Tuesday, February 21, 2012

Indian Federalism and I

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Indian Federalism and I

Tuesday, February 21st 05:23 PM IST

The NCTC standoff: Why the ‘F’ word will keep surfacing

R Jagannathan Feb 21, 2012



Is federalism the new bogeyman in Indian politics?
On the face of it, it appears so. In December 2011, political parties used the federalism argument to stymie the Lokayukta clause in the Lokpal Bill. A few days ago, several non-Congress chief ministers used federalism as an argument to delay or spike the National Counter-Terrorism Centre (NCTC).
Both the Lokpal and the NCTC are important national initiatives to deal with the nation’s twin enemies – corruption and terrorism. And yet, the states seem to be saying it does not matter.
What gives?
PTI
The truth is the ‘F’ word (federalism) is increasingly going to be used in Indian politics to justify all kinds of positions. The BJP, once the tiger on terrorism, would not mind using it to scuttle an anti-terror measure. All parties claim to be against corruption, but they will use the ‘F’ factor to delay or abandon the first serious anti-corruption measure in Indian history – the Lokpal and Lokayukta.
However, while the ‘F’ word is potent, it would be a mistake to believe that it is only going to be used for partisan politics.
It has a reality of its own. A nation of 1.2 billion people – the most diverse in the world – cannot be run in a unitary fashion. The more we try to centralise power, the more the damage we will do to India. In fact, one reason why India is becoming ungovernable is this explicit lack of federalism – where economic power is too concentrated at the centre, while political power has shifted to the states.
The NCTC, which is supposed to come under the administrative ambit of the Intelligence Bureau (IB), makes for a good case study on federalism. As B Raman noted in this column in Firstpost: “The IB is a secret intelligence organisation. It has no accountability to Parliament in respect of its work. We do not have a system of parliamentary intelligence oversight committees. We depend on the executive without any checks and balances to ensure that the IB functions according to the law of the land.”
It is an open secret that the IB is used for political spying by the centre. This is why several retired IB chief end up as state governors whenever there is a Congress regime at the centre. Putting the NCTC under the IB is thus the worst way to allay state fears of an intrusion into their legitimate domain.
In fact, this is exactly what Bihar Chief Minister Nitish Kumar believes. In a letter to the PM, he wrote that having the NCTC “under Intelligence Bureau with no accountability to Parliament was flawed”. The Indian Express reports that Kumar asked the PM to “reconsider NCTC and take along states to work out an effective counter-terrorism mechanism, keeping in mind the fine balance of power between the centre and states.”
Orissa CM Naveen Patnaik, in a parallel letter, asked Manmohan Singh to start consultations with states for necessary changes in the proposed body and claimed he had “no intention to politicise the campaign against terror, as has been stated by some of your ministers and senior officers to the media”.
However, this claim needs to be taken with a pinch of salt. When several non-Congress CMs jointly take up an issue with a Congress-led administration, there is nothing apolitical about it.
A Biju Janata Dal MP, Bhartruhari Mahtab, made the objectives of the non-BJP parties very clear. “Our objective is to create a platform where regional parties can form a force to withstand Central pressure. It is evolving into a potential group,” he told the Express.
The near-exclusion of the BJP from the regional revolt against the NCTC is significant. The regional parties could have done this for two reasons: one is fear of losing the minority vote in case they are seen to be working in cahoots with the BJP, and the other is the fear that the BJP is not really a regional party.
In other words, the BJP could – if it comes to power in the future – be as big a threat to federalism as the Congress. After all, between Congress and BJP, it is the latter that likes to wrap itself in the flag of nationalism.
To keep India united and take the tensions out of centre-state relations, India’s constitution needs some rewriting so that the states have adequate economic power to manage their own future.
This means the needless overlaps of the concurrent list should be eliminated – by rendering to the centre the powers that are the centre’s and to the states the bulk of the remaining powers.
It is the centre’s job to maintain the unity and integrity of India, run the macroeconomics, and defend it from external threats.
It is the states’ job to lift their citizens out of poverty. They need to control the levers of economic power for this.
When this is clear, centre-state tensions will be minimised. The brouhaha over the NCTC is merely a symptom. The real issue is that the states do not want to be patronised by the centre or be left to its mercies.
Till this issue is sorted out constitutionally, the ‘F’ word will keep surfacing in Indian politics.

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  • I beg your pardon. My dear R Jagannathan,
    I am Sid Harth.
    Loosely translated, you are talking nonsense. The whole article has total disregard for the constitutional, therefore, fundamentals of how a country ought to conduct its business.
    If and when, the States, acquire such and other special expertise, as Foreign (Affairs) policy, International Trade and Commerce, Monetary and fiscal responsibilities, local and regional balance of power and bunch of other related aspects, such as linguistic domination, I would most gladly allow these regional war lords to take full responsibilities in one or more aspects of Federalism.
    RSS, the Brahmin (supremacy) secret organization would sell their own mama to have all powers vested in one central government. Throughout their entire existence, they maintained that country is that which governs from top down.
    Down is lesser gods of Indian parliamentary system. The States.
    Go, read some of RSS views on what I said. You shall find it convenient to read them all. Apparently you did not do your homework.
    …and I am Sid Harth@sidileak.com
  • Radesa18 10 minutes ago
    This looks liek more biased article here if the intention is not crub the terrorism but to target the states , if Center is so serious in crubing the terrorism they will send strong signal through punish the caught terrorist isntead of giving them royal treatment and they dont keep defending them under Votebank Politics
  • Grajkumarr 23 minutes ago
    Well written article
  • Madhavsing 26 minutes ago
    when we already have the Election commission ,C. A. G. supreme court then why political parties are not pursuing the solution of corruption & terrorism
  • satyanarayan behera 26 minutes ago
    so called law experts who are now giving advise to remote controler  in the central are one by one trying to divert the powers to centre by making idle to the states who will at last wait for food from centre though they will harvest a lot. With out centre ‘s mercy you will one day find food is clooecting from our firmer and collecting by the centre and again recirculating back to state with the mercy of centre. Just like the JAMIDARS AND RAJAS>  they will collect all the harvest things from the farmer and give back with their mercy. which BRITISHERS WERE ALSO doing . Now cogress is going to do like this
  • This is the aerogent style of working of UPA government which is harming the nation. In case of Lokpal they hhavee not taken main opposition BJP in confidence and went ahead with a useless proposal of Sarkari Lokpal. Now in case of NCTC again they have not felt a need to talk to CM of stats before enforcing it. So, we can conclude that this is known stretegy of Congress to misslead people by creating controversy.
  • Ghoda Conversation starter 44 minutes ago
    Undoubtedly,  the  Khangress  is  all  out  to  gather  all  the  authority  to  destroy  this  nation. The authorities to govern the country should not be utilized to harass people via, IB, CBI, ED, etc. Khangress has mastered this art & hence it should be condemned.

[+] Hot Topics:
Federalism: Lessons from India
Indian federalism is the simultaneity of two processes – the unionization process and the regionalization
process. Ajay Kumar Singh
Bishnu Pathak, PhD.
Introduction
India became independent in 1947. Its parliament, also serving as a Constituent Assembly
(CA), drafted the new constitution that came into effect on January 26, 1950, establishing the
federal union of India.
India is the 7th largest country by geographic area, 2nd most populous, 4th largest in GDP
(Purchasing Power Parity), has the 3rd largest military force 1, and is the 12th largest economy
in the world. India is a republic consisting of 28 states and seven unions 2 with a parliamentary
form of democracy. A country the size of a continent, with an area of 13,654,000 sq. miles,
India is comprised of 16 percent Dalits, known as scheduled castes. Around 8 percent of the
population belongs to one of 461 indigenous adivasi groups. Many Indians speak more than
one language. The Indian census lists 114 languages (22 of which are spoken by one million
or more persons) that are further categorized into 216 dialects (mother tongues) spoken by
10,000 or more speakers. There is significant cultural diversity within the nation, as 40% of
the population belongs to disadvantaged groups; i.e. the scheduled castes (11.6%) and
scheduled tribes (31.8%).
An estimated 850 languages are in daily use, and the Indian Government officially lists 1,652
dialects. The teaching of Hindi and English is compulsory in most states and union territories.
Twenty-two languages are legally recognized by the constitution for various political,
educational, ethnic -cultural, and regional purposes: Assamese, Bengali, Bodo, Dogri,
Gujarati, Hindi, Kannada, Kashmiri, Konkani, Maithili, Malayalam, Manipuri, Marathi,
Nepali, Oriya, Punjabi, Sanskrit, Santhali, Sindhi, Tamil, Telugu, and Urdu. About 80.5
percent of the population is Hindu, 13.4 percent Muslim, 2.3 percent Christian, 1.9 percent
Sikh, 0.8 percent Buddhist, and 0.4 percent Jain and others 3. India’s literacy rate is 65%. The
government represents 1.17 billion people comprising 17 percent of the world population.
The States Reorganization Act of 1956 was formed on an ethnic- linguistic basis. Besides
states, India was further divided into 610 districts for basic governance and administration,
which were further divided into villages. Ethnic tensions were resolved reorganizing the state
Table 1: Geo-political, demographic, and ethno-cultural population of India
State Area
km²
dis. Population Offici al
language
Ethnicity/religion Established Etymology
Andra Pradesh 275,608 23 76,210,007
(5th)
Telugu,
Hindi,
Urdu
Telugu 56.75%,
Hindi 8.23%, and
Urdu 30.63%
November 1,
1956
Sanskrit4
Arunachal
Pradesh
83,743 16 1,091,117
(26th)
Assamese,
Bengali,
and Hindi
50 distinct
languages and
dialects
February 20,
1987
Sanskrit5
Assam 26,655,5
28
(14th)
27 26,655,528
(14th)
Assamese,
Bodo,
Bengali
115 ethnic groups6 August 15,
1947
Mahabharata7
Bihar 99,200 38 82,998,509 Hindu and Hindi 83% and 1912 Vihar (abode
2
(3rd) Urdu Islam 16.5%, in English
word) in
Sanskrit
word8
Chhattisgarh 135,194 18 20,795,956
(17th)
Chhattisgar
hi, Hindi 9
- November 1,
2000
Number10
Goa11 3,702 2 1,400,000
(25th)
Konkani May 30, 1987 Portuguese
language 12
Gujarat13 135,194 26 Gujarati
71% and
Hindi 29%
May 1, 1960 Ethnic
Gujjars14
Haryana 44,341 21 21,082,989
(16th)
Hindi 84%,
Muslim
15% Sikh
1%
Hindus 84%,
Sikhs 15%, and
Muslims 1%
November 1,
1966
Sanskrit15
Himachal Pradesh 56,019 12 6,077,248
(20th)
Hindi and
Punjabi
Hindu 95% January 25,
1971
Geography
(Mountains)16
Jammu and
Kashmir
222,236 22 10,143,700
(18th)
Urdu,
Kashmiri,
Dogri
Hindu 65%,
Muslims 31%, and
Sikhs 4.
October 26,
1947
Geography
(Jammu and
Kashmir
mountains)17
Jharkhand18 74,677 24 26,909,428
(13th)
Hindi and
Santali
Hindu 68.5%,
Islam 13.8%
November 15,
2000
Sanskrit19
Karnataka 191,976 29 52,850,562
(9th)
Kannada,
speaks by
65%
Hindu 83%,
Muslim 11%, and
Christian 4%
November 1,
1956
Land (black
region)20
Kerala 38,863 14 31,948,619
(12th)
Malayalam Hindu 56%, Islam
25%, and
Christianity 19%
November 1,
1956
Culture21
Madhya Pradesh 308,252 50 60,385,118
(7th)
Hindi Hindu 91% and
Muslim 6%
November 1,
1956
Geography22
Maharashtra23 307,713 35 96,752,247
(2th)
Marathi Hindu 80%,
Muslim 11%, and
Buddhists 6%
May 1, 1960 Sanskrit24
Manipur 22,347 9 2,388,634
(22nd)
Manipuri
(Meiteilon)
and English
Meiteis and the
nagas groups
January 21,
1972
Sanskrit
(ethnicity)25
Meghalaya 22,720 7 2,306,069
(23rd)
Khasi,
Garo, and
Jaintia
Christianity 70%
and Hindu 13%
January 21,
1972
Sanskrit
(language) 26
Mizoram27 21,081 8 888,573
(27th)
Mizo,
English
Christianity
(Mizos) 87% and
Hindu 4%
20 February
1987
Ethnicity28
Nagaland29 16,579 11 1,988,636
(24th)
English30 Christianity 90%
and Hindu 8%
December 1,
1963
Ethnicity
(Kirant)31
Orissa 36,706,9
20
30 36,706,920 Oriya Hindu 95% and
Christian 2%.
April 1, 1936 Ethnicity32
Punjab33 50,362 20 24,289,296
(15th)
Punjabi Sikh 60% and
Hindu 37%
November 1,
1956
Geography
(River)34
Rajasthan35 342,269 33 56,473,122
(8th)
Rajasthani Hindu 89% and
Muslim 9%
November 1,
1956
Language36
Sikkim37 7,096 4 540,493
(28th)
Nepali and
English
Hindu 61%,
Buddhism 28%,
and Christian 7%
May 16, 1975 Geography
and
language 38
Tamil Nadu39 130,058 32 66,396,000
(7th)
Tamil Hindu 88%,
Muslim 5%, and
Christianity 5%
November 1,
1956
Ethnicity40
Tripura 10,453 4 3,191,168
(21st)
Bengali,
Kokborok
Hindu 70% and
Muslim 23%
November 1,
1956
king and
water41
3
Uttar Pradesh 243,286 71 190,891,00
(1st)
Hindi and
Urdu
Hindu 80% and
Muslim 19%
November14,
1834
Geography42
Uttarakhanda 53,566 13 8,479,562
(19th)
Hindi,
Kumaoni,
and
Garhwali
Hindu 85% and
Muslim 11%
November 9,
2000
Holy land
(Sanskrit)43
West Bengal44 88,752 19 80,221,171
(4th)
Bengali Hindu 72% and
Muslim 23%
May 1, 1960 Language45
into ethnic and linguistic lines by means of the Act46. Several new states have been created
out of existing states since 1956. Bombay State was split into the linguistic Gujarat and
Maharashtra states on May 1, 1960 by means of the Bombay Reorganization Act. The Punjab
Reorganization Act of 1956 divided the Punjab into linguistic and religious lines that created
a new Hindu and Hindi-speaking state of Haryana, converting the northern districts of Punjab
into Himachal Pradesh.
Nagaland was made a state in 1962, Meghalaya and Himachal Pradesh in 1971, Tripura and
Manipur in 1972. Sikkim joined the Indian Union as a state in 1975. Similarly, Mizoram was
made a state in 1986, and Goa and Arunachal Pradesh in 1987. However, Goa’s northern
enclaves of Daman and Diu became separate union territories in 1987. Goa, which comprises
one-third of the population, is primarily Christian, but it is not a Christian State47.
Chhattisgarh was created on November 1, 2000 from eastern Madhya Pradesh; Uttaranchal
was renamed Uttarakhand on November 9, 2000 which created the Hilly regions of northwest
Uttar Pradesh; and Jharkhanda was created on November 15, 2000 out of the southern
districts of Bihar. However, the demand for a separate state of Chhattisgarh arose in the
1920s48. Jharkhand is now advancing economically much faster than its northern neighbor,
Bihar. Unlike some other Indian states, Jharkhand’s reduction in poverty was faster in the
rural areas than in the urban ones. Uttarakhand is comprised of the Garhwal and Kumaon
Divisions, which has become the 27th state in India. In August 2006, the Uttaranchal state
assembly and leading movement members renamed Uttaranchal State, Uttarakhand.
Besides the 28 states in India, there are seven union territories; Andaman and Nicobar Islands,
Chandigarh, Dadra and Nagar Haveli, Daman and Diu, Lakshadweep, Pondicherry, and the
National Capital Territory of Delhi. A Union territory is a sub-national administrative division
of India, in the federal framework of governance. Unlike the states, union territories are ruled
directly by the federal central government, the president appoints an administrator or governor
in each territory. However, the capital of Delhi, the Union territory of Delhi, and Pondicherry
have been given partial statehood49.
All of India was not satisfied when it declared itself a republic through a New Constitution.
Dr. B. R. Ambedkar, Chairman of the Constitution Drafting Committee in India and PM,
Jawaharlal Nehru, were in favor of unitary state. Sardar Patel, then a powerful Home
Minister, played a pivotal role in the cause of federalism. When the New Constitution was
adopted in 1950 by the CA, India had large federal states, including Assam, Jammu-Kashmir,
Bihar, Uttar Pradesh, and Orissa which were formed on geo-political foundations, with the
exception of Orissa. Orissa was developed along ethno -cultural lines. Notably, Uttar Pradesh
and Bihar had already been practicing semi-autonomy before the constitution came into
effect.
4
In 1956, eight-new federal states emerged based on ethnic- linguistic diversity, following the
State Reorganization Act of that year. They are: Andra Pradesh, Karnataka, Kerala, Madhya
Pradesh, Panjab, Rajasthan, Tamil Nadu and Tripura.
In between 1960 and 1966, five-new federal states such as Gujarat, Maharastha, West Bengal,
Nagaland, and Haryana were established. Similarly, Maghalaya, Manipur, and Himanchal
Pradesh were made states between 1971 and 1972. Sikkim, the ethnic Nepalese majority state
by Lecha and Limbu, finally merged with India and became the 22nd Indian state on May
16th, 1975 when 59 percent of the Sikkimeli voted in favor of the merge through referendum.
In 1987, three states were formed; Namely, Arunachal Pradesh, Goa, and Mizoram. Goa is
India’s smallest state in terms of area, It is located on the west coast of India. The Portuguese
first landed there as merchants in the early 16th century, and conquered it soon thereafter. The
Portuguese overseas territory existed for about 450 years, until it was annexed by India in
1961. Consequently, it still exhibits the influence of Portuguese culture50. Uttarakhanda,
Jharkhand, and the Chhattisgarh have become India’s 26th, 27th, and 28th states.
Insurgency within Federalism
India was colonized from powerful European powers such as Portugal, the Netherlands,
France, and the UK, starting in the 16th century and continuing to 1947. On August 15, 1947,
India attained independence from British rule, but ceded Muslim- majority areas to Pakistan
soon after. The transitional phase was ended in January 1950 when India became a federal
republic officially in its constitution.
However, India has faced several challenges such as religious violence, caste discrimination,
naxal- ism as well as terrorism. Regional separatist insurgencies continue, particularly in
Jammu and Kashmir as well as Northwestern and Northeastern India. The territorial disputes
with China since the Sino-Indian War of 1962 have not been solved. Sikkim was an Indian
protecto rate from 1947, but became a full state in 1975.
North-East India became a part of India politically under the Palas Empire. Assam, Nagaland,
Mizoram, and Meghalaya were just parts of political India, where Assam had been an
independent state. Nagaland, Mizoram, and Meghalaya were princely states in terms of
history, Manipur, and Tripura. Arunachal Pradesh was beyond the outer line of British India
resulting in the Sino -Indian War in 1962, which is not resolved yet. Sikkim was not within
the mandate of political British India either. Since 1947, extension of the political apparatus
of Indian states has been a challenge.
India has encountered several insurgencies, along with terrorist activities, particularly by
Islamic fundamentalists, Sikhs and Naxalites within Punjab, New Delhi, Jammu and Kashmir,
Mumbai, etc. Naxalites inhabit Central-southwestern India along with independence and
autonomy movements in the seven sister states of Arunachal Pradesh, Assam, Meghalaya,
Manipur, Mizoram, Nagaland, and Tripura51. The sister states, which lie in north-east India
and contain 3.8 of the country’s population52 have been particularly effected by ethnic and
linguistic tension. The northeastern states are small; 25 representatives (4.6% ) in the Lok
Sabha out of a total of 543 seats. Besides, Sikkim, some parts of North Bengal also fall within
north-east India. These states are very distinct from one-another in terms of ethnicity,
5
language, and culture. As of 2006, at least 232 of India’s 608 districts were effected by
insurgent or terrorist activities53. In such districts, tension exists between the state
governments and tribal people as well as the central government due to local desire for
sovereignty54. Various groups waging insurgencies due to ethnic and linguistic differences are
connected through the “chicken neck” of the Siliguri corridor to the rest of India. Some
extreme insurgents demand completely autonomous states.
History of Jammu-Kashmir Violence
The names 55 Jammu and Kashmir came into existence when the Mughal Emperor, Akabar, invaded
Kashmir in 1586, defeating Turk ruler Yusuf Khan with the support of his generals including his aide,
Ramchandra I. Then Akbar appointed Ramchandra I as the governor of the Kashmir. Ramchandra I
established the city called Jammu (Hindu goddess Jamwa Mata).
In 1780, Jammu and Kashmir were captured by the Sikhs under Ranjit Singh of Lahore and became a
tributary to the Sikh power until 1846. Ranjit’s grandnephew, Gulab, appointed him as the Governor
(Raja or king) of Jammu in 1820. Soon, Gulab captured Ladakh. The influential Kashmiri leader, Sheikh
Abdullah, who died in 1857, was in a favor of greater autonomy for Jammu and Kashmir within the
framework of Indian constitution.
In 1845, the First Anglo -Sikh War, Gulab became an advisor of Sir Henry. Two treaties were held where
State of Lahore, west of Punjab, east of Indus River and west of Ravi River was handed over to the
British with 1.7 million rupees of indemnity. Gulab’s great grandson Hari had ascended the throne of
Kashmir in 1925 as an independent state.
On October 20, 1947, Pakistan invaded Jammu and Kashmir. The Maharaja Hari Singh initially fought
back, appealing to British Governor-General Louis for assistance, but he agreed on the condition of that
the ruler accede t o merge with India. When the treaty was signed, Indian soldiers entered into Kashmir
with orders to stop any further occupation. India asked the UN to vacate the areas Pakistan had
occupied, but Pakistan refused. Because of soured diplomatic relations, three Indo-Pakistani Wars in
1965, 1971, and 1999 occurred. India now controls 60 percent, Pakistan 30 percent, and China 10
percent of the area of the former princely state of Jammu and Kashmir. Since violent groups initiated an
insurgency in the late 1980s with the backing of Pakistan, the region has seen a prolonged, bloody
conflict between militants and the Indian Army.
Source: en.wikipedia.org/wiki/India
India, particularly the urban centers, has proven an easy target for insurgent and terrorist
activities. Some of the insurgent groups include the Achik National Volunteer Council, Al-
Badr (Kashmir), al-Qaida (international), Al-Umar-Mujahideen, All Tripura Tiger Force
(Tripura), Babbar Khalsa International (Punjab), Communist Party of India (Maoist), Deendar
Anjuman (Karnataka, Andra Pradesh, and Maharastra), Dukhtaran-E-Millat, Harakat ul-
Mujahidin (Kashmir), Hizbul Mujahideen (Kashmir), International Sikh Youth Federation
(Punjab, international), Jaish-e-Mohammed (Kashmir), Jammu and Kashmir Islamic Front
(Kashmir), Kanglei Yaol Kanba Lup, Kangleipak Communist Party, Khalistan Commando
Force, Lashkar-e-Toiba (international), Liberation Tigers of Tamil Eelam (international),
Manipur People’s Liberation Front (Manipur), National Democratic Front of Bodoland
(Assam), National Liberation Front of Tripura (Tripura), People’s Liberation Army, People’s
Revolutionary Party of Kangleipak (Manipur), Revolutionary People’s Front (Manipur),
Students Islamic Movement of India (Uttar Pradesh), Tamil Nadu Liberation Army (Tamil
Nadu), Tamil National Retrieval Troops (Tamil Nadu), United Liberation Front of Asom
(Assam), and United National Liberation Front (Manipur)56.
6
In Bihar, southwestern India, terrorist activities are not considered a major threat by the state.
However, groups like the CPI (ML), People’s War, MCC, Ranvir Sena, and Balbir militias
have been a major concern as they frequently attack local security personnel and politicians
who are allegedly indulging in corruption, malpractice, or discrimination. Due to poor
governance and the law and order situation in Bihar, the Ranvir Sena has become quite
powerful in Naxalite areas. Its militia represents upper caste groups while victimizing helpless
people (including women, elderly and children). Many have been killed in caste massacres.
The Sena’s offensive activities lead to a growing sense of alienation among the low caste.
Such violence has encouraged many low caste people to join the CPI (ML), MCC, and
People’s War to take up arms against the establishment, or appendages of the rich including
the Sena57. The Communist Party of India (Maoist)58 has been a severed headache for Indian
security forces, as it spreads violent activities through many districts there. It is an
underground organization, which was formed from merging the Maoist Political Parties in
India – the Communist Party of India (Marxist-Leninist) People’s War, and the Maoist
Communist Centre of India on September 12, 2004 under the leadership of Ganapati as
General Secretary. The media and other sectors refer to these groups as “Naxalites,” derived
from the Naxalbari insurrection by radical Maoists in West Bengal in 1967.
The Indian Green Revolution, which was implemented during the 1970s by the Sikh
community in Punjab to increase economic prosperity, led to the rise of Sikh militants,
namely Khalistan. Khalistan sought independence from the India in the 1980s. The
government suppressed their activities, alleging that neighboring Pakistan supported the
militants. Thus, The Blue Star operation of 1984 was conducted by the order of Indira
Gandhi. It culminated in an assault on the Golden Temple complex in a 74-hour firefight,
killing 83 Indian army personnel, who were pitted against 493 militants, where 249 armies
and 85 militants were injured. That led to the assassination of Indira Gandhi, the then PM of
India, in 1984 by the Sikh, aide-de-camp. Similarly, a Sikh militant assassinated the CM
(Chief Minister) of Punjab in 1995. In 1985, Sikh insurgents bombed Air India flight 182
from Canada to India, killing 329 people. The Babbar Khalsa, a hardcore terrorist group
banned by Canada, the United States, the United Kingdom, Germany, and India, took
responsibility. On June 23, 1985 a Boeing 747-237B was bombed by terrorists over Irish
airspace and killed all on board. On December 13, 2001, terrorists attacked the House of
Parliament. About a dozen people were killed59.New Delhi also suffered from a series of
bomb explosions on October 29, 2005 and September 13, 2008.
In the course of the Uttar Pradesh conflict, Hindu fundamentalists attacked and demolished
the 16th century Babri Masjid at Ram Janmabhoomi in Ayodhya on July 5, 2005. In
retaliation, a two- hour gunfight between Lashkar-e-Toiba, Pakistan based terrorists believed
to be a creation of Dawood Ibrahim and Indian police, occurred, where six militants were
killed. A series of bombs were detonated across Varanasi, the Hindu holy city, on March 7
2006 by the Lashkar-e-Toiba killing more than one dozen innocent people and leaving 101
injured in retaliation of the Babri Masjid attack 60. Some of these organizations, such as
Babbar Khalsa International, Khalistan Commando Force, Khalistan Liberation Force, and
Khalistan Zindabad Force, are still active61.
Northeastern India consists of 7 states, popularly known as the seven sisters, comprising
Assam, Meghalaya, Tripura, Arunachal Pradesh, Mizoram, Manipur, and Nagaland. However,
conflicts exist between these states and the central government as well as amongst the native
7
tribal/ethnic people, and migrant people from different parts of India. There are territorial
disputes between Manipur and Nagaland. Regional movements and insurgent activities are on
the rise in the Assam, Nagaland, Mizoram, and Tripura. Some of these organizations demand
independent states with regional autonomy and sovereignty.
