Saturday, Oct 01, 2022

Without the connivance of the Centre, no state can be fiscally irresponsible: Y V Reddy

In terms of overall fiscal stability, the states are doing better than the central government, says Reddy.

Y V Reddy, former RBI Governor and chairman of 14th Finance Commission. Express file photo

Former RBI Governor and 14th Finance Commission Chairman Y V Reddy has contributed to the ongoing debate on fiscal federalism by analysing how it has stood the test of time and the new challenges to Centre-State fiscal relations in the backdrop of the Terms of Reference of the 15th Finance Commission which are being seen as controversial by some states. He has outlined all that in his new book on Fiscal Federalism along with G R Reddy, who is now Adviser to the Telangana government. Excerpts from an interview with Shaji Vikraman:

At the start of 15th Finance Commission itself last year, we have had controversies — on Terms of Reference and what some states complain is a new approach marked by one nation one policy — away from cooperative federalism touted by this government earlier. How do you view this change?

When the 14th Finance Commission gave its report, there were competing models of development— the Gujarat model or the Andhra model. That was the background in which the 14th Finance Commission’s recommendations were made and that was accepted as cooperative federalism. But in the course of the next three-four or five years, now suddenly the slogan is ‘one nation, one policy’. Once you go through the ‘one nation one policy,’ then the issue of competing models does not exist. I think this change is reflected in Terms of Reference or ToR of the 15th Finance Commission. And once the ToR reflected this change, I think there has been a political backlash from some states. The ToR represents a broader issue of Centre-State relations and so does the reaction of states. Other things have also happened such as GST and the replacement of the Planning Commission with the Niti Aayog. So cumulatively, there is a new logic. The Planning Commission, with all its infirmities, had a single point contact with the Centre and states. Now Niti Aayog has not taken that place, so in a way, there is a vacuum. There is no coherence in the fiscal relations on a continuous basis between the Centre and states. Each ministry now has its own policy in the Centre-State relations. Therefore, I think the Niti Aayog has not served the purpose—correcting the problems of the Planning Commission. The Finance Commission is being burdened too much. Its remit is fairly simple which is sharing of taxes between the Centre and states and 80 per cent of it is formula based. There is an inherent problem in trying to have development programmes through Finance Commissions as they come once in five years. Development policies will have to be on a continuous basis.

What you are implying is Finance Commissions can’t be instruments for conditionalities.

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Basically, Finance Commissions have two components. One is the sharing of taxes. Can there be conditionalities on sharing of taxes? You cannot. Essentially, 80 per cent of the recommendations relates to the sharing of taxes. My point is that the basic Constitutional provision does not provide for conditionalities. As far as the finance commission is concerned, the purpose is the sharing of taxes and there is no question of conditionalities. The grants come as a secondary item and the conditionalities can only be on the secondary item.

Some states have described the new approach as coercive rather than co-operative federalism.

It is not my description of the situation. Some people are resenting movement from co-operative federalism to coercive federalism. That’s because after the recommendations of the 14th Finance Commission were accepted as good signs of cooperative federalism, some developments have taken place. Cesses and surcharges have increased. The state governments have been asked to pay a greater share. A major share, 60 per cent, is now on centrally-sponsored schemes and the degree of freedom that state governments had are being reduced. Therefore, a number of developments taken place in the last four-five years which gave a feeling to some of the states that cooperative federalism is being undermined. So the question which is being raised by the book is – is it possible that we are going there? We are at a crossroads as far as fiscal federalism is concerned. There is some discomfort, in the way the ToR has been drafted. The direction which we take now will be very critical for the country.


So essentially, ToR of the 15th Finance Commission itself has fueled a controversy – raising questions on fiscal federalism.

Only one thing is clear. The 14th Finance Commission took the view that in terms of Constitutional propriety itself, it has to be formula based. Conditionalities are inappropriate and it has to be developed mutually between the Centre and states. The idea was that Finance Commission recommendations should not be an instrument of economic reform or the Union government’s priorities. But the way the ToR of the 15th Finance Commission has been drafted is that the Finance Commission should be an instrument of reform as defined by the Union Government. For the first time, it has become controversial and that’s why I have devoted a chapter to ToR in the book.

Increasingly, the Centre is taking the position that it is fiscal management by states which is a worry when for a better part of the past several years it is states which have been fiscally more responsible. Can the Centre take such a moral view given its track record?


In terms of overall fiscal stability, the states are doing better than the central government. Who is contributing to dissavings? It is the Centre. After liberalisation, you don’t have to go to the Centre for approvals. But investors need land, water, ensure law and order and local facilities. In fact, after reforms, the responsibility of states have increased and the private sector and the markets look to the states whose resources are less. In fact, there are hard budget constraints on states because they need the approval of the Centre for borrowings. Without the connivance of the Centre, no states can be fiscally irresponsible. Therefore, the risk of matters going out of hand for states does not arise as there is an authority to enforce discipline.

What’s the way forward in terms of a possible redesign of India’s fiscal federalism?

The starting point should be that, under the Constitution, states are as responsible as the Centre. To say that states should be given incentives for fiscal performance or disincentives to do something is like treating them like children. It is like saying that I will give you chocolate if you behave well or I will smack you if you don’t. Should that be the relationship between the states and the Centre? That’s the question which should be asked at this stage. There is no reason to distrust states unless there is empirical evidence. Being against the Union government does not mean being against the nation. That principle has to be drilled into the intellectual debate. And if they are talking of fiscal management, a lot of attention should rather be on the Centre.

We now have the minimum income support scheme and a move towards universal basic income. How do you see this?

There is a fundamental problem. Here is a government which has a revenue deficit. Here is a government which is drawing on household savings and then you are taking additional responsibilities. As there is a recurring commitment it should be a cause for concern. Though there is an FRBM, it is not statutorily binding.


When you talk of fiscal transparency, there is also the issue of data integrity. Hasn’t the frequent data revisions and the decision not to release the data on employment etc led to uncertainty on fiscal risks.

The troublesome thing is that people are not sure about the fiscal risks because of the controversy about the data. It may not be as bad as some people believe but nobody is able to defend that it is not bad or assure that it is good. That uncertainty should end. in India, we prided ourselves that even if there were mistakes, there was no motivation. Now there is a feeling, an allegation that there is motivation. That should be cleared and that should be behind us. Data integrity is an important public good for any economic debate and for any democracy itself. Some sort of a public action should be there like a quick review to have a system which will ensure credibility. Like a second National Statistical Commission like the one earlier under Dr.C.Rangarajan. The subject is important enough at this stage It should be looked into to provide an assurance to the public.

First published on: 09-03-2019 at 02:23:45 am
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