Is the Centre fair in imposing cuts in borrowing limits of States retrospectively?

The need for maintaining fiscal sustainability is unquestionable. This is a joint responsibility of the Centre and the states. While the Centre has been consistent in flouting the limits mandated under the Fiscal Responsibility and Budget Management (FRBM) Act with impunity, states have by and large maintained their fiscal indicators within limits. But surprisingly, a recent decision of the Centre penalises the states for their fiscal discipline. While communicating the net borrowing ceilings of states for the financial year 2022-23, the Centre, for the first time, indicated that off-budget borrowings raised by the state public sector corporations and special purpose vehicles serviced out of the state budgets from 2020-21 onwards shall be considered as borrowings made by the state and adjusted from the borrowing limits of states in four annual instalments from 2022-23. Following the states’ protests, the base for considering off-budget borrowings as states’ borrowings has been shifted to 2021-22.

The reason mentioned for taking 2020-21 as the base year for this purpose is that it coincides with the first year of the award period of the 15th Finance Commission (FFC). There is no specific recommendation to this effect by the FFC in the report for 2020-21. In its second report for the period 2021-26, the FFC recommended that governments at all tiers may observe strict discipline by resisting any further additions to the stock of off-budget transactions and contingent liabilities. It further observed that in view of the uncertainty that prevails now, the FRBM Act needs major restructuring. It recommended that the time-table for defining and achieving debt sustainability may be examined by a high-power intergovernmental group and that the FRBM Act may be amended as per the recommendations of this group to ensure that the legislations of the Union and the states are consistent.

While there is no denying the need to regulate off-budget borrowings serviced from budgets, states are aggrieved over the manner such regulation is imposed on them retrospectively and in a discretionary manner. In fact, the Centre had indulged in such borrowings indiscriminately mostly to fund subsidies and other revenue expenditure. The report of the C&AG on compliance of the FRBM Act, 2003 for 2017-18 and 2018-19 had pointed out serious lapses of non-compliance by the Centre. The report had observed as many as eight instances of meeting revenue expenditure mostly for funding subsidies through extra-budgetary resources (EBR) in 2017-18 and 2018-19. Revenue expenditure met through EBR amounted to Rs 81,282 crore in 2017-18 and Rs 1.58 lakh crore in 2018-19. The total extra budgetary borrowings for meeting revenue and capital expenditure amounted to Rs 1.69 lakh crore in 2017-18 and Rs 2.68 lakh crore in 2018-19. Such borrowings were only reflected in the accounts of the PSEs and not in the outstanding debt and the fiscal indicators of the Government of India.

In its response, the ministry of finance stated that after April 2018 amendment of the FRBM Act, EBRs were being disclosed in the Budget but not made part of the fiscal deficit as part of a conscious legal arrangement. Not satisfied with the response of the ministry, the C&AG observed that funding expenditure of government schemes through borrowings and not disclosing them in the Budget has led to understatement of revenue and capital expenditure and fiscal indicators.

Thus, it is evident from the above observations of C&AG that the union government has not made extra budgetary borrowings as part of its fiscal deficit and Central government debt.  It was only from 2019-20, the Centre started disclosing EBRs in its budgets. From 2016-17 to 2020-21, Centre’s EBRs amounted to Rs 5.99 lakh crore. From 2021-22, the Centre dispensed with the practice of raising EBRs. The Centre’s decision to shift the year from 2020-21 to 2021-22 for the purpose of treating off-budget borrowings as states' borrowings seems to have been driven by the fact that it dispensed with such borrowings 2021-22 onwards.

This a clear case of discriminating states and following a dual policy in so far as the implementation of FRBM dispensation is concerned. Any such policy should be uniform both for the Centre and the states. Such discriminatory treatment has given rise to a number of issues adversely impacting state finances. By the time the Centre communicated its decision to treat off-budget borrowing as states’ borrowings, most of the state budgets based on the borrowing limits as per the FFC recommendations have already been passed by legislatures. With the unanticipated cuts in their entitled borrowing limits, states will face immense problems in implementing their budgets and are left with no option but to cut down their capital expenditures. State economies are just recovering from the adverse impact of Covid pandemic and need a capital boost. This is no time to take a measure that will result in cuts to capital expenditure.  In contrast to the Centre, off-budget borrowings are being used for capital expenditure by states.

An important question that arises in this context is whether the states should be further penalised by this recent decision of the Centre even while they are observing fiscal discipline. States are already deprived of their due share in tax devolution with cesses and surcharges constituting 20 per cent of the gross tax revenue of the Centre. As a result, states are getting only around 30 per cent share in central taxes as compared with the mandated 41 per cent. For the first time, the Centre has departed from the convention of treating recommendations of a finance commission relating to fiscal transfers as an award. The Centre denied states special grants amounting to `6,764 crore and `7,735 crore of grants for nutrition recommended by FFC for 2020-21. In a similar manner, the Centre denied sector-specific grants of Rs 1.3 lakh crore and state-specific grants of Rs 49,599 crore to states for 2021-26.

These arbitrary decisions go against the commitment of the Centre to promote cooperative federalism and making states strong. The Centre failed to adhere to the recommendation to constitute a high-power intergovernmental group. The recent discretionary decisions of the Centre have widened the trust deficit. There is an imperative to bridge it.  To do so, the Centre should reconsider its decision to treat off-budget borrowings serviced from budgets as states' borrowings retrospectively from 2021-22 and make it applicable prospectively from 2023-24.