After the movement in Darjeeling, the most significant insurgency was initiated in Nagaland
from the early 1950s. The National Socialist Council of Nagaland-Isak-Muivah (NSCN-IM)
demands an independent Nagaland for which they have carried out several attacks on the
Indian establishment forces in the region. Between 1992-2000, 599 civilians, 235 security
forces, and 862 terrorists have lost their lives in these engagements62.
Assam is the most volatile state in the region after the Nagaland. Beginning in 1979,
indigenous people led by the All Assam Students Union in Assam demanded the detection
and deportation of all illegal Bangladeshi immigrants. The Assam Accord was signed with the
central government in August 15, 1985. The accord agreed to enfranchise anyone who entered
Assam illegally between January 1966 and March 1971. In Assam, the central government
gave special administration of autonomy to indigenous Bodos. The National Democratic
Front in Bodoland (NDFB) of Bodos still demands a separate Bodoland.63 This led to a clash
between the Bengalis, Nepali origin people, and the Indian military. Originally, the NDFB
was called the Bodo Security Force (BSF). The ULFA (United Liberation Front of Assam64)
is also in the forefront of those advocating independence and the establishment of a socialist
government in Assam. This has resulted in a huge loss of life and property. India believes that
most of the insurgent activities in the Kingdom of Bhutan have a strong link with Nepal’s
Maoists and the Naxalites. So, The Thimpu government killed more than a thousand alleged
terrorists, but the ULFA continues to be active in the region.
The Ganamukti Parishad movement led integration with India in 1949 within the Assam
state. Tripura, of which the majority of the population is comprised of Hindu Bengalis, came
as refugees from East Pakistan after independence in 1947. Tripura became a centrally
administered Union Territory on July 1, 1963 and attained full-fledged state status on January
21, 197265. The National Liberation Front of Tripura (NLFT)66 and All Tripura Tiger Force
launched terrorist activities in the 1990s in Tripura. New Delhi alleged Bangladesh was
providing shelter to these insurgents operating from its territory. The NLFT seeks secession
from India and the establishment of an independent state and has been banned in India. It has
been alleged that the NLFT produced pornographic films, kidnapping tribal men and women
at gunpoint, to support their financial activities. And their leaders are accused of sexual
harassment of the female prisoners. It has banned Hindu festivals including Durga Puja and
Saraswati puja as 90 percent of It’s members are Christians67.
In Manipur, The People’s Liberation Army, UULF, and PREPAK are active with the goals of
uniting the Meitei tribes of Burma and establishing an independent state – Manipur. However,
the movement was suppressed by Indian security forces in the mid 1990s. Presently, 19
separate rebel groups are active there68.
The Mizo National Front (MNF), Hmar People’s Convention-Democracy, and BNLF have
been fighting for over 2 decades with the Indian security forces for independence, but the
insurgency has been temporarily quelled by force. The Mizo National Famine Front dropped
the word “famine” and a new political organization, the MNF was born on 22 October 1961
8
under the leadership of Laldenga with the specific objective of sovereign independence of
Greater Mizoram69.
Karnataka lies to the south in India and is considered mildly effected by terrorism, even in the
IT hub of Bangalore. However, Naxalites attacked in Bangalore on July 26, 2008. Andra
Pradesh has been less effected in terms of insurgency, but suffers from the People’s War
Group (PWG). The PWG has targeted government officials resulting in about one hundred
people, including the insurgents, police, and civilians, being killed each year. It is believed
that it has close links with the Nepal’s Maoists and the Tamil, LTTE of Sri Lanka. The LTTE
(Liberation Tigers of Tamil Eelam) militants are still active, but less effective in Tamil Nadu
in concert with the Tamil Nadu Liberation Army. Similarly, attacks on trains by bombing or
sabotage by the insurgents have become very common for Indian Railways.
Over the past few years Mumbai has been witness to a wide range of terrorist activity. A
series of bomb attacks, including explosions in local trains were conducted in July 2006.
Similarly the most recent and unprecedented attack was of November 26, 2008, where two of
the prime hotels and another building, in south Mumbai, were held under siege. Mumbai has
been victimized by previous attacks such as on March 12, 1993, December 2, 2002, January
27, 2003, March 14, 2003, July 28, 2003, August 25, 2003, July 11, 2006, and November 26-
29, 2008 where a few hundred people were extra-judicially killed, leaving hundreds injured
by bomb blasts and gun shots.
Federalism and Autonomy
The North Sentinel70 Island in Andaman and Nicobar Islands; Bodoland Territorial Council
(BTC), Karbi Anglong Autonomous Council (KAAC), and North Cachar Hills Autonomous
District Council (NCHAC) in Assam; Ladakh Autonomous Hill Development Council
(LAHDC) at Kargil and Leh in Jammu-Kashmir; Garo, Jaintia, and Khasi Hills Autonomous
District Council (HADC) in Meghalaya; Chakma, Lai, and Mara Autonomous District
Council in Mizoram; Tripura Tribal Areas Autonomous District Council (TTAADC) in
Tripura; and Darjeeling Gorkha Hill Council (DGHC) in West Bengal exist as autonomous
regions in India 71.
The BTC enjoys legislative, administrative, executive, and financial powers in 40 policy areas
in the Territorial District Areas within four districts of Assam. This provision was established
in 1995 after the peace accord signed between the Government of India and Bodo rebels.
Similarly, all the development structures are under the administrative control of the KAAC.
Kargil and Leh are one of the three districts of Ladakh, which are controlled by Pakistan now,
under the (LAHDC). The LAHDC was created in 1995, accepting the Ladaki people’s
demands to make Leh district a union territory due to its religious and cultural differences.
The TTAADC is an independent council for the tribal areas of the state. The DGHC was
established in 1988 due to a strong, long term people’s movement demanding, on behalf of the
Indian-Gorkha people under the banner of Gorkha National Liberation Front (GNLF), a
separate state of Gorkhaland. However, the DGHC has limited autonomy72. The Assam
9
Reorganization (Meghalaya) Act 1969 accorded an autonomous status to the state of
Meghalaya73.
The Central Government of India of has provided varying degrees of full-semi-and- limited
autonomy within the state legislature. The autonomy is based on the sixth schedule to the
Constitution of India. Administration of Tribal Areas in the States of Assam, Meghalaya,
Tripura and Mizoram fall in the category of Autonomous districts and autonomous regions74
under the provisions of Articles 244(2) and 275(1) and under the framework of the Indian and
local governments.
When, India became independent from the United Kingdom in 1947, the Muslim Nizam of
Hyderabad wanted to retain his independence from India, but the people of the region
launched the movement to join the Indian Union75. After India’s independence, the Maharaja
of Mysore permitted his kingdom’s accession to India, but former Maharaja (king) acted as
head of state until 1975.
Conclusion
Nepali scholars as well as leaders of the parties talk a lot about European models of
federalism. Large sections of the people dream that a new Nepal would be similar to
developed European countries. However, leaders and scholars also talk of such models for
two reasons; to receive a huge sum of financial assistance and a long tour to Europe. They
care less about Europe’s homogenate similarities (less diversity) in terms of culture, language,
religion, and social security.
With regard to federalism, Nepal would do well to account for geopolitical structure,
population density, regional/economic disparity, ethnic diversity, linguistic multiplicity,
regional variety, religious heterogeneity, administrative accessibility, unequal development,
and spatial elements. India’s federal/unitary model may be the best example of federation for
Nepali people too due to our similarities in ethno-cultural diversity, regional particularity,
political arrangements, and ideological (liberal democratic) notions. In India’s context, federal
means 28 states with 7 union territories, and unitary means the president of the central
government has the authority to impose a state of emergency, ousting the elected government
at any time, in case of constitutional/political conflicts, on the recommendation of cabinet.
Due to several socio -cultural secessionist insurgencies, India may have to rethink its federal
model.
Moreover, Nepal should give extreme attention to national security, foreign affairs, monitory
policy, big hydro power, national highways, and an international airport in the course of
declaring a Federation of States. Indeed Nepal can neither be “One Himal One Pradesh” nor
“One Madhes One Pradesh.” Rather, the country needs ethno-cultural-regional states.
Considerably the country rush towards federalism in name, the most inclusively implemented
decentralization would be the best option for Nepal and Nepalis for peace, progress,
prosperity, and development over the long term. Only that could solidify the concept of unity
in diversity. It is not enough to have “participatory democracy.” Simply participating without
the ability to effect policy is an exercise in frustration. Local populations must be able to not
only have their voices heard, but acted upon. Federal states without inclusive democracy
10
would ultimately lead to the corrosion of Nepalese identity, united strength, and harmony as
each would fight for its own supremacy.
Federalism is not, its self, a solution for the people’s desire of food, shelter, clothing,
education, employment, health, and sanitation. One must remember that poor people seek
basic needs as much as basic rights in federation, as they could not fulfill their hopes and
expectations of “food and freedom” from the new governments formed after the Jana Andolan
(people’s movement) I and II.
If Nepal were to introduce federal states without calculating the pros and cons of federalism
and without precaution, it would be more vulnerable to socio -cultural ‘identity-based’ conflict
due to the elites’ present lack of statesmanship and unclear concept of independence and
integrity. Nepal should be aware that India suffers identity-based conflict in 64 percent (18)
of its states which may lead toward more secession in the near future.
==============
(*It is my privilege to pay special thanks to Neil Horning who has contributed to editing this article. I
also express sincere thanks to Professor Ananda Aditya, Surendra Uprety (PhD Scholar), Devendra
Uprety, Sugam KC (PhD scholar), Rita Chaudhary, Ganga Puri, and Meena Siwakoti who assisted in
this exercise).
1 http://en.wikipedia.org/wiki/India
2 Majeed, Akhtar (2009) Working of the Indian Federal System: Federal Studies Monograph Series.
Centre for Federal Studies. New Delhi: Hamdard University
3 Country Profile: India. December 2004. http://lcweb2.loc.gov/frd/cs/profiles/India.pdf
4 An Andhra Kingdom was mentioned in the Sanskrit epics such as Aitareya Brahmana (B.C.800) and
Mahabharata. The Natyasastra of Bharatha (1st Century B.C.E.) also mentioned the Andhra” race. The
roots of the Telugu language have been traced to inscriptions found at Bhattiprolu. http://en.wikipedia.org/wiki/Andhra_Pradesh#cite_note-5
5 Arunachal Pradesh means “land of the dawn lit mountains” in Sanskrit. It is also known as “land of the
rising sun” (“pradesh” means “state” or “region”) in reference to its position as the easternmost state of
India. http://en.wikipedia.org/wiki/Andhra_Pradesh#cite_note-2
6 http://en.wikipedia.org/wiki/People_of_India_project
7 Assam was known as Pragjyotisha in the Mahabharata; and Kamarupa in the 1st millennium. Assam
gets it name from the Ahom kingdom (1228-1826), then known as Kingdom of Assam. The British
province after 1838 and the Indian state after 1947 came to be known as Assam
http://en.wikipedia.org/wiki/Assam.
8 The name Bihar is derived from the Sanskrit word Vihara which means “abode”. The word Vihar is
itself derived from the word Brahmavihara meaning “Brahma abidings”, or “Sublime attitudes.” The
region roughly encompassing the present state was dotted with Buddhist vihara
9 Chhattisgarhi is a dialect of Hindi language or a language in its own right and it is spoken and
understood by the majority of people in Chhattisgarh. A total of 93 dialects or languages are spoken in
the state http://en.wikipedia.org/wiki/Chhattisgarh
10 36 (Chattis is thirty-six in Hindi and Garh is Fort)
11 http://en.wikipedia.org/wiki/Goa
12 The name Goa came to European languages from the Portuguese, but its precise origin is unclear. In
the bygone days it came to be known by many names such as Gomanta,Gomanchala, Gopakapattam,
Gopakapuri, Govapuri, Gomantak , etc. The Indian epic Mahabharata refers to the area now known as
Goa, as Goparashtra or ‘Govarashtra”‘ which means a nation of cowherds. Gopakapuri or
Gopakapattanam were used in some ancient Sanskrit texts, and these names were also mentioned in
11
other sacred Hindu texts such as the Harivansa and the Skanda Purana. In the latter, Goa is also known
as Gomanchala. Parashurambhoomi is a name that the region is referred to in certain inscriptions and
texts such as the Puranas.
13 http://en.wikipedia.org/wiki/Gujarat
14 Situated on the western coast of India, the name of the state is derived from Gujjaratta (Gurjar
Rashtra), which means the land of the Gujjars . It is believed that a tribe of Gujjars migrated to India
around the 5th century. http://en.wikipedia.org/wiki/History_of_Gujarat
15 The name Haryana means “The Abode of God” from Sanskrit Hari (the Hindu God Vishnu) and ayana
(home). http://en.wikipedia.org/wiki/Haryana
16 The literal meaning of Himachal Pradesh is Region of snowy mountains. Himachal Pradesh was also
known as Deva Bhoomi (the land of the gods). http://en.wikipedia.org/wiki/Haryana#Demographics
17 http://en.wikipedia.org/wiki/Jammu_and_Kashmir
18 http://en.wikipedia.org/wiki/Jharkhand
19 The name Jharkhand comes from the Sanskrit Jharikhanda which is the ancient name of the regions
dense forest – Jharikhanda. http://en.wikipedia.org/wiki/Jharkhand
20 Originally known as the State of Mysore, it was renamed Karnataka in 1973. the generally accepted
one is that Karnataka is derived from the Kannada words karu and nadu, meaning elevated land. Karu
nadu may also be read as Karu (black) and nadu (region), as a reference to the black cotton soil found
in the Bayaluseeme region of Karnataka. http://en.wikipedia.org/wiki/Karnataka
21 A 3rd-century -BC rock inscription by emperor Asoka the Great attests to a Keralaputra. Around 1 BC
the region was ruled by the Chera Dynasty, which traded with the Greeks, Romans, and Arabs.
http://en.wikipedia.org/wiki/Kerala
22 http://en.wikipedia.org/wiki/Madhya_Pradesh
23 http://en.wikipedia.org/wiki/Maharashtra
24 The antiquity of this region can be traced to approximately the 3rd century BC, which is when the
Maharastri language, a Prakrit version of Sanskrit from which the term ‘Maharashtra’ is derived, was
then in use. Marathi, which evolved from Maharastri-Prakrit, has been the lingua franca of the people
of this area from the 10th century onwards. And, in the course of time, the term ‘Maharashtra’ was used
to describe a region which consisted of Aparanta, Vidarbha, Mulak, Ashmak and Kuntal. The tribal
communities of Nags, Munds and Bhills inhabited this area, also known as Dandakaranya, in ancient
times. They were joined by the Aryas, the Shakas and the Huns, who came from the North, as well as
by foreigners, who arrived by sea. The Dravidians from the South colonised the land, joining a group
which collectively became known as ‘Marathas.’ http://en.wikipedia.org/wiki/History_of_Maharashtra
25 Hindi (maáipÅra), from Sanskrit (maáipÅra) “abundance of jewels”, also the third chakra; derived
from (maái) “jewel” (pÅra ) “abundance”. http://www.allwords.com/word-Manipur.html
26 The word “Meghalaya” literally means “The Abode of Clouds” in Sanskrit and other Indic languages.
http://en.wikipedia.org/wiki/Meghalaya
27 http://en.wikipedia.org/wiki/Mizoram
28 The origin of the Mizos, like those of many other tribes in the northeastern India, is shrouded in
mystery. The generally accepted view is that they were part of a great wave of migration from China
and later moved out to India to their present habitat. It is possible that the Mizos came from Sinlung or
Chhinlungsan located on the banks of the Yalung River in China, first settled in the Shan State and
moved on to the Kabaw Valley. It is also believed that Mizos originated from Mongolia, however there
is no written proof. http://en.wikipedia.org/wiki/Mizoram
29 http://en.wikipedia.org/wiki/Nagaland
30 Nagas speak 60 different dialects belonging to the Sino-Tibetan family of languages.
http://www.angelfire.com/nm/nagalim/origin.htm
31 Indo-Mongoloid tribal people of North East India
32 The word Oriya is an anglicized version of Odia, which itself is a modern name for the Odra or Udra
tribes. Orissa has also been the home of the Kalinga and Utkal that played a particularly prominent role
in the region’s history, and one of the earliest references to the ancient Kalingas appears in the writings
of Vedic chroniclers. http://en.wikipedia.org/wiki/Orissa
33 http://en.wikipedia.org/wiki/Punjab_(India)
34 Punjab in Persian literally means “five” (panj) “waters” (ab), i.e. the Land of Five Rivers, referring to
12
the five rivers which go through it. The first mentioning of the Sanskrit equivalent of ‘Punjab’, however,
occurs in the great epic, the Mahabharata (pancha-nada ‘country of five rivers’).
http://en.wikipedia.org/wiki/History_of_the_Punjab.
35 http://en.wikipedia.org/wiki/Rajasthan
36 The state of Rajasthan is also populated by Sindhis, who came to Rajasthan from Sindh province (now
in Pakistan) during the India-Pakistan separation in 1947.
http://en.wikipedia.org/wiki/Rajasthan#Demographics.
37 http://en.wikipedia.org/wiki/Sikkim
38 Sikkim (or Sikhim) means crested land in Nepali. The term, which was coined by the invading Gorkhas,
is derived from the Sanskrit word Shikhim which means “crested”, and is the most widely accepted
origin. Sikkim would thus owe its name to its almost entirely mountainous terrain. An alternative
etymology suggests that the name originates in the Limbu words Su, which means “new”, and Khyim,
which means “palace”. Hence the term Sikkim may also mean “New Palace”, in reference to the palace
built by the state’s first ruler, Panchen Namgyal. The Tibetan name for Sikkim is ‘Bras mo ljongs, which
means the “valley of rice”.
39 http://en.wikipedia.org/wiki/Tamil_Nadu
40 Tamils are an ethnic group native to Tamil Nadu, a state in India, and the north-eastern region of Sri
Lanka. http://en.wikipedia.org/wiki/Tamil_Nadu#Demographics_and_Religion
41 The origin of the name of Tripura is still a matter of controversy among historians and researchers.
According to the ‘Rajmala”, Tripura’s celebrated court chronicle, an ancient king named ‘Tripur’ ruled
over the territorial domain known as ‘Tripura’ and the name of the kingdom was derived from his name.
Many researchers explain the name ‘Tripura’ from its etymological origin: the word ‘Tripura’ is a
compound of two separate words, ‘Tui’ (water) + ‘Pra’ (near) which in totality means ‘near water’.
http://www.indiastudychannel.com/resources/2439-TRIPURA-ORIGIN-AND-HISTORY.aspx
42 The known history of Uttar Pradesh goes back 4000 years, when the Aryans first made it their home in
2000 BC. This heralded the Vedic age of the Indian civilization and Uttar Pradesh was its home.
Madhya Desha (midland) or Aryavarta (the Aryan land) or Bharatvarsha (the kingdom of Bharat, an
important Aryan king). In the ages to come, Aryans spread to other parts of the Indian subcontinent,
reaching as far south as Kerala and Sri Lanka. http://en.wikipedia.org/wiki/Uttar_Pradesh.
43 Literally North Country or Section in Sanskrit, the name of Uttarakhand finds mention in the early
Hindu scriptures as the combined region of Kedarkhand and Manaskhand. Uttarakhand was also the
ancient Puranic term for the central stretch of the Indian Himalayas. Its peaks and valleys were well
known in ancient times as the abode of gods and goddesses and source of the Ganga River. Today, it is
often called “the Land of the Gods” (Dev Bhoomi) because of the presence of a multitude of Hindu
pilgrimage spots. Kandari, O. P., and Gusain, O. P. Eds. 2001. Garhwal Himalaya : Nature, Culture
and Society. Srinagar: Transmedia.
44 http://en.wikipedia.org/wiki/West_Bengal
45 The exact origin of the word Bangla or Bengal is unknown, though it is believed to be derived from the
Dravidian-speaking tribe Bang that settled in the area around the year 1000 BC. Heitzman, James and
Robert L. Worden, ed. 1989. Early History, 1000 B.C.-A.D. 1202. Bangladesh: A country study.
Library of Congress. http://memory.loc.gov/frd/cs/bdtoc.html.46
http://en.wikipedia.org/wiki/States_and_territories_of_India
47 Frontline. Nov. 2000. A Conflict Deferred. New Delhi: The HIndu
48 http://www.humanrightsinitiative.org/programs/aj/police/chhattisgarh/background/default.htm.
49 http://en.wikipedia.org/wiki/Union_Territory
50 http://en.wikipedia.org/wiki/Goa
51 http://en.wikipedia.org/wiki/Seven_Sister_States
52 http://en.wikipedia.org/wiki/Northeast_India
53 http://en.wikipedia.org/wiki/Terrorism_in_India
54 http://en.wikipedia.org/wiki/Insurgency_in_North-East_India
55 The exact origin of the word Bangla or Bengal is unknown, though it is believed to be derived from the
Dravidian-speaking tribe Bang that settled in the area around the year 1000 BC. Heitzman, James and
13
Robert L. Worden, ed. 1989. Early History, 1000 B.C.-A.D. 1202. Bangladesh: A country study.
Library of Congress. http://memory.loc.gov/frd/cs/bdtoc.html.56
http://en.wikipedia.org/wiki/List_of_terrorist_organisations
57 http://en.wikipedia.org/wiki/Bihar
58 http://en.wikipedia.org/wiki/Communist_Party_of_India_(Maoist)
59 http://news.indiainfo.com/2006/07/11/major_terrorist_attacks_india.html
60 http://en.wikipedia.org/wiki/Terrorism_in_India
61 Singh, Nirakhar. Cultural Conflict in India: Kashmir and Punjab. Available on
http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1066&context=uciaspubs/research
62 http://en.wikipedia.org/wiki/Terrorism_in_India
63 http://en.wikipedia.org/wiki/National_Democratic_Front_of_Bodoland
64 http://en.wikipedia.org/wiki/United_Liberation_Front_of_Asom
65 http://en.wikipedia.org/wiki/Tripura
66 http://en.wikipedia.org/wiki/National_Liberation_Front_of_Tripura
67 http://en.wikipedia.org/wiki/Tripura
68 http://en.wikipedia.org/wiki/Manipur
69 http://en.wikipedia.org/wiki/Mizoram
70 It is home of the Sentinelese (world’s last un-contacted peoples) that resulted untouched by modern
civilization.
71 http://en.wikipedia.org/wiki/Autonomous_regions_of_India
72 http://en.wikipedia.org/wiki/Autonomous_regions_of_India
73 http://en.wikipedia.org/wiki/Meghalaya
74 Paragraph 1 has been amended in its application to the State of Assam by the Sixth Schedule to the
Constitution (Amendment) Act, 2003 (44 of 2003),s. 2 , so as to insert the following proviso after subparagraph
(2), namely: “Provided that nothing in this sub-paragraph shall apply to the Bodoland
Territorial Areas District
75 http://en.wikipedia.org/wiki/Andhra_Pradesh
Painting: Lona Towsley
Address at the International Development Research Centre (IDRC)
on
The Recent Evolution of Indian Federalism
Vijay Kelkar
Chairman
Forum of Federations, Ottawa
India Development Foundation, New Delhi
IDRC, Ottawa
March, 2010
IDRC, Ottawa, March, 2010 Page 2
1. I want to thank Ambassador David Malone, the distinguished President of IDRC for inviting me to speak today. I am going to speak on The Recent Evolution of Indian Federalism. I have had the pleasure of coming to IDRC last October when Ambassador Malone had kindly hosted the visit of the Finance Commission. After submitting the report to the President of India, I demitted office of the Chairman of the Finance Commission in January this year. I have now the honor of being the chairman of Forum of Federations. This Forum is undoubtedly one of the great initiatives that Canada has taken to share its “soft power” with the international community so as to foster democracy and improve global governance.
2. Over the last 10 years, the Forum has done splendid work towards the strengthening of theory and practice of federalism in the world. This was possible only because of the wise leadership of the distinguished Chairmen and Presidents over the last ten years and I want to particularly salute Mr. George Anderson, the present President for his outstanding contribution.
IDRC, Ottawa, March, 2010 Page 3
3. Federal system is essentially a post-industrial revolution phenomenon. I do believe there is an organic link between the growth of modern market-economy and federalism as there is synergy in these two systems or organizing principles viz., one relates to the governance of economic markets or exchanges and the other which relates to the governance of political markets or political interaction. Therefore, it is no wonder that federalism has seen even more dynamic growth over the last several decades and today almost 30 countries, accounting for more than 40 per cent of the world population, have federal structure. George Anderson’s lucid book on Federalism published recently by the Oxford University Press, is an excellent resource material on Federalism. This book makes an interesting observation that almost all democracies which are either large in area or has a population of more than 100 million have a federal system.
4. Although I have lived in three Federal Systems such as United States, Switzerland and India, I am more familiar with the federal system
IDRC, Ottawa, March, 2010 Page 4
of India and hence my today’s remarks will focus on some of the key aspects of India’s federalism.
5. India as a federal system is about 60 years old, compared to more than two centuries of the United States or Switzerland or Canada. The federal system has served extremely well for India to promote our democracy, to strengthen the national unity and to achieve economic progress.
6. One of the reasons why India has been successful in this is perhaps the Indian federal system has one important attribute and that is the “flexibility” of the system. The design of the Constitution as well as the approaches adopted by our political elite, or to put it differently, the political economy of Indian federalism is responsible for this happy outcome. When I say political economy of federalism, I mean the strategic interplay between the political and economic forces.
7. While describing federalism, people have described it in many ways. For instance, some scholars have described federalism as
IDRC, Ottawa, March, 2010 Page 5
“administrative federalism;” some have argued for “market preserving federalism” and some others have described it as “coming together federalism” vs. “holding together federalism”. Countries like USA are supposed to be examples of “coming together” federalism while India is supposed to be an example of “holding together” federalism.
8. In my view, the important feature of Indian federalism is what in India we call the “cooperative federalism” feature with formal and informal rules for maintaining the political system as well as for the peaceful change management. This is the feature that gives the “flexibility” to our Federation.
9. I think that it is this “flexibility” which helped the country to maintain unity while strengthening the democracy and I do believe that the democracy is one of the deep determinants of India’s growth performance. The U.S. constitution, over its 200 years or more of existence, has been amended only 27 times while in India, we have amended the Constitution 94 times in the first sixty years. In my view, this is the strength and not weakness of our system.
IDRC, Ottawa, March, 2010 Page 6
10. There is perhaps no other country which is as heterogenous as India in terms of religion, language, ethnicity, levels of income etc. When India became independent, the States were formed which were more or less on the pattern that British had organized for administration in terms of various provinces. But there was a political demand that we need States organized on the basis of language as an organizing principle. This was a reflection of sub-nationalism and in 1956 the States Reorganization Commission divided the country into States on the basis of language. Now, fifty years later, there is a new demand coming up claiming for smaller units of administration as a language based big states are turning out to be too large to address the regional aspirations within a State. The country is responding to this demand and some large States like Uttar Pradesh and Bihar have already been bifurcated though language remains the same. However, I do foresee some further restructuring of the States. In the coming decades, there may be a few city states emerging as growing urbanization makes some of these cities so large that they will demand a separate political space.
