The States Goods and Services Tax (SGST) collections are expected to contract by 30 per cent to ₹3.5 lakh crore in FY21 from ₹5 lakh crore in FY20, reflecting lower consumption of non-essential items in the aftermath of the Covid-19 pandemic, according to credit rating agency ICRA.

With the protected revenues of the States estimated at ₹7.7 lakh crore for FY21 (₹6.7 lakh crore in FY20), the agency anticipates a multi-fold spike in the State governments’ GST compensation requirement to ₹4.1 lakh crore in the current fiscal, from ₹1.7 lakh crore in FY20.

Of the State governments’ GST compensation, ₹1.2 lakh crore was released by the Centre to the States during FY20, leaving an unpaid balance of ₹50,500 core as of end-March, the agency said in a report.

Jayanta Roy, Group Head - Corporate Sector Rating, ICRA, observed that with the Covid-19 pandemic and associated lockdown expected to shrink non-essential consumption, the finances of the State governments would undergo a dual shock.

“Firstly, the SGST collections would contract by 30 per cent in FY21, entailing a spike in the compensation requirement to ₹4.1 lakh crore based on ICRA’s assessment. Simultaneously, the cess collections that are meant to be funnelled towards the GST compensation would dry up in the current environment,” said Roy.

Accordingly, the risk associated with the magnitude and timing of the release of the GST compensation to the State governments has escalated sharply and would exacerbate the fiscal and liquidity stress that the States are experiencing due to the Covid-19 crisis, he added

Under the GST (Compensation to States) Act, 2017, the level of protected revenues of the State governments is calculated based on a 14 per cent annual growth rate on the base year (FY16) revenues subsumed into the GST.

The gap between the State governments’ actual SGST collections and the protected revenues is required to be released by the Centre to the States in the form of GST compensation for the first five years after the transition to the GST regime. The source of funding the GST compensation is a cess levied on consumption of some specific items, including automobiles, coal etc.

The Centre recently enhanced the permitted net borrowing of the State governments in FY21 to 5 per cent of Gross State Domestic Product (GSDP) from 3 per cent of GSDP, to address the expected shortfall in their revenues related to the pandemic. Out of this, additional borrowing of 1.5 per cent of GSDP is conditional on the States executing reforms in FY21 in four areas outlined by the Centre, the accomplishment which is contingent on various factors.

ICRA has estimated the permitted enhanced unconditional borrowing of 0.5 per cent of GSDP for the State governments for FY21 at ₹1 lakh crore, which pales in comparison to the gap (of ₹3.9 lakh crore) between the estimated GST compensation requirement and the funding for the same through cess collections.

The agency estimates the total unconditional net borrowing that is now permitted to the state governments by the Centre at ₹7.4 lakh crore for FY21. Adding the estimated redemption of ₹1.4 lakh of State Development Loans (SDL) in FY21, the agency pegs the permitted gross market borrowings of the States at ₹8.8 lakh crore, nearly 38 per cent higher than the gross SDL issuance of ₹6.3 lakh crore in FY20.