Macroeconomy

In April to June 2021, India May Grow by 15-30%, But We’ll Still Be Catching Up

Summary: Base effect – The collapse in GDP during the April to June 2020 is going to make the GDP growth during April to June 2021 look fantastic.

I want to make a prediction here. And this is a fairly easy one.

A year from now, in early September 2021, you will see a spate of WhatsApp forwards and social media posts, which will say that India is the fastest growing large economy in the world.

And unlike most other times, when WhatsApp forwards and the social media are either trying to outrightly lie and if not that, then at least trying to mislead, this time around they will be 100% correct.

Of course, this grand success will be attributed to the greatness of the current government. And that’s where the misleading part will come in again.

All that will happen is the base effect will come into play. Now what’s the base effect? Instead of me giving you a definition and confusing you, let’s try and understand this in some detail, but in a simple way.

For the period April to June 2020, the Indian gross domestic product (GDP), a measure of economic size, was at Rs 26.9 lakh crore. This was 23.9% lower than the GDP during the period April to June 2019, which was at Rs 35.4 lakh crore. Hence, the GDP came down by a massive Rs 8.5 lakh crore.

The major reason for this was the massive contraction of 26.7% in private consumption, in comparison to April to June 2019. Over and above this, the investment in the economy contracted by 47.1%.

Given that consumption and investment are two major parts of the economy, it is hardly surprising that the economy contracted by as much as it did.

Nevertheless, as the economy opens up and people gradually go back to doing things like they always used to, the private consumption number is bound to improve gradually. The investment in the economy will also go up albeit at a much slower pace.
The reason for this lies in the fact that even before covid struck, the Indian industry had excess capacity and the capacity lying idle has gone up post covid.

This will ensure that the GDP figure for the current and the next two quarters will improve. By the time April to June 2021 comes around India will be in growth territory and that too a massive one.

The GDP during April to June 2021 is bound to be much more than the GDP during April to June 2020 (unless there is a lockdown of similar proportions). This is where things get interesting.

Let’s see what the GDP growth in April to June 2021 is likely to be at various levels of GDP in comparison to the GDP of Rs 26.9 lakh crore in April to June 2020. The chart plots various scenarios.

Up, up and away 

Source: Author calculations and National Statistics Office.

As can be seen from the above chart, the GDP growth figure is likely to be very high for the period April to June 2021.

If the GDP were to recover to Rs 30 lakh crore, the growth will be 11.5%. But in absolute terms we will still be where we were in April to June 2016, when the GDP was at Rs 29.7 lakh crore. So, we will be around five years behind.

If the GDP were to recover to Rs 31 lakh crore, the growth will be 15.2%. But in absolute terms we will still be where we were in April to June 2017, when the GDP was at Rs 31.4 lakh crore. So, we will be around four years behind.

If the GDP were to recover to Rs 32 lakh crore, the growth will be 19%.

If the GDP were to recover to Rs 33 lakh crore, the growth will be 22.7%.

If the GDP were to recover to Rs 34 lakh crore, the growth will be 26.4%. But in absolute terms we will still be where we were in April to June 2018, when the GDP was at Rs 33.6 lakh crore. So, we will be around three years behind.

If the GDP were to recover to Rs 35 lakh crore, the growth will be 30.1%. But in absolute terms we will still be where we were in April to June 2019, when the GDP was at Rs 35.4 lakh crore. So, we will be around two years behind.

In exact terms, India needs to grow by greater than 31.6% in April to June 2021 to be able to cross where we were in April to June 2019. Even in the most optimistic scenario, covid has probably cost us two years of growth.

Hence, the growth in April to June 2021 will look fantastic. And that’s simply because the GDP in April to June 2020 simply collapsed. This collapse will lead to the GDP growth April to June 2021 looking very good. And this, dear readers, is nothing but the base effect at play. Also, if the GDP figure for April to June 2020 gets revised downwards, as it is likely to be, then the growth figure will look even better.

