ensuring equity and efficiency- - finance...

ENHANCING FISCAL EFFICIENCY––

THROUGH FEDERAL FISCAL TRANSFERS

SECTION - I

REVIEW OF UNION AND STATE FINANCES

PREPARED FORTHE TWELFTH FINANCE COMMISSION

BYV.K.SRINIVASAN

Section-II 118

JULY 2004

Section-II 119

ENHANCING FISCAL EFFICIENCY––

THROUGH FEDERAL FISCAL TRANSFERS

SECTION - II

ISSUES IN FEDERAL FISCAL TRANSFERS

PREPARED FORTHE TWELFTH FINANCE COMMISSION

BYV.K.SRINIVASAN

Section-II 120

JULY 2004

Section-II 121

SECTION - I

REVIEW OF UNION AND STATE FINANCES

Section-II 122

Section- II


Contents

Section- I

Preface i-iiFederal Fiscal Transfers in India-A Retrospective View iii-xx

FINANCES OF THE UNION

Chapter 1Demands on the Resources of the Centre 1-70

A. Terms of Reference 1-14 Approach of the Finance Commissions

B. Resources of the CentreDeclining Tax BuoyancyErosion of Tax GDP RatioRecent Trends in Revenue

Tax Advisory Group’s Forecast 15-23

C Demands from Expenditure Needs 24-29Trends in Expenditure

D. Major Items of Expenditure 30-41 General Services, Civil Expenditure Police Internal & Border SecurityDefence Debt Servicing & Interest Payment

E. Expenditure Reform Commission 42-57Section-II 123

ERC ReportsFood Subsidy Fertilizer Subsidy Optimization of Staff Normative Approach

F. Inter Sectoral Priorities 58-63

G. Assessment of Expenditure Management of GOI 64-70Assessment Budget Support for the Tenth PlanDemands of the States

Section-II 124

FINANCES OF THE STATE GOVERNMENTS

Chapter II

A Macro View of State Finances 71-82Expenditure Management 1951-52 to 1999-2000Aggregate Budgetary Picture 1980-81 to 2000-2001Structural WeaknessEleventh Finance Commission Fiscal Outlook in Recent Years

Chapter III

Trends in Expenditure Management 83-96Patterns of Expenditure Development & Non-Development Resources for Basic Services Plan & Non-Plan Expenditure Sectoral Distribution

Chapter -IV

Debt Burden and Interest Payment 97-110Combined Liabilities of Centre & States Public Debt of State Governments Indebtedness to CentreMarket BorrowingsInterest Payments Statewise Details Off Budget Borrowings and Contingent Liabilities

Chapter V

Deficit Indicators 111-117Revenue Deficit

Gross Fiscal Deficit Current Status

Statewise Details ****

Budgetary Balance 2003-04 and Beyond i- iv

Section-II 125

Section- II


Chapter VIChanging Profile of Federal India 118-129

Changing Political MapFiscal Performance of the States

Growth Performance of the States

Chapter VIICriteria of Devolution 130-150

Vertical Sharing Horizontal Devolution

Geographical and Demographical FactorBackwardness

Income Criteria Choice of Criteria –

A Comparison of X & XI Finance Commission Recommendations

Tables

Chapter VIIIGrants-in-Aid to States 151-166

Constitutional Provisions Quantum of Grants & Federal Transfers

Grants from Finance Commissions Selection of States

Effective Targeting of Grants Suggestion of Standards

Chapter IXFinancing Disaster Management 167-175

Views of Previous Finance Commissions Suggestions

Chapter XCentral Plan and Centrally Sponsored Schemes 176-190

Constitutional PositionOrigin and Growth of CSSCSS and Gadgil FormulaViews of Tenth Finance CommisionViews of the Pay CommissionViews of CAG

Section-II 126

CSS TransfersViews of Planning Commission.Recommendation

Chapter XINorms For Maintenance Expenditure 191-199

Adoption of NormsAccounting and Monitoring SystemRecommendations

Chapter XII Off Budget Borrowing and Contingent Liabilities 200-206

Chapter XIIIFiscal Reform Facility 207-220

Deficit Indicators Tenth Finance Commission Analysis NDC DiscussionEleventh Finance Commission RecommendationState Fiscal Reform Facility – Notified Scheme Implementation Assessment

Chapter XIVRanking of States - Database & Criteria 221-232

Accounting SystemQuality of Budgetary Data Classification of States Ranking of States

Chapter XVLeveraging Grants for Ensuring Efficiency 233-255

A. Prescription Norms & Parameters Lessons from Reforms Experience Reforms in the Nineties RecommendationsB. Economy & Efficiency Revisiting Concepts C. A Macro Level Efficiency ParametersD. Micro Level Efficiency Parameters Recommendations

Chapter XVIMonitoring Mechanism 256-262

Monitoring of Projects

Section-II 127

Monitoring of Fiscal Reforms Recommendations

*******************

PREFACE

The Twelfth Finance Commission constituted by a Presidential Order dated 1st

November 2002, issued by the Department of Economic Affairs, Ministry of Finance and Company Affairs sought a study on Efficiency of Public Expenditure, setting out specific terms of reference for the study and time schedule for its completion (15 th September 2003 to 31st January 2004).

Apart from the Constitutional mandate for making recommendations on a) the distribution between the Union and the States, of the net proceeds of taxes and on their allocation between the states, b) the principles which should govern the grants in aid of the revenues of the state out of the Consolidated Fund of India and c) the measures needed to augment the Consolidated Fund of a State, the Twelfth Finance Commission is required to review the state of the Finances of the Union and the States and suggest a plan by which the Governments collectively and severely may bring about a restructuring of the public finances restoring budgetary balances and achieving macro economic stability, along with debt reduction and equitable growth. The enlarged terms of reference make the task of the Twelfth Finance Commission more onerous than its predecessors and at the same time provide an opportunity and specific mandate to conduct a deep and extensive probe into several of the inter related issues of revenue augmentation and expenditure management which the previous Finance Commissions may have sensed but could not fully settle within the ambits of their relatively limited frames of reference.

The Twelfth Finance Commission, has thus, a complex and challenging assignment, even as the Indian Economy and Financial systems, already launched on a reform path, grapple with reorientation of objectives and institutional changes to enable them meet the challenges of globalisation. The sweeping changes involve, among other things the redefining of the role of the state and re ordering of its priorities, with serious implications for fiscal management and pattern of control over the economy. The circumstances in which the Twelfth Finance Commission is placed are somewhat delicate, as the state of public finance need swift and strong corrective policies and effective implementation, and at the same time the socio economic and political compulsions demand circumspection and balancing of diverse forces and imperatives.

Section-II 128

Keeping this in view draft reports on the finances of the Union and the State Governments covering budgetary data and analysis, the approach of the previous Finance Commissions and some view points for the consideration of the Twelfth Finance commission were presented in February 2004. Offering comments on the draft reports, Member Secretary of the Commission sought clarification on some points and coverage of the recommendations of the Expenditure Reforms Commission by way of supplementation of the report. While attending to this, it was felt that the data covered in the draft report could be updated with specific reference to Union Budget for 2004-05.

Section-II 129

In the preparation of the Report we have drawn on primarily official reports and discussions with the officials of various State Governments, Union Finance Ministry and Planning Commission. Though literature survey and discussions with experts and officials were initially conducted, the references are restricted to official reports and those concerned with the previous Finance Commissions. As the report is intended primarily to assist the Twelfth Finance Commission in its deliberations, an attempt has been made to provide the alternative view points on the various issues in federal fiscal transfer.

We are conscious that various views are possible on some of the contentious issues that have been debated for long and that the Twelfth Finance Commission will be taking a final view on them. Our approach has been to place before the Commission, the conflicting views, and as a result, this report may appear inconclusive in some parts. Data and analysis have some times been repeated in some chapters only to facilitate easy reading. Smt. Sujatha Suresh made valuable contribution to the assembling and analysis of budgetary and other data relating to the Union Government and all the States.

Dr. N.J. Kurien, Adviser Planning Commission, Sri.K.Subrahmaniam, formerly Principal Finance Secretary, and currently Chairman Public Enterprises Review Committee. Sri.C.D.Seshadri, Engineer-in-Chief and Secretary Irrigation Department, West Bengal. Sri M.C.Swaminathan, former Director Economics and Statistics of Government of Andhra Pradesh, Dr.Nita Mukherjee, formerly Senior Vice-President ICICI, Dr.Shobana Vasudevan of Commerce Department , Poddar College, Mumbai provided specific inputs for the Study. The Library of the Indian Institute of Economics, a research organization established in 1953 now revived after a gap, was of immense help in the preparation of the study. We wish to express our grateful thanks to the Institute and its Director.

Miss. Pooja Sainani, in Bombay, and Mr. Naveen Srivastava in Hyderabad provided valuable assistance with the computer. Lanco Global Systems, a computer organization based in Hyderabad also provided valuable assistance.

This Report could not have been completed as per time schedule and Terms of Reference, without the willing and smiling cooperation of Sri.R.Ramanujam, Joint Secretary, who did not mind our interruptions with frequent queries. Smt.Madhulika, Director and Shri Kohli were of valuable assistance.

Dr.C.Rangarajan, Chairman, Sri.T.R.Prasad, Dr.D.K.Srivastava, and Dr. G.C.Srivastava Members of the Finance Commission were kind enough to clarify a few points at the crucial time.

21-07-2004 V.K.SRINIVASANHyderabad

Section-II 130

Federal Fiscal Transfers in India – A retrospective view

“Fiscal relation, in India have,” as pointed out by Dr. C. Rangarajan, “evolved over time through political, institutional and functional changes within the ambit of the provisions of the Indian Constitution. The Finance Commission has had an important role to play in this evolving structure because resource sharing based on constitutional division of functions and finances between the Centre and the states, is a critical element in the federal system”. (Perspectives of Indian Economy, pg-22, cited in Fifty Years of Fiscal Federalism – Finance Commission of India)

Constitutional frame work.

Federal polity in India has been sustained by a flexible legal frame work , Indian Constitution 1950, provided with foresight and fortitude by our Constitution makers, who while building on the pre-independence experience in provincial administration governed by the Indian Councils Act, 1909, the Government of India Act, 1919, and the Government of India Act, 1935 imparted to the Union of States a flexibility that has served the Nation well.

The nature and magnitude of the task completed by the Constitution makers can be gauged from the following

a) A representative Constituent Assembly with 389 members was set up to frame the constitution and its proceedings lasted from 9th December 1946 to 24th January 1950.

b) A Drafting Committee of eminent legal men and educationists, was set up on 29-8-1947 and it took over two years of preparation before the draft constitution was completed on 4-11-1949.

c) When the Assembly took up the draft for consideration, as many as 7635 amendments to the draft were tabled and 2473 amendments were moved.

d) The draft constitution and the amendments proposed were discussed in detail by the members of the Constituent Assembly for 114 days before it was approved on 26-11-1949.

As a result of the elaborate debate and discussion of the nuances of various provisions, formulated after studying constitutions of various countries, the Constitution approved by the Assembly became one of the lengthiest in the world, with 395 Articles and 8 schedules. During the course of the last 50 years, several amendments have been carried out, and the Indian Constitution, as it stands today, has 373 articles and 12 schedules.

As Granville Austin pointed out, the Indian Constitution, has not only provided a frame work for social and political developments and established the national ideals but also, more importantly, laid down the manner by which they are to be pursued. The

Section-II 131

Members of the Constitutional Assembly, “skillfully selected and modified the provisions they borrowed helped by the experts among their number” and “applied to their task with great effectiveness, two wholly Indian concepts-consensus and accommodation. Accommodation was applied to the principles to be embodied in the Constitution. Consensus was the aim of the decision making process, the single most important source of the Constituent Assembly effectiveness.” (The Indian Constitution, The Corner Stone of a Nation, Granville Austin). While the spirit of accommodation has been evident not only in the finalization of the provisions but also in the manner in which the Indian union and the constituent states have discharged their immense responsibilities of serving and sustaining the aspirations of an ever increasing population within a democratic frame work of Governance, the profile of Federal India has under gone significant changes over the last five decades, with the population increasing from 36.10 million in 1951 to 1027 millions in 2001, and the number of states increasing from 16 to 28 mainly on account of reorganization of states in 1956 in a major way and at subsequent points of time in a minor way. What has been significant is the remarkable continuity even while political and institutional changes were taking place.

Functions and Resources - asymmetry Distribution of resources between the Centre and the States and the perceived

mismatch between the functional responsibilities and revenues raising powers assigned by the Constitution to the two layers of Governments, has been the subject of considerable discussion.

It may be worth while to set out in brief, the constitutional position. The Indian Constitution has, under Article 246, and Seventh Schedule, distributed powers and allotted subjects to the Union and the States with a threefold classification of subjects.