IDRC, Ottawa, March, 2010 Page 7
11. The other examples of this flexibity are the 73rd and 74th constitutional amendments which were first introduced by Prime Minister Rajiv Gandhi and later piloted by Prime Minister Narasimha Rao. This resulted in the creation of the third tier of the government, namely Panchayati Raj in rural areas and elected urban bodies. This was in response to the need for effective decentralization or for the adoption of the “subsidiarity” principle in governance. I can give more examples of such politically alert responsiveness. What I wish to emphasize is that such a constitutional flexibility has been the secret of the Indian recipe for successfully nurturing democracy in a very large, but poor developing country.
12. I seek now your indulgence to highlight the other aspects of Indian federalism which is fiscal federalism. It is in this area that I think India’s performance is in contrast with many other emerging nations of Asia and Africa. I am going to spend more time on fiscal federalism because I know a little bit more about this area and its great importance in sustaining India’s federalism.
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13. Like other federal countries, Indian federation has two major fiscal issues, namely vertical imbalance and horizontal imbalance. Vertical imbalance refers to the imbalance faced by the different levels of the government in their relative ability to raise revenues vis-à-vis their expenditure responsibilities. Unlike the federations of United States and Canada, in India, the vertical imbalance is somewhat more acute as the taxation powers of the Union (the central government) are overwhelming compared to those of States or provinces. Indian Constitution envisages the States to tax income from land, sales tax on goods and of course other local taxes such as property tax, while the Union government has the taxing powers for corporate income, personal income, taxes on foreign trade, taxes on manufacturing and services sector as well as on major mineral resources. Such division of labour made sense in the formative years of the country as the capitalist class or the national bourgeoise wanted taxes on the mobile factors of production to be solely with the union government, while the large farmer and landlords or to use a more evocative phrase, the kulaks wanted that the powers of taxing income from land to be retained with the States. Regarding the expenditures, according to our constitution,
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the expenditure responsibilities of the States are much higher calling for, as compared to the central government, much greater revenue expenditure for the supply of employment-intensive public services such as health, education, law & order, etc. A ratio measuring the share of revenue expenditure by the States in total revenue expenditure by the centre and the States together has been almost like a gravitational constant in India and has been about 57-58 per cent for the last 60 years while the share of the revenues collected by the States in the total revenues has been around 40%. These two ratios indicate the high degree of vertical imbalance in our federation. In addition to this vertical imbalance, there is also the acute problem of horizontal imbalance occurring among the constituent members of the federation or amongst the different states because of the differences in their fiscal capacities to supply essential public goods or services.
14. Once again, the degree and nature of horizontal imbalance in fiscal capacities is much acute in India compared to the advanced federations such as USA, Canada or Australia. For instance, in advanced countries, the ratio of highest per capita income and the lowest per
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capita income amongst the states would be probably between 1.5 to 1.8, while in India it is in the ratio of 8:1. Even if we take off the outliers, this ratio will be 5:1. Hence, the fiscal capacities diverge sharply. As if such a high ratio problem is not enough, the poorer states are also some of the largest states in terms of population making the issue of horizontal equalization even more challenging. So, meeting the challenge of these twin imbalances is a fundamental issue facing India’s fiscal federalism.
15. Since 1982, in the Canadian constitution, there is a clear mandate for horizontal “equalization”. Section 36(2) of the Canadian Constitution commits the federal government to the “principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonable levels of public services at reasonably competitive levels of taxation” and this exercise is done annually. In India, the Constitution does not give such clear instructions.
16. To meet these fiscal challenges of vertical and horizontal imbalances, our Constitution has created an institution called the Finance Commission, which is an independent Constitutional body, appointed
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every five years and which reports to the President of India. Its basic terms of reference are set by Art 280 of the Constitution:
i. the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under Chapter I Part XII of the Constitution and the allocation between the States of the respective shares of such proceeds;
ii. the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India and the sums to be paid to the States which are in need of assistance by way of grants-in-aid of their revenues under article 275 of the Constitution for purposes other than those specified in the provisos to clause (1) of that article; and
iii. the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State.
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The first two tasks are aimed at meeting the challenges of vertical and horizontal imbalances while the third task has been added in 1993 when a Constitutional amendment formally added the third tier of government to the country’s governance structure.
17. Unlike the Constitutions of Canada or Australia, Indian Constitution does not give any precise guidance to the Finance Commission as to how horizontal equalization is to be achieved. In the absence of such guidance, each Finance Commission works out its own approach, devising a formula for sharing of the taxes, i.e. for vertical sharing and horizontal distribution. The recommendations are usually based on the Commission’s overall judgement for vertical devolution which takes into account the resource availability and needs of the Union government for fulfilling its own functions such as defence, internal security, debt repayment etc.
18. As regards horizontal distribution, it is formulaic, where the formula is based on objective and transparent parameters. The
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preferred parameters are (i) area (ii) population (iii) fiscal efforts index and (iv) fiscal distance index.
19. Fiscal distance index is aimed at equalizing amongst the states the resource envelope for supplies of public services, while the fiscal efforts index is to minimize the “moral hazard” in such equalization payouts by incentivizing the tax efforts of the states. Area and population are indicative of the fiscal needs of the states.
20. Such an institutional arrangement has served the country well. The reports of all past twelve Finance Commissions were unanimously accepted by the Parliament and the country. In my view, this has been an important reason for the durability of the Indian federation.
21. The Finance Commission is not the only channel for fiscal transfers in India. There is yet another institution, namely the Planning Commission. Also, block grants are given by the different Ministries. Historically, the share of Finance Commission transfers have been roughly 65-70 percent and the remaining have been the other transfers,
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including Planning Commission transfers to States. The Planning Commission is an executive body and not a Constitutional body like the Finance Commission. While the Finance Commission’s role is to ensure adequate resources for assuring reasonable levels of public services in every state for meeting their current expenditure needs, the Planning Commission transfers are for improving developmental outcomes through increased infrastructure and related public investments in the States. These are direct transfers to the state governments. Of course, from the budget, there are also indirect transfers from the central government. Subsidy programs such as food and fuel subsidy or schemes involving tax expenditures are examples of such indirect transfers. The Finance Commission’s remit is only for devolution of the tax revenues and does not cover what in Canada you describe “spending power” of the central government.
22. The Finance Commission’s devolution of taxes takes place under Art.280 of the Constitution, but there is also Art. 275 which enjoins the Commission to give State specific grants to ameliorate particular problems faced by individual States. It is through these grants that the
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Finance Commission meets the requirements of what we call ‘special category’ States, which are essentially micro States which have geographically difficult terrain such as mountainous regions and which are relatively more sparsely populated. The share of these Art 275 grants in the total Finance Commission’s transfers has been between 15-18 per cent.
23. While the Finance Commission transfers are predominantly formulaic, the Planning Commission transfers tend to be more state-specific depending on the developmental needs of an individual State.
24. While historically, the Constitution recognized only two tiers of government, namely the Union and the States, a major Constitutional amendment introduced by Prime Minister Rajiv Gandhi formally created the third tier of government, namely Panchayats in villages and urban local bodies. These are elected bodies. Technically, the third tier is still under the political authority of the States and it is the States through their legislative assemblies that exercise political control over the third tier. Of course, it is recognized that the third tier do have fiscal needs and
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these are supposed to be predominantly met by sharing States’ revenues. The Constitutional amendment also created “State Finance Commissions” for the devolution of state governments’ revenues to the third tier. Recognising that these resources may not be adequate, the new Amendment also gave the third task of the Finance Commission which is to give grants to the third tier which are supplementary to the devolutions by the State Finance Commissions. This has become now an important function of the Finance Commission.
25. Over time, India’s fiscal federalism has been flexible enough to change its structure. For instance, till 15 years ago, the Constitution envisaged sharing of revenues tax-wise; in other words, share could be at different rates for corporate tax, personal income tax or manufacturing taxes or import duties. This feature created a perverse incentive structure for India’s tax policy. For instance, this gave no incentive for central government to reduce import duties as constitutionally, it could retain all earnings from such import tariffs. When India embarked on its new economic policy in 1991, the Tenth Finance Commission recommended the pooling of all these taxes and have a common sharing
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formula in order to rationalize the fiscal system. In my view, this paved the way for India’s tariff reforms which saw one of the most dramatic reduction in tariffs when they came down from 150 per cent to 10 per cent. Similarly, the support to the third tier through Finance Commission grants has also given momentum to effective decentralization programme in India.
26. However, there are now new challenges for India’s fiscal federalism. Hence, in our recent report, we have proposed “a new architecture” for India’s fiscal federalism. What are these challenges? What are the elements of the “new architecture”?
27. As I mentioned, compared to the other federations, India has much higher incidence of vertical imbalance and it is increasing thanks to growing share of services sector in the Indian economy which only the Union government can tax, while the responsibilities on the States are increasing due to new “social entitlements” arising out of the “human rights” approach to economic development. This mismatch needs to be corrected. Towards this, what we have proposed in our report is a
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common indirect tax base for the central and state governments by introducing GST (Goods and Services Tax) which is a consumption tax. Our GST proposal is on the lines of the Canadian system. This means a dual GST system where both the Union and the states collect taxes, but with a common tax base. Such a GST system will substantially reduce the vertical imbalance as States will have now powers to tax services sector, the largest and growing sector of Indian economy. Hence, an introduction of the GST is a key element of the proposed new architecture. We have also proposed a “Council of Finance Ministers” as a consultative and supervisory institution to manage the new tax system which will be jointly run by the centre and the states. This would give the States a greater say in India’s indirect taxes.
28. India is now on the path of rapid urbanization requiring new public goods and supply of efficient urban public services. Given this new challenge of urbanisation, the States now demand for further reform of India’s fiscal federalism to give an enduring fiscal base to the third tier. The proposed GST which is a consumption based tax, provides such an opportunity of offering a tax base to the third tier. Such a sharing on the
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constitutional basis will enormously improve India’s cities and villages. Another issue which has now come up for fiscal federalism is the share in the rents from “national commons”. India is now discovering large off-shore reserves of hydrocarbons. There will be large rents from these vast resources and sharing of these resource rents has now become an issue for our fiscal federalism. Currently, such rents including the rents from “spectrum” allocation to telecom companies are the preserve of the Union government. The States want a share in this. In our report, we have proposed a Constitutional amendment to achieve this.
29. Yet another challenge for our fiscal federalism is the challenge of environment i.e., green federalism. Our current system of fiscal transfers do not recognize adequately the environmental externalities. For instance, States with large forests are now asking to be compensated for their providing public goods or environmental services to the entire federation. Similarly, States with large hydel power potential would like to be compensated for providing clean power for the federation. Similar issues have also come up regarding water transfers between different States sharing the same river basin. Towards this, we have made a
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modest beginning in Finance Commission’s report by outlining an incentive structure to the States that supply environmental services.
30. These are some of the new challenges facing India’s fiscal federalism requiring new approaches. I am quite confident that given our “cooperative federalism”, we would be finding innovative solutions to such issues and create a new architecture for India’s fiscal federalism.
Indian Federalism, Economic Reform and Globalization*
Nirvikar Singh
T. N. Srinivasan
UC Santa Cruz and Yale University
Revised Draft
May 20, 2002
Abstract
In this paper we examine several dimensions of economic reform in India, in the context of the country’s federal system and of globalization, i.e., we explicitly recognize that the national government has subnational governments below it, and that all these layers of government simultaneously interact with foreign governments and corporations in a global economy. We examine two groups of reforms, the first involving redrawing of state-market boundaries, and the second concerned with reconfiguring federal institutions themselves. The first group includes financial sector reforms, assignment of regulatory powers, infrastructure reform and development, and privatization. We note the progress made in financial sector reform but also the problems caused for the financial sector as a whole by state and central fiscal deficits. We discuss the extreme problems of the power sector, and the important federal dimensions that make reform more difficult there. We also highlight the regional concentration of FDI in India’s more liberalized economy. The second group of reforms includes tax reforms, reform of center-state fiscal transfer mechanisms, and local government reforms. To some degree, these reforms in federal governance hold the key to opening the door to further reform elsewhere, by reducing the fiscal burden placed on the private sector by government deficits. We acknowledge the political economy aspects of reform of governance, and discuss possibilities for politically acceptable packages of fiscal reforms, such as combinations of changes in tax assignment that would be acceptable to the center as well as the state governments. We also discuss the possibility that growing regional inequalities might require the intergovernmental transfer system to be more efficient and effective in its objectives.
* Parts of this paper draw on joint work of Nirvikar Singh with M. Govinda Rao. We are grateful to Pranab Bardhan, Urjit Patel and Jessica Seddon for helpful comments and suggestions; Jahangir Aziz, Paul Cashin, Saumitra Chaudhuri, M.R. Nair, M. Govinda Rao, Y.V. Reddy, Ratna Sahay, Christopher Towe and especially Laveesh Bhandari and Aarti Khare of Indicus for help with data; and to CREDPR at Stanford University for financial support. We alone are responsible for the views expressed here, and for any errors or omissions.
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
1. Introduction
India’s economic reforms began slowly in the 1980s, and then accelerated under the pressure of an external crisis at the beginning of the 1990s. The most visible and important component of the reforms so far has been the relaxation of various internal and external controls on private economic activity, the “license-permit-quota raj”. A significant objective of this liberalization has been achieving greater efficiency in resource allocation, and re-integration of India’s economy with that of the rest of the world.1 In addition to further removal of restrictions, there is an ongoing attempt to replace case-by-case, discretionary controls with more efficient forms of regulation, where market and informational structures make such regulation a positive input in the smooth functioning of markets. The financial, power and telecom industries are three somewhat different examples of where some kind of regulation is required because of potential monopolies, information problems, or both. The first two kinds of reforms can be viewed as redrawing the nature of the boundary between state and market in India.
Reform of governmental structures themselves can be another, significant component of reform. Some activities will continue to be handled by the government, whether from objectives of efficiency or of equity. There is at least some scope for improving the effectiveness of direct government activity within the economy, whether in terms of the efficiency with which it expends funds for public goods or to achieve redistribution, or of the efficiency with which it raises revenue through taxation or through borrowing (which ultimately will itself require some kind of taxation). Reform of government can also be clubbed with the development of new regulatory structures under the category of ‘institutional reform’. However, reforms such as decentralization of government have additional, noninstrumental objectives, and have been motivated at least as much by the intrinsic value of local democracy as by the desire to improve the efficiency and equity of economic decisions.
In the case of reform of governance, improved efficiency and effectiveness can be achieved by designing instruments better, or by changing the internal organization of government to provide more efficient incentives. Examples of the former are changing the nature of tax bases and rates to reduce allocative distortions, or redesigning intergovernmental transfer schemes to avoid distortions to incentives for transfer recipients. Examples of the latter are changing the structures of and relationships between the bureaucracy, judiciary, legislature or functional branches of government in general (taking account of government actors’ self interested natures), and changing the structure of and relationships between different geographically defined governmental jurisdictions.
The existence of well-defined governmental jurisdictions at subnational levels is the essence of what we call federalism. Changing the nature of intergovernmental relations can involve many different dimensions, but much of what is possible in India, and what might be viewed as efficiency enhancing, can be gathered under the umbrella of decentralization. Of course some kinds decentralization may conflict with efficiency (e.g., tax competition), and may make achieving equity goals more difficult. Perhaps one
1 See, for example, Srinivasan and Tendulkar (2002).
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Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
of the biggest concerns with decentralization is the impact on fiscal discipline. Nevertheless, given India’s centralized nature, the presumption is in favor of decentralization on at least some dimensions.
The above discussion is partly represented schematically in Figure 1 below. Note that the three dimensions shown in the figure are not independent in practice, though they may often have different motivations, and different constituencies supporting or opposing them. For example, we have noted that withdrawing the government from certain kinds of control of private economic activity may require the introduction of effective arm’s length regulation, rather than a completely hands off approach. In the case of regulation, the question of assignment of regulatory powers becomes a component of the design of the federal system, since regulatory authority must be assigned to the appropriate level of government. Another example is the liberalization of capital markets, which frees private actors from government controls, but also affects how governments at all levels may set about raising funds for their own activities. Yet another example is the possible privatization of delivery of some components of goods and services that have a mixed public-private good character, such as in the areas of education and health. Many more examples of interaction between the different components or dimensions of reform can be given.
Figure 1: Dimensions of Economic Reform
Of course India’s economic reforms are not taking place in a vacuum. Other countries are also pursuing similar reforms, particularly with respect to integration with the world economy. In many cases, these countries are ahead in the game. Since part of economic reform includes trying to capture the benefits of participating more fully in the global
Examples: Securities and Exchange Board of India, Telecom Regulatory Authority of India
Arm’s Length Regulators
Market
Examples: removing licensing controls, privatization
Central Government
Examples: more discretion to states, strengthening of local government, reform of intergovernmental transfer system
Subnational Governments
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Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
economy, the proper perspective on reform must be one of reform in the context of globalization. Globalization can be thought of abstractly in terms of freer movements of goods and of factors. This may bring down prices of some goods, lead to more efficient allocations of factors, and allow relatively capital-scarce countries such as India to gain greater access to foreign capital and technology for enhancing economic growth. This is the standard way in which openness supports private (and potentially also public2) economic activity. From the perspective of the government, however, there may be new challenges in a world of factor and goods mobility. The ability of the government to tax is affected, since mobile factors can escape the incidence of taxes that initially are placed on them. Furthermore, regulatory policies can be subject to similar problems in the face of factor mobility, as in fears of races to the bottom in standard setting.
An important aspect of openness in a federal system is the extent to which subnational governments can make policies independently. While only the national government can determine import duties, subnational governments will typically have some freedom in policies that affect the incentives of foreign capital to enter their jurisdictions. Note that, from the perspective of a subnational government, say an Indian state, capital from another country or from another state can be viewed through the same lens, and must be treated equally in typical policy environments. The final impacts of the entry of capital on a subnational government will therefore depend also on the internal mobility of capital and labor. Hence, an important point that emerges from considering subnational jurisdictions in a federal system is that attention must be paid to internal mobility of goods and factors, in addition to external liberalization. Thus subnational tax and regulatory policies can assume great importance in a scenario of economic reform under globalization. A further consideration, which we shall also explore, is that the fiscal health of the states that results from their policies is likely to impinge on the entire nation’s credit rating in world capital markets.3
The above discussion should provide sufficient motivation for examining a particular set of issues that are all currently receiving the attention of economic reformers in India, and bringing out their interrelatedness. In this paper, we examine the following dimensions of reform and its consequences for India, where we explicitly recognize that the national government has subnational governments below it, and that all these layers of government simultaneously interact with foreign governments and corporations in a global economy.
1. Financial sector reforms
2. Assignment of regulatory powers
3. Infrastructure reform and development
4. Privatization
2 This is particularly the case when the government produces private goods.
3 The mechanism by which this occurs can be indirect, through explicit central counter guarantees for state guarantees to foreign corporations, or direct, through the observation of larger deficits for the center and states combined.
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Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
5. Tax reforms
6. Reform of center-state fiscal transfer mechanisms
7. Local government reforms
8. Patterns of change in regional inequality
The first seven topics can be organized into two groups. The first four topics are concerned directly with state-market boundaries, while the next three deal purely with internal government decisions (though of course these have implications for the private sector). The eighth topic focuses on the possible impacts of various dimensions of reform, or their absence. Clearly, there are feedback effects from patterns of change in regional inequality, and of who wins and loses in general, to the manner and extent to which policies in any of the first seven categories can be implemented.
One can organize the first seven topics in other ways as well. For example, topics 1 and 3-7 all have implications for the government’s overall finances. Topics 3 and 7, and to some extent 4 and 6, deal directly with the issue of effectiveness of government expenditures on classical public goods. Topics 1, 5 and 6 deal with the revenue side of government at different levels. Topics 2, 4 and 7 deal directly with institutional reforms. And so on. These alternative groupings merely highlight the interconnectedness of the topics. We organize the paper as follows. Section 2 provides an overview of India’s economy and recent economic reforms. Section 3 gives a summary analysis of India’s federal structures, touching on its fiscal situation. Section 4 examines the first four topics in our list, while section 5 tackles the next three. Section 6 deals with regional impacts, the last topic on our list. Section 7 provides a summary conclusion.
2. Overview of India’s Economy and Recent Reform
India is a large and relatively poor developing country. After independence in 1947, it pursued economic policies that gave the government a primary role in promoting economic development. While the country’s size dictated some kind of federal structure, the arrangements that were adopted in the Constitution (ratified in 1950), and their subsequent evolution gave the central government a dominant position vis-à-vis the constituent units of the nation (states and territories). India’s leaders aspired toward an indigenous version of Fabian socialism, with government as benevolent guardian, leavened with a smattering of Gandhian influences in favor of smallness, self-sufficiency and rural traditions.
Through the 1970s, India’s economic growth was reasonable, averaging between 3 and 4 per cent per year, but this was not rapid enough to significantly diminish the number of poor people, nor to deal comfortably with the strains associated with governing a country with substantial ethnic, linguistic and religious diversity along with economic inequalities. Nevertheless, India was able to preserve its unity, as well as the political system of parliamentary democracy adopted in its early years. However, this political stability was accompanied by the evolution of an economic system riddled with increasing rigidities and inefficiencies, the so-called ‘license-quota-permit raj’.
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In the 1980s, partly through fresh ideological influences, and partly through the observation of faster growth in many East Asian economies, India’s economic policymakers began to seriously attempt some changes in the overall approach to the role of government in the country’s economic development, introducing some liberalization in the trade regime, loosening of domestic industrial controls, and promotion of investment in modern technologies for areas such as telecommunications. Growth accelerated past 5 per cent, but this came at the cost of macroeconomic imbalances (fiscal and current account deficits), which worsened at the beginning of the 1990s as a result of the collapse of the Soviet Union, which had become a major trading partner and ally, and of turmoil in the Middle East.
In 1991 India faced a severe balance of payments crisis, and this circumstance became the occasion for a substantial advance in the pace and nature of economic reforms that were being attempted. In particular, the major steps taken were further trade liberalization, in the form of reductions in tariffs and conversion of quantitative restrictions to tariffs, and a sweeping away of a large segment of restrictions on domestic industrial investment. These two changes in the early 1990s have come to symbolize or encapsulate the term ‘economic reform’ in India. Note that the collapse of the Soviet Union in 1991 and the stellar growth performance of China after its opening to the world economy and initiation of market oriented reforms in the 1980s were two very significant developments that supported India’s reform in the 1990s, and distinguished it from the temporary response to an earlier balance of payments crisis in 1966.
The move to reduce the role of government in directly controlling the working of markets had additional implications. It was recognized that sectors such as finance and telecommunications required a new set of regulatory structures suitable for an environment in which bureaucrats were no longer making discretionary judgments on a case-by-case basis. This need was strengthened by the direct and indirect impacts of technological change in such sectors. Furthermore, it was recognized that removing industrial investment controls could not by itself solve India’s problem of slow growth, but needed to be complemented by restructuring the working of the labor market, and by improving the economy’s physical and institutional infrastructure. Achieving the first of these objectives has been hampered by understandable interest group pressures, while the second goal has been constrained by the continued high level of the government’s fiscal deficit. The high fiscal deficit, in turn, is traceable to interest group subsidies, as well as the nature of the interaction between the central and state governments.
Despite the roadblocks to accomplishing comprehensive economic reforms, India was able to achieve a slight acceleration of growth in the 1990s as compared to the previous decade. However, growth statistics suggest that there was a deceleration in the latter half of the 1990s, even before the current global recession took hold. Tables 1 and 2 provide a summary of the size and structure of India’s economy and changes over time (Table 1), and economic performance along a wide range of dimensions over the last two decades (Table 2). One of the striking features of growth in the last decade has been the anemic performance of Indian industry, and lack of a shift from agriculture to industry in the 6
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
share of GDP. On the other hand, services have done well, partly as a result of the boom in software exports and IT-enabled services such as call centers. These aspects of services have also contributed to India’s reasonably good export performance, and its avoidance of further balance of payments difficulties.
Underlying the aggregate performance statistics, we therefore have a story of incomplete economic reforms, with sectors such as agriculture still shackled by an inefficient public procurement and distribution system and severe input market distortions, industry hampered by small scale reservations and inefficient financing, a financial sector still dominated by direct and indirect public control of investible resources, and labor market rigidities that hamper the entire organized (as opposed to informal) segment of the economy. Liberalization of trade and foreign investment – the ‘globalization’ aspect of India’s reforms – has helped in some areas, but has not been sufficient to promote widespread competitiveness, nor to overcome or rectify the poor state of India’s infrastructure. Thus the economic reform agenda in India remains lengthy as well as complicated.
A further complication, one that is a major theme of our paper, is that the decade of the 1990s has seen a substantial increase in regional inequality. We shall document this in subsequent sections. Here we note that, while inequalities may have widened within states as well (for example, the coast and urban areas of Maharashtra and Gujarat versus their interior rural regions), the main focus has been and will be on widening disparities across the states themselves. This is natural, given the size and political importance of the states, and the fact that the states are the direct and indirect channels for numerous kinds of transfers from the central government. The goal of the rest of the paper, therefore, is to examine the interaction of key pieces of the reform agenda and the mechanisms within India’s federal structures for managing and reducing inter-state inequalities, in the context of a situation where some aspects of economic reform, as well as larger global economic forces, are increasing regional inequalities within the country.
3. Overview of India’s Federal Structures and Fiscal Situation
In this section, we focus on the institutions and mechanisms that govern fiscal federal arrangements in India, particularly center-state transfers. We preface this discussion with an overview of India’s broader federal structure. India is comprised of 28 states, and seven “Union Territories” (see Figure 2). Of the seven, two Union Territories (Delhi and Pondicherry) have their own elected legislatures whereas the remaining ones are governed directly by appointees of the center. All the states have elected legislatures and Chief Ministers in the executive role. The constitutional assignment of certain statutory powers to the states is what makes India a federal system. The exact nature of the assignment of powers, and how that has played out in practice, determine the extent of centralization within this federal system. In addition, the size of the states also has implications for this characterization. For example, since many of the Indian states are quite large in terms of population (with the largest dozen being comparable in population to larger European countries), devolution of powers to the states without any further decentralization below that level may still represent a relatively centralized federation. In
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practice, devolution to both the states and to substate (local) government bodies has arguably been quite weak.
