Tuesday, April 5, 2016

India’s new federal polity takes root

In the past six weeks or so, beginning from just before the presentation of the Union budget on 29 February, several state governments have been, almost unnoticed by the national media, presenting their own budgets. Treating it as business as usual means we are missing a key moment in the evolution of India’s new federal polity.
This is because these state budgets are now beginning to reflect the radical makeover in fiscal relations between the Union government and the states that were put in place by the implementation of the recommendations of the 14th Finance Commission (FFC) chaired by former Reserve Bank of India governor Y.V. Reddy.
At its core, the FFC championed the idea that one size cannot fit all; particularly relevant in such a large country like India, which is culturally, topographically and economically so diverse. To be sure, this shift has been in the making, incrementally albeit, for the past two decades beginning with the 10th Finance Commission; what the FFC has done is to accelerate this pace dramatically.
The FFC abandoned the idea of tied aid—in the form of centrally sponsored programmes and grants—and instead trusted states to manage their own fiscal future. Not only did the states get the freedom to prioritize spending, the new formula sharply increased the share—from 32% to 42% of net Union tax receipts—of fiscal resources accruing to states. It further allowed states committing to greater fiscal discipline greater leeway to borrow from the market to fund their development priorities.
Effectively, the FFC had sowed the seeds of cooperative federalism as states have been accorded unprecedented fiscal freedom. For the first time, public expenditure is now decisively in the jurisdiction of states. Consequently, states are now greater stakeholders and the implementation of the single goods and services tax—pending before Parliament for the past 10 years and more—will only bind this relationship further.
The states took some time in absorbing this tectonic shift in fiscal federal relations and it is only from this year that they have begun to truly reflect in state budgets. Given that states prefer to use regional languages and do not often provide an English version, it is a struggle to follow these budgets. (The empowered group of state finance ministers should address this in haste; surely it can’t be difficult to come up with a bilingual version. After all, it is not just curious journalists, even foreign investors now closely scrutinizing states are a target group that should not be overlooked.)
The good news though is that PRS Legislative Research, a New Delhi-based independent research initiative to make the legislative process more transparent and accountable, is systematically tracking them down in a standard format. A cursory glance tells us how states have begun to prioritize their spending—natural, given that the socioeconomic needs cannot be the same across the country. For instance, Bihar has focused its resource allocation on the sectors of health, energy and panchayats, while in the case of Madhya Pradesh and Rajasthan, it is the social sector and energy.
Alongside, the Union government also launched an unprecedented clean-up of the power sector—mired in accumulated debt of nearly Rs.4 trillion, which was not only impeding fresh investments, but also threatening to snowball into a balance sheet crisis for banks that had loaned funds to state power utilities.
The Ujwal Discom Assurance Yojana or UDAY, launched last November, drew up a contract between the Union government and volunteering state governments (Nine, including Uttar Pradesh ruled by an opposition party, have inked this deal and have already begun implementing it) wherein the discom debt was transferred to the state government—who, in turn, would float bonds to fund it. Further, the discoms were required to adopt transparent pricing rules and also overhaul the creaking power infrastructure in their state—with the end objective of providing 24x7 power.
Taking the two developments together—a new formula to share fiscal resources and a structural fix to the power sector—means the Union and state governments together have hit the reset button on the federal polity. While one would resolve a key infrastructure bottleneck (even while it addresses a mindset about public utilities being required to bear the burden of political populism), the other provides unprecedented fiscal room to states.
Effectively, it confirms a new federal compact: an India where the sum of the parts will be greater than the whole.
Anil Padmanabhan is deputy managing editor of Mint and writes every week on the intersection of politics and economics.

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