List I, the Union List containing 97 subjects in which the Union Government has exclusive authority and Parliament can legislate. This includes subjects of national importance such as Defense, External Affairs, and Communications Higher Judiciary Elections

List II the State List containing 66 subjects in which the State Governments have exclusive authority and the State Legislatures can enact laws. These include subjects which impact on the life and welfare of the people such as Public Order, Police, Local Government, Agriculture, Land Water, and Public Health.

List III Concurrent List containing 47 subjects in which the Union and the States exercise concurrent powers. This covers administration of Justice, Economic and Social Planning Trade and Commerce, which have National and Inter-state implications.

As per article.248, the Union has exclusive power on any matter not enumerated in the State or Concurrent List and as per Article 254, in case of conflict between union laws and the state laws, the Union law shall prevail

Section-II 132

The enumeration of taxation powers places in the Union List, taxes on Income other than Agricultural Income, Excise Duties, Customs and Corporation Tax. The State List contains Land Revenue, Excise on alcoholic liquors, Tax on Agricultural Income, Estate Duty, Taxes on sale or purchase of goods, taxes on vehicles, taxes on profession, luxuries, entertainment, stamp duties etc. The Concurrent List does not include any tax power.

Two points have been made in this regard, one that there is a mismatch between the functions allocated to the centre and the states , and their powers of taxation and two , that the more buoyant tax areas , have been assigned to the centre. but it has also been pointed out that “the Constitution recognizes that the division of resources and functions between the Union and the States was such that there would be imbalance between them” and that “the Finance Commission periodically corrects the imbalance bringing about an alignment between them”.(Fiscal Federalism in India ,B.P.R.Vithal , October,2000 ,P. 229) A moot point is whether relative responsibilities of centre and the state could be defined and worked out in financial terms . The Constitution makers, have gone far and wide, in search of good practices prescribed in different Constitutions and have given a workable Constitution , that can sustain the Federal Spirit and the frame work for long, and in the context of the changes in a growing economy , it is good that they did not freeze the financial relations in a tight frame, and chose to provide an institutional mechanism like the Finance Commission to be appointed every five years with powers to make recommendations for statutory devolution and grants.

Political environment:

The Constitution of India, had ushered a Union of States, giving the nation a Federal character even while several features appeared to be those of an unitary state. The democratic frame work sustained through regular elections to the Union Parliament and State Assemblies has brought India credit in the comity of nations, but the history of Federal Republic that came into existence –1950 has not been without challenges. The spirit of federalism has however been kept alive, overcoming stress and strain inevitable in a nation marked by economic and cultural diversity. The first three General Elections in 1952, 1957 and 1967 brought the same party to power at the Centre and nearly all the states and no serious strain emerged in the relations between the Union and the State Governments.

When the General Elections of 1967 resulted in different political parties occupying positions of power at the Centre and the States , the Prime Minister told the nation in a broad cast on 15th March 1967 , “ You , the free citizens of India have not merely made your choice of elected representatives but even more triumphantly demonstrated our common faith in the democratic system. The majority enjoyed by the ruling party had been reduced in the centre and in many states. In some states, one or other party or parties previously in opposition have come to power either singly or in coalition. This is a significant development . Democracy implies choice. Choice involves alternatives. It is a healthy sign that alternatives are emerging and competing”

Section-II 133

While the Prime Minister initially and the President later clarified the political dimensions of the Indian Federal System , the Deputy Prime Minister who was in-charge of Finance took the opportunity, at the Conference of the Chief Ministers held in April 1967 to clarify the financial aspects of federalism, by stating that, “ it is true that Centre’s resources are larger than the resources of any state. This was deliberately designed by the framers of the Constitution . The liability of the Centre is larger than the liability of any one of the states….. The Constitution has provided for the appointment of a Finance Commission periodically for sharing some of the taxes which the Centre levies. Over and above that, what ever resources are available with the Centre are also shared with the States. There is no question of the Centre being the giver and the states being the receivers. Both are sharers…..As to the question of devolution of taxes, it is actually a question of sharing the resources between the Centre and the States. As it is difficult for all the states to agree in the matter of division of resources, the Centre has to under take the responsibility of doing so. The Centre tries to do it in the best and most equitable manner possible. Just as the states are not able to resolve their disputes, it is difficult for the Centre also to satisfy each State.”

That was the clarity with which the spirit of federalism was asserted on the eve of what later turned out to be a major ideological divide within the ruling party in 1969, and significant shift in the economic philosophy and re-structuring of banking and credit institutions following which the Union Government, after the elections of 1971 , announced “New Initiatives for Growth with Social Justice” . The seventies were politically significant, marked as it were by the imposition of the emergency in 1975 followed by a change, for the first time in the political stewardship of the Union Government following the defeat of the Congress party in the General Elections of 1977. The Janata party which came to power sought to signal a change in the approach to economic development and Federal Governments but its tenure was rather short.

The Congress returned to power in 1980, and its tenure during the 80’s was marked by a recognition that the approach to Central planning at National level and regulated conduct of the economy by the Union and State Governments needed modification. It has been argued by some that the change in approach evident after 1984 elections was the harbinger of the economic reform. The General Elections of 1989 – 1990 was marked by a fractured verdict from the electorate with no political party securing a clear parliamentary majority, and the Union Government became the responsibility of a minority party, enjoying support of other parties not participating in the Government. The preoccupation with political survival was such that the Government did not notice that the economy and public finances of the nation were slipping into an enervated phase that soon turned into a crisis. The secular deterioration in fiscal balance led to macro economic vulnerability, and budgetary deficits, revenue and fiscal, appeared to set the economy on a medium term path of stagflation and recurring balance of payments problem, which was aggravated by rapid changes in the word economic environment. The Nation faced a major economic crisis in 1991.

However the General Elections of 1991, brought back the Congress party as a single largest party in the Parliament, though without an absolute majority on its own. Section-II 134

The change in political stewardship of the Union Government resulted in an reorientation of economic and political philosophy centreing on the role of the state in the conduct of economy, and a definite move in the direction of economic structural adjustments. While the economy was put on a path of recovery, public finances continued to pose a major concern with the accentuation of fiscal imbalances at both the Union and States. Fiscal consolidation was declared as a major objective of budgetary management and reforms of Industrial, Trade, Monetary and Banking sectors were initiated as part of a broad band economic reforms. But the fractured verdict in the General elections of 1996 created an uncertainty in the conduct of economic and political affairs, resulting in the nation going to the polls once again in 1998 and 1999. The politics of numbers in the Parliament gained precedence over need for immediate repairs to public finances. While the causes of fiscal malaise were diagnosed with a fair measure of accuracy the treatment could not be rigorous. With different political parties in power at the Centre and the States, the Union Government could neither coax nor coerce the State Governments into a regime of fiscal discipline. The Union finances themselves were such, that the Centre could not set itself as a model of fiscal rectitude.

The Elections of 1999 placed the reins of the Union Government in the hands of a National Democratic Alliance, a multi-party coalition, with a National Agenda for Governance. The gravity of fiscal emerged when the Union Finance Minister placed the interim report of the Eleventh Finance Commission on the tables of the Lok Sabha, on March 16th 2000, declaring “ the critical challenges posed by weakening fiscal situation must be squarely confronted and over come. A long history of high fiscal deficit has left a legacy of huge public debt and ever growing bill of interest payments. Although in the current precarious fiscal situation of the Centre it would be burden some on Centre’s finances to accept the recommendations, but the states’ finances are also severely strained and therefore in the spirit of federalism, Government has accepted these recommendations. While the need of non plan grants to cover the residual revenue deficits of the states is manifest, the problems that have in the first place caused this high revenue deficit , need to be addressed . In this context it is pertinent to mention that the challenge of fiscal management is not confined to the Central Government. The Financial position of the state Governments has deteriorated sharply in the last few years. Revenue deficits have widened and borrowings are being increasingly used to meet revenue expenditure. Fiscal reform at the state level has acquired great urgency. While we have gone out of our way to help state governments , the determination showed by some states to deal with these issues has also helped enormously” (para 10 of the Action Taken Note of the Ministry of Finance , placed in the Lok Sabha 16th March 2000.)

The Union Finance Ministry, with expert inputs from the Reserve Bank of India Planning Commission and the Eleventh Finance Commission sought to provide incentives for the states with a special scheme of State Fiscal Reform Facility, along with specially designed incentives programmes for Power, Irrigation, Urban Reforms and Rural Infra structure. But the fiscal indicators of the Union and of the States did not show any improvement, and the deficits continued. The inability of the Centre to insure fiscal consolidation was attributed to the political compulsions of a Coalition Government with multiple party representation and dependence on some regional parties for Parliamentary Section-II 135

majority. The NDA Government however managed to generate a spirit of confidence in the economy seeking higher levels of economic growth rate, though agriculture, a sector of importance to the states posed problems with its dependence on uncertain monsoon.

Seeking Lok Sabha polls earlier than its due date, NDA Government presented in February 2004 an interim budget for 2004-05. The General Elections in May 2004, resulted in lack of absolute majority for any political party in the Parliament and Fourteen political parties combined to form United Progressive Alliance and manage the Union Government, with a Common Minimum Programme, covering a wide range of social and economic promises for a major thrust in the areas like Health, Education and Agriculture which are in the domain of the States.

The time frame and the modes of mobilization of the required resources for implementing the CMP were still to be worked out. Dr. Manmohan Singh, the Prime Minister, however indicated that the Electoral results were for “a change in the manner in which the country is run, a change in national priorities and a change in the processes and focus of Governance”. Sri. P.Chidambaram, Union Finance Minister, spelt out seven clear objectives while presenting the regular budget for 2004-05. These included, “Accelerating fiscal consolidation and reform and ensuring higher and more efficient fiscal devolution” What these changes imply for Federal Fiscal Frame work and the Centre-State relations needs to be seen, as pressures of a multi-party Coalition on the Government appear to be continuing and the centre announcing, a Backward States Grant Fund, even while the Finance Commission is finalizing its report.

Changing Institutional Frame-work

Over the last five decades, even as the nation grappled with rapidly rising popular aspirations of an ever increasing population and the governments, at the Centre and in the States struggled to mobilize the required finances for discharging their administrative responsibilities and implementing development plans to meet these aspirations, an institutional frame work emerged to deal with centre state financial relations. The main pillars of this frame work were

(a) Finance Commission appointed as per articles 280 of the Constitution of India. Intended to address the vertical imbalance in financial resources between the centre and states and the horizontal distribution of resources among the states.

(b) Planning Commission, a body of experts, set up by a Resolution of the Government of India dated 15th March 1950 to make an assessment of the material, capital and human resources of the country, and formulate a plan for most effective and balanced utilization of the countries resources.

(c) National Development Council, set up in August 1952 to strengthen and mobilize the effort and resources of the nation in support of the Five year plans, and composed of The Prime Minister of India, Chief Ministers of all states and the Members of the Planning Commission.

Section-II 136

Central Transfers - Pattern and Magnitude

Federal transfers to the States, are made in three streams, as

(1) Devolution of States share in Central Taxes (2) Grants from Central to the States covering

(i) Non-Plan grants – (a) Statutory grants recommended by the Finance

Commission to cover gap in revenue.(b) Assistance for relief measures after natural calamities (c) Non Statutory grants

(ii) Plan grants –(a) State plan schemes(b) Central plan schemes(c) Centrally sponsored schemes(d) North Eastern council/Rural electrification etc

(3) Loans from Centre(i) Plan loans(ii) Non Plan loans including Ways and Means Advance

The Finance Commissions, Planning Commission and the various Ministries of Government of India have taken over the years, qualitatively significant and quantitatively demanding decisions resulting in an increasing level of transfer of resources from Centre to the States. The total transfers from Centre to the states was only Rs.1,431 Crores in Ist Five Year period 1951-56 comprising Finance Commission transfer Rs.437 Crores (31.20 %) of total, Plan grants and loans Rs. 350 Crores (24.5 %) and centrally sponsored schemes and other transfers Rs. 634 Crores (44.30 %). During the Seventh Five Year Plan (1985-90). It had grown to Rs.1,14,424 Crores comprising of Finance Commission transfers Rs. 56691 Crores (49.4%) Plan Grants and loans 38351 Crores (35.32 %) and CSS and other transfers Rs. 19832 Crores (16.94 %).The nineties have witnessed a sharper increase in annual gross transfers from Rs.40859 crores in 1990-91 to Rs.1,39,661 crores in 2000-01 and further to Rs.152563 in 2002-03. The transfer of Rs.1,39,661 Crores in a single year (2000-01) exceeded the transfer of Rs. 1,14,424 crores made during the five year period (1985-1990).

During the Eighth Plan period (1992 – 97), the transfers on account of devolution and non plan and plan central assistance amounted to Rs. 276554 Crores covering Finance Commission Recommendations Rs. 145341 Crores (52.6 %).Plan grants and loans Rs. 131213 Crores. There were also transfers on other accounts. The nineties have witnesses a sharper increase in annual gross transfers from Rs.40859 Crores in 1990- 91 to Rs. 1,39,661 Crores in 2000 – 01 and further to Rs. 152563 Crores in 2002 – 03. The trasfer of Rs. 1,39,661 Crores in a single year (2000-01) exceeded the transfer of Rs. 1,14,424 Crores made during the five-year period (1985 – 1990).

