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    VIEW: Centre's terms for States extra borrowing impractical; will mar relations

    VIEW: Centre's terms for States extra borrowing impractical; will mar relations

    VIEW: Centre's terms for States extra borrowing impractical; will mar relations
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    By Latha Venkatesh   IST (Published)

    By far, the most impactful announcement in the fiscal package till now is to allow the states to borrow 2 percent more of the Gross State Domestic Product (GSDP).
    This amounts to an extra borrowing of Rs 4.28 lakh crore, which is equal to extra borrowing that the Centre is planning for itself. Of course, a large part of the states' borrowing will be to make up for tax shortfalls. The shareable pool of taxes includes income tax and GST and most economists are working with a tax shortfall of at least 1% of the GDP for the Centre. It could well be more.
    Also the states’ own revenues, excluding GST – ie taxes on petroleum products, electricity, and alcohol; as well as land revenue and stamp duties will be hit. Yet, it is possible there could be a small bit, maybe 0.5 percent of SGDP of the extra borrowing, which can be used to support the states’ economies.
    The other ramification of this extra state borrowing will be on interest rates. The state bonds, or state development loans (SDLs) are sub-sovereign bonds and the sudden increase in the amount of SDLs by Rs 4 lakh crore will cause yields to rise. Since corporate bonds trade at a spread over state loans, any rise in SDL yields will increase the cost of borrowing for corporates.
    It will be interesting if, in the interest of rate transmission, the RBI takes the unprecedented step of including SDLs in its open market purchases (OMOs).
    But the most important impact of the announcement of the extra states borrowing is the challenge it throws to fiscal federalism. The Finance Minister’s presentation said that while 0.5 percent of the SGDP will be allowed to be borrowed unconditionally, the balance 1.5 percent will be linked to specific reforms:
    1. Ensuring sustainability of the additional debt through higher future GSDP growth and lowered deficits
    2. Promote the welfare of migrants and reduce leakage in food distribution
    3. Increase job creation through investment
    4. Safeguard the interest of farmers while making the power sector sustainable
    5. Promote urban development, health, and sanitation.
    These conditions raise some practical questions. How is one to measure “higher future GSDP” – you will only know that only in hindsight.
    Who decides what level of migrants’ welfare is good enough?
    What are the measures of urban development, health, and sanitation? And most importantly, how does one measure power sector reforms, while linking it to farmers. Will a state that refuses free power to farmers not qualify for the extra borrowing?
    Even more important is whether the Centre has the moral authority to impose these conditions. The Constitution treats states and centre as co-equal sovereigns and the quality of a state government’s performance will be judged by its electorate, not the Centre.
    And what is the Centre’s record on sustainable fiscal deficit? The CAG itself has called out the Central government on its repeated understatement of deficit. Since the start of the FRBM(Fiscal Responsibility & Budget Management) Act in 2003, Central governments have missed their budgeted fiscal targets in most years. As for food distribution leakages, the Centre’s Food Corporation, is the leakiest giant. The moral authority of the Centre to act as the judge of states’ behaviour is clearly shaky. Its constitutional authority, even more so.
    The 15th Finance Commission’s terms of reference (clause 4) allow the commission to propose performance-based incentives for states, but the criteria it mentions do not quite tally with what the finance ministry has proposed today. Anyway, this clause in the terms of reference evoked considerable anger from the states, especially the one that said states will be measured based on the achievements of the flagship schemes of the Government of India.
    The states may still be willing to be lectured to or measured by the finance commission, which is a constitutional authority. But why would states as co-equal sovereigns allow themselves to be judged by one ministry of the Central government?
    Incidentally the 15th Finance Commission has not made any recommendations in its interim report for the year 2020-21 on this performance parameter and said it will deal with it in its October report.
    There is the final question of the amendment of the FRBM Act. Both the Centre and the states are breaching their deficit limits by huge margins. It may be a good time to remove the ill-advised clause that the government may exceed the deficit limits in times of war, famine, or grave national crisis by 0.5 percent. The original version of the FRBM Act in 2003, as recommended by the Y V Reddy-led committee, did not contain the number 0.5 percent. It merely said deficit targets will stand null and void in times of crisis. It is time to restore section 4, sub-section(2) of the FRBM to that recommended by Dr Reddy. In a crisis, there should be no limits to the sovereign's power
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