Synopsis–Underlying the procedural lapse and its consequences for the finance minister is a far more vexed issue of the fiscal compact between the Centre and states coming under severe strain due to revenue disruption.
Kerala’s Finance Minister Thomas Isaac is a beleaguered man. For the first time in the state’s history, a minister had to face the Privileges and Ethics Committee of the assembly to explain accusations of a breach of privilege. Isaac had to explain why he revealed to the media contents of a Comptroller and Auditor General report that termed a foreign borrowing underwritten by the state as unconstitutional.
The minister had publicly slammed the CAG’s observations. The government is obliged by law to first table CAG reports in the assembly. Underlying the procedural lapse and its consequences for the finance minister is a far more vexed issue of the fiscal compact between the Centre and states coming under severe strain due to revenue disruption. Impractical institutional arrangements for sharing resources have added to the woes, with states looking for alternative routes to raise money without triggering deficit limits.
For example, the statesponsored Kerala Infrastructure Investment Fund Board had issued Rs 2,150 crore of rupee-denominated masala bonds overseas in May 2019 to build roads, bridges and other infrastructure. “There is no space left for capital investments for states after meeting fiscal responsibility targets,” says R Ramakumar, professor at the Tata Institute of Social Sciences and member of the Kerala Planning Board. Ramakumar says Kerala merely found an innovative way within the legal framework to finance infrastructure building.
A simmering row escalated in August after the Centre said it could not compensate states for loss of tax revenue because of the pandemic-induced economic slowdown. It asked the states to borrow through the finance ministry or by themselves. After prolonged bickering, states agreed to the Centre borrowing from the market on their behalf. Media reports quoting analysis by rating agency ICRA said states’ borrowings in nine months of the financial year went up 43.5% to Rs 5,55,900 crore, two-thirds of which were by the highly industrialised states of Maharashtra, Tamil Nadu, Karnataka, Andhra and Telangana.
The Centre has been seeking more control over states’ fundraising, as detailed in its memorandum to the 15th Finance Commission (FFC). It reportedly told the FFC to define what would be permissible as states’ borrowings and bar them from incurring liability outside the parameters. It wanted power to reduce permissible borrowings by a state if it contracted unauthorised debt. “There is a need to tightly define states’ borrowings,” the Centre told the FFC last year. A fresh restructuring of resource sharing would happen from April when the recommendations of the FFC come into play. The continuing economic uncertainty means the Centre and states would be competing for resources in the next fiscal year too. And without high government spending, an economic revival appears distant.
Bank credit growth this year has been just 5.7%, against 7.9% in the year-ago period, despite the Emergency Credit Line Guarantee Scheme announced to support industry. While the Centre has announced several measures to support industry, big direct spending has been largely limited to food supply and the rural job guarantee programme, MGNREGA.
In fact, the job scheme has spent less than what it did in the previous two years as a proportion of budgeted expenditure. In the past couple of months, its actual spending has also been shrinking. While the economy shrunk by nearly 24% in the first quarter of the fiscal year, it contracted only 7.5% in Q2, raising hopes of a faster recovery. “The second half will be different,” says Dharmakirti Joshi, chief economist at CRISIL.
Although the “Covid-19 will leave a scar on the debt-GDP ratio”, he does not expect government expenditure to fall any further because economic activity and tax revenues are improving. So far, markets have been awash with liquidity. A senior fund manager on the fixed income desk of a large fund house says with core liquidity, including government balances, hovering near `8 lakh crore and demand from industry very low, the government will have no dearth of relatively low-cost funds. But “market hopes rest completely on proper distribution of a vaccine.” If those hopes are dashed, the government could be in a spot. While all pandemics have severely impacted the economy, the recovery pattern has been similar. After the outbreak of the bubonic plague in 19th century India, the RBI said recently, it took nearly three to four years for the growth rate to reach pre-pandemic levels.
Public health and infrastructure played a pivotal role in policy responses, it noted. In the first half of this year, the focus of capital expenditure was on health and education; other critical sectors may get attention in the second half, the RBI added. The faster capex picks up, the better for the economy. In an earlier study, the RBI said every rupee the Centre spends contributes three times to the GDP. For states, one rupee of capital expenditure only doubles in GDP value. So the Centre has a bigger multiplier effect.
– Centre says states have been borrowing more from the market
– State development loans up from 16.50% (2008-09) to 29.06% (2018-19)
– GoI share falls from 83.41% (2008-09) to 70.94% (2018-19)
– State debt has been more attractive to investors
– Weighted average yield up from 7.48% in 2016-17 to 7.60% in 2017-18
– Average spread of state debt over GoI bonds up from 38 bps (2014-15) to 59 bps (2017-18)
(Source: Government and 15th Finance Commission projections reviewed by ET)
The FFC, which submitted its report to the President of India on November 9, is learnt to have projected that after deducting cesses and other amounts set aside for the Centre, states would get about `52 lakh crore, including grants, between 2021-22 and 2025-26. That may not be much at a time when government spending has to increase. The sharing is arranged in such a way that the Centre would retain about two-thirds of its revenues. The commission is learnt to have provided a net borrowing limit of 4% of GSDP in 2021-22 and 3% in the fifth year. The Centre has got more leeway as it is responsible for “macrostabilisation”. All these indicate federal relations might be entering an extended period of friction.
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