Given this, the GDP growth numbers during 2021-2022, the next financial year, will have to be taken with a pinch of salt. The numbers from April to June 2022 onwards will tell us the real story about economic growth being back on track or not.

Of course, given that most of us do not understand basic fifth standard mathematics or simply choose to ignore it, we will buy into this massive double-digit growth story.

Yes, we did it. It’s always been more fun to believe in rhetoric than use the brain. And a year down the line in history isn’t going to change that.

Winter and Money Printing are Coming to India, In a Few Months

The Controller General of Accounts publishes the state of government finance at the end of every month. This data is published with a gap of one month. Hence, on 31st August, the data as of 31st July, was published.

This data, not surprisingly, doesn’t make for a good reading. The fiscal deficit, the difference between what a government earns and what it spends, for the period April to July 2020 stood at Rs 8.21 lakh crore. The fiscal deficit that the government had plans to achieve during the course of the current financial year (2020-21) stands at Rs 7.96 lakh crore. Hence, at the end of July, the actual fiscal deficit of the government was 103.1% of the budgeted one.

But given the state we are in this is hardly surprising. Nevertheless, there are several reasons to worry. Let’s take a look at it pointwise.

1) Tax collections have collapsed. Between April and July 2020, the gross tax revenue, which brings in a bulk of the money for the central government and which it shares with the state governments, is down 29.5% to Rs 3.8 lakh crore, in comparison to the same period in 2019.

Let’s look at the different taxes collected by the government between April and June this year and the last year.

They all fall down


Source: Controller General of Accounts.

 

As can be seen from the above chart, the collections of all major taxes are down big time.

Take the case of central goods and services tax. (GST) or the part of GST that ends up with the central government. During April to July 2019, the total collections of the central GST had stood at around Rs 1.41 lakh crore. During the same period this year the collections have fallen by 34% to Rs 92,949 crore. Other taxes have fallen along similar lines.

The fall in GST collections is a reflection of a massive slowdown in consumption. A slowdown in consumption ultimately reflects in a slowdown in income of individuals as well as incomes of companies. Ultimately, one man’s spending is another man’s income.

But there is something that the above chart does not show, the excise duty collections of the central government. They are up year on year by 23.8% to Rs 67,895 crore. This despite the fact that the consumption of petroleum products between April and July is down 22.5% in comparison to 2019.

So, how have excise duty collections gone up? The central government has increased the excise duty on petrol from Rs 22.98 per litre to Rs 32.98 per litre. The excise duty on diesel has been raised from Rs 18.83 per litre to Rs 31.83 per litre. Also, a substantial part of this duty is a cess, leading to a situation where the central government does not have to share the revenue earned through the cess with the state governments.

In the process, the central government has captured a bulk of the fall in oil prices.

2) As mentioned earlier, the central government needs to share a part of the money it earns with state governments. Between April and July it shared Rs 1.76 lakh crore with states, against Rs 2 lakh crore, during the same period last year. This is 12% lower, during a time when the states are at the forefront of fighting the covid-epidemic.

The ability of the state governments to raise taxes, after having become a part of the goods and services tax system, is rather limited. Take the case of petrol and diesel. The central government has raised excise duty by such a huge extent that the state governments aren’t really in a position to raise the value added tax or the sales tax on petrol and diesel, which they are allowed to charge, without having to face political repercussions for it.

3) The central government has more ways of raising money than the states. One such way is disinvestment of its stakes in public sector enterprises. This year the government plans to earn a whopping Rs 2.1 lakh crore through this route. The original plan included the plan to sell Air India. Whether that happens in an environment where the airlines business has been negatively rerated in the aftermath of covid, remains to be seen.

The other big disinvestment plan was that of the government selling its stake in the Life Insurance Corporation of India through an initial public offering. There are one too many regulatory hurdles that need to be removed, before a stake in India’s largest insurance company can be sold to investors. Long story short, it looks highly unlikely that the government will get anywhere near earning Rs 2.1 lakh crore this year, through the disinvestment front.