Figure 2: India – States and Union Territories
Political and Administrative Structures
The primary expression of statutory constitutional authority in India comes through directly elected parliamentary-style governments at the national and state level, as well as nascent directly elected government bodies at various local levels. To the extent that the essence of federalism is based on representative democratic politics, the role of political parties in the interactions between central and state level politics is a crucial aspect of federal structures. To illustrate, consider the extreme case where government powers are notionally decentralized, with all residuary powers assigned to the state level, but the national and all state governments are controlled by a single, rigidly hierarchical political party. Here the outcome will effectively be the same as in a centralized, unitary system, since decisions are made at the top of the political hierarchy. For example, during the Nehru era, the Prime Minister’s personal authority and prestige were combined with almost complete legislative control of the center and the states by the Congress Party led by Nehru. In such circumstances, issues of center-state relations were often played out within the ranks of the Congress party. 8
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Over time, Indian political parties have embodied varying degrees of centralization, including the regional political bosses of the earlier Congress party,4 the tightly controlled personalized approach characteristic of the later Congress under Indira Gandhi, the more institutionalized hierarchy of the BJP, and the emergence of explicit regional parties. Overall, however, we may argue that the institutional expression of federal or centralized structures in political parties has not been a major independent factor in shaping India’s federal system, because other forms of central control, administrative, legal and fiscal, have mattered more.5
The next level of governance that embodies aspects of federal structures is the bureaucracy. If elected politicians act as agents of constituents or voters, bureaucrats in turn act as the agents of elected officials. Bureaucrats, as career employees, are partly insulated from political whims and pressures, but ultimately in a democracy must be subordinate to the people’s elected representatives. This means that a unitary, hierarchical bureaucracy cannot by itself negate a federal political structure in the same way that a powerful, centralized, national political party might. However, a centralized bureaucracy can act as the agent of such a political party, in acting against the requirements of a federal system. There are elements of such action in the workings of Indian bureaucracy.
The Indian bureaucracy is provided constitutional recognition. The central and state level tiers of the “public services” are given shape through the provisions of part XIV of the Constitution. Of course any bureaucracy in a federation will have a federal character in the sense that each layer of government requires its own administrative apparatus to accompany the political structures. In particular, state governments must be able to appoint and dismiss6 bureaucrats to implement state-level policies. This is certainly the case in India, where there is a central bureaucracy as well as an independent bureaucracy in each state.
A key component of the central bureaucracy, the Indian Administrative Service (IAS) has a dual allegiance. The IAS is an all-India bureaucratic hierarchy: its members are chosen by a central process, and trained together. However, they are then assigned to particular states, and become, technically as well as in most practical matters, members of a state-level bureaucratic hierarchy as well. While an IAS member’s entire early career is spent within the home state, and senior level appointments at the state level carry considerable
4 Following Manor (1995), we may characterize the Congress party structure itself as federal in nature at this time. In some respects, however, Nehru’s personal authority after independence allowed him to dominate decision-making, as we have noted above. The pre-independence Congress was actually more decentralized, with provincial units playing a significant role, and provincial leaders being powerful in their own right, with prominent positions in the formal party hierarchy.
5 There are many nuances that this conclusion glosses over. See Rao and Singh (2001) for a more detailed discussion.
6 In practice, dismissal is almost impossible, something that is true for the entire organized sector in India. However, state governments use (and misuse) the power to transfer bureaucrats to assert political control over the bureaucracy.
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power and prestige, the most prestige, power, and resulting attraction tend to lie with appointments within the central government.
While the structure of the IAS was designed as a compromise between, on the one hand, the desire to have an effective administrative apparatus at the state level, to which most of the tasks of day-to-day administration, development, and law and order were assigned by the Constitution, and on the other hand, the fear of promoting regional loyalties over national ones (with the further fear of national disintegration), this compromise has been somewhat problematic. A bureaucracy in a democracy is the administrative tool of elected politicians, and a lack of clear lines of authority creates difficulties for incentives.
The efficiency consequences of the scope of bureaucratic governance are, to some extent, independent of the structures of federalism. They point to guidelines for constraining bureaucratic interventions at any level, whether national or subnational. However, the consequences of mistakes in assignment with respect to bureaucratic authority will be felt more widely in a centralized structure, since the geographic scope is wider and the pressure of competition is less. Competitive federalism is more likely to lead to corrections than is a unitary state, to the extent that electoral monitoring and incentives are better targeted, and therefore more effective, in a federal system. While competition among subnational jurisdictions may lead to a race to the bottom in tax rates or environmental regulations, it also puts more pressure on politicians to correct mistakes in bureaucratic decision-making than may exist in a centralized system.
The judiciary is, in some respects, a specialized bureaucracy, but is conceptually more separate, constituting a distinct branch of government at its higher levels. Much judicial activity involves judging whether the law was broken and who broke the law in particular cases, in which capacity the judiciary acts as a specialized agent of elected officials who frame laws. The higher levels of the judiciary also act as judges of the laws themselves, within the context of the overarching legal and constitutional framework. Furthermore, the judiciary in theory can check the actions of politicians in ways that may be difficult for bureaucrats: “no one is above the law”.
The Supreme Court stands at the top of the Indian judicial hierarchy. Its powers include broad original and appellate jurisdiction and the right to pass on the constitutionality of laws passed by Parliament. In practice, there has been conflict between the Supreme Court and the legislature/executive over the scope of these powers, and their boundaries remain subject to bargaining. The President, in consultation with the Prime Minister, appoints Justices of the Court. At the state level, below the Supreme Court, are the High Courts. Each High Court’s justices are appointed by the President, in consultation with the Chief Justice of the Supreme Court and the state’s Governor. Paralleling the situation at the Center, the state’s Chief Minister is in a position to influence the Governor’s advice. High courts also have both original and appellate jurisdiction. In addition, they superintend the work of all courts within the state, including district courts, as well as various courts subordinate to the district courts. These subordinate courts are specialized, with smaller civil matters being separated out from criminal cases, for example. Criminal cases are dealt with in magistrates’ courts.
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The formal judiciary, therefore, is a well-defined hierarchy, with a relatively clear assignment of tasks. This assignment and hierarchy are overly centralized, in the sense that not enough matters are disposed of at lower level courts. This partly reflects a lack of resources devoted to lower level courts (though the resource problem exists at all levels), but also a centralized assignment of scope of jurisdictions. The problem is compounded by the nature of the appeals process, and by the failure of higher-level courts to control appeals.7 Note also that judges below the state level are typically not appointed by local government officials, representing a significant departure from a federal system below the state level.
The microeconomic inefficiencies of the judicial system in India partly reflect inadequate decentralization within the judiciary itself, but are also a consequence of inadequate delegation of powers by the legislative/executive branch. For example, the expansion of state intervention in the economy that occurred in the first three decades after independence was effectively outside judicial review. Inadequate judicial power is a constitutional problem, because this delegation is absent in some of the particulars of the Constitution. While a weaker central legislature may allow the national judiciary, particularly the Supreme Court, to play a more effective checking role, it does not solve the resource allocation problems that must ultimately be corrected for smoother working of day-to-day judicial functions. The pressure for correction might come from competition among subnational jurisdictions pursuing commercial motives. As states and localities try to attract investment and commercial activity, they may well come under pressure to provide judicial systems that support such commercial activity. It should be noted that this argument applies to areas such as contract enforcement, or property rights enforcement more broadly, rather than to the criminal justice system. In this respect, the lack of training of India’s lawyers and judges in even rudimentary economics has sometimes led to judicial decisions with substantial negative impacts on the economy.
Finally, the police have a special role, involving both the bureaucracy and the judicial system. Ideally, the police are impartial investigators and monitors, preventing violations of law where possible. Their role complements that of the judiciary in enforcement. However, the police are also organized as a bureaucracy that is under the control of politicians, like other branches of administration, but unlike the judiciary, with its notional independence. The actual functioning of the police therefore becomes subject to politicization and the encroachment of the central government into law and order, constitutionally a state subject.
The Indian Police Service (IPS), which is the superior officer cadre for the police in India, is organized on similar dual lines to the IAS, that is, centralized recruitment and bureaucracy, but without the same key role in the Central government that belongs to the IAS. This latter difference reflects the fundamental difference between the generalist IAS and the functional specialization of the IPS. The IPS follows only the Indian Foreign
7 ‘Public interest petitions’ to the higher courts, while democracy enhancing in spirit, have also sometimes been used for obstructionist purposes to benefit particular interest groups. 11
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Service and the IAS in prestige.8 Furthermore, the fact that the IPS is a central bureaucracy, as in the case of the IAS, puts its members on a different footing than members of state police forces, which are recruited directly by state governments, even though IPS officers are assigned to particular states.9 While each state has its own police force, the central government possesses several police forces also, giving it considerable power over policing, well beyond what might be suggested by the constitutional assignment of powers. In practice, therefore, the Center has taken a substantial role in the maintenance of law and order.
To conclude this description, we note that the existence of different dimensions of governance implies that a federal political system cannot exist simply through a constitutional assignment of responsibilities to different layers of government. Each level of government in a federal system must not only have authority to raise revenues, but it also must have the authority to carry out decisions made at that level. In India, the IAS, the IPS and the judiciary are all perhaps more centralized than they need to be, given the current federal political system. While independent India began with a relatively circumscribed federal model, independent political competition at the state government level has thrived in recent years. This decentralization has not necessarily been matched in the other dimensions of government, but may need to be for a more effective federal system to operate.
Assignments and Transfers
Assignments of authority include important non-fiscal dimensions, as we have briefly discussed in the context of politics, administration and law. However, control over how public resources are raised and spent represents a crucial aspect of any federal system. We describe the tax and expenditure assignments that form the basis of India’s fiscal federal institutions, and consider the system of Center-State transfers that results from, and complements the assignment of fiscal authorities in India.
The essence of economic theories of government is the idea that some goods or services are not well provided by the market mechanism. If a good is non-rival (can be consumed by someone without reducing its availability to others) and non-exclusive (others cannot be prevented from consuming it), it is a pure public good, and a candidate for provision by government. This economic rationale for the existence of government does not justify a hierarchical structure. However, geographic distance can matter, by limiting the number who benefit from provision of a public good. If the information available to governments is not perfect and they are not intrinsically benevolent, subnational or local governments will be better able to judge the desired levels of some public goods, and can be given more powerful or refined electoral incentives to do so. Given the motivation for decentralization of government down to lower levels, based on better information and better incentives, the assignment of expenditure responsibilities follows. Wherever
8 The high status of the IPS appears to be a vestige of colonialism, especially when other specialized or technical services such as the Indian Economic Service and Indian Statistical Service are considered to be inferior.
9 For example, recently the Chief Minister of Tamil Nadu, J. Jayalalitha, came into conflict with the center over the posting of IPS officers in her state.
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economies of scale, access to resources and externalities or spillovers do not indicate otherwise, the expenditure assignment should match the locus of beneficiaries. In other words, if the benefits of a public good are local, then local government should have the responsibility for provision.
With respect to revenue authority, tax assignments are what matter as a first approximation (neglecting intergenerational issues), since the interest on borrowing must also come out of taxes. Putting aside issues of collection efficiency, the allocational efficiency of different tax assignments is most significant. For example, mobility across jurisdictions within a federation is greater than mobility across nations. A tax base that is mobile may shrink dramatically in response to a tax. Therefore, it is harder for subnational jurisdictions to raise revenue from taxes than it is for the central government.10 If this factor implies that more taxes should be collected by the center, there will be a tendency for there to be a mismatch between revenues and expenditures for subnational jurisdictions, to the extent that subnational governments are relatively better able to respond to diversity of preferences, as noted above. A further push toward more centralized assignment of taxes may come from redistribution motives. The result of the differing determinants of optimal assignments of expenditure and tax authorities can be a “vertical fiscal imbalance”, where subnational governments rely on the center for revenue transfers. However, the divergence of revenue and expenditure decisions at the margin can have adverse incentive effects.
The Indian Constitution, in its Seventh Schedule, assigns the powers and functions of the center and the states. The schedule specifies the exclusive powers of the center in the Union list; exclusive powers of the states in the State list; and those falling under the joint jurisdiction are placed in the Concurrent list. All residuary powers are assigned to the center. The nature of the assignments is fairly typical of federal nations. The functions of the central government are those required to maintain macroeconomic stability, international trade and relations and those having implications for more than one state. The major subjects assigned to the states comprise public order, public health, agriculture, irrigation, land rights, fisheries and industries and minor minerals. The States also assume a significant role for subjects in the concurrent list such as education and transportation, social security and social insurance.
The assignment of tax powers in India is based on a principle of separation, i.e., tax categories are exclusively assigned either to the center or to the states. Most broad-based taxes have been assigned to the center, including taxes on income and wealth from non-agricultural sources, corporation tax, taxes on production (excluding those on alcoholic liquors) and customs duty. A long list of taxes is assigned to the states. However, only the tax on the sale and purchase of goods has been significant for state revenues.11 This
10 Of course for internationally mobile factors, even national jurisdictions face problems in collecting taxes. A further qualification is that mobility also depends on the relative benefits provided through public expenditures, so that jurisdictions are able to counter mobility in response to marginal taxes by also providing appropriate benefits at the margin to those who are taxed.
11 This tax assignment implies that the introduction of value added taxes in India (see section 5) has been subject to institutional difficulties with respect to the proper roles of center and the states.
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narrow effective tax base is largely a result of political economy factors that have eroded or prevented the use of taxes on agricultural land or incomes by state governments. The center has also been assigned all residual powers, which implies that taxes not mentioned in any of the lists automatically fall into its domain.
The tax assignment system has some notable anomalies. The separation of income tax powers between the center and states based on whether the source of income is agriculture or non-agriculture has opened up avenues for both avoidance and evasion of the personal income tax. Second, even though in a legal sense taxes on production (central manufacturing excises) and sale (state sales taxes) are separate, they tax the same base, causing overlapping and leaving less tax room to the latter. Finally, the states are allowed to levy taxes on the sale and purchase of goods (entry 54 in the State list) but not services. This, besides providing avenues for tax evasion and avoidance, has also posed problems in designing and implementing a comprehensive value added tax.
The result of the Indian assignments of tax and expenditure authority, and of their implementation has been a substantial vertical fiscal imbalance. In 1997-98, the states on average raised about 31 per cent of total revenues, but incurred about 57 per cent of total expenditures. The balance was made up by transfers from the center. In fact, the ability of the states to finance their current expenditures from their own sources of revenues has tended to decline over time, from 69 per cent in 1955-56 to around 55 per cent in the 1990s.
The Constitution recognized that its assignment of tax powers and expenditure functions would create imbalances between expenditure ‘needs’ and abilities to raise revenue. The imbalances could be both vertical, among different levels of government, and horizontal, among different units within a sub-central level. Therefore, the Constitution provided for the assignment of revenues (as contrasted to assignment of tax powers), sharing of the proceeds of certain centrally levied taxes with the states, and making grants to the states from the Consolidated Fund of India. The Constitution also provided for the compulsory sharing of the net revenue from non-corporate income tax (Article 270), and optional sharing of the proceeds of Union excise duty (Article 272). Recent constitutional changes in this scheme are discussed in section 5. The shares of the center and the states and their allocation among different states of both the taxes are determined by the Finance Commission appointed by the President of India every five years (or earlier if needed). In addition to tax devolution, the Finance Commission is also required to recommend grants to the states in need of assistance under Article 275.
A notable feature of India’s federal fiscal arrangements is the existence of multiple channels of center-state transfers. First, as noted, the Finance Commission decides on tax shares and makes grants. Second, the Planning Commission makes grants and loans for implementing development plans. Finally, various ministries give grants to their counterparts in the states for specified projects either wholly funded by the center (central sector projects) or requiring the states to share a proportion of the cost (centrally sponsored schemes).
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Historically, as development planning gained emphasis, the Planning Commission became a major dispenser of funds to the states. As there is no specific provision in the Constitution for such plan transfers12, the central government channeled them under the miscellaneous and ostensibly limited provisions of Article 282. Before 1969, plan transfers were project-based. Since then, the distribution has been done on the basis of a consensus formula decided by the National Development Council (NDC)13. However, various central ministries still felt the need to influence states’ outlays on selected items of expenditure through specific purpose transfers, with or without varying matching requirements: these are monitored by the Planning Commission. There are over 100 such central sector and centrally sponsored schemes, and several attempts in the past to consolidate them into broad sectoral programs have not been successful.
Overall, as noted, transfers from the central government contribute significantly to state finances. Until 1993-94, the growth of transfers was faster than both the center’s and the states’ own revenues. Thus, the share of transfers in central revenues increased from 32 per cent in 1970-71 to 44 percent in 1993-94, and then declined to 39 per cent in 1995-96. Similarly, the share of transfers in state revenues increased from 39 per cent to 44 per cent and declined to 38 per cent in 1995-96. State expenditures increased even faster during this period, so that the share of transfers in state expenditures declined steadily. However, they still finance almost a third of state expenditures. The relative shares of the three channels of central transfers to states since the Fourth Plan (1969-74) bring out two important features. First, there has been an increase in the discretionary element of transfers. Second, within statutory transfers, the proportion of tax devolution, which had already been high, has shown a steady increase while that of grants has declined.
So far, eleven Finance Commissions have made recommendations and, barring a few exceptions, these have been accepted by the central government. However, the working of these Commissions, their design of the transfer system, and the approach and methodology adopted by them have come in for criticism. The main criticisms are (i) the scope of the Finance Commissions through the Presidential terms of reference has been too restricted; and (ii) the methodology for the transfer scheme employed by the Commissions has not led to optimal equity and incentive consequences. We shall return to these concerns in section 5. However, we may note here that two developments are closely related to the functioning of India’s system of intergovernmental transfers, and heighten the need for reform in this dimension. First, India’s growing overall fiscal deficit reflects larger government deficits at the subnational level. Second, there is a documented increase in inter-state inequalities in the last decade.
As noted earlier, plan transfers from the center to the states consist of grants and loans. The Planning Commission works out five-year-plan investments for each sector of the economy and each state. With this as background, the states work out their respective
12 The Planning Commission was established by a Cabinet resolution, and the constitutionality of its transfers has, in fact, been seriously questioned.
13 The NDC is chaired by the Prime Minister and its members include all cabinet ministers at the center, Chief Ministers of the states, and members of the Planning Commission. The formula is known as the ‘Gadgil formula’, after the Deputy Chairman of Commission in 1969. 15
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annual plans for each year, based on estimated resource availability, which includes the balance from current revenue, contributions of public enterprises, additional resource mobilization, plan grants and loans, market borrowings and other miscellaneous capital receipts. The Planning Commission then approves the state plans. Thus, given the amount of central transfers to the states as determined by the Gadgil formula, at the margin it is mainly the states’ own resource position that determines their plan sizes.
Finally, assistance given to states through central sector and centrally sponsored schemes, constituting about 15-20 per cent of total transfers, is in some respects the most controversial form of transfers, being wholly discretionary. Central government ministries initiate a number of “National Programs”, either by themselves, or at the request of the relevant ministries at the state level. Central sector schemes are assisted entirely through central grants, and the states merely have the agency function of executing these programs. Centrally sponsored schemes are cost sharing programs, and the share of central assistance is through grants or loans decided for each individual program. The ostensible rationale for these programs is financing activities with a high degree of inter-state spillovers, or which are merit goods (e.g., poverty alleviation and family planning).
These programs have provided the central government with an instrument to actively influence states’ spending. Until 1969, the volume and pattern of assistance to state plan schemes were decided for each project, and the central government did not need such transfers. Once plan assistance was given according to a formula, the center introduced these specific purpose transfers and expanded them significantly. At present, there are hundreds of centrally sponsored schemes with detailed conditionalities, such as requirements on staffing patterns, which tend to distort the states’ own spending. Also, the proliferation of schemes seemingly has increased the size and control of the bureaucracy. Therefore, the NDC appointed an investigative committee, which recommended scaling down and consolidating centrally sponsored schemes. This recommendation, however, has only been partially implemented.
4. Finance, Privatization, Infrastructure, and Regulation
After the liberalization of international trade arrangements and industrial controls that constituted the bulk of the initial economic reforms of 1991-92, much attention was focused on replacing rigid or discretionary controls with effective regulation suitable for market-based economic activity, and with encouraging private investment in areas where the government’s role was recognized to have been misdirected, or to have been insufficient. Financial sector reform, privatization, initiatives for private investment in infrastructure, and the creation of new regulatory bodies were all interconnected parts of this effort. While progress has been dishearteningly slow in some areas, and there have been significant missteps, all these aspects of reform have stayed on the policy agenda. The issues involved are much broader than the scope of our analysis, which focuses on the intersection of these reform areas with India’s federal system.
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Finance
Much of financial sector reform has focused on making India’s capital markets more efficient. Simple institutional improvements such as electronic trading and settlement, guidelines for corporate governance, and so on, have begun to take hold. The nature of financial markets requires some regulation, both by market participants and the government, and the development of regulatory institutions for financial markets in India is still taking place, as we discuss later in this section. Many of the issues with respect to financial sector reform are at the national level, and so India’s federal system is not directly of concern. However, the nature of the financial system overall involves ‘financial repression’, which in turn has had implications for central and state fiscal deficits. We will explore this connection between financial sector reform and federalism.
One innovation in the Eleventh Finance Commission’s recommendations was its consideration of the overall fiscal position of India’s federal system, in particular the Central and state governments. This was, in fact, a significant part of the Commission’s terms of reference, and represented a welcome broadening of its scope. It was clearly motivated by the ongoing issue of fiscal deficits that India has struggled with for the past decade. Furthermore, the problem of fiscal deficits has, to a large extent, been pushed down to the level of the state governments, making it very much an issue of federalism.
Fiscal deficits at the state level have increased despite the central government’s apparent formal authority to strictly control state borrowing. There are two causes of this phenomenon. First, the central government has increasingly used discretionary loans, often with interest subsidies or even ex post conversion of loans to grants, as a component of political influence. This statement is based on casual empiricism, but is consistent with the political effects found in analyses of explicit transfers (Rao and Singh, 2001). Second, the states have used public sector enterprises and other off-budget devices to run larger deficits in practice.14 For both the center and the states, the ultimate enabler of both these trends has been the nature of India’s financial system. Severe financial repression, along with direct ownership and control of much of the financial system, has permitted governments to ‘park’ deficits in the financial system without having to print money and cause politically dangerous inflation. One indicator of government financial control is the large percentage of credit allocation by commercial banks that goes to ‘priority sectors’. As Table 3 shows, this ratio has not fallen appreciably since reform began, and is much higher than in 1969, when the banks were nationalized.
The cost of financial repression and deficit parking has been continued inefficient capital allocation and lower growth than might otherwise be attainable. If growth is to be promoted by improvements in the efficiency of capital allocation, and not just increases in savings and investment, a broad reform of the financial sector is required. While such reform has, as noted, been taking place in areas such as the functioning of Indian stock markets, corporate governance, regulation of banking, and methods of central government borrowing, the constraints imposed by the web of government-controlled financial institutions and their ‘bad’ loans to the public sector are a severe hurdle to more
14 See, for example, Lahiri (1999), Rao (2000b), and Mohan (2001).
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thorough financial sector reform. Hence, while tax reform and decentralization (section 5) are directly issues of reform of India’s federal structures, tackling the ways in which public sector capital finances are handled is a case of interaction of the private and public sectors. Financial sector reform threatens the public sector house of cards, and is therefore held back. Furthermore, both the public sector and private financial sector in India are vulnerable to downgrading by international ratings agencies such as Moody’s and Standard & Poor’s15, making India susceptible to the kind of severe financial crisis that ultimately hit Argentina at the end of 2001.
The problem as stated is well recognized. The solution may not be so clear, or easy to implement. The Eleventh Finance Commission recommended a slew of measures to promote fiscal discipline: an overall ceiling of 37.5% of gross receipts of the Center for all transfers to the states; hard budget constraints for all levels of government with respect to wages and salaries; ‘greater autonomy’ along with hard budget constraints for public sector enterprises; more explicit controls on debt levels for state governments; and improvements in budgeting, auditing and control. We would like to suggest that “greater autonomy along with hard budget constraints for public sector enterprises” will not work. Furthermore, by not working, it will continue to undermine any limits on states’ debt levels. The only clear-cut solution is privatization of public sector assets. We discuss this below.
Note that the center-state issue with respect to the working of the financial sector has not been just one of levels of credit, but also of credit allocation across states. Hence, our discussion of fiscal deficits also relates to concerns about political economy influences and growing interstate disparities. In fact, the problem grew after the nationalization of commercial banks in 1969, which concentrated economic power in the hands of the center. With insurance and many other financial institutions already under central control, the central government became a virtual monopolist in the financial sector. It might even be argued that, in such circumstances, the role of the formal intergovernmental transfer system has been overshadowed by invisible transfers.
Privatization
Privatization is obviously not restricted to the financial sector. With the government owning enterprises in a broad cross-section of industries, the scope of potential privatization is quite sweeping. The political difficulty of this task is highlighted by the absence of any meaningful privatization in a decade of economic reform. It differs fundamentally from other aspects of reform, involving more than just reform within government or changing the nature and methods of regulating the private sector, instead explicitly shifting the boundary between private and public ownership. The large implicit subsidies for those employed in public sector enterprises have clearly been an important aspect of the resistance to privatization, and one can guess that patronage and rent-
15 For example Standard & Poor’s lowered its long-term local currency rating to ‘BBB-‘ from ‘BBB’ and revised its outlook on local and foreign currency to negative in August 2001, citing ‘the continued deterioration of the government’s financial profile, with persistently high fiscal deficits resulting in a rising burden of public debt.’ This followed other recent downgrades of other debt categories and outlooks for India. (http://www.standardandpoors.com/forums/ratingsanalysis/sovereigns/articles/121201/india.htm) 18
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seeking opportunities have contributed to the lack of political enthusiasm from government ministries. Finally, in the case of state-level public enterprises such as the State Electricity Boards (SEBs), there are additional twin problems of huge deficits and the need for coordinated reform of the power sector (see below).
Focusing on the financial sector, privatization can affect the nature of the demand for credit by reducing politically motivated subsidies, and by reducing overall interest rates through a reduction in government crowding out of private borrowing. The other side of the equation concerns the supply of credit. Deficit parking has been abetted by the existence and operation of public sector financial institutions. The need for privatization applies to these as well. Where does this leave the different levels of government with respect to financing the urgent needs for public infrastructure? One might be tempted to condemn privatization of the financial sector if the past approach of public subsidies and directed lending had been successful in efficiently and effectively building such infrastructure: in fact, it has failed badly, as we discuss below.
In the context of federalism, privatization in the financial sector not only can have direct impacts on efficiency and growth, but it can also support the objective of allowing explicit center-state transfers to meet their own objectives more effectively. With respect to transfers for capital purposes, we suggest that, while central and state governments will always have the option of making conditional grants and project loans to lower level governments, the practical limitations on monitoring and incentives of such transfers (including the ultimate fungibility of transferred funds) support the greater use of unconditional block grants, with marginal capital funds coming through market borrowing.16 Ultimately, since repayment of such borrowing comes from taxes and user charges, this means that each level of government is more responsible at the margin, and responsive to its constituents’ preferences. This recommendation is perhaps as drastic a reform of ‘development finance’ in India as that of curtailing the Planning Commission’s role (discussed in section 5), but it seems to be a necessary complement to other aspects of financial sector reform.
Another aspect of privatization that has impacted center-state relations is the response of state governments when public sector enterprises in their jurisdictions have been privatized or proposed for privatization. Since privatization has been so limited, there are few examples, but the initial cases have served as a test. Recently, the central government created the post of a Minister of State for Disinvestment, and in this position Arun Shourie has drawn up a list of 27 public sector units to be ‘disinvested’ as soon as practical. These include Air India, VSNL, Hindustan Copper Ltd, India Tourism Development Corporation, State Trading Corporation, and Indian Petrochemicals Corporation Ltd. The first significant privatization that occurred was of the Bharat
16 Obviously, the smaller the government, the less will be the feasibility of significant reliance on the market. However, as we have emphasized earlier, many of the Indian states are comparable to countries in terms of population size and fiscal domain. The possibility of market borrowing raises issues of institutional reform to allow indebted state governments to seek funds in the capital market without permission from higher level governments, as well as the need for a credit rating agency to rate state governments. Credit rating in India is in its infancy, but is developing rapidly (for example, see www.icraindia.com).
