Rift Over Public Funding Comes to a Head in Virus-Ravaged India

(Bloomberg) -- India’s government has failed to pay states the compensation it promised for supporting a nationwide tax reform, setting the stage for a showdown between Prime Minister Narendra Modi’s administration and the provinces.

The dispute is over 3 trillion rupees ($41 billion) that Modi’s government owes states this year, because the account from which the funds are disbursed is short by about 2.35 trillion rupees. For now, the federal administration is encouraging states to borrow the shortfall amount, promising to resume payments as tax revenue improves when the economy fully reopens from the coronavirus-induced lockdowns.

Some states ruled by opposition parties have rejected this offer and have threatened action including urging the courts to intervene.

“The law says that if there’s a dispute in the council a dispute resolution mechanism will have to be put in place,” said Manpreet Singh Badal, finance minister of the northern Indian state of Punjab and a member of the Goods and Services Tax Council that administers the indirect tax rates. “If need be, we would go to Supreme Court. But we will exhaust this option of approaching the Parliament first.”

The dispute comes at a critical time for India’s economy, which posted the biggest contraction among major economies last quarter, and can crimp public expenditure -- further delaying a recovery. India’s 29 states rely on fund transfers from the federal government to pay salaries, subsidies, and infrastructure creation after they gave up the bulk of their tax-making powers to allow the introduction of GST in 2017.

Read: India Posts Worst GDP Slump of Major Nations as Virus Spikes

Badal said Punjab has already deferred capital expenditure because of the delays -- which was described as “act of sovereign default” by Hemant Soren, the chief minister of Jharkhand state. Thomas Isaac, the finance minister of the southern Indian state of Kerala, said the federal government should borrow to compensate the states.

The GST law requires the federal government to compensate states for five years through March 2022 for any revenue loss on account of the new tax.

India’s constitution requires states to deliver health care. In the middle of a coronavirus epidemic that this week became the second largest in the world with more than 4.3 million infections, the states need all the funds they can get to ramp up the country’s rundown health system.

While federal Finance Minister Nirmala Sitharaman last month said that tax collections were strained due to “an act of god,” one of her secretaries later said the administration isn’t relinquishing its responsibility because of this “act of force majeure.”

“We are due to pay the whole amount, but the attorney general has also confirmed that we are only due to pay when the cess is available,” Expenditure Secretary T. V. Somanathan said in an interview to BloombergQuint.

Economists see little option available to the states than borrowing or squeezing spending. A decision is due at the GST council’s next meeting later this month.

“Revenue expenditure will have to be squeezed, some states may not be able to pay salaries or pension,” State Bank of India Economist Soumya Kanti Ghosh said by phone from Mumbai. “What’s more important is how do states mobilize resources?”

©2020 Bloomberg L.P.