Having said that, the government can always resort to some accounting shenanigans, like getting one public sector enterprise to buy another, and pocketing that money. This is likely to happen in the second half of the year.

Over and above this, the government earns a lot of money from the dividends that it earns from public sector enterprises as well as banks and financial institutions. The target for this year is around Rs 1.55 lakh crore. Public sector banks will continue to remain on a weak wicket through this year, hence, their ability to pay dividends is rather limited.

The only way the government can make good this target is by raiding the balance sheet of the RBI for money. Also, the government is likely to raid the cash balances of public sector enterprises which have them, by asking them to pay special dividends.

4) The money that gets invested into various small savings schemes, which includes schemes like Post Office Savings Account, National Savings Time Deposits ( 1,2,3 & 5 years), National Savings Recurring Deposits, National Savings Monthly Income Scheme Account, Senior Citizens Savings Scheme, National Savings Certificate ( VIII-Issue), Public Provident Fund, KisanVikas Patra and Sukanya Samriddhi Account, net of the redemptions, is a revenue entry into the government budget.

This time it has been assumed that the government will get Rs 2.4 lakh crore through this route. Between April and July, Rs 38,413 crore or just 16% of the targeted money has come in. Last year, during the same period, 38% of a much lower target of Rs 1.3 lakh crore had been achieved. Clearly, this target is also going to be missed.

5)  Of course, the government understands this and which is why in early May it increased its borrowing target from Rs 7.8 lakh crore to Rs 12 lakh crore, by more than 50%. The government borrows money to finance its fiscal deficit.

What this means is that the government wants to at least keep the fiscal deficit to around Rs 12 lakh crore. The question is will that happen? Gross tax revenues are already down 30%. Of course, as the economy keeps opening up, this number will look better. Having said that, even if tax revenues are down by 15% as of the end of the year, we are looking at a shortfall of Rs 2.5 lakh crore for the central government. The other big entries of disinvestment and the net-revenue from small savings schemes, are also looking extremely optimistic in the current situation.

Even if the government achieves a fiscal deficit of Rs 12 lakh crore and the economy shrinks by around 10% this year, we will be looking at a central government fiscal deficit of 7% against the targeted 3.5%.

In this scenario, it is now more than likely that the RBI will resort to direct financing of government expenditure by printing money and buying government bonds. The government sells bond to finance its fiscal deficit.

This isn’t to say that the RBI hasn’t printed money this year. It has. But it has chosen to operate through the primary dealers. But the mask might come off in in the time to come and the RBI might decide to buy bonds directly from the government.

Winter and money printing are coming to India, in a few months.

 

The US Economy Contracted by 9.1% and not 32%. India’s Economy Contracted by 23.9%.

Summary: I had absolutely no plans of writing this. But given what has been happening on Twitter and WhatsApp since the morning, I was forced to write this. Please read and share widely.

There is a full-fledged controversy raging on the internet where people have said that the economy of the United States, as represented by its gross domestic product (GDP), contracted by 32%, during April to June 2020. This was worse than India’s contraction of 23.9%.

This comparison is totally wrong. The way the United States reports GDP growth/contraction is different from the way India does. Let’s try and understand this in detail.

In April to June 2020, the US economy contracted by 9.1% in comparison to January to March 2020. This is a quarter on quarter comparison. This figure is then annualised.

How do we annualise it?  We do that by assuming that the US economy will continue to contract by 9.1% quarter on quarter, over the next three quarters (basically we compound in a negative direction, since the economy is contracting). Let’s understand this through a simple example.

So, let’s say during the January to March 2020, the size of the US economy or its GDP was $100. In April to June 2020, this contracted by 9.1%. The size of the economy came in at $90.9 ($100 – 9.1% of $100).

In July to September 2020, the economy will contract further by 9.1% to $82.63 ($90.9 – 9.1% of $90.9).