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Aluminium Company (BALCO). As might have been expected, the company’s labor unions opposed the privatization and went on strike. Less predictably, the government of the new state of Chhattisgarh (carved out of Madhya Pradesh) took an aggressive stance against the disinvestment. While some substantive issues of the fairness of the bidding and the sale of tribal land were involved, the case raised the potential of states obstructing privatization when the center had finally got it rolling. The Supreme Court, however, finally upheld the sale of the company, and dismissed actions by the state government against the new private sector owners.
Infrastructure
The term ‘infrastructure’ can include various physical, social and economic indicators, but attention is usually focused on public and quasi-public goods such as electric power, irrigation, roads and railways, telecommunications and ports. Various aggregate measures of infrastructure are possible. Table 4 reproduces data on an infrastructure development index produced by the Centre for Monitoring the Indian Economy (CMIE) from Ahluwalia (2001, Table 8). The states are ordered according to their per capita Gross State Domestic Product (GSDP) in the initial year, from poorest to richest. If these data are not weighted by population, then they show a remarkable amount of stability over the period, with simple correlations between any two years all being over 0.96, and the coefficient of variation showing a slight decline, from 0.35 in 1980-81 to 0.29 in 1996-97. According to this measure, up to 1996-97 there was no appreciable divergence in the major Indian states’ infrastructure development.
Part of the Indian economic reform agenda has been to attract foreign direct investment (FDI), especially that which will bring in new technology and improve infrastructure. Statewise data for total FDI approvals for the ‘reform decade’ 1991-2001 is presented in Table 5. Using the 1991 population figures from the census of India, we also calculate per capita approvals. The simple correlation of the per capita FDI approvals with the infrastructure index for any of the three years in Table 4 is quite low, ranging from 0.03 to 0.07. To some extent, this reflects the unreliability of FDI approvals as an indicator of actual investment, but more importantly, this is a consequence of the particular infrastructure index used, in which, for example, a state such as Karnataka is measured as having very low infrastructure development, despite its concentration of workers with high levels of technical skills. Most significantly, the coefficient of variation for the per capita FDI approvals (using population weighted measures of mean and standard deviation) is 0.93, which is much higher than the corresponding measure for the infrastructure index. Thus it appears that FDI is seeking a few favored locations, with a concentration even more than would be dictated by broad infrastructure measures.
To the extent that variations in FDI across states are influenced by specific policy initiatives and narrowly focused government investments in infrastructure, such as might be the case in Karnataka, there is scope for state governments to compete more effectively for FDI that might have a longer-term impact on infrastructure. For example, Punjab, with the highest index of infrastructure, lags substantially in FDI, but might conceivably correct this with policy adjustments. In general, the result of economic reform has been to remove central efforts to direct the location of FDI, as well as to relax 20
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restrictions on its nature and amount. The regional concentration of FDI is less of a concern if labor mobility is sufficient to ensure that workers can go where new jobs are created, and if public resources are channeled in ways that allow basic social infrastructure such as urban sanitation to complement private sector investments in aspects of infrastructure such as telecommunications, where the private returns to be captured are potentially higher. The importance of the system of taxation and of intergovernmental transfers in this arena will be highlighted in the next section.
Regulation17
In areas such as finance and telecommunications, the creation of new regulatory institutions such as the Securities and Exchange Board of India (SEBI), and the Telecoms Regulatory Authority of India (TRAI) has been essentially at the national level, with the central government shaping the evolution of these bodies. Each of these regulatory bodies has had problems in creating and implementing a new regulatory framework that does not involve ex ante case-by-case discretion. However, given their national focus, we shall not treat them further in this paper. In the case of electric power, however, the federal issues with respect to regulation are more salient. Electric power is a concurrent responsibility of the center and the states. Each state has had a State Electricity Board (SEB) that is vertically integrated with respect to generation, transmission and distribution, and is part of the state government. Various political compulsions and inefficiencies have led to large losses by the SEBs, and they have been the single largest contributor to India’s fiscal deficits. Furthermore, power generation has lagged seriously behind targets, and availability of reliable electric power has become a serious bottleneck for growth.
Given the situation described above, and the power sector received early attention in the economic reform process, with attempts to attract private participation in the power sector, set forth in a 1991 policy document. Over the next decade, Rs. 373 billion in FDI in the power sector was approved, making up 14 per cent of total approvals, but actual investment has lagged, with several well-publicized disputes and withdrawals by foreign companies, the Enron case being only the most prominent of these. The need to dismantle the vertical integration of the power sector, the simultaneous involvement of the central and state governments, the lack of understanding of the technical details of power contracting by some of those on the Indian side, and the role of various interest groups all had an effect in delaying or even derailing power sector reform.
In 1997, the central and state governments tried again, with a Common Minimum National Action Plan for Power (CMNAP). The CMNAP recommended corporatization of the SEBs, though within a public ownership framework, and the creation of independent regulatory commissions at the central and state levels. The CMNAP also recommended some specific regulatory approaches, and private entry in the distribution component of the sector. While Andhra Pradesh, Haryana and Orissa had already set up their own State Electricity Regulatory Commissions (SERCs), other states moved after the center passed legislation in 1998 to set up its Central ERC, and to enable the states to create their own SERCs. State governments proceeded to do this the following year, and
17 This section draws on Dossani and Crow (2001).
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some also moved forward with corporatization and some unbundling of generation, transmission and distribution. The delay in creating effective independent regulatory bodies, however, has meant that reform has proceeded in a somewhat chaotic manner. The regulatory commissions have not been able to establish the rules of the game, both because they have been pre-empted by earlier ad hoc decisions, and because they have not had much time to establish their own rules of operation. However, independent regulation and private sector participation appear to be the only route out of the political quicksand into which the power sector has fallen.
5. Transfers, Taxes and Decentralization
We described India’s fiscal and other federal institutions in section 3. In this section, we examine some of the ongoing and potential reforms in the system of center-state transfers and in the tax system. We also examine the issue of decentralization to the local government level, where issues of expenditure assignment have been partially dealt with, but where the new system of state-local transfers has a long way to go to be effective, and where tax assignments may need to be rethought to enable effective decentralization (defined as more efficient delivery of public goods and services) to occur.
Center-State Transfers
What are possible reforms that can be made in the transfer system? One example of the process of reform comes from the case of tax sharing arrangements. The Constitution specified certain categories of centrally collected taxes that were to be shared with the states, according to criteria to be determined by the Finance Commission. In particular, personal income taxes were a major component of tax transfers from the center to the states, which received 87.5% of such tax revenues. On the other hand, income tax surcharges were kept entirely by the center. Academic commentators suggested that there were obvious incentive problems with such arrangements, and the Tenth Finance Commission recommended alternative arrangements whereby a proportion of overall central tax revenues would be devolved to the states. This required bargaining and agreement among the center and the states, as well as a constitutional amendment, but this has all been accomplished.18
Tax sharing between the center and the states reflects one dimension of the bargaining that must take place among a federation’s constituents. Presumably, the initial effect of the change will be to leave the overall shares of the center and the states in aggregate near their previous values, avoiding the problem of creating clear initial losers from the reform. Principles of this sort might be used to tackle a harder problem, that of revising the formulae used to divide the states’ share of tax revenue among them. These formulae are quite complex, without embodying any clearly defined objective, either of interstate (horizontal) equity, or of provision of incentives for fiscal prudence. Given that there are other transfer mechanisms as well, and that those will be used with discretion, there is a case for the Finance Commission overhauling its formulae completely, to achieve greater
18 See Rao and Singh (2001) for further detail on the new arrangements, as well as initial implementation by the Eleventh Finance Commission.
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simplicity. Such an overhaul can in theory be designed to respect the present status quo to a great extent, but to deal more aggressively with future increases in interstate inequality.
We would argue that an approach that builds equity concerns into a formula is preferable to one in which ad hoc grants are made at the margin. In this respect, one welcome change related to tax sharing is recommended in the Eleventh Finance Commission report. This is the reversal of a practice – introduced by the Eighth Finance Commission – of keeping a portion of shareable tax revenues from Union excise duties exclusively for allocation among states according to the amount of their estimated post-tax-devolution deficits. This amounted to a conversion of a part of the share of taxes into “gap-filling” grants, lacking both in transparency and efficient incentive provision.
The case for reform of transfer formulae applies equally strongly to the portion of Planning Commission transfers that are calculated on the basis of the 1969 “Gadgil formula”. One of the problems in the past has been the overly narrow scope of Finance Commissions, much narrower than what the Constitution of India implies for their role. Moving away from this restriction, one welcome innovation in the latest Finance Commission’s terms of reference was the consideration of the overall fiscal position of India’s federal system. The Commission forthrightly recommends a reassessment of plan transfer formulae, with this task to be brought within the scope of the Finance Commission.19 The latest report also notes the severe muddle with respect to Planning Commission transfers, with economically meaningless distinctions between plan and non-plan categories of expenditure. It recommends reform of the financing of the plans so that plan revenue expenditure is financed from available revenue receipts after meeting non-plan expenditure, with borrowing used only for investments. Finally, a recommendation for multi-year budgeting could presumably be a step away from the artificial cycle of five-year plans, which, as the evidence in Rao, Singh and Vashishta (2002) suggests, may introduce temporal distortions in transfers.
We are not suggesting that any of these proposed reforms would solve the problem of divergence that seems to be creeping up quite quickly in India. Instead, they would make the formal transfer system clearer and simpler, which should make it easier to understand its objectives and its impacts. This is a first step in actually tackling problems of divergence, or of convergence to greatly different steady states. We are also not suggesting that this is the only channel for impacts on interstate inequality. Rao, Shand and Kalirajan (1999) have noted the important regressive impacts of implicit transfers and of private sector investment flows. They also point out the unknown regional effects of direct central government expenditures, which will also incorporate individual MPs’ pork barrel efforts. Finally, there will always be some component of explicit transfers that is subject to central government discretion. However, in our view, removing a significant portion of center-state transfers outside the political economy arena, clearly targeting them toward horizontal equity objectives, and doing so in a manner that does not create perverse incentives for recipients, is both feasible and desirable.
19 The broader issue of what the role of the Planning Commission should be is addressed below.
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We have argued for integrating and simplifying the formulaic components of center-state transfers, focusing them more clearly, and expanding their importance relative to discretionary components. We suggested that the success of the recent overhaul of tax sharing arrangements provides evidence that reform in this area is feasible and workable. The recommendation of the Eleventh Finance Commission to bring formulaic plan transfers under the scope of the Finance Commission raises some interesting broader issues. The resources that have been devoted to the operation of the Planning Commission stand in stark contrast to the minimal assistance provided to the Finance Commission. It has also been argued (e.g., Rao and Singh, 2001) that the Finance Commission could be more effective if provided with ongoing resources for conducting its analysis and recommendations.
One might extend the argument to question whether the resources used by the Planning Commission provide any benefit in an economy where liberalization has taken hold. Where there is a justification for national level coordination because of externalities that cross state borders (as in the case of roads or power, for example), different ministries or even state governments can negotiate and cooperate. Where there is no such justification, unconditional grants, determined by the Finance Commission, that do not distort states’ fiscal incentives seem to be the appropriate channel. The Planning Commission may be largely redundant in such an institutional framework. Tackling this issue head on is likely to be politically infeasible, but gradually shifting responsibility and resources to the Finance Commission may well be a possible approach.
This last recommendation flows directly from the discussion of how to improve the center-state transfer system. Three other areas of ongoing reform also bear on the transfer system, either by changing the environment within which it works, or through direct interactions. The assignment of tax authority is obviously important in influencing the starting point from which intergovernmental transfers are made. Second, the explicit strengthening of local governments, with formal transfer systems being introduced for state-local transfers, must impact center-state fiscal relations. Finally, financial sector reform interacts with the conditions under which subnational governments or other public entities can obtain funds for capital projects. Since funds are fungible, the institutions for current and capital transfers affect each other. We have discussed financial sector reform in section 4, and consider the other two issues next.
Tax Reform
Some elements of tax reform in the last decade (some beginning earlier) are well known: a reduction in tariff rates, reductions in direct tax rates coupled with attempts to broaden the tax base,20 and a gradual movement from excise duties and sales taxes to VAT at both the central and state levels. If we compare 1990-91 with 1999-2000, the impact of some of these changes has been as follows: an increase in the direct-tax-to-GDP ratio from 2.16% to 3.24 %, accompanied by an increase in the number of filers from 6.1 to 17.8
20 For example, the income tax base was redefined based on identifying asset ownership and consumption patterns (e.g., having a car or house). However, weaknesses in information systems and enforcement mechanisms mean that continued collection from the broader base may be difficult (Das-Gupta and Mookherjee, 1998).
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million; more than offset by a decrease in the central indirect-tax-to-GDP ratio from 8.84 % to 6.23 %, driven by reductions in the percentages of central excise duties as well as customs duties.21 State sales taxes and excise duties have also shown some proportionate decline, so that the overall tax-GDP ratio has declined by almost two percentage points in the 1990s (Rao, 2000a). While the overall decline merely reverses an increase that took place in the 1980s, the fact that it has occurred at higher income levels, and during a period of economic reform, raises questions about long-term implications. Some of the issues are connected to dimensions of tax reform that have yet to be effectively tackled.
The Tax Reform Committee of 1991 had also recommended minimizing exemptions and concessions, simplification of laws and procedures, development of modern, computerized information systems, and improvements in administration and enforcement (Rao, 2000a). Work in the mid-1990s by Das-Gupta and Mookherjee (1998, Chapter 6) detailed the problems with Indian tax administration, both in terms of the incentives of those paying taxes and those enforcing them. However, in May 2001, Singh and Modi (focusing on central tax collection) were still led to write, “The tax enforcement effort has left much to be desired … from the view point of a decline in total tax collected as a percentage of collectible tax, the pendency of assessment work and the dilatory process of the Appeal redressal mechanism.” Thus it is clear that much remains to be done in this respect. We would like to suggest here that the benefits of improvements in this area are likely to be large, not only because of the direct benefits of improvements in central information systems and institutions of enforcement, but also because these can provide a model for states to improve their tax administration as well.
A reform that more directly affects India’s federal system lies in indirect taxes, which, as we have noted, have not increased proportionately with GDP in the last decade. As Rao (2000a) puts it, “The most important challenge in restructuring the tax system in the country is to evolve a coordinated consumption tax system.” In Section II, we noted some of the problems with the current assignments of indirect taxes. Rao provides some detailed recommendations in this regard, with respect to issues such as rates, interstate sales taxes, and tax administration for a dual VAT coordinated between the center and the states. Rao also notes the problem created by the failure of the Constitution to explicitly include “services” within the scope of states’ sales tax authority. This problem has been recognized for some time, and is clearly in need of correction, as also recommended by the Eleventh Finance Commission in its report.
Moving taxation of services from the Union list, where it implicitly lies through the center’s residual powers over taxes not explicitly specified in the Constitution, to the Concurrent list will require a constitutional amendment. Such an amendment must be proposed by the central government, but will benefit the states. Rao incorporates political economy considerations of the kind that we have discussed in earlier sections, by suggesting that an amendment be tied persuading the states to reduce and eventually eliminate taxation of interstate sales, thus removing some of the internal barriers that have plagued the development of a true national market within India.22 This will also
21 These figures are from Singh and Modi (2001), Tables I, III and IV.
22 While the fundamental problem in India is the absence of an interstate commerce clause such as that in
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smooth the implementation of a destination based VAT for the states. Note that such reforms can also reduce tax exporting by the richer states, (Rao and Singh, 1998), complementing the role of transfers in keeping interstate divergence from becoming politically unacceptable.
The case of taxation of services illustrates a broader issue that was addressed by the eleventh Finance Commission. Its report recommended in general terms a reduction in the vertical fiscal imbalance by reassignment of tax authorities, giving the states more power to tax. This approach takes some pressure off the fiscal transfer system, allowing states that can obtain political support to more flexibly tax their own constituents to deliver benefits to them. Another possible example of such a tax reassignment would be to allow states to piggyback on central income taxes. This, too, would require a constitutional amendment. It might seem redundant where tax sharing exists, but with tax sharing no longer applied to specific tax “handles”, but to tax revenues in total, this change would give states more flexibility at the margin, where they properly should have it. Note that states are already assigned the right to tax agricultural income, though their use of this tax is minimal. This separation has no economic justification, and merely promotes tax evasion. Piggybacking, along with a removal of the distinction between nonagricultural and agricultural income, would represent a major improvement in tax assignments. The latter would also be an important step forward in broadening the direct tax base. Whether the political economy logic can work for this case of tied reforms, as suggested for the case of services above, is worth considering.
To summarize our discussion, much remains to be done in terms of tax reform. While some measures can be initiated by the center acting alone, many others require agreement or coordination between the center and the states. These include possible reassignments of tax authority, as well as changes in tax administration. Recognizing the play of differing interests may help in devising reform packages that balance potential losses against gains, and thereby increase the probability of acceptance.
Decentralization
The political motivations and history of local government reform in India have been quite different from those that led to the economic reforms of the 1990s. Nevertheless, there is a complementarity between the two sets of reforms that benefits from their fortuitous temporal coincidence. After a long history of debate on decentralization, a central government committee recommended that local bodies should be given constitutional status. Two separate amendment bills were introduced, covering panchayats and municipalities23 respectively, passed by parliament in 1992, ratified by more than half the state assemblies, and brought into force as the 73rd and 74th amendments to the Constitution of India in 1993. These amendments required individual states to pass appropriate legislation, since local government remained a state subject under the
the US constitution, there is still room for bargained solutions that will reduce internal trade barriers. For example, the recent replacement of local transit taxes (octroi) with state entry taxes in some states has shifted the problem up one level, reducing the number of entities that have to be involved in the negotiation.
23 See also Mathur (1999) for an assessment of urban governments and reform.
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constitution, and individual states have done so. These legislative changes are the beginning of a process of local government reform in India.
There are three tiers of rural local governments, roughly described as village, block and district. The population per village government is extremely small, raising questions of economic efficiency. Populations per block are considerably larger, and blocks approximate the constituencies of Legislative Assemblies, the lower houses of the state legislatures. The highest tier, the district, is approximately the size of the constituency of the member of the Lok Sabha, the lower house of the national parliament. The block and district levels – particularly the latter – have been important components of the central administrative and plan implementation apparatus.
Until the recent legislative changes, the ability to exercise local suffrage was very limited: at any given time since independence, 40-50 per cent of local government bodies in India had been under state supersession (Dillinger, 1994). Also, there was previously a structural limitation on local suffrage, since in most states only the lowest level of rural local government had directly elected local government officials. Some states did not have even indirect elections at the higher two levels of rural local government, those bodies instead being nominated by state governments. The 73rd and 74th amendments reduced state government discretion concerning elections to rural local government bodies. Direct elections to local bodies must be held every five years. Elections to constitute new bodies must be completed before the term expires. If a local government is dissolved prematurely, elections must be compulsorily held within six months, the new body to serve out the remainder of the five-year term.
Rao and Singh (2000, 2001) have characterized the above aspect of local government reform as replacing ‘hierarchy’ with ‘voice’24 as the primary accountability mechanism, and have explained this as a positive step based on the ability to provide more refined incentives, subject to the caveat of effective monitoring and transparency being achievable. Local government reform has also changed the nature of tax and expenditure assignments to local governments, and instituted a system of formal state-local transfers modeled on the component of the existing center-state system that is governed by the Finance Commission. While there are some serious issues with the new assignments, including problems of local capacity and efficiency, both with respect to revenues and expenditures, we refer readers to Rao and Singh, and focus here on the new transfer system.
While one view has been that formal transfers from the center and states to local governments have the potential to accentuate fiscal deficit problems, our perspective suggests that a formal, rule-governed system will make such problems more transparent. In fact, the evidence suggests that this is the case. Local government finances, particularly for urban bodies, have steadily worsened over the period before local government reform, under a system of hierarchical control and supposedly strict monitoring by state governments. This is not to imply that the new institutions, particularly the State Finance Commissions (SFCs), represent an immediate
24 See Hirschman (1970) for the introduction and discussion of this terminology.
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improvement. Almost all SFCs have given their initial reports, and the Eleventh Finance Commission sums up its appraisal of them as follows:
Many SFC reports have not addressed the specific terms listed in articles 243I and 243Y, nor have they provided a clear idea of the powers, authority and responsibilities actually entrusted to the local bodies. Many of these reports also do not clearly indicate the principles formulated for sharing or assignment of State taxes, duties, tolls, fees and the grants-in-aid. (Paragraph 8.11b)
However, this situation is no worse than the previous one of ad hoc and discretionary transfers and control of local bodies by state governments.
The Eleventh Finance Commission has been reluctant, and rightly so, to provide the states with grants requested by them to supplement the states’ own transfers to their local governments, noting that the amendments do not justify this softening of the states’ budget constraints. The Commission’s main recommendations with respect to local government relate to assignment and incentive issues for various sources of tax revenue. Land and profession taxes are identified as two possible sources of revenue. Perhaps the most promising is the recommendation of surcharges on state taxes earmarked for local government, similar to the piggybacking we proposed for the states on central taxes. These recommendations are straightforward at this general level – the real problems arise in defining details and assuring implementation. This point also applies to the Commission’s discussion of property tax, replacements for octroi, and local user charges.
The analysis of Rao and Singh suggests that incentive efficiency with respect to government expenditure must be the starting point for revenue enhancement efforts. Here the Commission is right to suggest a quicker transfer of expenditure responsibilities to local governments: they are unlikely to do worse than state governments have so far done, in the provision of basic civic amenities. Grants to the lowest tier of local government recommended by the Commission may help to jumpstart the process of making local governments effective providers, if they can break out of their historical low-level equilibrium of revenue collection and service provision.
The Commission also recommends grants for improved accounting, auditing, and database building for local governments. These measures, if implemented effectively, can have a substantial positive impact on capacity, transparency and accountability in the delivery of street-level government services. The report also discusses some of the potential conflicts between the existing institutional apparatus of central and centrally sponsored schemes and the role envisaged for local governments, and problems that are arising from states’ reluctance to devolve authority to their subordinate governments. One example of the latter problem is the failure of state governments to implement their own SFCs’ reports. In the case of the central Finance Commission, the bargaining power of the states, and the role of precedent have worked to ensure the implementation of most recommendations. In the case of the states, local governments may need outside help, for example from the courts, to pressure reluctant state governments.
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To conclude this discussion, we note that there is a clear conceptual and empirical connection between the nature of past regulation of local governments in India and the general top-down approach to economic policy, relying on the case-by-case discretion of government decision-makers in areas such as industrial location and expansion, which characterized pre-reform policy-making. The key point here is that the ideas that are guiding changes in how the national government interacts with the private sector are also important for how state governments interact with local governments. The expanded assignments legislated for local governments, and the increased role for local ‘voice’, together require the state governments to fundamentally change their regulation of local governments underneath them.
Furthermore, expanding and strengthening the scope of the central Finance Commission in determining center-state transfers, while simplifying the formulae that govern them (something we have advocated earlier in this paper), can have the added benefit of giving states a clearer road in achieving their own devolution to local governments. Currently, central discretionary transfers, which are meant to be implemented at the district or block level, swamp local government capacity for action and for their own revenue raising (Rajaraman, 2001). Replacing these with conditional or unconditional grants from the states (with the ultimate source possibly being unconditional grants from the center), will allow more effective functioning of local governments. Thus, our perspective on local government reform ties in with our earlier discussion of reform of the center-state transfer system.
We can summarize the main message of this section as follows. Overall, we suggest that a further devolution of expenditure assignments, as is being implemented in the ongoing local government reform, makes sense from an efficiency perspective, because it allows incentives to be more refined and effective. This must be accompanied by devolution of tax assignments, to keep vertical fiscal imbalances from overwhelming such incentives. Since vertical fiscal imbalances will still arise, we argue for a simpler transfer system that does not distort marginal incentives. While there is still room for transfers and loans that are earmarked for capital expenditure, we argue that here, too, marginal incentives are crucial, and that providing these through the market may be the only efficient avenue in practice. This argument is based on the recognition that political influences will distort choices in the absence of such discipline, no matter how legal restraints are structured. Thus our recommendations here are in keeping with our discussion of the political economy of center-state transfers earlier in this section. While decentralization and privatization may seem to exacerbate problems of interstate inequality and divergence, a counterargument is that, instead, they enable higher-level governments to focus more clearly and directly on redistribution as an objective where it is deemed necessary.
6. Regional Inequalities
Many studies have now examined the issue of regional inequalities in India, and in particular whether the evidence suggests that they are increasing, and how changes are affected by initial conditions such as the level of infrastructure development. These issues are particularly important as India integrates into the global economy, with the fear that
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has been expressed by some that enclaves that successfully pursue this integration will grow rapidly, leaving the rest of the economy behind. We review a subset of the studies, and draw some tentative conclusions for policy reform.
Rao and Singh (2000) focus on political influence effects, but also look at equalizing effects of different categories of transfers. Their regressions tell a somewhat different story than simple correlation coefficients, which support the view that Finance Commission transfers have favored states with lower per capita State Domestic Product (SDP)25, more so than Planning Commission transfers (Table 6 in Rao and Singh, 2000). Instead, the fixed-effect regressions provide a more ambiguous picture. For example, when state fixed effects are included, per capita Finance Commission transfers do not vary inversely with per capita SDP. While more empirical work needs to be done, the general point is that conditional on political and economic factors that may affect bargaining power, the equalizing impact of center-state transfers is unclear. Whether this should be of concern when the unconditional impacts – as reflected in the simple correlation coefficients – are in the right direction is a separate matter. We would argue that it is of concern, because economic reform has changed the nature of central government control of the economy in a way that increases the potential for greater disparities across states, putting more of the burden on an effective system of center-state transfers. Of course, extending the argument in the previous section, transfers must be designed in a way that does not dilute incentives of the states to exploit opportunities opened up by reform, as well as to be fiscally prudent. We pursue these issues after examining the evidence on convergence and divergence across the states of India.
The mushrooming of papers on convergence or divergence among the Indian states has been driven by the general resurgence of growth theory as much as by the experience of India. Studies of convergence across countries have focused on catching up by poorer nations through faster growth. Where faster growth is also affected by other variables besides initial income levels, the convergence is conditional: in other words, a poorer country (or region) may converge to a steady state that is different from that of the richer country (or region).26 Variables such as literacy, health and physical infrastructure may be the conditioning variables, as well as the economic policies followed. Clearly, the conditioning variables themselves may be endogenous. While the evidence for any type of convergence across disparate countries is quite weak, one might expect greater possibilities for convergence across similar regions or constituent units of a federation such as India.
In one of the first studies of convergence within India, Cashin and Sahay (1996), examined data for the period 1961-91, thus excluding the reform period of the last
25 All studies use SDP as a proxy for State National Product, which would be the appropriate measure of state income, because no data is available for the SNP. While SDP is far from ideal as a proxy, it is the only feasible measure for empirical work.
