Borrowing room for states, sans cooperative federalism

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Published: June 2, 2020 6:30 AM

The stimulus announced by the Union finance minister in five instalments is not likely to have much impact in reviving the economy in the short term.

 At a time when it is important to stimulate demand, the conditions stipulated for borrowing could lead to the unintended result of compressing capital expenditures.At a time when it is important to stimulate demand, the conditions stipulated for borrowing could lead to the unintended result of compressing capital expenditures.

Even after nine weeks of lockdown, there are no signs of the coronavirus curve flattening anytime soon. As the GDP estimate for the fourth quarter of FY20 shows, even before the lockdown was announced, the economy had witnessed a sharp downturn to record just 3.2% growth, and combined with revision of the estimate for other quarters, the estimate for FY20 has been dragged down to 4.2%, the lowest in the last 11 years.

There is pessimism all around, and the partial relaxation of the lockdown has not helped much in terms of economic recovery, because over 70% of businesses are concentrated in the hotspots. Most observers see a sharp contraction in the economy this year, by at least 5%, unless the government comes out with a significant fiscal stimulus to revive demand conditions.

The stimulus announced by the Union finance minister in five instalments is not likely to have much impact in reviving the economy in the short term. Of the Rs 20.97 lakh crore stimulus announced, Rs 8 lakh crore was from RBI, for augmenting liquidity and other support measures for SMSEs and NBFCs, Rs 3 lakh crore from the banks for collateral-free loans to SMSEs, Rs 2 lakh crore concessional credit to farmers through Kisan Credit Cards, Rs 1 lakh crore infrastructure fund from Nabard and Rs 1.9 lakh crore were earlier liquidity measures.

The total budget outgo from the central government was just about Rs 1.7 lakh crore, or 0.8% of the GDP. The reduction in the policy rate by RBI and the liquidity enhancing measures can work only when the businesses start their operations and, again, we can take the horse to the water, but can’t make it drink.

The states are on the forefront of this battle, but have lost their fiscal power. The lockdown has completely eroded their revenue from the meagre handles at their disposal, and there will be sharp reduction in tax devolution from the Centre. Even the promised GST compensation by the Centre has not been forthcoming. As the GDP in the country is expected to contract during the year, the divisible pool of central tax revenue is likely to shrink substantially. The estimates vary, but the tax devolution is likely to be lower by at least Rs 2.5 lakh crore.

Faced with such a distress situation, the states were hoping that the announcements made by the finance minister would have a Covid-19-grant component to cover at least a portion of the loss in tax devolution. Instead, the finance minister has allowed the states to borrow an additional 2% of GDP from the market. The states have been allowed to increase their borrowing by 0.5% of the GSDP without any conditions. Additional 1% of GSDP can be availed only by fulfilling four reform conditions, each allowing an additional 0.25%. The reforms to be undertaken are (i) one nation, one ration card which requires linking Aadhaar number to ration cards and installing point of sale machines in all fair price shops, (ii) improvement in ease of doing business according to the norms specified by DPIIT, (iii) power sector reforms that entail reducing aggregate technical and commercial (AT&C) losses, direct benefit transfers to farmers instead of lower tariffs and reducing the gap between average cost and average revenues, and (iv) urban local body reforms requiring the states to notify property tax floor rates according to circle property values and notify water and sewer charges. If at least three of the four reform conditions are satisfied, the states can avail the remaining 0.5% of the GSDP as well.

The permission to avail additional borrowing comes as a relief, but raises the question of appropriateness of using the distress situation to force the states to implement the Centre’s agenda. There is nothing unconstitutional about this as Article 293 (3) requires the Union government to permit the states to borrow when they are indebted to it and Article 293(4) enables that, “A consent to borrow may be granted subject to such conditions, if any, as the Government of India may think it appropriate”. However, this precedence can open the Pandora’s box. The Centre can impose conditions in the future, irrespective of their merits.

There may not be anything wrong with the conditions by themselves. Linking of ration cards with Aadhaar is certainly desirable to ensure nationwide portability. However, this does not solve the problem of not having the ration card itself. It is also important to reduce the discom losses, but the problem is not the same for all states, and the ‘one size fits all’ reform may not yield the desired results. Property taxation can be an important source of revenue to the urban agglomerations, but may not be easy to implement in places like Maharashtra that are still smarting under the Rent Control Act.

Finally, promoting competition to achieve ‘ease of doing business’ may precipitate such an outcome better than micromanaging policies and their implementation. In any case, these reforms could have been discussed with the states in the spirit of cooperative federalism, and each state could have been allowed to implement them in a manner best suited to it, instead of thrusting the reforms on the states, taking advantage of their distress. Moreover, it is not possible to ensure that the reforms undertaken will remain. Nor are these ‘once for all’ reforms; they require periodic changes.

What could be the outcome of stipulating these conditions? The states will weigh these conditions and carry out the reforms they deem feasible. Most of the states have already linked Aadhaar numbers to the ration cards, and it may not be difficult to install POS machines in the shops. Similarly, most states may work on ease of doing businesses at least on paper. There may also be attempts to reform the urban property taxes, but to what extent it will increase the property tax revenues remains to be seen.

Politically, power sector reform will be the most difficult to implement. Clearly, the states will implement only those reforms that are politically easy. It is possible that some of them may even forgo borrowings and instead, prefer to cut capital expenditures. At a time when it is important to stimulate demand, the conditions stipulated for borrowing could lead to the unintended result of compressing capital expenditures.

Former director, NIPFP, and member, Fourteenth Finance Commission
Views are personal 

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