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15th Finance Commission must win the trust of Chief Ministers: Y V Reddy

The 15th Finance Commission (FC) has to submit its report in October 2019, which will be another important event in the evolution of India’s fiscal federalism framework.

business Updated: Mar 31, 2019 09:26 IST
Roshan Kishore
Roshan Kishore
Hindustan Times, New Delhi
Finance Commission,Y.V. Reddy,Narendra Modi
Former Reserve Bank of India (RBI) governor Y. V. Reddy, who also chaired the 14th Finance Commission. (HT PHOTO)

The tenure of the Narendra Modi government has seen important changes in India’s fiscal federalism set-up such as the abolition of the Planning Commission (PC) and the roll-out of the Goods and Services Tax (GST). The 15th Finance Commission (FC) has to submit its report in October 2019, which will be another important event in the evolution of India’s fiscal federalism framework. It is in this backdrop that Hindustan Times spoke to former Reserve Bank of India (RBI) governor Y. V. Reddy, who also chaired the 14th FC, about his latest book, India’s Fiscal Federalism. Edited excerpts from the interview:

Q. Your book gives a snapshot of the evolution of fiscal federalism in India. What are the three most important milestones after India’s independence in this journey?

A. The first landmark is the establishment of the PC in 1950. This was not envisaged in the Constitution, unlike the FC. PC’s creation was essentially a step towards centralisation in a federal set-up. It created a rival for the FC. Once the PC came, the first FC itself made it very clear that it would only deal with revenue expenditure.

The second landmark, I would say, is the third FC. It said that even within the revenue account, the Plan revenue account would be outside the jurisdiction of the Commission.. This created an impression that the PC was encroaching upon the FC’s role. Such developments also created a demand from the states to adopt a formula for sharing of resources between the centre and the state. It was in this background that the Gadgil Formula for distribution of plan assistance came into being in the 1960s.

The other important milestone came in the 10th FC, which said that all the taxes should be pooled. While there has been a somewhat arbitrary scheme-wise allocation to states after that, the FC has more or less stuck to its brief up to the 14th FC. The 14th FC brought a drastic change by abolishing the distinction between Plan and Non-Plan expenditure, and in a way it brought back the original constitutional intent of the FC. This strengthened co-operative federalism in India in a big way and received widespread praise.

Q. How important would the work of 15th FC be in India’s fiscal federalism journey?

A.The 15th FC has come in very different context compared to its predecessors. In addition to operationalization of 14th FC recommendations, the implementation of the Goods and Services Tax (GST) has also changed the fiscal federalism scenario in India. However, some of the considerations in the terms of reference (ToR) of the 15th FC appear as though there will be more centralisation than before. I think that is a perception problem. But in reality what happened is that some chief ministers, particularly from southern states, made a representation to the President, demanding that the ToR of the 15th FC be amended. This is unprecedented. So we now have an unprecedented situation now where the FC, which generally did not face controversies, is starting with the disadvantage of a controversy. Whether it is true or not is a different matter, but they (FC) have to build the confidence of the chief ministers because any award should have their respect and acceptability. This will be the biggest challenge for the 15th FC.

Q. Issues of fiscal federalism get far less attention in our public discourse than matters such as farm loan waivers. The former is perhaps more important for our federal setup. How do you see this?

A. Yes, but actually if you look at the public discourse, we have to make a distinction between English and vernacular language newspapers. If you read the former, you will get the impression that the government of India (GoI) does everything, whereas, if you read the vernacular papers, then state governments seem to be working more. As far as the common man is concerned, I think the state government matters more for them.

Fiscal federalism is important because it has a bearing on the space available to the states relative to the centre. The main problem is (that) there is an impression that the central government in India is playing a judgmental role whether some programme is good or not. State governments are duly elected bodies, and once tax sharing takes place, it is for the state government to decide whether a programme is good or not. I’ll give you one example. For a state like Tamil Nadu, very often programmes such as Amma Idli etc. are seen as waste of money. But Tamil Nadu is growing well; its social expenditure is good. So may be the Tamil Nadu government knows what it should be doing. As long as states observe fiscal discipline, nobody else is affected whether they implement farm loan waivers or any other policy. But in the case of GoI, there is nobody to discipline the central government, unlike state governments. This is the crucial difference.

Q. Revenue and expenditure projections are extremely important in deciding FC’s awards. At a time when even our GDP estimates are under controversy, how do see this impacting the 15th FC’s work?

A. There are three important problems on this front. One, the FC has to factor for the possibility that forecasts by both the centre and states might not be reliable to suit their interests. Two, you also have to compare forecasts by different states as their assumptions might be different. All previous FCs have tried to handle these issues. The issue of lack of trust about GDP numbers – which are crucial for forecasting revenue and fiscal deficit – has created an additional problem and the state governments are likely to be uncomfortable vis-à-vis this issue. Not just state governments, but markets, economists and other data users are also concerned. I am confident that the issue of data and its reliability will be sorted by the GoI in the next few months. But if the uncertainty continues, the 15th FC might have another problem on its hands.

Q. India has witnessed relatively lower inflation growth in the last few years. Do you see this adversely impacting revenue growth, which is based on nominal GDP growth? Lower food inflation has also worsened agrarian distress, which has created more pressure on the states.

A. With regard to inflation targeting leading to moderation in inflation, I do not think it will have a significant effect on revenue growth. We should remember that low inflation also has a positive impact on growth. So, if real growth looks up, we should have a healthy revenue growth as well.

Agrarian distress is a serious problem and it is essentially a state subject. So, any all-India solution will be extremely hard because of different circumstances and inadequate knowledge of the local conditions. Also, the solution for agrarian distress lies outside agriculture. As the income originating in agriculture as a percentage of GDP goes down, you have to take people out of agriculture. Here, there is a fundamental issue. In the past, businessmen were looking towards GoI for many things. Now with deregulation, what matters is supply of infrastructure and social services. It is the states rather than the Centre which now play a bigger role in attracting capital. One good thing the GoI is doing (is that) through NITI Aayog, (it) is comparing the performance of states with each other and incentivising them for good work.

Q. Your book has talked about problems of centralisation with the PC. How do you see the impact of ToR of the 15th FC and the NITI Aayog – created under this government – on the centralisation versus cooperative federalism tension in India?

A. If you want my frank opinion, many of the considerations under the ToR of the 15th FC are in the jurisdiction of the NITI Aayog. Main focus of the FC is tax sharing, whereas almost the whole mandate of the NITI Aayog is in terms of grants. So, if you want to have effective conditions and bring about incentives and disincentives for the states under the FC, it is NITI Aayog’s work. So in a way what has happened is you are asking the FC to do the job of the NITI Aayog. The ideal thing for the FC would be to list important considerations, but outsource them to an organisation within the government rather than the FC giving recommendations.

First Published: Mar 30, 2019 14:20 IST