The Federal Fiscal Transfers, as they now stand cover (a) State share of Central Taxes and duties (b) Non Plan grants and loans (c) Central assistance for State plans (d) Section-II 137

Assistance for Central sector and centrally sponsored schemes. This will be Gross Transfers. The Union Government recovers its loans and advances, due from the States. This will give net transfers, centre receives interest on loans from the states. While Centre was earlier transferring 80% of net small savings, the change from 1-1-2003 implies transfer of the entire net collections to the States. Central assistance is also provided for Rural electrification, North Eastern Council and Union Territories without legislature. The details of the transfer of recent years are shown in the following table. Transfer of resources from Centre to the States Rs. Crores

Grants and loansYear TD

1NPGL

2CASP

3CSS

4Total

2+3+4=5

Loan Recovery

6

Net1+5-6

=7

Interest Recovery

8

Small Savings

9

REC Etc10

1990-91 14535 11588 10909 5785 27682 3816 37332 5174 7026 14531995-96 29285 16505 17910 7033 41448 5350 65521 13002 9990 19442000-01 51688 14577 34623 8902 58102 11445 98335 26970 33265 33462001-02 52485 17276 36077 9875 63228 10412 105661 35515 34560 27952002-03 61235 19780 44121 10105 74006 13463 121778 27898 32000 2498 RE 56141 17602 43332 8918 69852 11379 114614 30125 52200 2539 AC2003-04 63758 18790 46314 11249 76353 13488 126623 30781 60000 2508 RE 65784 15850 46165 9568 71583 57289 80078 28867 2495 AC2004-05 78591 19881 51209 10928 82018 12798 147811 29982 2495

TD – Tax devolution, NPGL – Non Plan grants and loans, CASP – Central assistance for state plans, CSS – Central sector and centrally sponsored schemes, REC – Rural electrification, NEC – North Eastern Council, UT – Union Territories without legislature

The gross transfers from Centre as per the budget estimate for 2003-04 will be Rs. 2,00,111 crores. This will including states’ share in Central Taxes(Rs.63758 crores ) plan and non plan grants and loans from the Centre (Rs.76353 crores) and share of small savings Rs.60,000 crores and after recovery of loans and advances (Rs.13488 crores) and after addition of assistance (Rs.2508 crores) for Rural Electrification Corporation and North East Council, the net transfers will be Rs.1,89,131 crores. In the above table interest paid by the states small saving transfers and NEC/REC/UT transfers have not been included in arriving at the net transfer amounts.

The level of transfers, whether viewed in gross terms or net terms show that over the decades the transfers from Central to the States have been increasing in absolute terms but, as we shall see later, the States have a different perception on this. We need to look into not only the sums in all but also the manner of transfer, whether statutory or discretionary, and whether as a share of Central revenues or of State expenditure.

Finance Commission Transfers -

As many as Eleven FCs have sought to establish a workable, system of resource sharing between Centre and the States. As can be seen from the table below the transfers recommended by the successive Finance Commissions have increased from Rs. 412 Crores in the period (1952-57) covered by First Finance Commission. To Rs. 226643 Crores in the period (1995-2000) covered by the Tenth Finance Commission. Between Section-II 138

1952 and 2000 Tenth Finance Commissions had recommended the transfer of sums totaling Rs.4,26,079 crores , (Rs.3,76,235 crores by way of devolution of taxes and duties and Rs. 49,844 crores as grants-in-aid) and the Eleventh Finance Commission commenced the new millennium with its recommendations for transfer of Rs. 4,34,905 crores ( Rs.3,76,318 crores by way of devolution and Rs.5,87,587 crores as grants.) for the period 2000-05. That the Eleventh Finance Commission recommended transfer during five years, of a sum higher than what the previous Ten Commissions had done for the previous five decades (see table below) , carries with it , the ominous import of incrementalism, practiced in Indian Fiscal and Planning arenas. That during the 90’s covered by the Ninth and Tenth Finance Commission Centre’s revenue deficits increased from Rs. 18562 Crores in 1990-91 and to Rs. 77425 Crores in 2000-01 and fiscal deficits increased from Rs.44632 Crores to Rs.111275 Crores during the same period needs to be kept in view. Centres own expenditure commitments have also increased. This sets the context for the Twelfth Finance Commissions recommendations on the relative shares of Centre and the States with a holistic approach to restoration of nation’s fiscal health.

Finance Commission Transfers (Rs.Crores)

Devolution grants Total Increase over PFC (%) % of Total Transfer

Devolution Grant

I FC (52-57) 362 50 412 88 12

II FC (57-62) 852 197 1049 120 81 19

III FC (62-66) 1068 244 1312 25 81 19

IV FC (66-69) 1323 422 1745 33 76 24

V FC (69-74) 4605 711 5316 205 87 13

VI FC (74-79) 7099 2510 9609 70 74 26

VII FC (79-84) 19233 1610 20843 117 92 8

VIII FC (84-89) 35683 3769 39452 89 90 10

IX FC 1989-90 11785 1877 13662

303 83 17 1990-95 87882 18154 106036

X FC (95-00) 206343 20300 226643 89 91 9

XI FC (00-05) 376318 58587 434905 92 87 13

Total 752553 108431 860984 87 13

Relative Shares of the Centre and the States

While the magnitude of transfers particularly on account of the Ninth , Tenth and Eleventh Finance Commissions have become staggering, some of the States have been arguing that the Finance Commissions have not rendered adequate justice both in determ4ining the share of the states in the divisible pool of Central taxes, and in laying down criteria for distributing the states share among individual states. They have been buttressing their claims for increased transfer, with the argument that while the transfer of

Section-II 139

resources have increased in absolute terms, there is decline in the assistance viewed, as a share of (i) the total Revenue receipts of the Centre and (ii) as a share of the aggregate expenditure of the states. Between 1990-91 and 2000-01, as a share of Centre’s receipts, gross transfer declined from 39.0% to 31.0% and net transfers from 31.2% to 22.0%. As shares of the States Aggregate expenditure gross transfers fell from 44.8% to 39.8% and net transfers from 34.8% to 28.5%. Adjudicating this difficult issue, after analyzing the trend of states share in central taxes rising from 15.62 % in the First Finance Commission award period to 26.88 % in the award period of the Ninth Finance Commission, the Tenth Finance Commission came up with an Alternative Scheme in its report of November 1994 suggesting that the state’s share be 26 % of the gross receipts of the Central taxes with a further share of 3% of gross tax receipts of the centre in lieu of additional excise duties , thus totaling 29% of the gross receipts of the Centre and that this share should be suitably provided in the Constitution and be reviewed once in fifteen years.

The Union Finance Minister appeared to accept this in his budget speech of 1997 and the Inter State Council supported this in 1997 with some Chief Ministers proposing review every five years. The required constitutional amendment was made only in 2000, stipulating state’s share as a definite proportion of all central tax and duties, as against the earlier practice of sharing only the proceeds of Income tax and excise duty. While the fifteen years freeze was not accepted, the amendment also indicated the states share as of net receipts as against gross receipts recommended by the Tenth Finance Commission.

The Eleventh Finance Commission, on the other hand, suggested that the amount involved by way of tax devolution, plan and Non-plan grants should not exceed 37.5% of Gross Revenue receipts of the Centre. The Union Finance Minister informed the Parliament in July 2000, that the Government of India has accepted this ceiling on total revenue account transfers, with a rider that “the acceptance does not imply the establishment of a principle of mandatory sharing of a fixed percentage of centre’s revenue, receipts with the States. ” While the Tenth Finance Commission recommended , a minimum of 29% of tax receipts for transfer to the states, the Eleventh Finance Commission approached the issue from the other end suggesting a cap of 37.5 % of gross revenue receipts on the quantum of total transfer of resources, as a share of Centre’s revenue receipts. The issue has not yet been finally settled, either in terms of prescribing the share of the states as the floor or as a ceiling. This has given the states yet another opportunity to raise with the Twelfth Finance Commission, their claim for higher levels of transfers from centre to the states. An objective analysis will leave one with the uncomfortable thought that the previous Finance Commissions, in trying to transfer higher level of resources to the states, to help them out of their financial distress , have unwittingly or otherwise, led the Central Government to meet a relentless series of revenue deficits and daunting gross fiscal deficits, from year to year.

Distribution among the states

In their approach to horizontal devolution, every one of the previous Finance Commissions has come up with its own formula, with changes in criteria adopted and

Section-II 140

assignment of weights to different criteria for determining the share of individual states in the total states’ share of Central resources. The choice of criteria and the weights assigned by each commission had regularly provoked not only reaction from the State Governments but also critical comment from academics and Public Finance experts. As the examination of the recommendation in a later section reveals that the total transfers, as also the share of each state in tax devolution and grants do not reveal a consistent pattern, owing to frequent change of criteria and weight-age for inter-se allocation among the States. It has been claimed that these were made often on considerations of ensuring equity with various Finance Commissions pursuing re-distributive principles. In retrospect it does appear that the transfer scheme, taking into account pre devolution and post devolution financial position of the states helped the relatively poorer states. However this approach has led to criticism that the “gap filling approach‘ of the successive Finance Commissions, have encouraged fiscal imprudence of some of the states. Some State Government have been arguing that progressive states have been penalized and inefficient ones rewarded.

The relative importance to be attached to equity in distribution and efficiency in

utilization of resources in determining the respective shares of various states in federal transfers has become a critical factor. Amaresh Bagchi, a Member of the Eleventh Finance Commission, has stated that “Resolving the tension between equity and efficiency is a fundamental challenge in public policy. In the federal context, this creates a dilemma for those entrusted with the task of adjudicating the transfer of federal funds to sub-national governments. Addressing this will be a challenge to the Twelfth Finance Commission too, given that the terms of reference seem to give conflicting signals (Issues before the Twelfth Finance Commission , Financial Express, Nov. 18th 2002).Ensuring equity in distribution of resources while paying attention to the efficiency exhibited by the state governments in mobilization of resources on their own, and performance of services will be the unenviable task of the Twelfth Finance Commission.

Deterioration of the Finances of the States

The perceptible sense of dissatisfaction with Finance Commission recommendations , expressed by some states may be emanating from another factor, the declining cover for states expenditure provided by transfer of centres resources. The table below shows the absolute amounts transferred in gross and net terms and the cover they provided for states’ expenditure

Table :States’ expenditure ,central transfers and % cover (Amount in Rs.crores)Year Expenditure

of statesGross transfer Net Transfer

Amount % cover Amount % cover1985-86 44867 21951 49.0 17633 39.31990-91 91242 40860 44.9 31685 34.81996-97 202769 81974 40.4 60585 29.91999-00 325663 129066 39.6 93712 28.82000-01 347198 107483.7 30.9 69514 22.02002-03 BE 430934 148010 34.3 104261 24.1Section-II 141

Section-II 142

While the decline in cover provided by Centre’s transfer is established , it must be noted that the sharp increase in the total expenditure of the state governments and repayment of loans to the Centre provide part of the explanation for this inadequate cover. The other part of the explanation should necessarily be found on the relatively lower rate of growth in the revenues of the state and the states own contribution as evident from the table below.

Table : States’ Receipts and Expenditure (Rs.Crores)Year Expenditure

of statesRevenue Receipts Capital receipts

Total States Own Total States Own1985-86 44867 33424 19841 5579 22571990-91 91242 66466 39581 24847 108721995-96 177584 136803 86760 43630 291661999-00 325663 207201 135270 101611 520852001-02 377555 255599 163977 124507 975482002-03 BE 430934 306943 190377 118811 873572002-03 RE 442609 293873 185312 143419 1131592002-03 BE 476039 332919 210585 136527 102580

The data shown in the table above indicate that while total expenditure of the states have been increasing, the total revenue and capital receipts have not been able to keep pase and the states own revenue and capital receipts have been lacking behind.

Even a cursory examination of States finance shows that the revenue surplus of Rs.1,486 crores years in 1980-81 has disappeared, and the level of revenue deficit has increased from Rs.5,309 Crores in 1990-91, to Rs.56,801 Crores in 1999-2000, Rs.53,569 crores in 2000-01 , and further to Rs.59,233 Crores in 2001-02. In 2002-03, the deficit estimated at Rs.48,314 crores at the budget stage had increased to Rs.61,302 crores in the revised estimate. Between 1990-91 and 2000-01 gross fiscal deficit of the states increased from Rs.18,787 Crores to Rs.89,532 Crores with further increase to Rs.95,986 crores in 2001-02 . Between the budget and revised estimates for 2002-03 the GFD has increased from Rs.1,02,882 crores to Rs.1,16,730 crores. The budget estimates for 2003-04 have placed the total revenue deficit at Rs. 49008 Crores and gross fiscal deficit at Rs. 108861 Crores, both of which may show increase at the revised estimate stage, if past experience is any guide.