In October to December 2020, the economy will contract further by 9.1% to $75.11 ($82.63 – 9.1% of $82.63).

In January to March 2021, the economy will contract further by 9.1% to $68.27 ($75.11 – 9.1% of $75.11).

Hence, by the end of one year, the economy has contracted from $100 to $68.27 or by 31.73%, which is nearly equal to 32%.

This is how the GDP growth/contraction numbers in the US get reported. Hence, by this logic, on an annualised basis, the US economy contracted by close to 32% in the period April to June 2020, in comparison to January to March 2020. But this figure can’t be compared with the Indian figure.

The Indian system is different. The GDP during a particular quarter is compared to the GDP during the same quarter in the last year. In the Indian case, the GDP contracted by 23.9% during April to June 2020, in comparison to April to June 2019 (and not January to March 2020, as is the case with the US). The Indian comparison is a year on year one and not a comparison with the previous quarter. The US comparison is a quarter on quarter comparison which is then annualised.

If the US were to report the GDP growth/contraction in the same way as India, its GDP during April to June 2020 contracted by 9.1% in comparison to the GDP between April to June 2019. The Indian economy contracted by 23.9% during the same period. That’s the right comparison.

This is the right way of looking at things and not how they are being misrepresented on the social media, even by experienced economists.

Explained: Why Central Govt Needs to Compensate States for Collapse in GST Collections

Summary: I went looking for the legal reasons being offered by the central government to not compensate the state governments for the dramatic fall in GST collections. I found a central government paper explaining the logic with a lot of legalese. This piece tries to summarise the legalese in simple English. Along with that, I offer many reasons as to why the central government needs to adequately compensate the states. This is definitely not something you will read in the mainstream media.

As has been reported almost everywhere by now, the central government doesn’t want to compensate the state governments for a shortfall in goods and services tax (GST) collections that is going to happen through this year.

In an earlier piece I had explained why this was a bad decision. In today’s piece we will try and understand the central government’s reasoning behind this decision, at the same time we shall also see why the central government is in a much better position to deal with the situation than states are.

The Story So Far

The GST collections between April and June this year have been around 34.5% lower at Rs 2.73 lakh crore than during the same period in July 2019. As the economy contracts in the aftermath of covid-19, the collections will continue to remain subdued during the remaining part of the year.

The central government needs to share a significant part of the GST with the state governments. Over and above this, there is also a guarantee of 14% growth in GST collections for states for the first five years until 2022. If this is not achieved, the central government needs to compensate the state governments for any shortfall.  The central government has decided not to do so.

The Legalese

This public paper explains the central government’s position on the issue. Let’s see why the government is saying what it is saying.

The Constitution (101st Amendment) Act 2016 contains the following provision:

“Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax [emphasis added] for a period of five years.”

Following the above provision, the Parliament enacted the Goods and Services Tax (Compensation to States) Act 2017. The preamble of this Act reads as follows:

“An Act to provide for compensation to the States for the loss of revenue arising on account of implementation of the goods and services tax [emphasis added] in pursuance of the provisions of the Constitution (One Hundred and First Amendment) Act.”

In fact, the emphasised parts (in bold italics) in both the 101st amendment as well as the Goods and Services Tax (Compensation to States) Act 2017, read exactly the same. What does this mean in simple English? It means that state governments will be provided a compensation if there is a loss of revenue on account of problems with the implementation of GST (of course, there have been problems galore, but let’s not go there now).

Hence, the central government could have used this technicality in denying the state governments any compensation for a fall in GST collections.

As the policy paper referred to earlier points out: “The Constitution and the preamble to the Act lay out the spirit and purpose of the GST compensation: namely that it is to compensate states for loss of revenue “arising on account of implementation of GST”. The wording of the Constitution and statutory preamble make it clear that the spirit of the law is not to compensate states for all types of revenue losses, but rather for that loss arising from GST implementation.” Ultimately, the GST collections in 2020-21 will fall majorly because of the negative economic impact of the covid-19 pandemic and not just because of the loss of revenue thanks to the botched up implementation of the GST by the central government.