26 Thus, one can identify three possible scenarios: absolute convergence, where different entities are moving toward the same steady state, conditional convergence, where they are converging to (possibly very) different steady states, and divergence, where there is no evidence of convergence. The last case is inconsistent with neoclassical growth models, but conceivably fits some endogenous growth models. Note that conditional convergence is quite consistent with increasing disparities across entities.
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decade, but including the Rajiv Gandhi reform period of the 1980s. The analysis is performed on 20 states, thus including some of the special category states, which receive central transfers according to different, and typically much more generous formulae than the major states. This is important to note because the authors measure state disposable income per capita by adding in all central transfers, except for shared taxes, to SDP.27 They find some evidence for unconditional convergence in the period of analysis, with the strongest effect being identified in the 1961-71 decade. These results are not changed in essence by controlling for other variables. Furthermore, the results indicate much slower convergence than that found across regions of developed countries such as the US and Japan. This meant that cross-sectional dispersion of per capita incomes across states actually increased over the three decades studied, despite the inclusion of center-state transfers (though dispersion was greater when these were excluded). Cashin and Sahay also examine the role of internal migration in convergence, and find it to be weak.
Several analyses followed Cashin and Sahay. Rao and Sen (1997) argue that the inclusion of four special category states in the Cashin-Sahay sample muddies their analysis. Furthermore, they argue that adding of transfers to SDP involves some double counting. Finally, they also take issue with the analysis of the equalizing effect of transfers, arguing that excluding shared taxes gives misleading results. Cashin and Sahay’s response, however, disputes these criticisms on empirical and conceptual grounds. Marjit and Mitra (1996) independently analyze a data set similar to Cashin and Sahay’s, but with different empirical methods: they argue that the evidence for convergence is weak.
Nagaraj, Varoudakis and Véganzonès (NVV, 1998) examine data on 17 states for 1970-94 (including three special category states). They find no evidence for absolute convergence. Using panel data (rather than a cross-section as in Cashin-Sahay) and per capita SDP (excluding transfers), NVV find that there is evidence for conditional convergence, with the conditioning being done on the share of agriculture and the relative price of agricultural and manufactured goods. Adding infrastructure indicators substantially strengthens the estimated rate of conditional convergence. While NVV do not explicitly consider transfers, they emphasize the importance of infrastructure and nonmeasured political and institutional factors (captured in state fixed effects) in explaining differences in steady state growth rates across states. To the extent that center-state transfers have a potential role in affecting these determinants of growth, they are important in this analysis.
Rao, Shand and Kalirajan (RSK, 1999) examine data for the 14 major states, for the period 1965-95, using SDP as the output measure. RSK find evidence for absolute as well as conditional divergence, a result that is quite robust across sub periods as well. They suggest that the speed of divergence increased in the last half-decade of their sample. However, this does not seem to be the decisive factor in explaining the difference from Cashin-Sahay: instead, the exclusion of special category states and of center-state transfers is of greater importance. The differences in conditioning variables and
27 This appears to be a partial attempt to deal with some of the problems with using SDP, but it suffers from its own inconsistencies, including some ‘external’ receipts of the states but not others. Subsequent studies have always used SDP.
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estimation methodology from NVV (who use a fixed-effects panel model) may explain the difference in conditional convergence results between RSK and NVV. RSK emphasize the role of private investment in explaining growth differences across states. They find that private investment goes disproportionately to higher-income states, as well as to states that have higher per capita public expenditures.28 RSK also argue that explicit center-state transfers have had moderate impacts on interstate inequalities, and that these effects have been outweighed by implicit transfers through subsidized (public and private) lending and through interstate tax exportation.
Ahluwalia (2000, 2001) examines the most recent data on the performance of India’s states. He does not consider convergence, but directly examines inequality by using the Gini coefficient for the 14 major states. He finds that interstate inequality, after being stable for most of the 1980s, increased starting from the late 1980s, and even more in the 1990s. Many of the factors that he identifies as affecting growth performance are those emphasized earlier by NVV and RSK, suggesting that the fundamental situation that India faced earlier in the reform period has persisted through the decade of the 1990s.29 Ahluwalia (2000) does argue for reform of the center-state transfer system, but in the direction of imposing more effective conditionalities on transfers, to improve the use of transferred funds by the states. In fact, this would work against reduction in interstate inequalities. Furthermore, this recommendation seems to implicitly assume that the center (the Planning Commission in particular) is able to impose and monitor such conditionalities in an effective manner. Our consideration of the political economy evidence and effectiveness of monitoring leads us to be more cautious about such an approach. Ahluwalia (2001) adds some simple regressions to his earlier analysis, but these do not change the overall analysis or conclusions.
Two final studies of possible convergence among India’s states are those of Bajpai and Sachs (1999) and Aiyar (2001). The former study examines data for a sample of 19 states for 1961-93. For the subperiod 1961-71, they find some evidence of convergence, but not for later subperiods or for the period as a whole. Allowing for conditional convergence does not qualitatively alter these results. Aiyar also uses the 19-state sample, for 1971-96. He finds weak evidence of absolute convergence for the 1970s, but divergence for later subperiods (especially the 1990s), as well as for the overall period. He estimates a panel with fixed effects, as do NVV, in which he does find evidence of conditional convergence. His conclusions are similar to those of NVV and RSK, emphasizing the importance of infrastructure, private investment, and nonmeasured institutional factors.
A different approach to examining changes in regional inequalities is to see if one can identify any changes in regional flows of capital and labor. While not much data is available on such flows, one can try to make inferences from what we have. We have
28 Marjit and Ghosh (2000) obtain results quite consistent to those of RSK, for the period 1970-96, using a slightly different sample of states and somewhat different data. Interestingly, they exclude most of the special category states ‘endogenously’, based on an outlier analysis.
29 See also Shand and Bhide (2000) for further empirical analysis, including sectoral decompositions. Chaudhuri (2000) also profiles Indian states’ growth experience, amplifying the work of Ahluwalia, and highlighting some of the differences between the 1990s and earlier decades.
32
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
already noted the regional concentration of FDI flows. In order to see if we can identify interstate movements of domestic capital, we examine data for the one source where we have state-level data, namely bank deposits and credit. We calculate the credit-deposit ratios for the 14 major states, and examine trends over the last two decades. This is done in Table 6. The average credit-deposit ratio shows a slight decline from 1980 to 1995, and is thereafter about the same in 2001. While we do not have a good explanation for interstate variations in the ratio, the standard deviation creeps up from the initial year to 1995, and increases further in 2001. While the increase is not spectacular, the sharp decline in the credit-deposit ratio for the states of Bihar and UP is quite striking. Most striking is the fact that the correlation between the ratio and per capita GDP jumps dramatically from 1995 to 2001, after a smaller increase in the earlier period (1980 to 1995). This is in a period when the coefficient of variation of per capita SDP for these state actually declines slightly. It is possible that this data is picking up a change in some dimension of the domestic allocation of capital, though a more definite conclusion will require further investigation.
In Table 7, we extend our analysis of financial variables and growth, by estimating some simple convergence regressions, focusing on three different financial variables: FDI approvals per capita over the decade 1991-2001, 1990 per capita bank credit (which is Aiyar’s measure of private investment) and 1990 credit-deposit ratios. We focus on the 14 major states, and our study uses 1998-99 as the latest year, updating all the studies discussed above. The results are quite striking. First, note that the evidence for conditional or absolute divergence is not strong, since even when the point estimate is above one, the 95% confidence interval extends considerably below one. More interestingly, any one of the financial variables taken individually is estimated to have a significant impact on growth of SDP. When two or more financial variables are included, there is evidence of multicollinearity, but otherwise the results seem quite robust. They are quite consistent with a story where domestic and foreign capital are complements, and taken together with our earlier discussion of credit-deposit ratios and of FDI approvals, the evidence is suggestive of mobile domestic and foreign capital driving growth. From an efficiency point of view, this is probably a good thing, but the equity consequences bear some consideration.
What can we conclude? The evidence weakly supports the idea of absolute divergence among the Indian states in the past two decades, with the rate increasing in the 1990s. The evidence on conditional convergence is less decisive, but even if one accepts conditional convergence as descriptive of India’s states, the conclusion remains that they may be converging to very different steady states.30 The differences in infrastructure and institutions that seem to explain interstate differences have been persistent, as we have partly indicated in section 4, and neither Finance Commission transfers, Planning Commission transfers, nor centrally sponsored schemes have made a substantial dent in regional inequalities in India.
30 Here it is useful to repeat the caveat that the empirical work relies on SDP rather than SNP. Thus remittances by internal migrants (e.g., Biharis working as agricultural laborers in Punjab) and external ones (Keralites working in health care in the Middle East) are being missed by the analysis
33
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
One might argue that the center-state transfer system is being asked to do too much, both in terms of short term amelioration of interstate inequalities or in promoting development and poverty alleviation in the long run. If that is the case, however, the present tangle of multiple channels of transfers, with its combination of two extremes of complex formulae on one hand and ad hoc discretion on the other, ought to be simplified dramatically. Alternatively, one can argue that the transfer system has an important role to play in overall national development, and that this role has become more important if centrifugal forces of economic reform put pressures on the other institutions of India’s federal system, and perhaps even on India’s political fabric.31 This is not to say that the transfer system’s role is to remove regional inequalities – that is clearly neither desirable nor feasible. Nevertheless, some degree of equalization can be important in ensuring the wider political acceptability of continued economic reform, and a simpler, better targeted transfer system can be useful in achieving this.
7. Conclusion
Our paper has sought to examine several dimensions of economic reform in India, in the context of the country’s federal system and of globalization. In our analysis, we have explicitly recognized that the national government has subnational governments below it, and that all these layers of government simultaneously interact with foreign governments and corporations in a global economy. We have examined two groups of reforms, the first involving redrawing of state-market boundaries, including changes in ownership and regulation, and the second concerned with reconfiguring federal institutions themselves. The first group includes financial sector reforms, assignment of regulatory powers, infrastructure reform and development, and privatization. Despite the incomplete nature of financial reform, we have presented some evidence in the last section that liberalization is making a difference, with foreign and domestic capital together driving growth, and leading to some of the differential growth across states that has been observed in the last decade.
The second group of reforms includes tax reforms, reform of center-state fiscal transfer mechanisms, and local government reforms. To some degree, these reforms in federal governance hold the key to opening the door to further reform elsewhere, by reducing the fiscal burden placed on the private sector by government deficits. We have acknowledged the political economy aspects of reform of governance, and discussed possibilities for politically acceptable packages of fiscal reforms, such as combinations of changes in tax assignment that would be acceptable to the center as well as the state governments.
The benefit of an approach that explicitly takes account of India’s federal institutions is that we have been able to identify some areas in which the states may be able to achieve positive reforms acting independently, and other areas where coordination between the
31 This point also applies if one considers migration, a factor that has received relatively little attention after Cashin and Sahay’s effort to quantify its impacts. While migration may help to support convergence, in a heterogeneous country such as India, it may bring its own set of problems with it. If effective equalizing fiscal transfers can reduce interregional migration pressures or slow down the process, they may have a positive role in preserving interethnic, or other intergroup, peace.
34
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
central and the state governments in designing and implementing reform policies may be more appropriate. Furthermore, we have highlighted the challenges of greater openness to the world economy, and of growing regional disparities. The former requires urgent attention to the financial position of the government in particular, as well as of the financial sector as a whole. The latter requires more efficient mechanisms for managing internal inequities. Together, they suggest some avenues of further reform that we have outlined in the paper.
References
Ahluwalia, Montek S. (2000), “Economic Performance of States in Post-Reforms Period,” Economic and Political Weekly, May 6, 1637-1648.
Ahluwalia, Montek S. (2001), “State Level Performance under Economic Reforms in India,” Working Paper No. 96, Center for Research on Economic Development and Policy Reform, Stanford University.
Aiyar, Shekhar (2001), “Growth Theory and Convergence across Indian States: A Panel Study”, Chapter 8 in India at the Crossroads: Sustaining Growth and Reducing Poverty, ed. Tim Callen, Patricia Reynolds and Christopher Towe, International Monetary Fund.
Bajpai, Nirupam, and Jeffrey Sachs (1996), “Trends in Inter-State Inequalities of Income in India,” Development Discussion Paper No. 528, Harvard Institute for International Development.
Cashin, Paul, and Ratna Sahay (1996), “Internal Migration, Center-State Grants, and Economic Growth in the States of India,” International Monetary Fund Staff Papers, 43, 1, 123-171.
Cashin, Paul, and Ratna Sahay (1997), “Internal Migration, Center-State Grants, and Economic Growth in the States of India: A Reply to Rao and Sen,” International Monetary Fund Staff Papers, 44, 2, 289-291.
Chaudhuri, Saumitra (2000), “Economic Growth in the States – Four Decades-1”, Money and Finance, Oct.-Dec., 45-69.
Dasgupta, Sugato, Amrita Dhillon and Bhaskar Dutta (2001), “Electoral Goals and Centre-State Transfers in India”, processed, Indian Statistical Institute, New Delhi.
Das-Gupta, Arindam, and Dilip Mookherjee (1998), Incentives and Institutional Reforms in Tax Enforcement: An Analysis of Developing Country Experience, Delhi: Oxford University Press.
Dillinger, William (1994), Decentralization and Its Implications for Urban Service Delivery, UNDP/UNCHS/World Bank Urban Management Programme Discussion Paper, UMP 16.
35
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Dossani, Rafiq and Robert T. Crow (2001), Restructuring the Electric Power Sector in India: Alternative Institutional Structures and Mechanisms, Working paper, Asia/Pacific Research Center, Stanford University.
Finance Commission (2000), Report for 2000-2005, Government of India: New Delhi.
Hirschman, Albert O. (1970), Exit, Voice, and Loyalty; Responses to Decline in Firms, Organizations, and States, Cambridge, MA: Harvard University Press.
Lahiri, Ashok K. (1999), “Practising Sub-National Public Finance in India”, NIPFP, New Delhi, paper presented at The First Meeting of the Global Network Conference, Session on Decentralization, Governance and Public Goods in Large Economies, Bonn, Germany, December.
Marjit, Sugata, and Buddhadeb Ghosh (2000), “Economic Growth and Regional Divergence in India, 1970-1996,” processed, Centre for Studies in social Science, Calcutta.
Marjit, Sugata, and S. Mitra (1996), “Convergence in Regional Growth Rates: Indian Rsearch Agenda,” Economic and Political Weekly, 31, 33.
Mathur, Om Prakash (1999), “Decentralization in India: A Report Card”, Working Paper, National Institute of Public Finance and Policy, New Delhi, March.
Mohan, Rakesh (2001), “Achieving Higher Economic Growth: The Fiscal Deterrent”, paper presented at Stanford Conference on Indian Economic Reform, June.
Nagaraj, Rayaprolu, Aristomene Varoudakis and Marie-Ange Veganzones (1998), “Long-Run Growth Trends and Convergence across Indian States,” OECD Technical Paper No. 131.
Rajaraman, Indira (2001), “Growth-Accelerating Fiscal Devolution to the Third Tier”, paper presented at NIPFP-DFID-World Bank conference on India: Fiscal Policies To Accelerate Economic Growth, New Delhi, May.
Rao, M. Govinda (2000a), “Tax Reform in India: Achievements and Challenges”, Asia-Pacific Development Journal, 7, 2, 59-74.
Rao, M. Govinda (2000b), “Fiscal Decentralization in Indian Federalism”, processed, Institute for Social and Economic Change, Bangalore.
Rao, M. Govinda (2000c), “Invisible Transfers in Indian Federalism”, Public Finance/ Finances Publiques.
Rao, M. Govinda, and Kunal Sen (1997), “Internal Migration, Center-State Grants, and Economic Growth in the States of India: A Comment on Cashin and Ratna Sahay,” International Monetary Fund Staff Papers, 44, 2, 283-288.
Rao, M. Govinda, Ric Shand and K.P. Kalirajan (1999), “Convergence of Incomes across Indian States: A Divergent View,” Economic and Political Weekly, March 27-April 2.
Rao, M. Govinda, and Nirvikar Singh (1998), “Fiscal Overlapping, Concurrency and Competition in Indian Federalism”, Working Paper 30b, Center for Research on Economic Development and Policy Reform, Stanford University
36
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Rao, M. Govinda, and Nirvikar Singh (2000), “The Political Economy of Center-State Fiscal Transfers in India”, paper presented at the Columbia University-World Bank Conference on Institutional Elements of Tax Design and Reform, February 18-19, 2000, forthcoming, ed. John McLaren.
Rao, M. Govinda, and Nirvikar Singh (2001), “Federalism in India: Political Economy and Reform”, paper presented at the conference, “India: Ten Years of Economic Reform”, at the William Davidson Institute, University of Michigan, September 2001
Rao, M. Govinda, Nirvikar Singh, and Garima Vashishta (2001), “The Political Economy of Center-State Transfers in India: Further Analysis”, in progress.
Shand, Ric and Shashanka Bhide (2000), “Sources of Economic Growth: Regional Dimensions of Reforms,” Economic and Political Weekly, October 14, 3747-3757.
Singh, N.K., and Arvind Modi, “Direct Tax Reform in India”, paper presented at Stanford Conference on Indian Economic Reform, June.
Srinivasan, T.N., and Suresh D. Tendulkar, Reintegrating India with the World Economy, Washington, DC, Institute for International Economics.
37
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Table 1: Gross Domestic Product and its Sectoral Share
Gross domestic product (GDP)
Sectoral share in GDP*
(per cent)
(At factor cost)
(At market prices)
Agriculture & allied
Industry
Services
At 1993-94 prices
Rs. Crores
1950-51
141557
149594
55.4
16.1
28.5
1960-61
207704
222161
50.9
20.0
29.1
1970-71
298580
329227
44.5
23.6
31.9
1980-81
404246
442319
38.1
25.9
36.0
1990-91
694925
773349
30.9
30.0
39.1
1991-92
705149
781575
30.0
29.4
40.6
1992-93
737018
818544
30.2
29.1
40.7
1993-94
781345
859220
33.6
23.7
42.7
1994-95
835864
922289
33.0
24.2
42.8
1995-96
896990
992877
30.7
25.3
44.0
1996-97
964390
1061902
31.0
25.2
43.8
1997-98
1012816
1110384
29.2
25.3
45.5
1998-99
1081834
1185399
29.2
24.7
46.1
Note: * At factor cost and figures up to 1992-93 relate to prior to revision of GDP. http://meadev.nic.in/economy/gdp.htm
38
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Table 2: Major Economic Indicators – Annual Growth Rates (per cent)
Year
Gross national product*
Gross domestic product*
Agricultural production Index
Food grains production
Industrial production Index
Electricity generation
Wholesale price index
Consumer price index
Money supply (M3)
Imports*
Exports*
1981-82
5.8
6.1
5.6
2.9
9.3
9.9
–
12.3
12
– 4.4
2.6
1982-83
2.6
3.1
– 3.8
–2.9
3.2
7
4.9
8.8
16.6
–2.6
4.6
1983-84
7.9
8.2
13.7
17.7
6.7
7.6
7.5
12.1
18.2
3.5
3.8
1984-85
3.8
3.8
–1.2
– 4.5
8.6
12.1
6.5
6.3
19
–5.9
4.5
1985-86
4.1
4.1
2.5
3.4
8.7
8.4
4.4
6.8
16
11.5
–9.9
1986-87
4.0
4.3
– 3.7
– 4.7
9.1
9.8
5.8
8.7
18.6
–2.1
9.4
1987-88
4.1
4.3
– 0.8
– 2.1
7.3
8.8
8.2
8.8
16
9.1
24.1
1988-89
10.2
10.6
21.4
21
8.7
10.2
7.5
9.4
17.8
13.6
15.6
1989-90
6.9
6.9
2.1
0.6
8.6
11.2
7.4
6.1
19.4
8.8
18.9
1990-91
5.2
5.4
3.8
3.2
8.2
7.8
10.3
11.6
15.1
13.5
9.2
1991-92
0.5
0.8
–2.0
– 4.5
0.6
9.1
13.7
13.5
19.3
–19.4
–1.5
1992-93
5.2
5.3
4.1
6.6
2.3
5
10.1
9.6
15.7
12.7
3.8
1993-94
6.2
6.2
3.8
2.7
6
7.3
8.4
7.3
18.4
6.5
20.0
1994-95
7.7
7.8
4.9
3.8
8.4
8.1
10.9
10.3
22.3
22.9
18.4
1995-96
7.8
7.6
– 2.7
– 5.8
12.8
8.6
7.6
10.2
13.7
28.0
20.9
1996-97
8.1
7.8
9.1
10.5
5.6
4.3
6.4
9.3
15.9
6.5
5.3
1997-98
5.0
5.0
– 5.4
–3.5
6.6
6.6
4.8
7.0
17.3
6.1
4.5
1998-99
6.8
6.8
7.5
5.6
4.0
6.5
7.0
13.1
19.4
15.7
7.4
1999-2000
6.4
6.4
-0.7
1.4
8.2
6.9
3.3
3.4
13.9
14.7
16.6
2000-2001**
6.0
6.0
1.5
-
6.0
4.5
6.5
7.0
15.0
21.0
18.4
Note: * revised (at 1993-94 prices). **Projected @ Figure relates to Base 1993-94 http://meadev.nic.in/economy/mei.htm
39
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Table 3: Commercial Bank Deposits and Priority Credit
1969
1990
1993
1996
1997
1998
1999
2000
2001
Deposits of Scheduled Commercial
Banks as percentage of National
Income (at current prices)
15.5
48.6
50.4
46.3
46.4
49.6
50.3
53.5
55.7
Share of Priority Sector
Advances in total
14.0
40.7
34.4
32.8
34.8
34.6
35.3
35.4
..
Source: RBI various statistical tables, www.rbi.org.in.
Note: 1969 data are for June, other years for March
40
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Table 4: Relative Infrastructure Development Indices, 14 Major States
1980-81
1991-92
1996-97
Bihar
83.5
81.7
77.8
Rajasthan
74.4
82.6
83.9
Uttar Pradesh
97.7
102.3
103.8
Orissa
81.5
95.0
98.9
Madhya Pradesh
62.1
71.5
74.1
Andhra Pradesh
98.1
96.8
93.1
Tamil Nadu
158.6
145.9
138.9
Kerala
158.1
158.0
155.4
Karnataka
94.8
96.5
94.3
West Bengal
110.6
92.1
90.8
Gujarat
123.0
122.9
121.8
Haryana
145.0
143.0
137.2
Maharashtra
120.1
109.6
111.3
Punjab
207.3
193.4
185.6
All India
100
100
100
Source: CMIE and Ahluwalia (2001)
41
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Table 5: FDI approvals August 1991- July 2001, 14 Major States
FDI Approvals
(Rs. Million)
1991 Population
(Million)
FDI per capita
(Rs.)
Bihar
8833.43
86.374
102.27
Rajasthan
25916.69
44.006
588.94
Uttar Pradesh
43304.25
139.112
311.29
Orissa
82289.14
31.660
2599.15
Madhya Pradesh
97709.14
66.181
1476.39
Andhra Pradesh
124701.31
66.508
1874.98
Tamil Nadu
222804.00
55.859
3988.69
Kerala
14360.83
29.098
493.53
Karnataka
208156.32
44.977
4628.06
West Bengal
84234.59
68.078
1237.32
Gujarat
168555.48
41.310
4080.26
Haryana
31947.46
16.464
1940.44
Maharashtra
456286.23
78.937
5780.38
Punjab
19519.22
20.282
962.39
14 States
1588618.09
788.846
2013.85
Sources: FDI – Secretariat for Industrial Assistance Newsletter, August 2001; population – http://www.censusindia.net/data.html
Note: Figures for Bihar, Madhya Pradesh and Uttar Pradesh include FDI approvals for Jharkand, Chhattisgarh and Uttaranchal respectively
42
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
Table 6: Credit-Deposit Ratios by State
1980
1995
2001
Bihar
0.41
0.33
0.24
Rajasthan
0.68
0.46
0.48
Uttar Pradesh
0.42
0.35
0.28
Orissa
0.59
0.54
0.41
Madhya Pradesh
0.56
0.53
0.47
Andhra Pradesh
0.74
0.76
0.63
Tamil Nadu
0.94
0.91
0.91
Kerala
0.68
0.45
0.43
Karnataka
0.75
0.68
0.59
West Bengal
0.60
0.54
0.44
Gujarat
0.58
0.47
0.49
Haryana
0.72
0.47
0.42
Maharashtra
0.79
0.70
0.85
Punjab
0.43
0.41
0.41
Average
0.65
0.58
0.57
Std. Deviation.
0.15
0.16
0.18
Coeff. of Var.
0.22
0.27
0.32
Coeff. of Var. (SDP)
0.32
0.40
0.36
Corrn. with per capita SDP
0.11
0.18
0.59
Sources: RBI Bulletins, National Accounts Statistics, and Indian Census. Figures for Bihar, Madhya Pradesh and Uttar Pradesh in 2001 include Jharkand, Chhattisgarh and Uttaranchal respectively. SDP and population figures used to calculate correlations were for closest available years.
43
Indian Federalism, Economic Reform and Globalization, Nirvikar Singh and T. N. Srinivasan
44
Table 7: Growth Regressions
Dependent variable is log of 1998-99 per capita SDP
t-statistics in parentheses
Variable
(1)
(2)
(3)
(4)
(5)
(6)
(7)
Constant
-0.86
(-0.94)
-0.02
(-0.02)
-0.70
(-0.76)
-1.16
(-1.65)
0.13
(0.11)
0.84
(0.79)
1.18
(1.12)
1990-91 ln SDP per capita
1.14 (9.75)
1.02
(9.79)
1.08
(9.71)
1.14
(12.71)
0.96
(6.41)
0.90
(6.21)
0.85
(5.95)
FDI approvals p. c. 1991-2001
5.4E-05
(2.76)
2.4E-05
(0.81)
6.3E-06
(0.19)
3.3E0-5
(1.25)
Credit-deposit ratio 1990
0.35
(1.34)
0.52
(3.10)
0.33
(1.26)
Credit per capita 1990
8.9E-05
(1.12)
9.7E0-5
(1.19)
16.6E-05
(2.71)
Asymmetric Federalism in India
M. Govinda Rao and Nirvikar Singh
3
Asymmetric Federalism in India
M. Govinda Rao and Nirvikar Singh*
Introduction
There can be a variety of motivations for various units to come
together to constitute a federation. The political and economic theories
of federalism attempt to understand the rationale for the “coming
together” to form federations and once they are formed, analyse the
conditions for “holding together”. The political impulse for the smaller
units to federate has to be found in issues of freedom, security, political
stability and strength while keeping a separate group identity. Similarly,
access to a larger common market, reaping economies of scale in the
provision of nation level public goods and availability of wider choice in
the bundle of services to meet diverse preferences are some of the
economic reasons for the smaller units to come together to form a
federation. Each federating unit will try to bargain terms advantageous
to it to join the federation while the federation will try to attract entry and
control exit. In this situation, symmetry in intergovernmental
relationships may not be possible.