There are systemic factors underlying the deterioration of the Finances of the states. The Tenth Finance Commission report drew attention to the fact that from a revenue surplus, the economy moved into a continuous revenue deficit in 1982-83, and that almost all states have gone through a three phase deterioration in the revenue account balance, and observed that all the States have had almost identical turning points seems to suggest that there are systemic factors underlying the deterioration rather than State specific reasons.” (Report of the Tenth Finance Commission, P.5).

The RBI’s report on Currency and Finance, 2002. P. IV.25) has indicated that “four factors have been identified as responsible for the deterioration in the fiscal

Section-II 143

conditions of the states. These are rising interest payments, inadequate recovery of user charges, rising expenditure on wages and salaries and sluggishness in the central transfer of resources.” The Ministry of Finance, in its Economic Survey 2002-03, as drawn attention to, “ the near total stagnation in the growth of revenues, the rigidities in controlling expenditure on the revenue sides, bulk of which consists of wages and salaries and interest payments” and observes that” the quality of expenditure has worsened over the years. (Page 40 of Economic Survey).

A study of Public Expenditure Management by State governments, by the Indian Institute of Economics conducted for the Planning Commission, concludes that “ the most important contribution to fiscal imbalances in the states have been on the Expenditure side” and identifies other problem areas like falling levels of budgetary marksmanship, declining standards of public accountability, leakage and wastage of funds in programme implementation, tardy devolution of funds to local bodies and continuing intra–state disparities.

Several studies have established that while the states own revenue sources are not

increasing fast enough to match the rising expenditure, its repayment obligations are increasing and even with increase in Central transfers in gross terms , the central devolution and other assistance when taken in net terms are not adequate to cover the gap. The crucial question is whether Centre should continue to bail out the state governments, while its own fiscal balance has been in serious jeopardy for over a decade. This will be a crucial question to the examined by Twelfth Finance Commission.

One must note that the fiscal position of the Centre and the States viewed together has not been very comfortable, as can be seen from the following table :-

Combined Finances of Centre and States Rs. Crores

1990-91 1995-96 2001-02 2002-03 BE 2003-04 BETotal receipts 152398 296629 655907 736538 804738Revenue receipts 105757 217527 400229 490665 520320Tax receipts 87564 174852 313937 388015 411263Non Tax receipts 18193 42675 86292 102650 109057Capital receipts 46641 79102 255678 245873 284408Total expenditure 163673 303586 653354 741724 811321Development expenditure

98686 165361 329007 372374 399926

Non Development expenditure

64987 138225 324348 369350 411395

Revenue deficit 23871 37932 159395 143691 161300Gross fiscal deficit 53580 77671 226418 226864 251951Primary deficit 28585 18598 84048 64442 76463

The nature of the fiscal problem faced by the nation is such that the measures of deficit of Central and State Governments do not give any comfort. While the increase in

Section-II 144

absolute terms can be seen from the above table. It must be noted that as a percent of GDP the combined revenue deficit had initially fallen from 4.2 % in 1991 to 3.2 % in 1995-96 only to increase to 6.9 % in 2001-02 and gross fiscal deficit likewise fell from 9.4 % in 1991 to 6.5 % in 1995-96 only to resume its upper climb to 9.5 % in 2000-01, 9.9 % in 2001-02. In 2002-03 while the BE placed revenue deficit at 5.6 % and gross fiscal deficit at 8.9 %, the revised estimates showed an increase to 6.7 % and 10.1 % respectively.

The fiscal consolidation measures envisaged expenditure compression and improvement in Tax revenue through widening the tax based and better compliance did not materialize. As a result the deficits kept increasing in both absolute terms and as percentage to the GDP obliging Governments to increase their borrowings by an annual average of 15.3 % between 1990-91 to 2002-03. This approach resulted in the increase of outstanding liabilities of both the Center and the States as discussed below.

Debt burden -

Outstanding Liabilities of the Centre and the States

Outstanding liabilities Debt to GDP ratio (Rupees crore) (in per cent)

Year Centre State Combined Centre States Combined(end-March) 1990-91 3,14,558 1,10,289 3,50,957 55.3 19.4 61.71996-97 6,75,676 2,43,525 7,73,629 49.4 17.8 56.52001-02 13,66,409 5,89,797 16,32,084 59.5 25.7 71.12002-03 RE 15,61,876 6,94,289 18,66,626 63.2 28.1 75.52003-04 BE 17,80,064 7,90,702 21,10,681 64.9 28.8 76.9

The burgeoning burden of debt of the Center and the states has a serious implication for the fiscal balance of the states. The component wise analysis of the debt burden of the states show that an high proportion of the outstanding debt relates to loans from the center which stood at 45.1 % of the total at the end of March 2001. In more recent years the states have relied increasingly on borrowing from the market and financial institutions, which have implications for their interest payments. While in the early nineties the weighted average was around 13.5 %, there has been certain softening of the average interest rate. The RBI reports that the average rate has come down from 14 % in 1995-96 to 9.2 % in 2001-02 and 7.5 % in 2002-03.

It is in this context that one should welcome the attention paid to the reduction of the debt burden, with the Union Budget for 2003-04 announcing a debt swap scheme that would enable the states to prepay their high cost debt. Under the scheme all state loans from the Centre bearing coupons in excess of 13 % could be swapped with market borrowings .It is understood from RBI sources that in 2002-03, 25 states excluding Maharashtra , West Bengal and Sikkim pre paid high cost debt from Centre partly out of small saving collections and partly through fresh market borrowings of Rs.10,000 crores

Section-II 145

raised in February and March 2003, During the FY 2003-04 the states have raised Rs.23,000 crores for this purpose. The reduction of the debt burden is a step in the right direction and should be continued further with the Twelfth Finance Commission paying close attention to the fact that the repayment schedule of market loans of the State Governments indicate that the total amount of repayment will go up from Rs.1789 Crores in 2002-03 to Rs.4145 Crores in 2003-04 and move further up to Rs. 6274 Crores in 2005-06 reaching Rs.16261 Crores in 2009-2010. A suitable scheme of debt relief will help the states considerably.

Fiscal consolidation and reform -

The continuing deterioration in the Finances of the states, had made the Government of India to request the Eleventh Finance Commission “to draw a monitor able fiscal reforms programme aimed at the reduction of revenue deficit of the states and recommend the manner in which the grants to the states to cover assessed deficit in their non plan revenue account may be linked to progress in implementing the programme”. As per the suggestion of the EFC, the Center had created a State Fiscal Reform Facility to be operative between 2000-01 to 2004-05. As required under the scheme 22 states had submitted the medium term fiscal reform programmes and for approval and 15 states signed Memoranda Of Understanding with the Ministry of Finance. A mid term assessment by the Ministry of Finance in October 2003 concluded that “though the gross fiscal deficit and revenue deficit have come down and are projected to improve further, the EFC suggested strong reforms objectives of a GFD at 2.5% of GDP and zero revenue deficit by 2004-05 are not likely to be achieved. A programme that does not fully addressed the problem of a plan revenue deficit will not be sufficient to eradicate the revenue deficit all together. The facility as largely failed to address the problem of a steady convergence to a stable, sustainable, debt path”. The review observes that “If the limited improvements made are not to be derailed, the facility must be strengthen and the weakness address by taking properly targeted correctives. This appears to give the impression that while the states have been sensitized, the reform land mark objectives have not been achieved. There has been some response from the State Governments.

Another dimension to fiscal reforms was brought out by the Reserve Bank of India in its Annual Report (2001-02. P.125) “The fiscal positions of the State Governments has remained under pressure throughout the 1990s. The large magnitude of committed expenditure – viz. salaries, pensions and interest payments has severely constrained the States ability to undertake developmental activities. Recent policy initiatives by the States reflect the growing urgency for fiscal stabilization and reforms. Each State has devised its own strategies. Yet a common thread runs through them all expenditure containment, revenue augmentation reform of public enterprises and reduction in subsidies. A critical desideratum of the quality of fiscal reforms is the availability, quality and delivery of public services such as public health, education, water supply and sanitation. States have an important role in the development of social infrastructure. Therefore it is important to ensure that fiscal consolidation process does not lead to reduction in the States’ support to these activities.”

Section-II 146

Public Expenditure and Equitable Growth

It has also been realized that pursuit of fiscal consolidation mainly through expenditure reduction has its snares, since government expenditure on consumption and investment constitute an important part of aggregate demand in the economy with its impact on the growth prospects. Need for public spending on physical capital creation and on human capital formation have come to be realized. There has been increasing emphasis on proper attention to the expenditure side of fiscal restructuring in programmes for structural adjustment and fiscal stabilization. Concomitant attention to expenditure reduction and to improvement in quality of public spending is thus crucial to ensuring economic growth with equitable distribution of benefits among various social classes and different regions of the country.

The need to ensure fiscal consolidation without affecting the pace of economic growth and distributive justice, has placed the policy maker on the horns of a dilemma, leading to certain concern for ensuring efficiency in the expenditure. It may be mentioned that, the terms of reference to Sixth Finance Commissions setout in the Presidential orders of 28th June, 1972 called for consideration to the “scope for better fiscal management and economy consistent with efficiency which may be effected by the states in their administrative, maintenance, development and other expenditures (see 4.vi of Terms of Reference of Sixth Finance Commission) Similar references have been made in the Terms of Reference’s for Seventh Eighth, Tenth and Eleventh Finance Commissions. However, those Commissions did not set out any specific criteria for assessing efficiency or make its observance a condition for release of Central funds.

The Tenth Finance Commission had, in its Report, argued that equity and efficiency are not mutually exclusive and that it has given weight to efficiency on the revenue side, by recognizing tax effort. The Eleventh Finance Commission, considered both tax effort and fiscal discipline as criteria for determining the share of the states in devolution. It must be noted that, as pointed out by A Premchand and Saumen Chattopadhyay, there are significant conceptual differences between efficiency and economy in practice though they are used synonymously. “ Efficiency refers to the process of gaining more outputs for a given quantity of inputs. Economy refers to using fewer inputs to gain a specified level of outputs. The scope for achieving either is largely dependent on two factors (a) a consideration given to these aspects in the initial design of a programme and (b) at a later stage the economy derived and efficiency secured through the exploitation of competitive pressures in the procurement of materials and equipment and in the utilization of management techniques to reduce inventories, overlapping services and administrative overheads”. The two authors draw attention to the features of the existing system of expenditure management that make the pursuit of the economy and efficiency extremely difficult. It is with a realistic appreciation of the problems of designing a resource mobilization and expenditure management system that one can take the level of fiscal management in India higher.

Section-II 147

What is significant and should not be missed by any one is that in India, the processes of economic growth and financial management are inextricably intertwined with social and political objectives of governance. Rate of growth is to be assessed along with its quality, and distributional equity. That has been the sheet anchor of our development planning. Reiterating this, in his address to the nation on June 25 th 2004, the Prime Minister Dr. Manmohan Singh observed that “ Equity and efficiency are complementary, not contradictory, and we must move forward on both these, while maintaining a high degree of fiscal and financial discipline and a robust external, economic profile”. The Prime Minister also observed, that “ at a regional level the disparities are high and while some regions of the country seem to be on an accelerating growth path, there is a concern that other regions are not only lacking but are also falling behind” and that “ as a nation we cannot accept such disparities”.

A crucial question is whether the Centre should take the entire responsibility for removal of disparities among the states or only assist the states in their efforts to raise themselves to the level of their more advanced brethren. Since the Central Government’s own financial position, is not among the most commendable, with persistence of revenue and fiscal deficits of high order, leading to the sliding down of the target of wiping out revenue deficit set in the Fiscal Responsibility and Budget Management Act 2003 from 2007-08 to 2008-09, the federal transfer system needs to be retuned and the states made to assume greater responsibility for managing their fiscal situation and achieving budgetary balance. Five states Karnataka, Kerala, Punjab, Tamil Nadu and Uttar Pradesh have already enacted their own versions of fiscal responsibility and budget management legislations. Maharashtra has also moved in this direction. More states should be encouraged to follow suit. Design of Federal Transfers should be such as to facilitate this movement.

Federal Fiscal System has thus reached the crossroads. Finance Commissions of the past and the Planning Commission, have in their approach to transfer of Central resources to the States have taken the laborious path of looking behind and after, appraising the quantitative and assessing the qualitative aspects of public expenditure. That the nation has moved forward is a tribute to not only the Constitution makers, who designed the federal system but also those who have, carried it forward notwithstanding the stresses and strains involved. Stepping up the rate of growth and improving its quality calls for incentives to the performers forging ahead and intelligent guidance to those lagging behind. Monetary incentives are only a small part of a well designed scheme for improving performances. Assessing the strength and weaknesses of the existing financial systems in the states and improving them is the more challenging part. The Twelfth Finance Commission should address this.

In the interest of improved federal fiscal framework, and of ensuring equal availability of quality public services in all states, it is imperative that an attempt is made to utilize the federal transfers, as an instrument to prod the States into more efficient ways of utilizing their own revenue and the resources transferred by the Centre by careful planning and budgeting of expenditure and improved systems of monitoring.