The interesting thing is that the government hasn’t used the above explanation to deny compensating the states for the GST shortfall. It has gone deeper into the legalese to deny the states a compensation.

But before we get into that, the central government has this to say about the GST shortfall: “Parliament obviously could not have contemplated a historically unprecedented situation of huge losses of revenue [thanks to the spread of covid-19] from the base—arising from an Act of God [emphasis added] quite independently of GST implementation—affecting both Central and State revenues, direct and indirect.”

This is where the act of god phrase came into being, also telling us that the government doesn’t do or say anything without putting it on kagaz [paper] first.

Now let’s get back to why the government has denied compensating the states for the GST shortfall. The Section 7 of the the Goods and Services Tax (Compensation to States) Act 2017, provides the detailed mechanism for the calculation as well as the payment of compensation to the state governments when there is a shortfall.

Nevertheless, Section 7 doesn’t make any distinction between the shortfall in GST collections happening due to implementations reasons and non-implementation reasons. As the government paper points out: “Compensation is payable for the entire shortfall (even if it is not on account of GST implementation). This position has been clarified by the Attorney General and is accepted by the Central Government [emphasis in the original].”

So, if this interpretation has been accepted by the central government, why isn’t it compensating the state governments? If your head is already spinning by now, I don’t blame you for it. The legalese behind which the central government is hiding keeps getting better. Let’s move ahead.

The Section 10 of the Goods and Services Tax (Compensation to States) Act 2017 prescribes the manner of payment of the compensation to state governments in case of a shortfall. Let’s look at this pointwise.

1) The compensation is to be paid out of the non-lapsable GST Compensation Fund.

2) Money flows into the GST Compensation Fund from the GST Compensation Cess levied on sin and luxury goods under Section 8, which includes everything from cigarettes to expensive cars. This is made clear under Section 10(1).

3) Section 10(1) also makes it clear that money can flow into the GST Compensation Fund through “such other amounts as may be recommended by the Council”. Hence, other than the GST Compensation Cess only something cleared by the Council can flow into the GST Compensation Fund.

4) Section 10(2) says that compensation under Section 7 “shall be paid out of the Fund”.

Basically, what the government is saying here is that any compensation to state governments on account of a loss of revenue needs to be paid out of the GST Compensation Fund.

So, the government summarises its position by saying: “The states are entitled to compensation…regardless of the cause of the shortfall. However, compensation is to be paid only from the Compensation Fund and it is not an obligation of the Government of India in the event of a shortfall. It is for the GST Council to decide on the mode of making good the shortfall.”

Of course, with the GST collections falling, the compensation cess will not be enough to make up for the shortfall. Also, what the central government is saying is that the GST Council is a different entity from it. This is the point being made on the basis of some complicated legalese. And this rather complicated legalese has been used to basically shaft, for the lack of a better word, the state governments. The central government paper also talks about the spirit of the law.

As far as the act of god point goes, if a fall in GST collections due to covid-19 is act of god for the central government, it is also an act of god for the state governments as well. What are they expected to do in such a scenario?

And given that, the law needs to be changed, simply because the facts have changed and the situation that has arisen currently wasn’t taken into account when the law was first framed. If every law was perfect as it was written first time around, there wouldn’t be so many amendments going around. As the famous British economist, John Maynard Keynes, once supposedly said: “When the facts change, I change my mind. What do you do, sir?”

The Central Government Needs to Compensate

The central government needs to compensate the state governments for this shortfall in GST collections. The state governments are at the forefront of fighting the pandemic and hence, need money. Also, state governments spend more money than the central government during the course of any year and that needs to be kept in mind as well, in a scenario, where the private expenditure has collapsed dramatically post covid.

