The FM assured states that under option 1, the Union government will arrange borrowing at a very reasonable interest rate.

FM nirmala speaking at a press conference closeup shot wearing a pink mask
Money GST Friday, October 16, 2020 - 19:50

Hours after the Union government announced that it would be borrowing the GST compensation and lending to states as back-to-back loans, Finance Minister Nirmala Sitharaman wrote to the states on the details of the same. 

In the letter, she pointed out that the Union government has also been affected by the pandemic due to fall in revenue and enhanced expenditure. She stated that the Union government faces “serious budgetary constraints” and that the fiscal deficit will be far in excess of what was budgeted.

Detailing how the borrowing will work, she wrote that the Centre will receive the amount and pass it on back-to-back as a loan. This, she said, “will enable ease of coordination and simplicity in borrowing, apart from ensuring a favourable interest rate”.

With these funds, the quantum of resources available to the state is “adequate to meet the entire amount of compensation which would have been payable this year”, the FM wrote in the letter, adding that the interest rate will be “very reasonable”.

The minister added that the interest and principal will be paid off with future proceeds of the GST compensation cess (extended to 2024) and the Union government will eventually pay off all arrears of compensation. She also said that the borrowing will be directly arranged by the Union government.

Stating the Union government’s legal position as per the Attorney General, the Finance Minister said that the compensation will only be paid from the proceeds of the GST Compensation Cess and is “not an obligation of the Central Government to pay it from the Consolidated Fund of India”.

The FM assured states that under option 1, the Union government will arrange borrowing in a manner that will ensure that cost will be the same as, or close to the interest rate of the Union government.

She added that she is sensitive that states need to be protected from the adverse consequences of higher borrowing in the form of interest liability and addition to debt.

“As regards the additional debt, it has been made clear that the debt through the special window will not be accounted for as State's debt for the purpose of Finance Commission and other such norms,” she wrote.

Under option-1 that was accepted by 21 states, they will get a loan of Rs.1,10,208 lakh crore through a special window to cover the shortfall. Interest on the borrowed amount would be the first charged on the cess.

The letter added that the second source of funds for states is additional unconditional market borrowing, where the condition levied as part of the Centre’s borrowing package will be relaxed, and states can borrow up to 0.5% of their Gross State Domestic Product (GSDP) without meeting any conditions.

“The amount of funds available to States collectively under Option- works out to Rs.1,10,208 crores (special window) plus Rs.1,06,830 crores (0.5% of GDP without condition). Hence, a total of over Rs.2.16,000 crores of resources is unconditionally available under Option-I. This more than covers the funds which would have been received during the current financial year, if total compensation were paid in full. (I am informed that out of an estimated shortfall of Rs.2.35 lakh crores accruing in the current financial year, Rs.1.83 lakh crores would have been payable this year and the rest next year.) In other words, under Option, the State will not face any cash shortfall relative to the hypothetical position if they had got the total compensation under the Act,” the letter states.

The principal and interest will be paid from the proceeds of the cess, and hence doesn’t have to be paid from the regular budgetary resources of the state, the FM said.

“We have attempted to structure the special window in the optimum manner to protect the long term economic interests of the nation, including public and private sector. Long term macro-economic stability is the responsibility of the Centre; but it is also in the interest of the States who are partners in our system of cooperative federalism,” she said.

“The bona fide opinion of the Central Government on this macroeconomic issue is that borrowing on the books of Centre will not be optimal in the national interest,” the letter further states.

In conclusion, she said they are moving ahead with the special window, and that unconditional borrowing upto 0.5% GDP has already been made operational for states.

Watch: What GST compensation is and why is it important to states

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