Section-II 148

Scope of Study

Primarily designed to assist the Twelfth Finance Commission in its deliberations by organizing data and alternative view points relevant for evolving criteria for devolution of central taxes to the states, and determination of the principles to govern statutory grants, the study is organized in Two Sections.

The First Section is devoted to Finances of the Union and the State Governments. Keeping in view the terms of reference to the Twelfth Finance Commission and the more limited terms for this study it examines the approach of the previous Finance Commissions and analyses the resources available to the Centre and the demands on these from its own expenditure areas of civil administration, defence, debt service etc and proceeds to examine the recommendations of the Expenditure Reforms Commission and offers some views on Expenditure Management by the Union Government.

Presenting a macro view of the Finances of State Government and the Recent Trends in Expenditure Management, the Study seeks to identify structural and process related sources of inefficiency at the state level, through an analysis of the performance of the state governments, in the light of various budgetary indicators. This is followed by an analysis the burden of debt and interest payment and highlights the recent trends in revenue and fiscal deficits of the states, presenting aggregate and state wise details.

The Second Section deals with Issues in Federal Fiscal Transfers, and focuses on the criteria for devolution, the principles governing grants-in-aid, Central Assistance for Disaster Relief, Central Sector and Centrally Sponsored Schemes, norms for maintenance of capital assets and recent trends in off-budget borrowings and assessment of the States Fiscal Reform Facility. In the light of an analysis of past experiences in Administrative and Economic Reforms, in the country, the study examines the scope for prescription of norms and efficiency parameters while utilizing federal grants as a lever in promoting greater efficiency in expenditure management and achieving a quicker equalization of public services across the States.

The Study also provides an account of the structure of Union and State budgets, and accounts and highlights the problem of comparability and quality of budgetary data in determining ranks of the states utilizing available fiscal indicators and draws attention to the indices of fiscal management drawn up by the Comptroller and Auditor General of India, on the basis of audited accounts and uses these indices for ranking of states. As mere prescription of norms and parameters by the Finance Commission may not be adequate, for ensuring greater fiscal discipline and efficiency in expenditure the study suggests procedural and institutional changes for adoption by all the states. The study, also examines the existing mechanism for monitoring implementation of schemes and projects and suggests steps for streamlining the implementation machinery and improving utilization of funds.

Section-II 149

Chapter 1

Demands On the Resources of the Centre

The Twelfth Finance Commission has been required by the Presidential notifications of 1st Nov, 2002,”to have regard, among other considerations, to(i) the resources of the Central Government for five years commencing on 1st April 2005, on the basis of levels of taxation and non tax revenues likely to be reached at the end of 2003-04.(ii) the demands of the resources of the Central Government in particular, on account of the expenditure on Civil Administration, Defence, Internal and Border security, Debt servicing and other committed expenditure and liabilities” (Para 6 i & ii).

The twin tasks set may be reviewed against the backdrop of (a) the terms of reference set for the earlier Finance Commissions (b) the approach and methodology used by them for the estimation of the resources available to Central Government and (c) the recent trends in revenue and expenditure of the Central Government.

A. Terms of Reference

While an estimation of the resources of the center was implicit and in fact the first step in the determination of tax revenue share of the states and grants in aid from the center, specific reference to the demands on the resources of the center on account of its responsibilities was first made in the Terms Of References (TOR) of the Fifth Finance Commission (see para5 of Presidential order of 29.2.1968) and repeated

for the Sixth Finance Commission, (Para 7of the TOR dated 28/6/72), Seventh Finance Commission (Para 5.1 of the TOR dated 22/6/1977),Eighth Finance Commission (Para 5.1 of the TOR dated 20/6/1982),Ninth Finance Commission (Para 4.1 of the TOR dated 17/6/87), Tenth Finance Commission (Para 4.2 of the TOR dated 15/6/1992) and Eleventh Finance Commission (Para 5.1 of the TOR dated 3/7/1998).

We must note that the terms of reference for the Eleventh &

Twelfth Finance Commission are much broader than those set for

the earlier commissions. The Presidential notification constituting

the Eleventh Finance Commission (EFC) gave it the responsibility

Section-II 150

for suggesting “ways and means” for restructuring the public

finances of the Center and the States. But the Twelfth Finance

Commission was required to suggest “a plan” for restructuring of

the public finances of the centre and the states. While the EFC was

required to keep as objectives, restoration of budgetary balance and

maintenance of macro economic stability, the Twelfth Finance

Commission has been required to keep in view further objectives

of debt reduction and equitable growth. The Presidential

notification also suggested that certain “considerations” should be

taken into account by the two Commissions while making the

recommendations.

There are other qualitative differences in terms of reference. (a) The TOR for Twelfth Finance Commission, mentions, the demands on the resources of the centre, without a corresponding mention of the demands on the resources of the States following Para 6 (iii) which mentions “the resources of the States, for the five years commencing on 1st April 2005, on the basis of the levels of taxation and non-tax revenues likely to be reached at the end of 2003-2004”. (b) The TOR for the Tenth Finance Commission referred to the requirements of the states for modernization of administration, as also for meeting the non- plan revenue expenditure also keeping in view the potential for raising additional taxes”. (Para 4.iv and 4vi of the Presidential Notification of 15.6.1992). The TOR for the Eleventh Finance Commission stipulated the Commission to have regard “to the requirements of the States for meeting the plan and non plan revenue expenditure keeping in view, the need for generating surplus for capital investment and reducing fiscal deficit”(See Para 5ii and iii of the Presidential Notification of 30th July 1998)

Whether the reference to the “demands on the resources of the Centre” amounts to a preemption of the resources has evoked discussion. Dr.I.S.Gulati, a member of the Sixth Finance Commission had in 1987 drawn attention to “the lack of explanation of parameters taken into account by the various commissions in determining ‘what is left with the Centre after meeting the inescapable expenditure of Defence, subsidies and interest payments which’ alone absorb nearly half the Center’s revenues” Dr.Gulati had however added that,“ a view could no doubt be taken that a commission’s award reflects its judgment with respect to the extent to which the States should reasonably partake in

Section-II 151

the center’s resources through the steam of statutory transfers given its assessment of the center’s resources and commitments”

Dr.Gulati had also drawn attention, to what he called the practice that has grown of pre-exempting resources for the so-called “committed expenditures regardless of the ranking of the item in terms of national priorities and or constitutional division of roles” and observed that “ if no questions are to be asked about the nature of committed liabilities, about whether or not they conform to the constitutionalised division of obligations between the Centre and the states, the Centre could, over a period, so commit itself that very little is left for distribution out of its kitty to the states.” He strongly suspected that “it is this sense of commitment to committed expenditure that has come in the way of an equitable sharing of budgetary resources”(See Centre-State Budgetary Transfers Ed.I.S.Gulati, published for Sameeksha Trust by Oxford University Press, 1987 pages 6 to 9)

Doubts have been expressed on the legality and the constitutionality of the practice of Union Government, prescribing “the considerations” to be kept in view by the Finance Commissions in making their recommendations. State Governments have often felt uneasy over this, as introducing a slant in centre’s favour, and have demanded that the TOR are better settled after consultations with the state or discussion in the Inter-State Council. It should however be noted that this prescription did not disturb the deliberations of the Commissions or unduly influence their recommendations. In his study on Fiscal Federalism in India Shri B.P.R Vithal a member of the Tenth Finance Commission has listed as many as fifteen considerations that have been indicated to the various Finance Commissions and has pointed out that this practice may have started in the interest of maintaining a certain continuity in the frame of reference for Finance Commissions which are constituted every five years with a limited period of tenure. In Vithal’s opinion “ there would be no dispute if in the interests of a well structured enquiry by the Finance Commissions ‘additional matters’ and ‘considerations’ were included in the Terms of Reference. This should however be settled after genuine consultation between the center and the states” (page 57) He later sums up the position stating that “the constitution recognizes that the division of resources and functions between the Union and the States was such that there would be imbalance between them” and that “the Finance Commission periodically corrects the imbalance bringing about an alignment between them”. (Fiscal Federalism in India, October, 2000, P. 229)

Approach of Previous Commissions

Considerable debate has been generated over the manner of distribution of resources between the Centre and the States and over the perceived mismatch between the functional responsibilities and revenues raising powers assigned to the two layers of Governments, it may be useful to take note of the manner in which the various Commissions viewed the asymmetry between functional responsibility and resource mobilization powers and capacity. Divergent views have been expressed, considerable heat generated and no doubt, some light has been shed on this issue.

Section-II 152

Every Finance Commission had taken pains to explain its approach to the ticklish problem and the manner in which it has sought to maintain balance between the Centre and the States. The First Finance Commission referred to the ‘impressive case made by the States, for increased assistance to meet the growth needs ,’ and explained that” we had however to take into account not merely the needs of the States but the ability of the Centre as well to assist the States by the transfer of large portions of its revenues.” In the first chapter of its Report, the First Finance Commission explained,” In drawing up the scheme of assistance, we have kept three main considerations in view. Firstly, the additional transfer of resources from the centre must be such as the centre could bear without undue strain on its resources, taking into account, its responsibilities for such vital matter as the defense of the country and the stability of its economy. Secondly, the principle for the distribution of revenues between the states and the determination of grants in aid must be uniformly applied to all the states. Lastly the scheme of distribution should attempt to lessen the inequalities between states”

Subsequently there have been variations of this theme with the Second Finance Commission speaking of Centre’s “immense responsibilities for defense and national development”. The Fourth Finance Commission reviewed the relation between functions and revenue raising and drew attention to the failure of the rigid division between central and provincial heads of revenue and observed that” the experience of the Nineteen Twenties led, however to the emergence of the idea that the authority most suited for discharging a particular government function need not necessarily be the authority most suited to raise the financial resources required to discharge the function” and referred to the recognition of this in the Govt.of India Act of 1935 and the Indian Constitution as also of the principle that “ in regard to some of the major revenue yielding taxes and certain other taxes where a country wide uniformity of rates is desirable, the best authority for legislating and in most case also of collecting is the union Govt.”(Para 10 of the report of the Fourth Finance Commission)

While Fifth Finance Commission noted that “ a large transfer means a greater dent on the funds of the Govt.Of India who have to provide for the compulsive requirements of the national defense, situation of national emergency and the imperative overall needs of planning” it recognized that “ the pre emptive character of the financial needs of the Union constitutes a limiting factor in formulating the scheme of transfers to the states” and that” it is the task of the Finance Commission to strike a dynamic balance between the competing claims of the two layers of Govts and to allocate the available resources between them so as to serve the needs of country’s welfare and development as whole. In the case of both, existing levels of taxation and expenditure are not adequately indicative of their potential resources and reasonable requirements. It is these factors that the Commission has to take into account in making the recommendations”

The Sixth Finance Commission struck a healthy and wholesome note, by drawing attention to the remarkable resilience of Indian federal fiscal system in coping with new demands made on to it from time to time. Clarifying that “its observations should not be construed as implying that the present matrix of financial relations between the Centre and the States does not admit of improvement or signification, the Sixth Section-II 153

Commission stressed the adequacy of financial provisions in the Constitutions in reconciling conflicts of interests between the Union and the Constituent units.

It attributed the signs of dissatisfaction discernible in the actual conduct of financial affairs between the Centre and the States,” to the stresses and strains which the national economy as a whole, has had to face in the recent years and to spirit in which the provisions of the Constitution have been worked. After reviewing the trend in the resources transferred through various alternative routes between 1951-1974, totaling Rs.31866 crores (Finance Commission Award Rs.10053, crores Planning Commission Recommendations Rs11,109 crores and other transfers ,Rs.10,704 crores), the Sixth Finance Commission remarked that the rising trend could be interpreted as “ an indication of the increasing dependence of the States on the Centre and therefore of an unhealthy development in our federal polity” as also as of the fact,’ that’ despite the centralization of resources inherent in a growing economy, the Centre has responded to the expanding needs of the States and thereby ensured the use of national resources in a decentralized fashion.”

If the Sixth Finance Commission’s diagnosis of the reasons for discontent among the States, despite the rise in the flow of funds to them from Centre was a welcome departure from the usual sniping, even more wholesome was its observation that “it is misleading to speak in terms of redistribution of resources between the Centre and the States. It will be more appropriate to view the problem as one of the distribution of resources as between the subjects coming constitutionally within the constitutionally within the competence of the Centre and those coming within the purview of the States.” Sixth Finance Commissions referred to the gains of the country from the maintenance of a vast unified market within which there if free movement of goods and men (Para 3) and observed that “in the sphere of planning there is a growing realization that the Central and State Plans reinforce each other and together sub serve certain widely shared economic and social objectives”. This has enormous relevance to the current decade in which on the one hand, the Indian economy is getting integrated with the global economy and drawn, irreversibly into a world of competitive economies, and on the other the emergence of regional political parties with focus on the local issues at the cost of national ones pose the need for reassertion of economic interdependence of the States and for refocusing attention on the strengthening of national efforts.