Also, as the government paper points out: “The notion of borrowing by the GST Council is not practically or legally feasible or desirable. This leaves the options of Central or state borrowing.” Let’s look at what the central government is offering the states as a compensation.

1) The shortfall arising out of the loss of revenue due to the GST implementation has been estimated by the central government to be at Rs 97,000 crore. The state governments can borrow this money under a special window coordinated by the finance ministry. The states can repay both principal and interest by using the money they receive from the compensation cess. Also, this borrowing shall not be treated as debt. Hence, it will not limit any state’s overall borrowing ability.

2) The overall shortfall (thanks to implementation and covid impact) in GST collections has been estimated to be at Rs 2.35 lakh crore. The state governments can borrow this entire amount from the market. An amount of Rs 1.38 lakh crore (Rs 2.35 lakh crore minus Rs 97,000 crore) will be considered to be as debt of the state governments. The state governments will have to repay this debt from their own resources. They can repay the principle from the compensation cess.

The government’s logic in getting states to borrow directly from the market is rather bizarre. Nevertheless, let’s take a look at this.

This is what the government paper says: “The Government of India faces a very large borrowing requirement this year. Additional borrowing by the Centre influences the yields on Central government securities (g-secs) and has other macro-economic repercussions. The yield on G-secs acts as a benchmark for State borrowing as well as private sector borrowing. Hence any rise in Central borrowing costs ipso facto drives up borrowing costs for all borrowers, including not only the States but also the entire private sector. On the other hand, the yields on State Government securities do not directly influence other yields and do not have the same type of macroeconomic repercussions.”

What does this mean in simple English (now how many times will I end up saying this)? The central government will end up borrowing more this year than in other years. In this scenario, it will end up needing a greater amount of financial savings to fund itself. This will push up interest rates at which the central government borrows. When the rate of interest at which the central government borrows goes up, the rate of interest for the entire financial system goes up because lending to the central government is the safest form of lending. When this happens, both the private sector as well as the state governments will end up paying higher interest rates on the money they borrow.

The central government’s contention is that the above logic does not apply to when state governments borrow. Their borrowing doesn’t end up pushing overall interest rates.

This is bizarre to say the least. If the state government borrows more from the same pool of savings, it will end up pushing the overall interest rates in the financial system, upwards.

The question is why doesn’t the central government want to borrow more. The government originally expected to borrow Rs 7.8 lakh crore to finance its fiscal deficit in 2020-21. Fiscal deficit is the difference between what a government earns and what it spends. This has already been increased by more than 50% to Rs 12 lakh crore. Any further borrowing will mean, the central government’s already terrible numbers on the fiscal front, will end up looking even more terrible.

I guess that is the logic running in the minds of the babus at the finance ministry and their minister. The trouble is this logic doesn’t hold. Irrespective who borrows, the state governments or the central government, the public debt or the overall debt of the public sector, will go up. Further, there is an implicit sovereign guarantee on state government debt.

As Shaktikanta Das, the governor of the RBI said in November 2019: “There is an implicit sovereign guarantee in them… On the due date of repayment, RBI automatically debits the state government account and makes the repayment. So, there is an implicit sovereign guarantee.” Hence, ultimately, if there is any trouble on this front, it is the central government’s problem.

Further, the central government is in a much better position to raise money. It can sell its stakes in public sector enterprises. It can also sell their land. It has access to a variety of cesses (tax on tax) from which it can earn money. This is money it doesn’t need to share with state governments. It also has access to the profit made by the Reserve Bank of India, as well as its reserves. The ability of the state governments to tax post GST has come down.

Also, various central government institutions (from banks to insurance companies) end up buying bonds issued by the state governments. In that sense the interest on these bonds gets paid to them. The profits made by these institutions end up with the central government, one way or another (corporate income tax/dividends/special dividends etc.).

Hence, there are many reasons as to why the central government should compensate the state governments for a fall in GST collections. But the biggest reason as the deputy chief minister of Bihar, Sushil Modi told the the Press Trust of India: “It is the commitment of the central government to compensate the states for the shortfall in GST collections. It’s true that it is legally not binding on the Centre, but morally, it is.”

