The Budget may provide some additional fiscal space to states if they implement certain citizen-centric reforms as a special dispensation in line with the Aatmanirbhar Bharat (Self-reliant India) stimulus package that raised their borrowing limit by 2% of gross state domestic product (GSDP) in 2020-21, amounting to over 4.27 lakh crore, people familiar with the development said.

The role of states is crucial in a rapid recovery of the economy ravaged by the Covid-19 pandemic. States will require additional resources in achieving faster economic growth, which would mean borrowing beyond the limit of 3% of GSDP, two persons said, requesting anonymity.

The Union government is scheduled to present the Budget for fiscal year 2021-22 on February 1, which is expected to focus on reviving economic growth, which was battered by the nationwide lockdown imposed on March 25 to check the spread of Covid-19. As a result, the Indian economy contracted by 23.9% and 7.5% in the quarters ending June and September, and according to the first advanced estimate by the National Statistical Office (NSO), the country’s GDP is expected to contract by 7.7% in fiscal 2020-21.

“One of the options is to allow a special borrowing dispensation beyond the available space for fiscal deficit, which could be conditional and linked with specific reforms that will help to boost growth,” one of the two persons cited above said. Under the Fiscal Responsibility and Budget Management (FRBM) Act, states are allowed to keep their fiscal deficit at 3% of GSDP.

On May 17, 2020, the government raised the borrowing limit by an additional 2% of GSDP in 2020-21, worth over 427,300 crore.

While the first 0.5% or 106,830 crore was unconditional, another 1% was on condition that the states implement four citizen-centric reforms with a 0.25% value each — put in place a one nation, one ration card system, improve ease of doing business, reform urban local bodies and the power sector. The remaining 0.5% was conditional on states implementing three out of the four reforms. Later, this was relaxed for states if they opted for the first borrowing option of plugging their shortfall in Goods and Services Tax (GST) revenue of 1.10 lakh crore.

The Union finance ministry on Thursday said 10 states have so far implemented the one nation, one ration card system, seven of them have undertaken measures for ease of doing business and three states have implemented reforms in urban local bodies. They have been permitted additional borrowings of 54,190 crore.

Experts said that for a rapid economic recovery, states must be allowed to borrow more than usual and money must be spent judiciously. DK Srivastava, chief policy adviser at consulting firm EY India, said, the financial year 2021-22 would be critical for providing a significant growth push to GDP through the central and state budgets.

“As such, both central and state governments may have to rely on fiscal deficits that are well above their respective FRBM norms. A continued relaxation of states’ fiscal deficit by a margin of 2% points of GDP in FY22 should be considered a welcome step,” he said.

Commenting on the ongoing additional borrowing dispensation in 2020-21, he said states could not avail of the entire fiscal space that had been given to them because of excessive conditionalities attached to the scheme. “The only relevant condition that should be imposed with respect to additional borrowing should relate to ensuring that the additional borrowing is spent fully on additional capital expenditure.

This would be prudent in the long run because additional liabilities due to borrowing would be matched by additional assets through infrastructure spending,” he said.

“The citizen-centric reforms linked to additional borrowing are not relevant in the context of borrowing.

Those incentives should be separately designed and linked to the centrally sponsored schemes. In any case, these reforms are better implemented in a normal year rather than in a Covid affected abnormal year,” he added.

Divakar Vijayasarathy, founder and managing partner at consulting firm DVS Advisors LLP, said that although performance-based incentives for state governments “is a tricky issue, going forward, this could become the norm”.

He said states are “more inclined towards adhering to the Finance Commission recommended performance parameters since the commission is a constitutional body, independent of the central government”.