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INTERVIEW

Govinda Rao says COVID-19 to hit Centre-state ties

 

Cogencis, Monday, Apr 27

By Adrija Chatterjee

NEW DELHI - The relations between the Centre and states could worsen due to differences over financing and handling of the COVID-19 pandemic, according to M. Govinda Rao, who was a member of the 14th Finance Commission.

"At this time, you can see issues coming up in Centre-state relations on matters of finances, taxes, decision on relaxing the lockdown,” Rao told Cogencis in an interview.

Rao, Who Is Member Of The Economic Advisory Council To The 15th Finance Commission, Said The Centre Has To Help States Financially As They Are At The Forefront Of Fighting The Economic Fallout Of COVID-19

Rao, who is member of the Economic Advisory Council to the 15th Finance Commission, said the Centre has to help states financially as they are at the forefront of fighting the economic fallout of COVID-19.

"It should not be the case the central government will go on adding to its deficit, and the states have to be starved of funds. The states are suffering since revenues have dried up due to the lockdown and they need support," Rao said.

Rao said the 1.7-trln-rupee relief package announced by the central government was inadequate as there was hardly any additional expenditure involved in it.

"The first fiscal package presented by the Centre hardly had any additional expenditure. The major item there was food grain distribution and that is not actual money. Allowing loans from the employees' provident fund is not government expenditure," he said.

Rao also advocated that states should be allowed to borrow more from the market upfront in a bid to meet additional expenditure to fight the pandemic.

Below are the edited excerpts of the interview:

Q. The government seems to be reluctant about letting Reserve Bank of India directly monetise deficit?

A. The government may postpone the move to allow the Reserve Bank of India to directly monetise the deficit, but at some point of time they have to confront it because there will be a significant shortfall in tax revenues from what has been budgeted. It is not just at the Centre, but also the states are facing huge problems. Much of the fight against coronavirus and its economic impact is being fought by states. They are the frontline soldiers, but they don't have money. The central government needs to come up with a plan to help the states. The first fiscal package presented by the Centre hardly had any additional expenditure. The major item there was food grain distribution and that is not actual money. Allowing loans from the employees' provident fund is not government expenditure.

Even the person who had sort of put an end to monetising deficit, former RBI governor C. Rangarajan has come out and said that this year, considering the magnitude of the problem, some monetisation of the deficit may be unavoidable. So the government may postpone it, but they have to do it at some point of time. One has to see how things work out. At the end of the day markets also have to function. The market also has less appetite to take borrowing, and foreign money is not coming in much. Corporates do not have appetite to borrow at present and, banks can give money to the government. But there will be pressure on the market and yields will go up. The cost of borrowing is a problem.

Q. Both the government and the 15th Finance Commission need to review their projections taking into account the coronavirus pandemic.

A. The 15th Finance Commission's math has now gone for a toss due to the coronavirus. The difference between the Finance Commission's projections for central tax revenue estimate and Budget itself is large and the tax devolution would be lower by 710 bln rupees just on this account. On top of it, if you consider the actual collections in 2019-20 and adjust for growth slowdown due to coronavirus, the share of states in tax devolution is likely to go down by 2.1 trln rupees. There has to be a way of helping states at this juncture.

Q. Is it a good idea for states to borrow more from the market to fund their spending at this juncture?

A. I am of the view that the states should be given more borrowing space upfront to give them a measure of comfort in this war. It should not be the case the central government will go on adding to its deficit, and the states have to be starved of funds. The states are suffering since revenues have dried up due to the lockdown and they need support. For a state like Punjab, revenue from alcohol was quite a substantial amount. The Centre has given a broad guideline restricting inter-state movement, but in states where there are hardly any cases of coronavirus some relaxations should be allowed so that they can initiate some economic activity. And, the central government should allow states to take calls on lockdown relaxations. States have also been demanding to increase their deficit limit to 5%. I think immediately they should allow states to breach it to 4%.

There is a view that the states can invoke the escape clause in the Fiscal Responsibility and Budget Management Act like the Centre, but even that has to be allowed by the Centre. Under Article 293 (3) of the Constitution, states have to seek permission of the Centre to borrow. Most state governments may now have to cut down their capital expenditure. And, that money will have to be diverted to meet higher revenue expenditure requirements due to coronavirus. Some states have already delayed salary payments, or only partially paid salaries. At this time, you can see issues coming up in Centre, state relations on matters of finances, taxes, and decisions on lockdown.

Q. Should the Centre completely ignore fiscal prudence at a time like this?

A. The central government may have to breach their fiscal target for the current year to borrow more from the market. They can do so by giving a credible path of return into austerity. The Centre has already used the escape clause to breach their fiscal deficit target for this year, but the situation is exceptional, and they will have to breach even these targets with a credible promise of returning to austerity when normalcy is restored. However, the issue is how the rating agencies will look at such a move. Flow of international funds and cost of funds will depend on what the rating agencies say. If the performance in other countries are worse, then rating agencies should look into the relative performance. We also have a comfortable external position and foreign exchange reserves, which should also matter for rating agencies.

Q. The RBI has been playing a consistent and active role in mitigating this crisis...

A. It is like this, the RBI has put all its arsenal and then created all necessary conditions for the economy to take off. But necessary conditions are not sufficient conditions. Sufficient conditions require markets to function. So when the markets function, Reserve Bank of India's regulatory forbearance and steps to infuse more liquidity would work, but when markets do not function, who will borrow.

Q. What according to you will be the impact of the nationwide lockdown on India's growth?

A. Agriculture will continue to grow about 2-3%, but all other sectors will see an enormous contraction. The extent of contraction will depend on the longevity of the lockdown. Even if the lockdown is lifted, it will be lifted only in some places and sectors. So without full inter-state movement being allowed, supply management will be impossible. This year one could see economic contraction and negative growth. The situation is also difficult for businesses. Companies are being asked to pay salaries, but many companies may not be able to as there is no production. At the moment there is no way to know how long will it take to recover. It will take a long, long time before supply situation is normalised. The worst hit will be tourism, hospitality and aviation and automobile sectors. Export and small scale industry will also suffer a great deal. There could be a huge number of bankruptcies because of the economic fallout of this virus.

End

Edited by Vandana Hingorani

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