Modi belongs to the BJP.

India’s MIDNIGHT TRYST with GST is Turning into a Priyadarshan Comedy

Summary: 

There must be some kind of way outta here
Said the joker to the thief
There’s too much confusion
I can’t get no relief.

— Bob Dylan, All Along the Watchtower.

 

India’s midnight tryst with the Goods and Services Tax (GST) is a little over three years old and is looking more and more like a bad joke which, we brought upon ourselves.

The state of GST takes me back to the last thirty minutes of several Priyadarshan comedies, where everyone is running after everyone else and no one knows what is really happening. (Actually, it can also compared to the ending of the wonderful comedy Andaz Apna Apna).

In reel life, all this confusion has the audience in splits. In real life, those going through the experience feel like they are a part of surreal black comedy.

Yesterday, the finance minister Nirmala Sitharaman said that the covid-19 pandemic was an act of god and that would impact GST collections negatively. An act of god is essentially a natural hazard which is beyond human control, something like an earthquake or a tsunami for that matter. No one can be held responsible for it.

The act of god has led to a situation where the GST collections have nose-dived. This is hardly surprising given that private-consumption has come down over the last few months. Also, by characterising the fall as an act of god, the central government doesn’t want to be held responsible for the fall in GST collections.

Nevertheless, it needs to be said here that GST collections weren’t doing well even before covid-19 struck. Let’s take a look at the growth/fall in GST collections between August 2018 and February 2020, before the covid pandemic struck.

All is well?

   
Source: Centre for Monitoring Indian Economy.

The above chart clearly shows that the growth in GST collections had been falling since early 2019 though it did recover a little since late last year, before stabilizing at half of the peak growth. In November 2018, the growth in GST collections was 16.5%. In February 2020, it was at 8.3%.

The point here being that the growth in GST collections had slowed down since early 2019. It picked up again in late 2019, thanks to a cap on the input tax credit that certain businesses could take. Festival season sales also helped.

This slower growth in GST collections was a reflection of a broader economic slowdown, for which the botched up implementation of GST was also hugely responsible. Of course, the spread of the covid pandemic has only made the situation much worse, with GST collections falling between March and July.

In a normal scenario, a fall in tax collections would mean lower expenditure by the government. But the situation that prevails is nowhere near normal. With private consumption falling, the governments (states and central) are expected to continue spending money, in order to keep the economy going.  Also, state governments are at the forefront of fighting the epidemic and they need money to do that.

The GST collections are split between the central government and the state governments. One of the carrots that the central government had offered to the states in a bid to make GST acceptable and to hasten India’s midnight tryst with GST, was a promise of a compensation if the GST revenues did not grow by 14% from one year to the next. The GST(Compensation to States) Act, guarantees state governments a revenue protection of 14% for the first five years of GST.

Of course, it doesn’t take rocket science to understand that GST revenues will contract in 2020-21, the current financial year. Hence, as per the GST(Compensation to States) Act, state governments need to paid a compensation by the central government.
As per the law, a compensation needs to be paid to state governments every two months. In fact, the compensation due to states for the period April to July 2020, stands at Rs 1.5 lakh crore.

This money comes from the compensation cess which is levied on both sin and luxury goods. The trouble is that like the overall GST collections, the growth in collections of the compensation cess had been falling through most of 2019. This can be seen in the following chart.

To sin or not to sin?


Source: Centre for Monitoring Indian Economy.

In June 2020 and July 2020, the collections of compensation cess fell by 9.4% and 15%, respectively. It needs to be said that even during an economic slowdown or a contraction, the consumption of sin and luxury goods does not fall at the same pace as the overall consumption. But despite that, the compensation cess collected in 2020-21 will not be enough to pay state governments to ensure a 14% growth in overall GST earned.

