Finance Minister Nirmala Sitharaman on Friday writes a letter to states explaining the reason for the GST turnaround and informed that the central government has decided to borrow up to Rs 1.1 lakh crore on behalf of them.

The development comes after four months of confrontation over GST dues between the Centre and states.

“Based on the suggestion of many states, it has now been decided that the central government will initially receive the amount and then pass it on back-to-back to the states as loan. This will enable ease of coordination and simplicity in borrowing, apart from ensuring a favourable interest rate,” Nirmala Sitharaman explains.

In a statement, she said states were offered a special window to borrow ₹ 1.1 lakh crore over and above their existing limits to bridge the shortfall. The money will now be borrowed by the centre and passed on to states.

“The interest rate will be very reasonable. The interest and principal will be met from the future proceeds of the cess,” she said.

The entire arrear of compensation would eventually be paid to the states, she said.

Finance Minister further said she was “sensitive to the fact that states need to be protected from the adverse consequences of higher borrowing in the form of interest liability and addition to debt”. The centre would therefore arrange the borrowing in a manner that the cost would be at or close to the interest rate of the central government.

“Under Option-I States were to be provided a Special Window of Borrowing of ₹1.1 lakh cr, and over and above that, an authorisation for additional Open Market Borrowings of 0.5% of their GSDP. The authorisation for increased OMBs of 0.5% of GSDP has been issued by Ministry of Finance on 13th October and are in relaxation of the reform conditions that were stipulated for eligibility. Additionally, under Option-I, the States are also eligible to carry forward their unutilised borrowing space to the next Financial Year,” Ministry of Finance said in a press note.

Under the Special Window, the estimated shortfall of Rs 1.1 lakh cr (assuming all States join) will be borrowed by Government of India in appropriate tranches, it added.

This will not have any impact on the fiscal deficit of the Government of India. The amounts will be reflected as the capital receipts of the State Governments and as part of financing of its respective fiscal deficits.

This will avoid differential rates of interest that individual States may be charged for their respective SDLs and will be an administratively easier arrangement.

“It may also be clarified that the General Government (States+Centre) borrowings will not increase by this step. The States that get the benefit from the Special Window are likely to borrow a considerably lesser amount from the additional borrowing facility of 2% of GSDP (from 3% to 5%) under the Aatma Nirbhar Package,” it said.

A slowdown in the economy after the lockdown induced due to the coronavirus has resulted in a drop in GST collections.

Last month, in a debate in Lok Sabha, Finance Minister Nirmala Sitharaman had said that the GST council will discuss how it can compensate to the states.

“Even if we are in an act of God situation, but we will discuss in the Council how to give compensation to the states… The Council will take a call on how to borrow to meet the (revenue) gap,” she had said.

The states are staring at Rs 2.35 lakh crore GST revenue shortfall this fiscal. Out of this, considering the 10 per cent nominal growth and other assumptions, the shortfall on on account of GST implementation and COVID-19 pandemic are Rs 97,000 crore and Rs 1.38 lakh crore respectively.

The Centre had proposed two options for States—borrow either Rs 97,000 crore from a special window facilitated by the RBI, or Rs 2.35 lakh crore from the market. The Centre also proposed extending the compensation cess levied on luxury, demerit and sin goods beyond 2022 to repay the borrowing.