“Asymmetric federalism” is understood to mean federalism
based on unequal powers and relationships in political, administrative
and fiscal arrangements spheres between the units constituting a
federation. Asymmetry in the arrangements in a federation can be
* The authors are respectively, Director, National Institute of Public Finance and Policy, New
Delhi, 110067; India and Professor of Economics, University of California, Santa Cruz. CA
95064. U.S.A.
The author is grateful to Amaresh Bagchi and Richard Bird for extremely useful discussions
and detailed comments on the earlier draft of the paper. The usual disclaimers apply.
4
viewed in both vertical (between centre1 and states) and horizontal
(among the states) senses. If federations are seen as ‘indestructible
union of indestructible states’, and centre and states are seen to exist on
the basis of equality; neither has the power to make inroads into the
defined authority and functions of the other unilaterally. However, such
‘purists’ view of federalism is rarely, if at all, seen in practice. Even
when the constitution guarantees near equal powers to the states, in the
working on federal systems centre dominates in political, administrative,
as well as fiscal spheres. There is considerable volume of literature on
central domination in Indian federalism in the assignment system in the
constitution and central intrusion into the states’ domains in the working
of the federation.2 Unlike the classical federations like the USA, Indian
federation is not an ‘indestructible union of indestructible states’. Only
the union is indestructible and the states are not. Article 3 of the
Constitution vests the Parliament with powers to constitute new states by
separating territories from the existing ones, alter their boundaries, and
change their names. The only requirement for this is that the `Bill’ for
the purpose will have to be placed in the Parliament on the
recommendation of the President and after it has been referred to the
relevant state legislature for ascertaining their views (their approval is
not necessary). The federation is not founded on the principle of
equality between the union and states either. The central government in
India has the powers, and it actually does invade the legislative and
executive domains of the states (Chanda, 1965; Rao and Sen, 1996;
Rao and Singh, 2000). However, the nature and basis of relationship
between the centre and states is not the objective of this paper.
The focus of this paper is the usually understood aspect of
asymmetry in fiscal arrangements in Indian federalism, namely, unequal
arrangements and special treatments for some units within a federation.
Such an arrangement is quite feasible in an arrangement evolved from
bargaining and accommodation. It may also be desirable to have
special powers and asymmetric arrangements to accommodate diverse
group interests and identity and therefore, has an important role in
‘coming together’ federalism as well as ‘holding together’ federalism.
But such accommodation can only be at the margin and cannot violate
1 The words “centre”, “union”, and “federal” are used interchangeably in this paper.
2 For a survey of literature on centripetal bias in Indian constitution and in the functioning of
Indian federalism see, Rao and Chelliah, (1997).
5
the basic fabric of equality and fair treatment of jurisdictions. This would
also require transparency in the arrangements.
It is important to make a distinction between unequal
arrangement or asymmetry that are (i) transparent and rule based
evolved to facilitate the smooth functioning of the federation; and (ii)
those that are opaque and discretionary caused by the balance
administrative and political power and expediency. The first may be
built into the constitutional arrangement itself or may be evolved through
conventions for the smooth functioning of the federation. This type of
asymmetry is transparent and rule based and play an important role in
building the nation. In contrast, the second type of asymmetry can
simply be the result of administrative and political power play in a
federation. In India for example, the dynamics created by the end of
single party rule in the centre and states, emergence of coalition
government at the centre, and regional domination of regional parties in
the coalition and welding power in the states can create asymmetries in
the functioning of the federation on political considerations. This can
have serious repercussions for the future of federalism.
The paper examines the asymmetric features in Indian
federalism and evaluates its contribution. Section 2 will explore the
conceptual issues — the causes and consequences of asymmetric
federalism. In section 3, we trace the evolution of Indian federalism and
analyse the factors contributing to the asymmetric arrangements in
political, administrative, and fiscal relations. In section 4, we bring out
asymmetric arrangements arising out of constitutional arrangements or
conventions evolved over the years. In this, we discuss the special
arrangements in the Indian constitution to accommodate special cases,
such as Jammu and Kashmir, and the various north-eastern hill states.
The recent political developments and asymmetric treatments due to
administrative and political exigencies are analysed in section 5. The
important conclusions of the paper are summarised in the last section.
II. Asymmetric Arrangements – Some
Conceptual Issues
6
According to Riker (1975), federalism is an outcome of rational
bargain among various constituents. The bargain may be for political or
economic gains. In the political bargain, the constituents give up
political autonomy for security from external threat. The economic
bargain is to enable a common market and to ensure optimal provision
of public services by reaping economies of scale and catering to diverse
preferences. However while striking the bargain, the constituents try to
preserve their valued identity and seek special status. Motivation for
special status may be purely for expanding economic opportunities and
securing freedom from exploitation by larger and more powerful
members of the federation. The objective may be purely political — of
enhancing freedom and representation to constituents or to maximize
political power and influence. It may also be cultural or religious — of
preserving group identities. It may simply be a means of
accommodating diverse group interests within a unified framework.
If federalism were an outcome of rational bargain among
constituent units, differences in bargaining strength would be a source of
asymmetry. If the issues at stake have general applicability to majority
of units, then collective bargaining strength could result in greater
decentralisation and all subnational units getting greater autonomy. If
on the contrary, the issues at stake have applicability or relevance to
specific units and if they have the necessary strength to secure the
special dispensation, then this could result in asymmetric arrangements
in the federation. Such special arrangements may be de jure –
enshrined in the constitution itself or established by tradition, or may be
actually observed in practice (de facto) in the working of the federation.
Such arrangements may be evolving. In many cases, special
arrangements are accorded until the units are assimilated into the
federation. In other cases, bargains may have to be struck by giving
special status for holding the federation together. Yet other cases of
asymmetry may arise purely by political alignments in a democratic
polity. The way in which bargains are struck and special demands of
various constituents are accommodated through asymmetric
arrangements, have a vital bearing on the stability of the federation.
Asymmetric arrangements need not necessarily be the outcome
of constitutional arrangements. This can also result from the way in
which administrative, political, and fiscal systems are implemented in a
7
federation. De facto asymmetry can also be desirable and can
contribute to nation building if it is based on transparent principles. At
the same time special arrangements instituted to meet short term
political expediency or administrative discretion can cause secular
degradation of intergovernmental institutions. Such arrangements can
result in arbitrary conferring of special favours and in the long run can
contribute to greater disharmony and instability in a federation.
In a centralised federation, the central government has
considerable scope to discriminate among the units. The potential for
discrimination will be particularly strong when the government at the
centre is weak and states wield significant control over the centre even
in a centralised federation. The issue is pertinent when we consider
that regional parties in some states wield significant power over a
coalition government at the centre.
III. Evolution of Asymmetric Arrangements in
Indian Federalism
III.1. Historical Background:
The distribution of power between the centre and states on the
one hand and the treatment of different states on the other in the Indian
constitution owe much to historical and political factors. Although the
Cabinet Mission sent by the British Government in 1946 saw no virtue in
partitioning undivided India into two different independent nations, it also
recommended that the independent country should be governed by a
federal constitution with the central government dealing with only foreign
affairs, defence and communications, remaining vested with two groups
of provinces, one predominantly Hindu, and the other predominantly
Muslim. However, the insistence of the Muslim League to have a
separate nation for the Muslims led to the formation of Pakistan
comprising Muslim majority regions of the north-west part of the
subcontinent and eastern part of Bengal. In the event, it was no longer
necessary to create a weak federal government. Instead, the founding
fathers of the constitution decided to have a federation with a strong
8
central government to hold together the diverse economic, linguistic,
and cultural entities and to avoid fissiparous tendencies. Centralisation
was also found desirable to unify the country, comprising regions directly
ruled by the British and 216 princely states and territories.3
III.2. Asymmetric Structure at Independence
Thus, asymmetric arrangement in Indian federalism has a long
history and goes back to the way in which the British unified the country
under their rule and later the way in which the territories under the direct
control of the British and various principalities were integrated in the
Indian union. While the territories ruled directly by the British were easily
integrated into the Union, the treaties of accession signed by individual
rulers covered the integration of different principalities. The provinces
ruled directly by the British had a modicum of autonomy and
rudimentary form of parliamentary government as the British loosened
the grip gradually from 1919 onwards. The Constitution that was
adopted in 1951 itself classified the states into four categories. The
provinces directly ruled by the British were classified as Part `A’ states.
The princely states which had a relationship with the Government of
India based on individual treaties signed were classified as Part `B’
states. These included the states of Hyderabad, Mysore, Jammu and
Kashmir and 5 newly joined unions of princely states. In the case of
Jammu and Kashmir, the powers special powers were given in the terms
of accession. The remaining princely states acceding to the union were
grouped under Part `C’ states. Finally, the territories ruled by other
foreign powers gaining independence (French and Portuguese) and
areas not covered in the above three categories were brought under the
direct control of the union to form Part `D’ states or Union Territories.
Thus, the Union of India in 1947 began with a major asymmetry
between British India and the princely states and even among the latter,
the terms of accession differed depending on the bargaining strength. In
almost all cases, the princely states surrendered whatever notional
sovereignty they had to the new country of India, in exchange for a
guaranteed revenue stream: their “privy purses”. The nature of this
bargain was clear – security and money in exchange for giving up
authority or residual control rights. This is close to the standard view of
3 For a detailed account of the history leading to Indian independence, see, Chanda (1965).
9
federation as a political bargain, with the difference that the successors
of the British in India, the Indian National Congress, were in an
extremely strong bargaining position, even relative to the coalition of the
princes. This was illustrated in the case of the exceptions to voluntary
accession, such as Hyderabad, where military force (the authority over
which was also inherited from the British) ensured integration into the
new union.
III.3. Assimilation of Units after Independence:
While many of the former princely states, particularly the Part
`B’ states continued as administrative units after their integration into
India, this continuation was not an essential part of the bargain.
Furthermore, reorganization of state boundaries from 1953, freely
permitted to the centre by Article 3 of the constitution, gradually eroded
this status. The Constitution allowed sub-state structures for regions
closely tied to some former princely states, but this had little practical
import as the states became almost the sole significant subnational units
of governance. Thus, in general, the princely states ceased to matter as
geographic entities. In this respect, the outcome was completely
different from the standard case of federation, where the constituents of
the federation would normally retain their identities. Broadly, the
asymmetric arrangement was recognition of the different set of
institutions and administrative standards in the country, which over the
years, was unified. The asymmetries present in 1947 with respect to
almost all the princely states disappeared from Indian federalism.
III.4. Special Position of Kashmir:
The sole exception, of course, was the state of Jammu and
Kashmir.4 While this state included several diverse populations and
regions, the overwhelming majority of population in the Kashmir valley
was Muslim, and the state bordered the new nation of Pakistan. The
history of the conflict over Kashmir has been written on extensively,
even though there is no consensus on the interpretation of events in
1947-48. Here, we merely note that the state acceded to the Indian
4 A good discussion on the asymmetric arrangements in Jammu and Kashmir and northeastern
states can be found in Arora (1995)
10
union under very special terms, which were subsequently incorporated in
the famous Article 370 of the Constitution. This article provided the
state with a unique position in the Indian union, with its own constitution,
a title interpreted as the equivalent of Prime Minister for its chief
executive, and a special assignment of functional responsibilities.
Specifically, the jurisdiction of the centre was restricted to foreign affairs,
defense and communications, with the state’s legislature having
residuary powers. This was a striking contrast to the situation of other
states, where the centre’s assignment of responsibilities was much more
extensive, and where the centre retained residuary powers.
III.5. Integration of North-Eastern Hill States
The process of administrative reorganization of India focused on
the creation of new boundaries based on the main principle of language.
Typically, separate religious, caste, ethnic or tribal identities within these
boundaries were not the basis for further divisions. One major exception
to this has been the north-eastern part of India, where there is a distinct
difference in ethnicity from the rest of India, and several strong divisions
based not only on language, but also on culture and other traditions
(“tribal”, if one wishes to use that term). This part of India contains the
states of Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram,
Nagaland, Sikkim, and Tripura. Of these, only Assam has a population
comparable to other typical Indian states. Most of these states were
upgraded from the status of Union Territories,5 this reclassification
giving them, at one level, a political status equivalent to that of larger
states such as Bihar, Madhya Pradesh, and Uttar Pradesh. Each state
carries equal weight in mustering the 50 percent of states required to
ratify an amendment to the constitution.
Furthermore, there are various clauses in Article 371 which
accord special powers to north-eastern states. These provisions have
been introduced through amendments, typically at the time of
conversion of a union territory to a state, or in the case of Sikkim, after
its accession to India. The safeguards provided to these states through
these special provisions include respect for customary laws, religious
5 At independence, of course, this entire region except North Eastern Frontier Area (NEFA)
was administratively part of Assam province, and the union territories themselves were created
by separation from Assam. Meghalaya was directly carved out of Assam state, while Sikkim
was formerly an Indian protectorate. See, for example, Brass (1994) for a chronology.
11
and social practices, restrictions on the ownership and transfer of land,
and restrictions on the migration of non-residents to the state. State
legislatures are typically given final control over changes in these
provisions.
Thus, there are various provisions in the Indian Constitution to
protect group rights, and to compensate for initial inequalities in the
social system. Thus the constitution, while recognizing the idea of
fundamental human rights at the individual level, does not assume an
idealized initial condition of equality, either in pure economic terms or
otherwise. Thus there are allowances for separate laws to govern
different religious groups, and there are provisions for various kinds of
“affirmative action” for extremely disadvantaged groups. The first kind
of provision simply respects diversity (though this can create issues of
unequal treatment across subgroups, e.g., women in two different
religious groups). The second attempts to correct for specific inequities,
recognizing that legislative equal treatment from very unequal initial
conditions would not achieve desired equity goals. Conceptually, at this
level of ethical or normative judgement, there is no difference between
these provisions and the ones for the indigenous residents of northeastern
states, except that the latter happen to be geographically
concentrated into reasonable administrative units. If that is the case,
then the relationship to federalism is not essential.
IV. Asymmetries in Practice in Indian Federalism
IV.1. Economic Asymmetry
The coming together of units with diverse history, resources,
policies and institutions in a bargain to form a federation would certainly
entail de facto asymmetry in terms of inter-state differences in
geography, demography, and economy. At present, there are 28 states
in Indian federation in addition to 7 Union Territories.6
6 Union Territories are governed directly by the Central government. However, two Union
Territories namely, Delhi and Pondicherry have their own elected governments and legislatures.
12
The wide differences in the economic characteristics between
the states in Indian federation are highlighted in Table 1. It is seen that
in terms of area the biggest state, Rajasthan is 90 times bigger than the
smallest state, Goa. Similarly, in terms of population size, Uttar
Pradesh, the state with largest population is 308 times bigger than the
smallest state, Sikkim. The density of population varies from 13 in
Arunachal Pradesh to 901 in West Bengal. Maharashtra, the state with
the highest Net State Domestic Product (NSDP) had 284 times that of
the state with the lowest NSDP, i.e., Sikkim. There are significant
variations in per capita incomes as well. In 2000-01, Goa, a small state
in the western coast had the per capita NSDP of Rs. 44613, which was
almost 9 times that of Bihar with Rs. 4813.
For the sake of convenience of analysis, the states have been
classified into special category states and non-special category states.
The former states are those, that are given a special status in dispensing
plan assistance by the central government. The non-special category
states in turn are classified into high-income, middle-income and lowincome
states based on their per capita NSDP.7 It is seen from the
table that 10 special category states with covering 14 percent of
geographical area of the country have just about 5 percent of the
population and they generate just about 4 percent of the NSDP. The
importance of non-economic factors in determining the structure of
federalism is underscored by the fact that most of the special category
states are not economically viable. Even among non-special category
states, there are states that are too large like Madhya Pradesh, Bihar,
and Uttar Pradesh even after carving out the three new states of
Chattisgarh, Jharkhand, and Uttaranchal respectively from the territories
of these states in 2000.
Within the non-special category states, there are wide variations
in area, population, and income levels. The high income states with
about 18-19 percent area and population generated 29 percent of NSDP
whereas the low income states with 43-45 percent of geographic area
and population accounted for only 28 percent of income. There are wide
variations in the sizes and income levels within each of the categories of
states as well. On the whole, among the non-special category states,
7 The states with per capita NSDP more than 15% of the average are classified as High
income states and those with less than 10% of the average are classified as low income states.
13
the most populous state (Uttar Pradesh) had 123 times the population of
Goa, the least populous state and the income differences between the
highest and lowest income state was 36 times.
Table 1 : Some Characteristics of States in Indian Federalism
Area
(Sq. Km)
Population
(in ‘000)
Density
of Pop
NSDP
1999-00
Rs. million
Per
capita
NSDP
(1999-
00)
Percent
age of
total
area
Percent
age of
total
populati
on
Percent
age of
total
NSDP
High Income
States
601800 194065 322.5 4065770 22461 18.31 18.90 28.74
Gujarat 196000 50597 258.1 896060 18685 5.96 4.93 6.33
Goa 3800 1344 353.7 58620 44613 0.12 0.13 0.41
Haryana 44000 21083 479.2 424880 21551 1.34 2.05 3.00
Maharashtra 308000 96752 314.1 2131510 22604 9.37 9.42 15.07
Punjab 50000 24289 485.8 554700 23254 1.52 2.37 3.92
Middle
Income
States
725000 302633 417.4 4867930 17635 22.05 29.47 34.41
Andhra
Pradesh
275000 75728 275.4 1117530 14878 8.36 7.37 7.90
Karnataka 192000 52734 274.7 862980 16654 5.84 5.13 6.10
Kerala 39000 31839 816.4 569260 17709 1.19 3.10 4.02
Tamil Nadu 130000 62111 477.8 1143090 18623 3.95 6.05 8.08
West Bengal 89000 80221 901.4 1175070 14874 2.71 7.81 8.31
Low Income
States
1409300 458682 325.5 4022290 9013 42.87 44.66 28.44
Bihar 94000 82879 881.7 383260 4813 2.86 8.07 2.71
Chattisgarh 135100 20796 153.9 213310 10405 4.11 2.02 1.51
Jharkhand 79700 26909 337.6 232270 9223 2.42 2.62 1.64
Madhya
Pradesh
308000 60385 196.1 677780 11626 9.37 5.88 4.79
Orissa 156000 36707 235.3 311950 8733 4.75 3.57 2.21
14
Table 1 : Some Characteristics of States in Indian Federalism
Area
(Sq. Km)
Population
(in ‘000)
Density
of Pop
NSDP
1999-00
Rs. million
Per
capita
NSDP
(1999-
00)
Percent
age of
total
area
Percent
age of
total
populati
on
Percent
age of
total
NSDP
Rajasthan 342000 56473 165.1 710200 13046 10.40 5.50 5.02
Uttaranchal 53500 8480 158.5 Na Na 1.60 0.83 0.00
Uttar Pradesh 241000 166053 689.0 1493520 9323 7.33 16.17 10.56
General
Category
States
2736100 955380 349.2 12955990 14605 81.89 93.02 91.59
Special
Category
States
594000 63662 107.2 63930 10695 17.78 6.20 4.52
Arunachal
Pradesh
84000 1091 13.0 14270 13352 2.56 0.11 0.10
Assam 78000 26638 341.5 2533300 9720 2.37 2.59 1.79
Himachal
Pradesh
56000 6077 108.5 106570 17786 1.70 0.59 0.75
Jammu &
Kashmir
222000 10070 45.4 121820 12373 6.75 0.98 0.86
Manipur 22000 2389 108.6 28580 12721 0.67 0.23 0.20
Cont’d..
Meghalaya 23000 2306 100.3 29040 12063 0.70 0.22 0.21
Mizoram 21000 891 42.4 12880 14909 0.64 0.09 0.09
Nagaland 17000 1989 117.0 23300 12594 0.52 0.19 0.16
Sikkim 7000 540 77.1 7580 14751 0.21 0.05 0.05
Tripura 10500 3191 303.9 41930 13195 0.32 0.31 0.30
Uttaranchal 53500 8480 158.5 Na na 1.60 0.83 Na
All States 3276600 1010562 308.4 13595290 14359 99.67 98.40 96.11
Uts 10974 16453 1499.3 549870 31211 0.33 1.60 3.89
Total 3287574 1027015 312.4 14145160 13778 100.00 100.00 100.00
Notes: na – Not available. All State NSDP figure do not include SDP from
Uttaranchal. NSDP figures of uts exclude SDP from Dadra & Nagar Haveli,
Daman and Diu, and Lakshwadeep.
The above discussion brings out that economic viability has
never been a consideration in demarcating the states in India. Nor has it
been a factor in reorganization of the states despite the fact that the
constitution empowers the central government to reorganize them.
Thus, to begin with, intergovernmental relationships are placed on an
uneven economic keel. Naturally, uniform assignment system in an
unevenly endowed federating system results in large differences in fiscal
capacities. Varying sizes of states in terms of area and population,
demographic compositions, different terrain and topography cause
15
significant variations in the unit cost of providing public services varying
expenditure needs and places a heavy burden of equalisation on the
intergovernmental transfer system.
The implications of inter-state differences in economic
conditions on fiscal variables of the states are shown in Table 2. The
table brings out some important fiscal features of Indian federalism.
First, variations in economic characteristics has resulted in significant
differences in revenues collected in different states, partly owing to
differences in the capacity to raise revenues and partly due to
differences in their collection efficiency. By and large, the ratio of
revenues to SDP is positively related to the level of per capita. The low
income states had lower revenue ratios than the middle income states,
which in turn had lower ratios than the high income states. Second, the
ratio of revenues to NSDP was much lower in special category states
than general category states even when the latter had comparable levels
of NSDP. The singular exception to this is the case of Sikkim, which
had retained the power to levy income taxes while acceding to the
country. Thus, unlike other states, Sikkim has the power to levy income
tax and federal income tax cannot extend to Sikkim. Third, the small
size of jurisdictions in these states implies that they cannot reap
economies of scale in providing services. Besides, hilly and
inhospitable terrain in these states means that the unit cost of providing
public services will be higher than in other states. It is thus not
surprising to see overwhelming dependence of special category states
on central transfers. Thus, in 2001-02, non-special category states on
average raised revenues to finance over 50 percent of their current
expenditure whereas in special category states it was just about 20
percent. Thus, central transfers financed more than 80 percent of the
expenditures of special category states. In per capita terms, transfer to
special category states is more than four times that of the average
transfer received by general category states.
Table 2: Revenues and Expenditures of the States – 2000-01 (RE)
States Per
capita
SDP
(rupees)
Poverty
ratio
(percent)
1999-00
Per
capita
own
revenue
(rupees)
Own
revenue as
percentage
of SDP
Per
capita
transfers
Per capita
current
spending
(rupees)
Per cent
of own
revenue
to current
spending
High Income
States
22461 17.83 2931.6 13.1 500 4386.6 66.8
16
Table 2: Revenues and Expenditures of the States – 2000-01 (RE)
States Per
capita
SDP
(rupees)
Poverty
ratio
(percent)
1999-00
Per
capita
own
revenue
(rupees)
Own
revenue as
percentage
of SDP
Per
capita
transfers
Per capita
current
spending
(rupees)
Per cent
of own
revenue
to current
spending
Gujarat 18685 14.07 2684.6 13.2 863 5167.6 52.0
Goa 44613 4.4 14310.3 15.8 588 11904.8 120.2
Haryana 21551 8.74 3209.7 12.1 502 4107.9 78.1
Maharashtra 22604 25.02 2741.3 11.1 448 3852.6 71.2
Punjab 23254 6.16 3333.2 10.2 494 4712.7 70.7
Middle Income
States
17635 20.3 1868.8 10.6 658 3400.4 55.0
Andhra Pradesh 14878 15.77 1930.2 10.7 713 3320.2 58.1
Karnataka 16654 20.44 2148.1 11.3 686 3580.9 60.0
Kerala 17709 12.72 2295.8 10.2 690 3689.4 62.2
Tamil Nadu 18623 21.12 2342.5 11.3 658 3594.3 65.2
West Bengal 14874 27.02 1091.0 5.5 576 3092.7 35.3
Low Income
States
9182 34.28 858.5 9.3 673 2261.3 38.8
Bihar 4813 42.6 338.2 8.9 724 1515.5 22.3
Cont’d…
Chattisgarh 10405 NA 1264.0 4.9 NA 2455.2 51.5
Jharkhand 9223 NA 1128.0 9.0 NA 2229.4 50.6
Madhya Pradesh 11626 37.43 1061.9 11.5 624 2695.5 39.4
Orissa 8733 47.15 900.5 9.3 969 2785.3 32.3
Rajasthan 13046 15.28 1297.2 10.4 693 2864.2 45.3
Uttaranchal NA NA 1295.5 NA NA 4912.7 26.4
Uttar Pradesh 9323 31.15 791.2 8.1 598 2135.6 37.0
General Cat.
States
14605 25.97 1606.3 11.0 660 3060.9 52.5
Special cat.
States
10695 1032.2 9.7 2896 5126.7 20.1
Arunachal
Pradesh
13352 33.47 1067.8 5.3 7985 9992.3 10.7
Assam 9720 36.09 798.7 7.2 1216 3317.0 24.1
Himachal
Pradesh
17786 7.63 1660.5 7.8 3070 7420.6 22.4
Jammu &
Kashmir
12373 3.48 1150.4 7.9 4602 6080.0 18.9
Manipur 12721 28.54 406.0 3.1 3971 6032.3 6.7
Meghalaya 12063 33.87 1066.8 6.3 3149 5878.4 18.1
Mizoram 14909 19.47 679.0 3.8 9602 12845.6 5.3
Nagaland 12594 32.67 506.8 3.7 6332 7291.0 7.0
Sikkim 14751 36.55 5998.1 15.9 7945 12200.6 49.2
Tripura 13195 34.44 729.6 4.8 3376 5838.9 12.5
Uttaranchal na 1295.5 Na 4912.7 26.4
All States 14359 26.1 1570.1 10.9 768 3191.1 49.2
Source: 1. Finances of State Governments, 2001-02. Reserve Bank of
17
India
2. CSO, Ministry of Planning, Government of India
IV.2 Asymmetric Design of the Transfer System:
Thus, the different position of special category states is reflected
not only in structural asymmetries and fiscal arrangements, but very
importantly in the methods and patterns of central transfers to states. In
some respects, the small size of these states is an advantage in this
dimension. Transfers that are high in per capita terms for these states
may not place a significant cost on the rest of the nation. In fact, even
the entire group of these states has a population share that is just about
five percent and the rest of the members of the federation may not
perceive this as a significant cost. Also, this small size encourages
these states to combine politically for some purposes, in councils that
allow them to coordinate policies, or to collectively negotiate with the
centre. This is in contrast to the insignificance of zonal councils for
other states.
To understand the asymmetry, it is necessary to refer briefly to
the transfer system in Indian federalism. There are three sources of
transfers from the centre to states. The first is the statutory transfers
made on the recommendation of the Finance Commission appointed by
the President of India every five years. The second channel of transfer is
the assistance given for plan purposes by the Planning Commission.
Finally, individual central ministries design transfers to enhance outlay
on specified services in the states as desired by them. These central
sector and centrally sponsored schemes are in the nature of close-ended
specific purpose transfers with or without matching requirements and are
included in the plan schemes. There are over 200 such schemes
initiated and administered by various central ministries. The allocation of
resources in different states is also influenced by regional policy
followed by the central government including the direct central
investments.