An important change in approach came with the Seventh Finance Commission. While the earlier Finance Commission paid more attention to the examination in detail of the claims of the States than of the needs of the centre, the Seventh Finance Commission was the first to make a departure and make a detailed examination of the Centre ‘s resources by reassessing “the resources forecast made by the Centre in the light of the long term and recent revenues growth trends, elasticities of the revenues of different taxes with respect to Net National Product as well as the N.N.P originating in non- agricultural sector and the manufacturing sector as appropriate, and changes in the tax structure in recent years) (Page. 44 of the Seventh Finance Commission Report 1978) Assuming rates of growth higher than those indicated by the Central Government, the Section-II 154

Commission assessed that the total revenue receipts of the Centre during the five years between 1979 and 1984 would be Rs 80126 crores and after examination of the Expenditure items, and returns form the Central public enterprises, it concluded that there would be an overall improvement of Rs4626 crores over the resources forecast by the Central Government .One member Dr Raj Krishna came up with an higher figure –Rs 6000 crores.Evaluating the Seventh Finance Commission’s Award Dr Bhabatosh Datta ( a member of the Fourth Finance Commission) called this ‘a commendable innovation’ and commented that “the Seventh Commission has for the first time, after the first two Commissions, devoted full chapter. Details of the Central Govt’s own forecast of its revenues and expenditures have not however been given and its difficult therefore to evaluate the depth of the Commission’s exercise (EPW Jan 13,1979)

The Eighth Finance Commission felt that,” in the discharge of its functions, the Finance Commission has to perform a balancing exercise almost at every turn’ and observed that “ the crux of the problem is that the resources are limited and the need of the states are enormous” and that at the same time Finance Commission “has to have regard to the needs of the Centre which has many responsibilities. The over riding consideration which has guided this Commission is the national interest taken as a whole. Ultimately the solutions we have chosen has been judged on this touchstone.”

The Eighth Finance Commission indicated that in the Memoranda sent by the States, “ The extent of the share demanded by the states from the Centres’Revenue varies from 40% to 75% ” and stated that “ in this connection the demands on the Center’s resources also need to be remembered. The expenditure on defense, subsidies on food and fertilizers and interest payments is in the present circumstances inescapable. These items alone absorb nearly half the Centre’s revenues. Out of what remains with the centre about 37% is at present being transferred to the states largely on the recommendations of the Finance Commission and the Planning Commission”

Commenting on the award of the Eighth Finance Commission, Dr.D.T.Lakdawala (a member of the Fifth Finance Commission and later Dy.Chairman Planning Commission) observed, “the State Govts have often claimed that while their Revenue Expenditure forecasts were subjected to a great degree of scrutiny and even reassessed to determine the need for tax devolution and grants, the forecasts of the Central Govts were not treated with the same rigour to ascertain its capacity to pay. The Seventh Finance Commission for the first time devoted a chapter to the subject but fell short of the demand for equal treatment of the two major parties as it did not give parallel details for the centre in the Appendices. The Eighth Finance Commission has taken this further step and silenced the complaint of formal favoured treatment of the Centre” (EPW Sept 1 1964)

The Ninth Finance Commission was required by the Terms of reference “ to adopt a normative approach to assessing the receipts and expenditure on the revenue account of the states and the centre and in doing so, keep in view the special problems of each state if any, and the special requirements of the Centre such as Defence, Security, Debt Servicing and other Committed expenditure and liabilities” The Ninth Finance Commission considered the relative levels of revenue raised by the centre and the states in the light of the Constitutional division of tax power and observed that, “the major Section-II 155

productive source of revenue have been assigned to the Centre. Hence the Central Government has the responsibility of raising the major part of tax revenues”. It found that the Centre has been raising 66 to 67% of the combined tax revenues of the Centre and the States with the total tax revenue/GDP ratio being near 17.5% It observed that “while there is no way of definitively determining whether the magnitude of the relative share of taxes raised indicates an adequate relative use of tax powers, it is seen that the Centre is raising much the larger part of tax revenues” In its assessments of the Centre’s resources and expenditure, the Ninth Finance Commission assumed a price rise of 6% and a GDP growth rate of 6%. Aiming at the closing of the revenue deficits of both Centre and states by the end of Eighth Five Year Plan, it assumed that the rise in the Non Plan expenditure should be less than the rate of growth in GDP ( at the rate of 9% to 10% per year in nominal terms. Centre had indicated a growth of 14 to 16% in Non Plan revenue expenditure. As regards revenue forecast, while the centre assumed a growth rate of 10% for tax revenues, the Ninth Finance Commission assumed 12.8% and the dividends from the Central PSUs were assumed at normal rate of return of 6%. As a result of its labours, the Ninth Finance Commission revised the available surplus from the Centre’s forecast of Rs 46,394 crores to Rs 149271 crores for the period of 1990-95.the step up was Rs 102879 crores

The Tenth Finance Commission received for its consideration two forecasts made by the Ministry of Finance, first in July 1993 and then a revised one in May 1994 but found it difficult to accept the projections “as the assumptions underlying the forecasts are unsustainable” It examined the pre devolution revenue accounts on both revenue and expenditure by comparing the projected behaviour of major fiscal and budgetary variables for 1995-2000 with their observed pattern between 1980-85,1985-90 and 1990-95. After taking into account, “the historical patterns of the revenue mobilisation and expenditure behaviour, current trends and recent changes in the macro-policy framework, and blending them with prescriptive or normative consideration as appropriate” and stipulating buoyancy coefficients for major taxes, the Tenth Finance Commission revised the Ministry’s forecast for revenue receipts for 1995-2000 from Rs 834400 crores to Rs 925040 crores and Non Plan Revenue expenditure forecast from Rs 718603 crores to Rs 656640 crores.(See Table : 1.1) The combined effect of increasing revenue receipts by Rs 90640 crores and reducing expenditure by Rs 61963 crores, was an increase in the available surplus by Rs.152603 crores from the Ministry’s Projection of Rs 115797 crores to be estimated Rs.268400 crores.

Table 1.1 : Tenth Finance Commissions reassessment

Ministry's Forecast Reassessment Absolute % of GDP Absolute % of GDP

I.Revenue Receipts 834400 13.28 925040 14.31a.Tax Revenue 644553 10.26 70411 10.94

i.Income Tax 82326 1.31 85239 1.32ii.Corporation Tax 94043 1.5 100115 1.55

Section-II 156

iii.Union Excise Duty 292773 4.66 303710 4.7iv.Customs 162012 2.58 198198 3.07v.Other Tax Revenue 13399 0.21 20149 0.31

b.Non Tax Revenue 189847 3.02 217629 3.37I.Interest Receipts 115937 1.85 115934 1.79ii.Dividends 15363 0.24 29249 0.45iii.Other Non Tax Revenue 58547 0.93 72446 1.2

II.Non Plan Revenue Expenditure 718603 11.44 656640 10.16a.Interest Payments 368000 5.86 348138 5.38b.Defence Expenditure 111773 1.78 115063 1.78c.Other Non-Plan Revenue Expenditure 238830 3.8 193439 2.99

III.Non Plan Revenue Surplus 115797 1.84 268400 4.15

Eleventh Finance Commission’s Reassessment

In its assessment of Centre’s resources for transfer to the States Eleventh Finance Commission took into account, as required by the Terms of reference, the Centre’s own needs especially relating to expenditure on Civil Administration, Defence and Border Security, Debt Servicing and other committed expenditure or liabilities as also the need to restructure public finances for restoring budgetary balance.

The Central Government in its Memorandum to the Eleventh Finance Commission had requested that the Commission should not view the States’ share of Central taxes and Article 275 grants in isolation but to calibrate these transfers taking into account the overall resource transfers form the Centre to the States and had argued that such a holistic view was necessary to bring about the restructuring of the public finances. Expressing its agreement in principle with this view, Eleventh Finance Commission decided to indicate the extent of potential fiscal transfer, comprising all transfers to the States on revenue account in relation to the aggregate revenue receipts of the Centre. The Commission took note of the Centre’s plea that “continuing high level of transfer of resources to the states is one of the main reasons for the high fiscal deficit of the Centre,” that a substantial portion of discretionary transfers to the states is nothing but the Centre’s budgetary intermediation of debt for the states and that persistent and large fiscal deficits have greatly constrained the Centre’s capacity to pursue counter cyclical policy

The EFCs approach was to make an initial assessment for determining the base year figures and then to make estimates for the five-year period 2000-01 to 2004-05 on the basis of norms adopted by it. Its assessment was based on a macro economic scenario it constructed for the period 2000-01 to 2004-05 with certain assumptions regarding growth rate and other fiscal variables as indicated in Table 1.2

Table 1.21999-00 2000-01 to 2004-05

Growth rate of GDP

% per annum 5.9 7.0 to 7.5

Section-II 157

Inflation rate % per Annum 3.5 5.5 to 5.0Current Account deficit

% of GDP -1.5 -1.5

Revenue Deficit % of GDP 6.76 1Fiscal Deficit % of GDP 9.83 6.5Tax Revenue % of GDP 14.0 16.7Non Tax Revenue % of GDP 2.48 3.2Capital Expenditure % of GDP 4.17 6.6

In its estimate of revenue receipts, the Centre, the Eleventh Finance Commission took into account :-(a) Centre’s forecast of tax receipts and non tax receipts for 2000-05, made with assumptions of growth of 20% in Income Tax and Corporation Tax, 10% in Customs and 11% in Excise Revenues on rather optimistic terms so as to reach Tax GDP Ratio of 10% in 2004-05.Eleventh Finance Commission felt that there is need for further improvement and that the attempt should be to reach the Tax GDP ratio already achieved in 1987-88 and 1990-91(b)Eleventh Finance Commission went along with Budget estimates for 2000-01 for all items except corporation Tax which was revised downwards and made estimates for the subsequent four years by applying growth rates computed on the basis of buoyancy norms it had worked out. The growth rates assumed are shown in Table :1.3

Table :1.3 Growth Rates of Taxes (EFC) Buoyancy based Historical Corporation Tax 19.5 20.6Income Tax 18.85 18.74Customs 14.3 10.93Excise Duties 15.6 10.9

Buoyancy rates for each tax was worked out on the basis of (a)assumed nominal rate of growth of GDP (13% per annum)(b) Past growth rates for each tax for the period 1987-88 to 1999-00 (c) additional resource mobilization measure contemplated in Budget 2000-01 and (d) the need to raise by 2004-05 tax GDP ratio by 1.5% over the Gross Revenue / GDP ratio of 8.8% achieved in 1999-00.Eleventh Finance Commission assumes a small increase 0.25% of GDP for non tax revenue over 5 years though the Centre’s forecast projected a decline in terms of ratio to GDP.

In its projections for revenue expenditure, the Commission followed different rules for different items of expenditure and explains the basis for its assumptions and the comparison with the Centre’s forecast.Table 1.4 Growth Rates for Expenditure forecasts Centre's Forecast XI FC'sNominal GDP 14% 13%Salary Exp - 5% Interest Payment 16% 10Subsidies 16% 0

Section-II 158

Defence Exp 15% 10%Grants To States 15% -Other Non Plan Exp 14% 10Pensions 10

Eleventh Finance Commission indicated that “the main difference between the forecast of Ministry of Finance and its own assessment lies in the fact that we are envisaging a greater revenue effort and a marginal decline in the non plan revenue expenditure.” Translated into numbers, the profile of Central Finances presented by the Eleventh Finance Commission’s forecasts showed differences from the Finance Ministry’s forecasts in respect of Gross Revenue Receipts, Total Revenue expenditure and the revenue deficit. These are presented in the Table: 1.5

Table 1.5 Profile of Central Finances - EFC (Rs.Crores)

2000-01 2001-02 2002-03 2003-04 2004-05

Gross Rev Receipts 255690 298162 347684 405432 472780[-7158] [-5779] [-3877] [-1305] 2114

Gross Tax Rev 198226 230961 269185 313833 366002Net Tax Rev 144166 167935 195690 228109 265988Non Plan Rev Exp 228768 248788 2707818 294732 321018Plan Revenue Exp 50287 58133 66840 76528 87340Total Revenue Exp 279055 306921 337558 371260 408358

[-4133] [-17852] [-25144] [-46688] [-73723]Revenue Deficit 77425 71785 63369 51552 35593 [-4131] [-25228] [-41561] [-74098] [-113952]Note: Figures in brackets indicate the difference between the forecasts of Finance Ministry and the Finance Commission. Source : Eleventh Finance Commission

Examination of FCs forecasts

A review of the trends in the realization of revenue receipts, and

actual expenditure set against the forecasts made by the Finance

Ministry and the re assessment made by the Finance Commissions

show that there are significant deviations. For one thing it is

noticed that after the Finance Commissions began their

reassessment of Centre’s forecasts of resources and expenditure

and made their own forecasts of revenue and expenditure and the Section-II 159

surplus available with the Centre, the total transfers to the states

have shown a steeper increase, in comparison with the incremental

growth in the awards of the previous Commissions.

