentators as well as finance ministers of various states have said that it is unfair for the Centre to set conditions for the states to meet in these difficult times. Certainly, the ban of alcohol sales for about two months hit state government revenues, and the central government penchant to levy ‘cesses’ instead of straightforward taxes in many areas means less has to be shared with the states under the finance commission formula.
But, the conditions being insisted upon are more in the nature of reforms—in areas such as PDS, ease of doing business, power sector and urban local bodies—and can only benefit the states. The carrot-and stick approach is probably needed to push states into implementing the reforms. In the power sector, for instance, despite the Uday bailouts—and there was another around a decade before Uday—the states did precious little reform, as a result of which state electricity boards (SEBs/discoms) owe power-generating firms about Rs 90,000 crore. And instead of penalising state governments for this, the central government has once again agreed to bail out the SEBs with a Rs 90,000 crore loan package from PFC and REC. So, it is hardly unreasonable for the Centre to ask that states bring down the aggregate technical and commercial (AT&C) losses and also narrow the gap between average cost and average revenues. This should have happened in the normal course, but for the last two decades, states have failed to raise electricity tariffs to allow SEBs/discoms to break even. Indeed, the other conditions like those on property tax will only help urban local bodies function better since their finances will improve as a result. Also, ensuring that the one-nation, one-ration-card scheme gets going, and installing PoS machines at Fair Price Shops will ultimately benefit the local population, as will transferring cash to farmers instead of charging them lower power tariffs. The conditions may sound like diktats, but the fact is many states have been reluctant to reform. After all, if states comply with the DPIIT’s ease of doing business norms and the business environment improves, they will attract investment.
Instead of sitting back and complaining, the states might want to move forward on reforms since not doing so could cost them heavily. Given the expected 5% GDP contraction in FY21, and, therefore, a collapse in tax revenues, states will be left with very little to spend on capex. The budgeted Rs 7.8 lakh crore of devolution for FY21 could end up closer to Rs 5 lakh crore, a shortfall of Rs 2.8 lakh crore since the Centre’s Rs 24.2 lakh crore target will not be met. Also, since tax collections in FY20 were short by Rs 1.5 lakh crore, the states got Rs 53,700 crore extra of tax devolutions, and this will need to be returned. Revenues from local levies too will take a hit due to the lockdown and the slump in economic activity due to the pandemic. Given likely state government revenues, a back of the envelope calculation shows that if they are able to borrow 4% of GSDP, they may not need to cut capital expenditure by more than 50%. Else, the capex would need to be further axed. If they reform, however, it can be a win-win.