The framers of the constitution intended that transfers to states
should be based on the recommendations of an impartial semi-judicial
body appointed by the President every five years, namely, the Finance
Commission. So far eleven Finance Commissions have made
recommendations. However, over the years, with the centralised
18
development planning gaining focus, the Planning Commission gained
importance as a dispenser of both grants and loans. Thus, the scope of
the Finance Commissions has been confined to examining the non-plan
requirements of the states and providing transfers to meet these
requirements, and the Planning Commission has been assigned to deal
with the plan requirements. Initially, the volume of central assistance for
state plans as well as its grant-loan composition was determined on the
basis of the approved plan projects in different states. Since 1969,
however, the allocation is determined on the basis of a formula
determined by the National Development Council (NDC).8 However,
over the years, with increased earmarking of central assistance for
specific schemes, formula based component of central assistance for
state plans has been reduced and in 2002-03, it is estimated at just
about 46 percent. In addition, the central ministries exercised discretion
in transfers by increasing them under the central sector and centrally
sponsored schemes. Thus, as shown in Table 3, the Finance
Commissions transfer about two thirds of the transfers and this has
remained broadly constant since the early 1970s. However, transfers
given for both plan schemes and specific purpose transfers for central
sector and centrally sponsored schemes have increased over time.
What is more important, increasing proportion of assistance for state
plan schemes has been kept outside the formula based distribution
scheme and the proportion of normal assistance distributed according to
the formula is just about 46 percent of the total state loan assistance in
2002-03. Thus, on the whole discretionary element in the transfer
system has shown a steady increase over the years. These are
discussed in greater detail below.
IV.3. Finance Commission Transfers:
Finance Commission transfers comprise of tax devolution and
grants. The Commission’s methodology is to assess fiscal position of
centre and states, projecting revenues and non-plan expenditures of the
states for the ensuing five years, augmenting the projected revenues by
recommending share of central taxes to individual states based on the
chosen general economic indicators and filling the remaining gap
8 NDC is an intergovernmental body presided over by the prime minister of the country and has
cabinet ministers, members of the Planning Commission and chief ministers of states as
members.
19
between non-plan expenditures and revenues with grants in aid. This is
called the “gap-filling” approach.
Table 3: Central Transfers to States Through Various Channels
Rs. billion
Finance Commission
Transfers Plan Grants
Other
grants Total
Tax
Devolution
Grants Total State plan
scheme
Central
Scheme
Total
Fourth
Plan 45.6 8.6 54.2 10.8 9.7 20.5 9.3 83.9
(1969-74) (54.2) (10.2) (64.6) (12.8) (11.6) (24.4) (11.0) (100.0)
Fifth Plan 82.7 28.2 110.9 29.1 19.3 48.4 5.4 164.7
(1974-79) (50.2) (17.1) (67.3) (17.7) (11.7) (29.4) (3.3) (100.0)
Sixth Plan 237.3 21.4 258.7 73.8 69.0 142.8 15.1 416.5
(1980-85) (57.0) (5.1) (62.1) (17.7) (16.6) (34.3) (3.6) (100.0)
Seventh
Plan 494.6 62.7 557.4 155.2 165.1 320.3 35.2 913.1
(1985-90) (54.2) (6.9) (61.0) (17.1) (18.0) (35.1) (3.9) (100.0)
Annual
Plan 172.0 34.5 206.4 57.2 55.4 112.5 10.2 329.4
1991-92 (52.2) (10.5) (62.7) (14.2) (16.8) (34.4) (3.1) (100.0)
Eighth
Plan 1318.5 147.2 1465.7 483.4 364.7 848.4 58.4 2373.1
(1992-97) (55.6) (6.2) (61.8) (20.4) (15.4) (35.7) (2.5) (100.0)
Ninth Plan 2300.9 239.9 2540.8 777.0 469.4 1112.9 189.5 3972.6
(1998-02) (57.9) (6.0) (64.0) (19.6) (11.8) (28.0) (4.8) (100.0)
Note: Figures in parenthesis are percentages to total transfers.
Source: Indian Finance Statistics/Public Finance Statistics, Ministry of Finance,
Government of India.
Discretionary elements even enter into the formula based
transfers of the Finance Commission. The Commissions determine the
shares of the centre and states in central taxes broadly on the basis of
judgements pertaining to their relative requirements, but mostly on the
basis of past shares. For the period 2000-05, the Eleventh Finance
Commission recommended that 29.5 percent of the net collections from
20
central taxes should be transferred to the states. The relative shares are
determined on the basis of general economic variables with weights
assigned, as shown in Table 4. It is in the process of choosing the
variables and assigning weights for them that relative shares of the
states may be influenced. This, however, need not necessarily be a
source of unacceptable asymmetry as the formula used by the
Commission is transparent.9
Table 4: Criteria and Relative Weights for Tax Devolution
Criterion Weight (percent)
1. Population 10
2. Income (Distance Method)* 62.5
3. Area 7.5
4. Index of Infrastructure 7.5
5. Tax Effort** 5.0
6. Fiscal Discipline*** 7.5
Note: *The distance method is given by: (Yh-Yi)Pi/S(Yh-Yi)Pi where, where, Yi
and Yh represent per capita SDP of the ith and the highest income state
respectively and Pi is the population of the ith state .
** Tax effort (h) is estimated as (h) = (Ti / Yi) / (0.5 1/Yi) where, Ti is the per
capita tax revenue collected by the ith state and Yi is the per capita state
domestic product of the ith state.
*** estimated as the improvement in the ratio of own revenue of a state to its
revenue expenditures divided by a similar ratio for all states averaged for the
period 1966-99 over 1991-1993.
It is because of this that the framers of the constitution intended
that the distribution of transfers should be mainly undertaken through the
Finance Commission which is supposed to be a statutory semi-judicial
authority. However, the constitution of the commission, and the
approach and methodology adopted by them and their recommendations
have been a subject of controversy in recent times. Notable among the
criticisms is the use of poverty ratio as a criterion for distributing the tax
shares of the states by the Ninth Finance Commission. It was argued
that poverty alleviation is not an objective of general purpose transfers,
and this should be taken care of by the direct anti poverty interventions
initiated by rural development and urban development ministries. It is
also argued that the transfer system should not be used to reward a
9 There was, however, considerable controversy on the use of the variable ‘poverty ratio’ in tax
devolution formula in the first report of the Ninth Finance Commission. See, Bagchi (1988).
21
state not making enough effort to alleviate poverty. More important
criticism was the discretionary transfer made by the Ninth Finance
Commission for the slum clearance in Bombay (Mumbai) and Calcutta
(Kolkata) (Bagchi, 1988; Guhan, 1989). The Tenth Finance Commission
was similarly criticised for making transfers for one state (Andhra
Pradesh) as a compensation for the loss of revenue by following the
prohibition policy.10
More serious criticism of the Finance Commissions pertains to
the ‘gap-filling’ methodology. It is alleged that ‘fiscal dentistry’ practised
by the commissions have led to enlargement of ‘budgetary cavities.’
The states can gain more by lowering their tax effort and indulging in
profligate spending. In fact, serious deterioration in states’ finances
seen in recent years is in part attributed to the transfer system (Rao,
2002). This has resulted in the states resorting to frequent overdrafts.
As the states had to seek greater ways and means assistance, each of
the states was made to sign a memorandum of understanding (MoU)
with the centre to initiate measures to bring about correctives. What is
notable, however, is that the contents of the MoU signed by individual
states have not been placed in public domain. It is not known whether
the conditionalities are different for different states.
In spite of the MoU, the fiscal position has shown a steady
deterioration. Therefore, when the Eleventh Finance Commission was
about to submit its report, an additional term of reference was given to
the Commission to ‘… draw monitorable fiscal reform program aimed at
reduction of revenue deficit of the states and recommend the manner in
which the grants to states to cover the assessed deficit in their non-plan
revenue account may be linked to progress in implementing the
program’. Based on the recommendation of the Commission, the
centre has initiated the medium term fiscal reform program (MTFRP).11
Accordingly, a small portion of the transfers has been earmarked for
giving grants to the states on achieving five percentage point reduction
in the percentage of revenue deficits to states revenue receipts including
central transfers.
10 Prohibition policy refers to the policy of prohibiting the consumption of sale of alcoholic
products within the state. One state, Gujarat has consistently followed this policy right from
independence and some states like Tamil Nadu and Andhra Pradesh have followed this policy
from time to time for electoral reasons.
11 One of the members of the Commission, however, wrote a note of dissent stating that the
recommended design is inappropriate.
22
A number of shortcomings in the above scheme have been
pointed out. The amount earmarked for giving grants under MTFRP
constitutes less than 2 percent of the transfers recommended by the
Finance Commission. Along with other incentive based transfer
schemes, this has contributed to further segmentation in the transfer
system. More important criticism from the viewpoint of asymmetry is
that in the case of special category states over 80 percent of their
revenues accrue from central transfers. Inability to reduce the deficit
may be due to reduction in central transfers and this will be seen as the
state’s poor performance!
IV.4. Asymmetry in State Plan Assistance:
Asymmetric design in the transfer system in favuor of special
category states is seen very clearly in the distribution of plan assistance.
Until 1969 plan assistance for state plan purposes was given according
to the various plan schemes approved. To impart greater objectivity, the
NDC approved the formula in 1969 and the assistance has been
distributed to the states according to this formula modified by the NDC
from time to time.
The asymmetry in the plan assistance is seen mainly between
the special category states and non-special category states. The
formula that is applied at present is summarised in Table 4. First, 30
percent of the central assistance for state plans is earmarked to the
special category states even though their population share is only 5.4
percent. Second, 90 percent of plan assistance to special category
states is given as grant and the remaining as loan whereas the
proportion of grants in the plan assistance to other states is just 30
percent (Table 4).
This arrangement can not be entirely justified on equity grounds.
Surely, equity provides some justification for this. They may reflect
higher costs of providing the goods and services in remote mountainous
areas, owing to diseconomies of scale and scope arising from small
sizes of these states, and their internal diversity. Thus, higher per capita
spending than even high income states in these states seen in Table 1
may partly reflect higher costs of provision. Higher transfers may also
be needed to meet the special expenditure requirements, such as higher
levels of security, that are not required in other states. Thus, these
23
states may to some extent be acting as agents of the centre in the
provision of national public good of strategic stability and defence. A
part of the reason for higher transfers to these states may be because,
as they are located in international borders, the centre has not allowed
foreign investments to flow into these regions and therefore has the
responsibility of strengthening the regions to have domestic
investments.
Table 5: Formula for Distributing State Plan Assistance*
Criteria Share in
central
Plan
assistance
(percent)
Share
of
grants
And
loans
Distribut
ion
criteria
A. Special category states (11) 30 90:10
B. Non-special category states 17)
(a) Population (1971)
(b) Per capita income,of which:
(i) According to the `deviation’
method covering only the states with
per capita income below the national
average;
(ii) According to the `distance’
method covering all the fifteen states
(c) Fiscal performance,of which
(i) Tax effort
(ii) Fiscal management
(iii) National objectives
(d) Special problems
Total
70 30:70
60.0
25.0
20.0
5.0
7.5
2.5
2.5
2.5
7.5
100.0
Note: 1.The formula as revised in December, 1991.
2.Fiscal management is assessed as the difference between states’
own total plan resources estimated at the time of finalising annual plan
and their actual performance, considering latest five years.
3.Under the criterion of the performance in respect of certain
programmes of national priorities the approved formula covers four
objectives, viz. (i) population control, (ii) elimination of illiteracy, (iii)
on-time completion of externally aided projects, and (iv) success in
land reforms.
More important reason for large transfers in these states has to
be found in the political bargain that brought these areas firmly into the
24
Indian union, and keeps them there. This kind of reasoning is
particularly clear for such formal, separate induction into the union as
Sikkim, and for the case of Kashmir, but it also applies to cases such as
Nagaland, where a long insurgency after Indian independence was
finally brought under some control through the granting of statehood with
special provisions, and where an implicit political bargain may require
continuing transfers beyond the average.12
A notable feature of the state plan assistance is the steady
increase in its discretionary component. Although transfers are
supposed to be given according to the NDC formula, over the years,
increasing proportion of the assistance has been earmarked for specific
schemes and kept outside the formula based assistance. In 2002-03 for
example, the normal plan assistance for state plan schemes disbursed
on the basis of the NDC formula constituted only about 46 percent of the
total state plan assistance. The remaining portion included earmarked
assistance such as schemes for hill, border and desert areas, assistance
to north-east and Sikkim, slum development, accelerated power
development, accelerated irrigation benefit program, Prime Minister’s
Gramodaya Yojana (village development plan) and Prime Minister’s
rural roads program.
An important component non-formula based assistance under
state plan schemes is the pass through assistance from multilateral and
bilateral donors to the state governments. In recent years, there has
been a significant increase in lending by multilateral and bilateral donors
to the subnational governments and some discussion of this is in order.
These loans are a part of state plan assistance and therefore, discussion
on this is important. According to the seventh schedule to the
constitution all matters pertaining to international affairs (10), having
foreign jurisdiction (16), United Nations Organisation (12) and foreign
loans (37) fall within the jurisdiction of central government and states are
not allowed to borrow or take aid directly from bilateral or multilateral
donors. However, in recent years, the states have been allowed to
negotiate directly with multilateral and bilateral donors though the loans
12One other possible reason also involves strategic motives. For strategic reasons, the central
government may wish to restrict private investment, particularly, but not restricted to foreign
investment into these regions. Thus public spending may be a compensation for this
restriction. To some extent, this is also a consequence of features of the political bargain that
restrict non-residents of the state from certain kinds of ownership of property in the state, thus
acting as a restriction on investment.
25
are eventually routed through the central government. This has enabled
some states to seek substantial loans from multilateral donors whereas
others have not been able to access the assistance. Naturally, the
questions of propriety and partisanship in the selection of states have
come up. The states ruled by regional parties with pivotal support to
coalition government at the centre may find it easier to access the
facility than the states ruled by main opposition parties. In a situation in
which most of the states are ruled by the main opposition party, the
central government seems to have adopted a policy of going slow on
this aspect of liberalisation, though once started, the process is difficult
to fold back.
The discussion in plan assistance is not complete without
referring to the way in which the states’ borrowing operations are
conducted in Indian federalism. Article 293 of the constitution empowers
the states to borrow internally. They can either borrow from the centre
or from the market. It however, stipulates that they can borrow money
from the market without referring to the central government only if they
are not indebted to the centre. The centralised planning has ensured
that all states are indebted to the centre and therefore, market borrowing
by the states simply implies the allocation of market loans by the
representatives of Union Ministry of Finance, the Planning Commission
and the Reserve Bank of India. The stipulation of statutory liquidity ratio
to the commercial banks ensures that the state governments’ bonds are
subscribed by the banking system.
The way in which both central loans and market borrowings are
allocated to states is not made rule based and transparent and therefore,
has attracted resentment by some states. Generally, after meeting the
repayment liabilities, some additional resources are mobilised through
these instruments for spending on plan schemes. Asymmetry can result
from the volume of loans allocated to each state and the extent of
interest rate repression. Until the early 1990s, the rates of interest
charged on market states’ loans were substantially below the market
rates of interest, but thereafter, interest rates have been better aligned to
market rates. The whole process is not rule based and opaque, there is
significant scope for favouring some states over others in the allocation
of market borrowing. This is particularly true in a government ruled by a
coalition of parties and with some members of coalition wielding power
in the states.
26
There can be tremendous scope for discrimination among the
states arising from the practice of rescheduling and writing off of the
loans on special considerations. In the past, a number of Finance
Commissions were asked delve into states’ indebtedness and
recommend rescheduling and writing off, and it was on the basis of
these recommendations, that rescheduling was done. Referring to the
issue of states’ indebtedness was only a convention that was established
and not a constitutional necessity. In recent years, however, the central
government has written off states’ loans in Punjab, Jammu and Kashmir
and more recently proposes to write off loans of Nagaland without
referring the issue to anybody, on a discretionary basis. The reasons
advanced for this relief was that these states fought the nation’s battle
on terrorism/insurgency and in the process have had to suffer loss of
economic activity and revenues, and therefore need to be compensated.
They also had to create additional infrastructure to fight terrorism and a
part of the loan spent on this should be written off. Whatever be the
merits of these arguments, such practices have serious moral
implications and the arbitrary manner in which the central government
decides to write off the loans of the states creates asymmetry and scope
for discrimination, which may not be in the long term interest of Indian
federation.
IV.5. Central Sector and Centrally Sponsored Schemes:
The most important scheme of differential treatment, however,
is possible in the assistance given to states under a variety of central
sector and centrally sponsored schemes. The former is funded entirely
by the central government and the states are used merely as
implementing agencies. The latter, however, are closed ended specific
purpose transfer programmes intended to influence states’ priorities in
areas considered important by the central government. These do not
have constitutional sanctity, given purely on discretionary basis.13
Discretion enters in the choice of schemes, their design and the way
they are implemented.
There are over 200 central sector and centrally sponsored
schemes in vogue at present though, just 10 schemes account for over
13 Mr. K. K. Venugopal, an eminent constitutional expert has opined that giving grants for these
discretionary schemes is under Article 282 unconstitutional. See, NIPFP (1991).
27
75 percent of the total assistance given for central schemes. The
schemes are introduced by various central ministries and sometimes, on
the basis of announcements made by the Prime Minister from time to
time.14 Once introduced, they are continued. While the central sector
schemes are entirely funded by the centre, the centrally sponsored
schemes are shared cost programmes. But the schemes are designed
by the central ministries, and are mostly uniform across states. There is
scope for discrimination between states in the selection of schemes and
in its design. Often, new schemes can be introduced merely to favour a
particular state or group of states. The transfers given under these
schemes have received the strongest criticism, but that has not deterred
the central government from initiating more schemes. Nor has there
been any attempt to consolidate the schemes to allow greater say and
flexibility to states in their design and implementation. The ways in
which these are introduced and designed continue to be opaque.
IV.6. Other Sources of Asymmetry:
In economies subject to centralised planning and particularly in
those that had to traverse through acute scarcities, price and quantity
controls on both inputs and outputs are common. Once introduced,
these controls continue even when they have outlived their utilities,
either because no one bothers to reassess them or they create strong
vested interest for their continuance. In addition, there can be support
prices on various commodities introduced and these tend to be much
higher than border prices, introducing an element of implicit subsidy. All
these price and quantity controls are sources of invisible transfers and
can impact differently on different states. It is impossible to go into the
plethora of such controls and invisible transfers in Indian federalism, but
some important and obvious sources of inter-state discrimination may be
pointed out.
Determination of procurement prices of foodgrains is an
important source of invisible transfer. In an economy with high tariffs,
when the support prices declared by the government are significantly
higher than the prices that would have ruled in the market, and when the
government owned Food Corporation of India guarantees to purchase
14 Independence Day speech is one such occasion to announce new schemes.
28
the commodities at the declared price, the market prices will be
necessarily higher than it would be otherwise. As the support prices are
fixed mostly for agricultural commodities that are relatively price
inelastic, this tends to have significant regional redistribution. This
policy has a discriminatory impact on different states depending on the
product (crop) chosen for fixing support prices and the extent to which
support prices vary from the border prices (international price +
transportation cost). Not surprisingly, determination of support prices on
wheat, rice and other products is a matter of controversy in Indian
federation. It is not uncommon to see some of the regional parties
holding power in the states who are partners in the coalition government
at the centre influencing the determination of procurement prices.
Another recent example of price – quantity control system
impacting on the resource distribution in asymmetric manner is the
allocation of subsidised foodgrains to different states. The central
government has the discretion to allocate foodgrains to states for
distribution in fair price shops according to a formula determined by it,
but it can exercise considerable discretion in distributing foodgrains for
regions affected by drought and flood. It can render substantial relief to
states ruled by the “friendly” parties and make token releases to those
ruled by “unfriendly” ones. These examples can be multiplied.
Another important policy instrument that can discriminate
between the states is through regional policies, particularly the policy
regarding the location of central public sector enterprises and their head
office and regional/zonal offices. In a planned economy, locational
decisions are not taken necessarily on the basis of economic
considerations. In Indian case, during the first few plans, major
investments in steel and coal industries were made on the basis of
backward and forward linkage considerations. However, in more recent
years, the issue of locating central industrial units has been a subject of
controversy. Similarly, the location of regional offices of railways has
also been a subject of much discussion. Surely, this can be an
important source of discrimination between the states.
V. Political Elements in Asymmetric Practices.
A major source of asymmetric treatment of different states has
to be found in the nature of Indian polity and the way in which political
29
institutions have functioned over years. In the initial years of
independence the issue did not come to the fore because, the Indian
National Congress, which was in the forefront of independence
movement had little opposition and had a virtual monopoly in forming
the government at the centre as well as states. Since at both central
and state levels a single party ruled, and as the party itself was
centralised, there was little scope for disharmony between the centre
and individual states and for discrimination between the states.
However, four important developments in Indian federalism have
impacted to create asymmetric treatment of states in Indian federation.
These are discussed in the following.
The first important development is the increasing economic
centralization of Indian federalism. To begin with, as mentioned earlier,
the constitution adopted in 1951 had a strong centripetal bias to be
considered ‘quasi-federal’. The centralisation bias became stronger with
the adoption of planned development strategy that required the
concentration of economic powers and centralised allocation of
resources. The concentration of economic power reached the pinnacle
with the nationalisation of insurance and important commercial banks in
1969. The concentration of fiscal and financial resources with the centre
opened up vast scope for inter-state discrimination in the allocation of
resources.
The second important development is the end of single party
rule at the centre and states. The continuation of a single party rule for
relatively long period left two notable implications for intergovernmental
relations. First, strong authority of the party, more particularly the Prime
Minister had to be accepted and when there was a feeling of
discrimination, it was ignored in the larger euphoria of planning for
economic progress. Second, the concentration of power in the party and
resolution of centre-state and inter-state issues through informal means
through the party forum with the Prime Minister wielding paramount
authority meant that sufficient scope for development of formal and rule
based intergovernmental systems did not exist.
The third important development was the emergence of parties
with regional identity as ruling parties in some important states. In many
states, from time to time, the electorate perceived that the regional
interests and their distinct identity will be preserved better if they voted
the regional parties to power. The emergence of two Drawidian parties
30
alternating as ruling parties in Tamil Nadu, Telugu Desam reigning
power in Andhra Pradesh, and other parties such as Haryana Vikas
Party in Haryana, Biju Janata Dal with a distinct regional identity in
Orissa are cases in point. This has shifted the perspective of parties on
power at the state level towards strongly safeguarding regional interests
even if that beat the cost of the rest of the country.15
Fourth, is formation of coalition governments at the centre. As
none of the national parties emerging victorious during the last two
general elections, they had to forge alliances with other parties including
regional parties to form governments. The regional parties could force
their agenda and attempt to extract the maximum for the arrangements.
This is particularly true when the parties had a pivotal standing in the
coalition.
Finally, in general, the time horizon of the politicians and parties
has become more myopic in recent years. As the electorate have
become more cynical and their trust and faith in the politicians have
shown a nosedive, the probability of representatives getting re-elected
has declined sharply. In the last two general elections, only 33 and 38
percent of the members of parliament got re-elected. Given that the
probability of getting re-elected is low, the elected representatives find it
worthwhile maximising their personal gains when in office rather than
working for the welfare of their electorate.
Thus, on the one hand, the central government continues to
have enormous financial strength to dispense favours to state
governments and on the other, has lost enormous power to prevent the
strong states from bargaining and securing the allocation of resources in
their favour. The states ruled by regional parties with significant
strength in the parliament have become pivotal and have been able to
secure substantially higher resources relative to other states. This has
been achieved by the fact that significant proportion of explicit and
implicit transfers in Indian federation is discretionary. This dynamics of
Indian federalism summarises the recent developments in fiscal
asymmetry in Indian federalism.16
15 For the analysis of regional parties in India’s federal system, see Manor (1995); and Rao and
Singh (2001).
16 The above development has been a subject of consternation and concern. Referring to the
tactics adopted by the Chief Minister of Andhra Pradesh, an editorial in a leading daily stated,
31
VI. Concluding Remarks
This paper has attempted to bring out asymmetric arrangements
in Indian federalism. Asymmetry in administrative, political and
economic spheres in federal systems is unavoidable and in fact, may be
necessary not only to ‘come together’ but also to ‘hold together’.
However, while transparent asymmetric arrangements that can be
justified on grounds of overall gains to the federation contribute to nation
building, the discriminatory policies followed purely on short term
political gains can be inimical to the long term interests and stability of
federalism.
The rationale for asymmetry arises from the premise that inter
alia, federalism is a rational bargain of various units. Thus, the terms of
joining the federation depend on the bargaining strength. Further, even
in a federation with no provision for exit, political alignments determine
the bargaining strength of governments at different units in their
interaction with centre and this may result in discriminatory treatment of
various units. The potential for discrimination is higher in more
centralised federations and is inversely related to the political strength of
the central government vis-à-vis the various regional governments.
It is important to make a clear distinction between asymmetric
arrangements which are rule based and transparent and those caused
by political and administrative expediency. The asymmetric
arrangements built in the constitutional framework itself and those that
have been evolved to ensure smooth functioning of the federation
belong to the first category. These are rule based and transparent and
contribute to nation building. Over time, with changing situation, there
“…Armed with several spiral folders listing myriad demands, Mr. Naidu will characteristically
show the folders around, and in all likelihood, have his way too. Like he easily managed to get
10 lakh tons of rice from the food for work program, a new international airport, a drought relief
assistance and Rs. 1300.17 crores for countering extremism. . Already, there are charges that
a “weak” centre is being routinely “blackmailed” by Mr. Naidu. He has very cleverly used his
political leverage to the maximum, and much to the discomfiture of his detractors, he has also
got key Andhra politicians and bureaucrats into decision-making positions in Delhi” (Editorial in
Asian Age, June 11, 2003).
32
may be changes in the arrangement depending on factors such as the
extent to which various units assimilate themselves in the federation and
their relative bargaining strength. In contrast, the asymmetric
arrangements arising from political and administrative expediency are
opaque and discretionary. They can lead to degradation of
intergovernmental institutions and can be inimical to the stability of the
federation in the long term.
The paper has analysed both types of asymmetries in Indian
federalism in respect of administrative, political and fiscal spheres, with
greater emphasis on the last. It chronicles the growth of asymmetries
over the years. It argues that the rule based and transparent asymmetry
— the special treatment to certain states accorded in the constitution
and special treatment accorded to some of the states in evolving
intergovernmental transfer system, have contributed to the health of the
federation. In contrast, the discretionary treatment of states arising from
changing configuration of political power structure, vagaries of coalition
and regional party politics, weaken the institutions of intergovernmental
finance and can be harmful to the stability of Indian federation in the
long term.
33
References
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2. Bagchi, Amaresh 1988. First Award of the Ninth Finance
Commission – An Appraisal”, Economic and Political Weekly,
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3. Brass, Paul, R 1994. The Politics of India since Independence, 2nd
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4. Chanda, A. K 1965. Federalism in India, London: George Allen and
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5. Guhan, S 1989. “The Norm and the Tilt: First Report of the Ninth
Finance Commission”, Economic and Political Weekly, January 14.
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…and I am Sid Harth@mysistereileen.com
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