Table

1.6

Total Transfer

(Rs.Crores)

Differen

ce over

previous

FC

%

increase

VI FC 9608

VII FC 20842 11234 116.92

VIII FC 39452 18610 89.29

IX FC 106036 66584 168.77

X FC 226643 120607 113.74

XI FC 434905 208262 91.89

The increasing draft on centers resources on account of these

transfers need to be closely examined even though the states have

been arguing that the total resource transfers from centre to the

states have been declining whether viewed in terms of their ratio to

center’s gross revenues or to states’ aggregate expenditure.

The forecast made by Tenth Finance Commission differed from the forecasts in the Memorandum submitted by the Ministry in respect of revenue receipts, revenue expenditure and the surplus likely to be available with the Centre as shown in Table 1.7 . and 1.8. The actuals for the five year period 1995-2000, when totaled indicate that there

Section-II 160

were not only year-wise differences in all the three parameters but also in the aggregate draft on the Centre.

Table : 1.7 Revenue Receipts of Centre –Actuals (Rs.crores)

Revenue Receipts Tax Revenue

Non Tax Revenue

Gross Transfer Net 1995-96 110130 111224 29285 81939 281911996-97 126279 128762 35061 93701 325781997-98 133901 139221 43548 95672 382291998-99 149485 143797 39145 104652 448331999-00 181513 171752 43481 128271 53242 Total 95-2000 701308 694756 190520 504235 197073

Table 1.8 : TFCs Forecasts and Actuals 1995-2000

Ministry’s Forecasts

TFC's Estimate Difference Actuals Difference with

Gross Ministry FCa.Tax Revenue 644553 707411 +62858 694756 +50203 -2655b.Non Tax Rev 189847 217629 +278882 197073 +7226 -20556A.Revenue Receipts (a+b) 834400 925040 +90640 891829 +57429 -23211B.Non Plan Rev Exp 718603 656640 -61963 762522 -43919 +105882C. Non Plan Rev Surplus. 115797 268400 +152603 129307 +13150 +139093

It will be seen that the forecasts of both tax and non tax

revenues made by Finance Ministry and the Tenth Finance

Commissions are off the mark when judged in relation to the

actuals and that the Finance Commission’s forecast are much

higher in respect of revenue items and much lower in respect of

non plan revenue expenditure. The actuals of Non Plan revenue

expenditure 1995-2000 are higher than the Central Government’s

Section-II 161

forecast by Rs 43919 crores and far higher than the Tenth Finance

Commission’s estimate by Rs 105882 crores. With the Tenth

Finance Commission’s estimates differing from the Finance

Ministry’s forecasts on both the revenue and the expenditure side,

the non plan revenue surplus shows a huge difference of

Rs.152603 between the Govt’s forecast of Rs 115797 crores and

Tenth Finance Commission’s estimate of Rs.268400 crores. It can

be presumed that the Tenth Finance Commission’s decision to

more than double the quantum of resource transfer from Centre to

the States could have been routed in the over estimation of

Centre’s resources and under estimation of its commitments.

Much the same story is repeated when we examine the Eleventh Finance Commission’s reassessed forecast of revenue and expenditure with the actuals for 2000-01 and 2001-02.While the Finance Commissions forecast indicate an increase of tax revenue in 2001-02 over 2000-01 there is actually a decrease as shown below. (Table 1.9).

Table 1.9 (a) :EFC Forecasts and Actuals (Rs. in Crores)Gross Tax Revenue

2000- 01 2001- 02 2002- 03 2003- 04 2003-04

(AC) 2004- 05 XI FC Estimate 198226 230961 289185 313833 366002Actuals 188603 187060 216266 *254923 **317733Difference +9623 +43901 +72919 +58910 48269* RE ** BE

Table 1.9 (b) :EFC Forecasts and Actuals (Rs. in Crores)Net Tax Revenue

2000-01 2001-02 2002-03 2003-04 2003-04

(AC) 2004- 05

Section-II 162

XI FC Estimate 144166 167935 195690 228109 265988Actuals 136916 133662 159425 *187539 **233906Difference +7250 +34293 +36265 +40570 32082

Table 1.9 (c) :EFC Forecasts and Actuals (Rs. in Crores)Non plan Rev-Exp

2000-01 2000-01 2002-03 2003-04 2003-04

(AC) 2004- 05 XI FC Estimate 228768 228768 270818 294732 321018Actuals 242293 242293 268074 *284081 **293650Difference -13525 -13525 + 2744 + 10651 27368

* RE ** BE

While a detailed review of the forecast in revenue is outside

the scope of this study, it is necessary for us to take note of the fact

that the Finance Commissions forecasts, made on the basis of

certain norms, show significant deviations from the Finance

Ministry’s forecasts and that both the forecasts, are belied by the

actuals. This also calls for a close examination of the

methodologies adopted by the Finance Ministry and the Finance

Commission.

Choice of Methodology.Sophisticated methodologies and tools of analysis do help in processing of

information and computation of analytical results, but the usefulness of the exercise depends on the nature of assumptions and choice of methodology. As the implications of Finance Commission’s estimate for the budgetary balances of the Centre and the States are serious, there is need for exercise of an element of care in applying proper methodology for making the revenue forecasts for the period 2005-06 to 2009-10.

It may be mentioned that the Eighth Finance Commission had sponsored in 1984, a study by NIPFP whose ``basic thrust was on developing methodologies to project government tax revenues and non-plan revenue expenditure on a scientific basis`.`This study carried out by Dr.V.G Rao had subjected the forecasts of the state governments and the Finance Commissions during the Award periods of the Sixth and Seventh Finance Commissions to rigorous statistical tests and Examined the methodologies adopted by Section-II 163

them It pointed out the problem of under estimation of receipts and expenditure and opined that “these can not be explained in terms of or attributed to the base years choice” and concluded that ``a comparison of the forecasts adopted by the last three commissions and those supplied to the commissions by the state with their net (adjusted) realizations of the receipts and expenditures reveal that the realizations deviate from both sets of forecasts by margins which cannot be explained as the resultant of the operation of random forces’’. (See P.2. of Revenue and Expenditure Projections, Evaluation and Methodology Dr. V.G.Rao, revised and edited by Dr. Atul Sharma, Vikas Publishing House, Delhi. 1992)

The study also observed that (i) adoption of unadjusted long term growth rates observed for different items of revenue for different states would have reduced the deviations between realization and Commission’s forecasts. (ii) uniform growth rates for all expenditures across all states do not provide a good basis for forecasting the expenditures of individual state (iii) the use of nominal income elasticity in place of simple time growth rates helps in reducing the deviations of the forecasts from the realizations in respect of both receipts and expenditure and (iv) the decompositions of nominal income elasticity into real income and price elasticity helps in reducing the extent of deviation.

While the study was commissioned by the Eighth Finance Commission in 1984 and was completed in that year itself, it was published only in 1992 Publishing this study carried out by Dr. V.G.Rao, Dr. Amaresh Bagchi, Director NIPFP and later Member, Eleventh Finance Commissions had indicated that ``the methodologies suggested for the estimates provide useful guidelines as also benchmark estimates for possible use by future Finance Commissions, the states and also researchers in quantitative public economics.’’ It is difficult to say as to what extent, the suggestions on methodologies were taken into consideration by the Ninth, Tenth and Eleventh Finance Commissions. The Tenth Finance Commission found that the forecasts made by the state were not strictly comparable as the base year, basis of projections assumptions regarding inflation, treatment of committed liability of past plan schemes all varied. It commissioned a study on the Tax potential of the states by the Institute of Social and Economic Change, Bangalore. It did not however accept the recommendations of the study after giving due consideration to the issues raised, and preferred to carry out an in-house exercise with a regression based approach.

For forecasting the resources of the centre the Tenth Finance Commission carried

out an exercise to carefully arrive at the base year, and made projections for the award

Section-II 164

period on the basis of trend growth rates for a ten-year period. While it felt that there

were limitations in making forecasts based on buoyancy rates, it used the information on

buoyancy coefficients for forming its own judgement. The approach of the Eleventh

Finance Commission has been described by some analysts as quasi normative in view of

its attempt to bring in, normative elements in the assessment of both expenditure and

revenues, with out carrying it to the logical end. EFCs assessments for the five-year

period from 2000-01 to 2004-05 involved normative determination of the base year on

projections for the award period on the basis of growth norms. It made certain

adjustments in arriving at the base year magnitudes and did not depart too far from the

historical magnitudes of the base year, as a consequence EFCs projections are considered

by some experts as a compromise between norms and fiscal history.

What appears significant is that the forecasts by the later commissions, as indicated earlier also show significant deviations from the realizations and that these deviations can hurt both the Centre and the States who are already fighting a difficult battle in balancing Revenue and Expenditure. The Twelfth Finance Commission may need to specifically address this crucial issue and may decide, as appropriately as it can, whether the deviations observed between the forecasts and the actual realizations could be attributed to the quality of data in fiscal matters available in the country, or the choice of methodology for forecasts adopted by the state government and the Finance Commissions or to a combination of these two.

In a way, the Twelfth Finance Commission is eminently qualified to resolve the issue, as its chairman, Dr.C.Rangarajan has also been the Chairman, National Statistical Commission, set up by the Govt. of India to critically examine the deficiencies in our present statistical system and possible solution to correct them. Dr.Rangarajan had highlighted the critical issues before the Indian Statistical System in his address delivered at the conference of Central and State statistical organizations held on 23rd and 24th

October, 2000. (See Asian Economic Review Vol.42, No.3, Dec.2000.p.179 for the text of address). The need is urgent for, as commented editorially in the Economic and Political Weekly, Vol XXXVIII No.20, May 17.23, 2003)’’ there are problems of adequacy, reliability and transparency in Budgetary Data. “EPW has commented that,’’ the way the state budgets are framed and presented in the budget documents makes it very difficult to assess their fiscal health. For one thing, seen against the actuals and the

Section-II 165

revised estimates, budget estimates often turn out to have been way off the mark, raising questions about the integrity of the budget… while many of the deficiencies inhere in the Centre’s budget as well, non transparency in the case of state budgets seems to be more acute.”

Section-II 166

B. Resources of the Centre

Since the Twelfth Finance Commission has been assigned the task of assessment of the resources of the Central Government for five years commencing on 1st April 2005, on the basis of levels of Taxation and non-tax revenue likely to be reached by the end of 2003-04. One may highlight the important factors that deserve its attention while it makes its assessment of the resources of the Center for the period 2005 – 2010.

Secular Decline in Buoyancy

First as noted by the Eleventh Finance Commission the buoyancy of the tax revenues of both the Centre and the states which had been declining in the eighties as compared to earlier two decades, went down further in the nineties as shown in table:1.10.

Table : 1.10 Buoyancy Rates of Taxes –of Centre and States (Rs. in Crores)

DecadeCentre’s Gross Revenue

State’s Own Revenue

Total Tax Revenue (Combined)

1950-51 to 59-60 1.38 1.39 1.381960-61 to 69-70 1.15 1.17 1.161970-71 to 79-80 1.27 1.35 1.301980-81 to 89-90 1.15 1.12 1.141990-91 to 98-99 0.91 1.04 0.96Source : Eleventh Finance Commission

The Eleventh Finance Commission has also drawn attention to the fact that during the 1990’s Non Tax revenue as a proportion to the GDP increased in the Centre but declined in the case of the states and that “on the whole, non tax revenue growth has practically stagnated at both levels of government during the nineties.

Tax GDP Ratio

Specific attention should be drawn to the long-term erosion of Tax-GDP ratio since 1990-91 as shown below :-

Center, States combined CenterYear Direct Indirect Total Direct Indirect Total 1950-51 2.47 4.23 6.69 1.86 2.46 4.321960-61 2.48 5.85 8.33 1.80 3.72 5.521970-71 2.34 8.67 11.01 2.01 5.42 2.431980-81 2.40 2.19 14.59 2.20 7.49 9.69

Section-II 167

1990-91 2.29 14.09 16.38 2.06 8.69 10.752000-01 14.5 3.25 5.72 8.97

The Tax GDP ratio for Centre & States together, which showed a steady upward between 1960-61 to 1987-88, rising from 7.86 to 16.68, started to decline in the nineties, falling to 13.4% in 1998-99 before recovering to 14.2% in 1999-2000 and 14.5% in 2000-01. In respect of Central Government, Tax GDP Ratio moved up from 4.32 in 1950-51 to 10.75 in 1990-91 before declining to 8.97 in 2000-01.

