GST compensation: how some states are borrowing

  • IASbaba
  • November 12, 2020
  • 0
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Topic: General Studies 2,3:

  • Functions and responsibilities of the Union and the States, issues and challenges pertaining to the federal structure
  • Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment. 

GST compensation: how some states are borrowing

Context: After Puducherry, Congress-ruled Rajasthan last week became the latest Opposition-ruled state to opt for a special borrowing window for meeting its compensation shortfall under Goods and Services Tax (GST)

Other dissenting states — Kerala, Punjab, West Bengal, Chhattisgarh, Jharkhand — are yet to join any of the borrowing options floated by the central governmen

About GST Compensation

  • Before GST, States had the power to levy some indirect taxes on economic activity. Therefore, after GST regime was introduced (in 2017), the Centre promised guaranteed compensation to the States for the first five years, for the revenues they lost after the shift from the earlier system. 
  • The compensation is calculated at a growth rate of 14% keeping 2015-16 as the base year and by levying a Compensation Cess on Sin and luxury goods.

Background of the Issue

  • The total GST revenue shortfall for the current fiscal (2020-21) was estimated at Rs 3 lakh crore. Compensation cess collection for this fiscal is estimated at Rs 65,000 crore, thus leaving a compensation deficit/shortfall of Rs 2.35 lakh crore.
  • The Centre distinguished the GST shortfall into two types: 
    • (1) Due to GST implementation itself; 
    • (2) due to the impact of Covid-19 – which was termed as Act of God
  • The GST Compensation Act, 2017 had not envisaged Act of God events like COVID-19 and thus did not have any mechanism to deal with shortfall arising out of such crisis.
  • Thus, the Centre had earlier refused to compensate GST shortfall arising due to covid-19 to the states.
  • However, States argued that Centre cannot absolve of its responsibility to make up for GST revenue shortfall and thus demanded full compensation amount.

How did Centre try to solve the issue of compensation deficit?

  • Of the Rs 2.35 lakh crore compensation shortfall, Rs 1.1 lakh crore has been estimated as shortfall on account of GST implementation, while the rest (1.25 lakh crores) is being estimated as the impact of the pandemic (Act of God).
  • In August after GST Council meet, the Centre gave two options to the states
    1. Borrow Rs 1.10 lakh crores (revised figures) from a special window facilitated by the RBI at a reasonable G-Sec-linked interest rate. The amount can be repaid after five years ending 2022 from cess collections (on luxury goods).
    2. Borrow entire Compensation Cess (2.35 Lakh Crores) from the market facilitated by the Centre and RBI. In this case, the burden of repayment is on States and the Union government will provide relaxation of 0.5% in states’ borrowing limit under the FRBM Act.
  • States will have to bear the cost of borrowing in two cases, albeit at a reasonable interest rate. States had specifically asked the Centre to borrow and pay the compensation cess shortfall to them

What is the Central government’s new special window for borrowing?

  • The Centre would borrow from the market and then act as an intermediary to arrange back-to-back loans to pay the GST compensation shortfall of Rs 1.1 lakh crore to state governments. 
  • Also, States have been hence given additional unconditional borrowing freedom of 0.5% of the gross state domestic product (G-SDP) in FY21.
  • The states opting for this window are also eligible to carry forward their unutilised borrowing space to the next financial year.
  • This arrangement will not reflect in the fiscal deficit of the Centre, and will appear as capital receipts for state governments.
  • Kerala, Punjab and Chhattisgarh have insisted on further clarification and inclusion of the balance compensation deficit amount beyond the proposed borrowing of Rs 1.10 lakh crore, too, under the ambit of the back-to-back loan mechanism.

What are the merits of Centre enabled borrowing?

  • The earlier proposal was for a special window to be facilitated by the RBI and the Centre, but states would have had to tap the window separately. 
  • One of the primary concerns for earlier mechanism was that it leads to differential rates with a wide variance in interest rates between the states with more debt and those with less debt.
  • Also, the yields for state development loans (SDLs), which is the tool for market borrowing by states, are generally at a premium, higher than the yield on the central government’s G-Secs.
  • So, it would have been costlier for states to borrow rather than the Centre borrowing at a uniform rate and then passing it on to them as a back-to-back loan.
  • Also, Centre did not go for any immediate hikes in the tax rate as it would have overburdened consumers, especially during the ongoing economic slowdown.

How has the scheme progressed so far?

  • Under the special window, the Centre has already borrowed Rs 12,000 crore in two equal instalments and passed it on to 21 states and three Union Territories on October 23 and November 2. 
  • The second round of borrowing was done at an interest of 4.42%, and the first round at 5.19%, lower than the cost of borrowing for states.

What is the way forward for the rest?

  • The Finance Ministry is now engaged in dialogue with the opposing states to join the scheme. 
  • Economists say the borrowing issue has only been resolved for the compensation shortfall for this fiscal.
  • It remains to be seen how this issue will be resolved for the next fiscal, given that tax revenues are expected to grow at a lower rate than the 14% growth guaranteed to states under the compensation mechanism of GST.


Rather than waiting for the last moment and doing back and forth, the GST Council should have come out with a detailed resolution plan.

Connecting the dots:

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