Idea Exchange: States need to be rated on fiscal matrix, says NK Singh, chairman, 15th Finance Commission

Given that contingent liabilities arising out the large outstanding debt and rising losses of electricity distribution entities (discoms) remained an intractable problem and an unmitigated risk to states’ finances despite a series of financial bailout packages, ‘genuine reforms’ in the power sector could not wait any longer, 15th Finance Commission chairman NK Singh said on Wednesday. Unbundling of the state power utilities was still an unfinished task, he noted, and added that the issue of ‘regulatory capture’ – state electricity regulators being hamstrung by the political executive –, needed to be addressed on priority, along with a fast-tracking of privatisation of discoms.

Speaking at the Indian Express Idea Exchange, Singh said that although the Centre might not appear to be scoring higher than the state governments on the yardstick of spending quality, the states’ fiscal performances were very mixed, with some of them tending to be profligate, (primarily because the power sector is mired with large cross-subsidies, still-to-be-eliminated pilferage & theft and unsustainable freebies).

Asked why the RBI remained wary of invoking the tripartite agreement (among states, the Union government and RBI) which empowers it to deduct the default amounts from discoms and transfer these to the power generators (NTPC has recently asked for invocation of the pact), Singh said the issue must be seen in totality and in the context of separation of fiscal powers as defined in the Constitution.

Even as the states needed the Centre’s permission to borrow from the market, the market doesn’t distinguish much between states on the basis of fiscal performance, given the implicit state guarantee for the borrowings reliant on the contingency funds of states. He advocated a system of independent rating for states, depending on the quality of their finances.

He added that he was aware the Union power ministry was planning to amend the Central Electricity Act to enable much greater diligence to be exercised in appointing state power regulators and according them much greater flexibility and autonomy.

“On automatic debit (of default amount) by RBI, a proposal was put forth to the Commission in an impassioned way by the Union ministry of power. First of all, under which provision, can the RBI resort to this is a question.” Singh noted that unlike many other federal government structures in the world, there can’t potentially be sub-national bankruptcies in India. “California (state) in the US, for instance, can go bust, but there is no way when a state in India does market borrowing, (it could be under similar threat),” he said.

In its report, the 15th FC has allowed an additional borrowing limit of 0.05% of GSDP for a state, for reduction in AT&C losses as per targets and another 0.05% borrowing space for reduction in the ACS-ARR gap. Also, introduction of DBT to all farmers in a state in lieu of free electricity given to them will entail additional borrowing limit of 0.15%.

On the vertical devolution formula proposed by the commission, Singh said a fine balancing was done, ensuring that the Centre would have the resources, among others, to spend on emerging and evolving needs of defence and internal security and states got a good deal.

He cited a recalibration of the gross revenue receipts (GRR) of the Centre – rather than at the sub-levels of gross tax receipts and divisible pool which would have been more limiting for states – as part of the funding mechanism for the non-lapsable corpus for defence and internal security, a deepening of the centrally sponsored schemes in order to give the states’ more flexibility in choosing schemes and accessing funds and use of instruments like revenue deficit grants (to 17 states), as steps to make available adequate resources to states.

Singh said a more fundamental review of the norms for fiscal resource sharing might be possible with a re-look at the Seventh Schedule that defines separation of powers.

“We were persuaded (by the terms of reference) of the need for a non-lapsable fund for defence. One of the proposal was a defence cess, on which, we did not proceed. So, what we have done a combination of harnessing the internal resources of the defence ministry, namely the monetization of land, proceeds from disinvestment of defence PSUs and a recalibration of the GRR by one percrentage point to create the fiscal space from the Consolidated Fund of India,” he said.

Article 270 of the Constitution enables the Centre to levy any specific-purpose cess and retain it, and Article 271 empowers Parliament to levy a surcharge on any tax, for a short period. So while it was not upon the Commission to alter this, it recognised a rise in the incidence of these imposts (from 10.4% of gross tax receipts (GTR) in 2011-12 to 19.9% in 2018-19), and sought to arrest the trend through recalibration. During the commission award period, the proceeds of cesses and surcharges as a share of GTR will come down to 18.4%.

Incidentally, 4.6 percentage points of the 19.9% share of cesses and surcharges in GTR in 2018-19 was on account of the GST compensation cess of which the states are the beneficiaries. “Hopefully, if the compensation cess ends, that particular part will go off permanently from the reckoning of cess and surcharges,” Singh said.