The shortfall in GST collections as per the central government is expected to be at Rs 2.35 lakh crore. It has said that this shortfall cannot be paid for through the consolidated fund of India, which is a repository for all the money earned by the central government through taxes as well as the money it borrows.

Basically, the central government after promising a 14% growth protection to states on GST, has come back and told them, hey, now that we are in trouble, you are on your own. It reminds me of an old line in buses in North India, sawari apne samaan ke khud zimmedar hai (the travellers are responsible for what they are carrying). The joke, the way the drivers of these buses drove, was, sawari apni jaan ke bhi khud zimmedar hai (the passengers are also responsible for their lives). This is the kind of joke that the central government has just cracked on state governments. This is black humour of the finest kind, which you won’t even see in an Anurag Kashyap movie.

In order to fulfil the gap, the options offered to the state governments by the central government are: 1) To borrow Rs 97,000 crore at a reasonable rate of interest from a special window at the Reserve Bank of India. The Rs 97,000 crore number is an estimate of GST loss due to implementation issues. 2) To borrow the entire gap of Rs 2.35 lakh crore. These options are only for 2020-21. The states can repay the money in the years to come by using the GST compensation cess they receive in the years to come.

This leads to a few points:

1) The central government basically sold the state governments a dummy in promising a 14% growth in GST collections. A narrative was created, it was marketed and then the constituents of the narrative were abandoned.

2) The state governments were also responsible for this to some extent given their resistance to the original law. Also, the central government was in a hurry to ensure India’s midnight tryst with GST, in order to create a narrative.

3) It is easier for the central government to borrow than for the states to do so. It seems here that the central government doesn’t want to spoil its fiscal deficit number any further than it already will this year. Fiscal deficit is the difference between what a government earns and what it spends.

Nevertheless, whatever be the case, the total government borrowing (centre + states) is bound to go up. So, I really can’t understand what is the fuss around the central government borrowing more. Also, with the GST in place, the ability of state governments to tax more is rather limited. Their main taxes on alcohol, real estate, petroleum products and vehicles, have already taken a huge beating this year.

4) It will be interesting to see the legal logic being used by the central government to take this stance. From what I understand, the GST Council and the central government are being considered separate entities (Maybe some lawyer can explain this in simple English).

5) If the state governments borrow from the market, how is it going to impact bond yields?

6) Also, the compensation cess on luxury and sin goods, will now have to be extended beyond 2022 and this will not go down well with businesses, which are already struggling.

7) There is bound to be in increase in compensation cess on some luxury and sin goods during this financial year. That remains the easiest way for the government to increase tax revenues. Also, I sincerely hope the GST Council doesn’t start increasing tax rates on normal goods in a bid to shore up revenues (Governments and government bodies have a tendency to do that).

Of course, the move hasn’t gone down well with state governments. Sushil Modi, the deputy chief minister of Bihar told this to the Press Trust of India, even before the GST Council meet: “It is the commitment of the central government to compensate the states for the shortfall in GST collections. It’s true that it is legally not binding on the Centre, but morally, it is.” Modi belongs to the BJP.

West Bengal finance minister Amit Mitra said: “The question is who should borrow. The Centre… can get a better rate and has more debt servicing capacity.” The finance minister of Delhi, Manish Sisodia, accused the Centre of “betraying” federalism by “refusing” to pay GST compensation to states.

As stated earlier, these options are only for 2020-21. What happens next year? With covid-19 pandemic continuing, the negative economic impact of this might be felt next year as well. The states have a week’s time to get back to the GST Council.

Of course, until then and even beyond, all the confusion will prevail. As I said, the entire scenario now looks like the last thirty minutes of a Priyadarshan movie, where everyone is going after everyone else, and no one knows what is actually happening. The irony is that this is in real life and not something to laugh at. But then when a government talks about an act of god to wriggle out of something that it clearly promised to many other governments, what else can one do anyway but laugh in pain.

There’s has got to be some difference between the government of the world’s largest democracy and an insurance company?