Further, tax reform measures initiated by the Central Government have, while simplifying the system and seeking to rationalize the structure, appeared to have dampened the revenue growth. Between 1990-91and 2000-01,the Tax GDP ratio fell from 10.11 to 8.96 for gross tax revenue and from 7.56 to 6.49 for net tax revenue. While the declared objectives has been simplification to ensure better compliance, it is doubtful whether this has been achieved even while the impact on revenues has been found to be adverse. As the RBI report on Currency and Finance 2002 has observed ``tax reforms have generally led to a rise in tax revenue to GDP ratio across countries. In the Indian context, the expected increase in tax buoyancy a la ‘Laffer Curve Effect’ did not occur. Since the onset of tax reforms, the tax-GDP ratio of the central government has suffered a persistent decline - from 9.9% during the 1980’s to 9.7% in the first half of the 1990’s and further to 9.0% in the second half of the 90’s. The pattern is not the same across different types of tax as shown in Table :1.11

Table 1.11 :Tax GDP RatioFirst half Second half

1980's of 1990's of 1990'sTotal 9.9 9.7 9.0Direct 2.0 2.3 2.9

Indirect 7.9 7.4 6.1

Recent Trends in Revenue The recent trends in the receipt of the Center as percentage of GDP at current

market prices are shown in the Table 1.12.Table 1.12 :Trends in Receipts of Centre as % of GDP(CMP)

1970-71 1980-81 1990-91 2000-01 2003-04BEA) Gross Tax Revenue (I) Direct 1.92 2.02 1.94 3.25 3.49(ii) Indirect 5.1 7.12 8.17 5.72 5.68(iii) Total 7.02 9.15 10.11 8.97 9.17States Share (1.65) (2.64) (2.55) (2.48) (2.46)B) Tax Revenue net to Centre 5.37 6.51 7.56 6.49 6.71C) Non Tax Revenue 1.84 2.1 2.11 2.66 2.54

Section-II 168

D) Revenue Recepits 7.21 8.61 9.66 9.15 9.26Net of shared taxes E) Capital Receipts 4.48 5.51 6.86 6.38 6.74F) Total Receipts 11.69 14.12 16.52 15.53 16Total Receipts (Rs crores) 5339 20291 93951 325611 438795

It must be noted that the tax reform measures, particularly those relating to

widening of the tax base have been very successful. The steady claim of the number of

income tax payers from 49.30 lakhs in 1983-84 to 70.27 lakhs in 1989-90 and further to

86.39 lakhs in 1992-93 was noteworthy. There was a fall to 77.41 lakhs in 1993-94.

However with the introduction of the 6 economic criteria for submission of tax returns

has made significant difference. The number of returns (different from the number of tax

payers) which had increased from 35.25 lakhs in 1990-91 to 48.74 lakhs in 1993-94,

leaped forward to reach 142.42 lakhs in 1999-2000. The income returned had also shown

increase from Rs. 15,489 crores in 1990-91 to Rs. 28,993 crores in 19993-94 and further

to Rs.1,25,659 crores and the tax payable from Rs.2,817 crores in 1990-91 to Rs.5,388

crores in 1993-94 and further to Rs.10,376 crores in 1999-2000.

While improvement in tax GDP ratio in respect of direct taxes is attributed to reform, there are analysts who traced this to the implementation of the recommendations of V Pay Commission and revision of public sector wages. The RBI report however, states that, “the estimate of personal income tax buoyancy does indicate that while there was a positive impact of price hike, it has not been signification at the statistical level.’’ RBI report however states, that “unlike direct taxes, rate cuts have been important factors in reducing the indirect tax collection as there was no commensurate gains in terms of tax base expansion or better compliance.” Slowdown in industrial output, rising share of services in overall GDP, Extension of modvat and non-removal of concessions and exemptions have been cited as factors contributing to the decline in tax –GDP ratio in respect of indirect taxes.

A review of the budgetary figures show that after tax reform exercises of 1992-93 and 1997-98,actual tax revenues fell below budget estimates and the previous year’s actuals .In 1993-94 tax revenue (net) to the Centre fell to Rs.53449 crores (6-22% of the GDP) from the previous years actual of Rs 54044 crores (7.22% of GDP) mainly on

Section-II 169

account of fall in indirect tax revenue in gross terms .In 1998-99 the Direct tax revenue from Gross Terms fell to Rs 46595 from Rs 48274 in the previous year

The Eleventh Finance Commission had in its normative

estimates, projected that between 1999-2000 and 2004-05,the gross

tax revenue as % of GDP will improve from 14.09% to 16.7% for

Centre and States combined, from 8.80% to 1.28% for centre and

from 5.29% to 6.43% for the states. This projection made as part of

an exercise in fiscal restructuring does not appear to take into

account, the decline in buoyancy, the falling GDP ratio and the

more recent trends in central revenues, which has been marked by

non-realization of budget estimates. The Mid Term Appraisal of

the Ninth Five Year Plan by the Planning Commission (October

2000) has pointed out that.(a) Gross tax revenues declined in the period 1994-95 to 1999-2000 compared to the

period 1989-90 to 1991-92, in terms of collection as well as buoyancy in Non-Agricultural GDP.

(b) Gross tax revenue receipts have moved in a narrow band of 9.14% and 9.45% of GDP.

(c) The share of union excise and customs in total tax revenue has been declining during the three years of the ninth plan but still they constitute 71% of gross tax revenue from the major taxes and therefore the declining trend needs to be reversed.

(d) The decline in buoyancy of tax revenue is accounted also by a failure to realize even the budget estimated/ targets especially in the case of union excise & customs.

(e) The negative growth of income tax during 1998-99 and marginal growth of corporate tax in 1997-98 substantially affected revenue receipts during the initial periods of the plan. Incremental growths in per capital revenue collections declined with the higher growths in the number of assesses during 1996-97 and 1997-98. This supports the conclusions that lowering of tax liabilities did not result in improvement in tax compliance among higher income groups. Thus the question of arrears of income tax needs to be addressed in a more concerted manner. In the case of direct taxes in general, enforcement of tax compliance needs more attention. It is seen that the arrears demand as on 1.4.1999 was Rs.41827 crores, with little improvement, at Rs. 44861 crores, a year later. (On 1.4.2000) (Mid term appraisal of Ninth Five-Year Plan. Planning Commission Oct 2000. P.25)

Section-II 170

Another important factor to be taken into account is that the estimates in the recent Union Budgets have been off the mark. Actual central tax revenues, net of states share have been lower than Budget estimates by Rs 4094 crores in 1999-2000 and by Rs. 9293 crores in 2000-01. The Revised Estimates for 2001-02 showed shortfalls from the Budget Estimates to an extent of Rs 29956 crores in gross tax revenue (Rs 11,332 crores in direct taxes and Rs 18623 crores in indirect taxes) and Rs 20683 crores in net terms. Actuals net tax revenue were lower than Budget estimates by Rs.29369 crores, for 2002-03 Centre’s gross tax revenue were indicated at Rs 235800 in the Budget Estimates and Rs.221918 crores in the revised estimate but the actuals were only Rs.216266 crores. Net Tax Revenue to the Centre were shown at Rs.172965 crores (BE) and Rs 164177 crores in RE and the actuals were only Rs.159425 crores. For 2003-04, Gross Tax Revenues were indicated at Rs.251527 crores in the BE and Rs.254923 crores in the RE but the actuals are reported to be only Rs.248825 crores. Net Tax Revenue to Center were shown Rs.184169 crores in the BE and Rs.187539 crores in the RE. A similar fall is reported in the preliminary figures of the Controller of Accounts.

There appears to be a consistent trend in the actuals falling below the Budget Estimate in respect of tax revenue. The implication of this should be studied in the context of predictability as a significant attribute of a robust scheme of central transfers. As Dr. C.Rangarajan observed, “since devolution of taxes is recommended in terms of shares of central taxes, and the absolute amounts often fall short of those estimated by the Finance Commission, a suggestion had been made that a minimum amount under tax devolution should be prescribed. Under the provision of Aritcle 275 only a share of the states in central taxes is determined. This provides for automatic sharing of the central tax buoyancies. However, states have a genuine problem if growth in central taxes falls short of expectations” (Address in the NIPFP Seminar on ‘Issues before the Twelfth Finance Commission’ September 29-30th, 2003). The variations are not only large but fairly regular and can create serious problems of budgetary management at both the centre and the states.

Assessing trends of revenue in terms of the absolutes and in

terms of their proportion to GDP can give different pictures.

Between 1990-91 and 2000-01 while centre’s total receipts show a

decline as a percentage of GDP from 16.52% to 15.53%, there is a

substantial increase in absolute terms from Rs.93951 crores to

Rs.325611crores and Rs.362453 crores-2001-02. The picture of

2002-03 shown in table 1.13 (a) indicate an increase in actual

receipts over the previous year though the Budget & Revised Section-II 171

Estimates of Rs.410309 crores and Rs.404013 crores respectively

were not fulfilled.

Table 1.13 (a) Centre’s Receipts(Rs. In Crores)

2000-01 2001-02 2002-03 Actual Actual BE RE ACA) Total Receipts 325611 362453 410309 404013 400396 (15.5) (15.8) (16.7) (16.5) (16.2)B) Revenue Receipts 192624 201449 245105 236936 231748 (9.2) (8.8) (10.0) (9.7) (9.4) Net Tax Rev 136916 133662 172965 164177 159425 (6.5) (5.8) (7.1) (6.7) (6.5) Non Tax Rev 55708 67787 72140 72759 72323 (2.6) (3.0) (2.9) (3.0) (2.9)C) Capital Receipts 132987 161004 165204 167077 168648 (6.3) (7.0) (6.7) (6.8) (6.8)(i) Loans Recovery 12046 16403 17680 18251 34191 (0.6) (0.7) (0.7) (0.7) (1.3)

(ii)Disinvestment of PSE Equity 2125 3646 12000 3360 3151

(0.1) (0.2) (0.5) (0.1)(iii) Borrowings &

other Liabilities 118816 140955 135524 145466 131306

(5.6) (6.1) (5.5) (5.9)Source : GOI. Budget DocumentsFigures in Brackets % of GDP

The Revenues of 2003-04

The Twelfth Finance Commission has been mandated to have

regard to resources of the centre on the basis of levels of taxation

and non-tax revenues likely to be reached at the end of 2003-04.

The Union Budget for 2003-04 placed total receipts at Rs.438795

crores (16.0% of GDP). But the revised estimates were Rs. 474255

crores, with revenue receipts higher by Rs. 10,000 crores and Section-II 172

capital receipts by more than Rs. 27,000 crores mainly on account

of recovery of loans higher by nearly Rs. 46,200 crores. The

borrowings were shown at a lower level (See table 1.13(b)). Tax

gross tax revenues is reported to have increased by Rs. 3396 crores

from Rs. 251527 crores in the B.E to Rs. 254923 crores However,

the provisional data on actuals for 2003-04 places gross tax

collection at Rs. 248825 crores lower than both BE and RE.

Despite successive years of actual collection falling below BE and

RE the 2004-05 Budget places gross tax collections at Rs. 300323

crores and net tax revenue at Rs. 220132 crores, marking increases

of Rs. 48796 crores and Rs. 35963 crores respectively over 2003-

04 (BE). What is significant is that the RE of 2003-04 marked

13.50% increase of the actuals of 2002-03 and the budget for 2004-

05 assumes 24.72 % increase in net tax revenue over the revised

estimates of 2003-04. The variations between Budget Estimates

and Actuals is shown in table 1.14(Rs. In Crores)

Table 1.13 (b) Centre’s Receipts 2003-04 2003-04 2003-04 2004-05 2004-05

BE RE AC Interim RegularA) Total Receipts 438795 474255 457434 477829 (16.1) (17.2)B) Revenue Receipts 253935 263027 290882 309322 (9.3) (9.5) (9.4) Net Tax Rev 184169 187539 220132 233906 (6.7) (6.8) (7.1) Non Tax Rev 69766 75488 70750 75416 (2.6) (2.7) (2.3)C) Capital Receipts 184860 211228 166552 168507Section-II 173

(6.8) (7.7)(i) Loans Recovery 18023 64625 14100 27100 (0.7)(ii) Disinvestment 13200 14500 16000 4000(iii) Borrowings &

other Liabilities 153637 132103 136452 137407

(5.6)Source : GOI. Budget Documents, Figures in Brackets % of GDP

Table 1.14 Tax Revenue Receipts of the Centre Tax Non-Tax Total2000-01 BE 146209 57464 203673 RE 144403 61763 206166 Actual 136916 55708 1926242001-02 BE 163031 68714 231745 RE 142348 70224 212572 Actual 133662 67787 2014492002-03 BE 172965 72140 245105 RE 164177 72759 236936 Actual 159425 72323 231748 2003-04 BE 184169 69766 253935

RE 187539 75488 2630272004-05 BE 233906 75416 309322

One finds it difficult to accept the estimates for 2004-05 which plays the gross tax revenue at Rs.317733 crores, which after deducting states share of Rs.82227 crores will yield net tax revenue of Rs.233906 crores and non-tax revenue of Rs. 75416. The break up of major items are as follows :-

Taxes on 2002-03 (AC) 2003-04(BE) 2003-04(RE) 2004-05(BE)IncomeIncome Tax Corporation

829283685846172

955694407051499

1032554026962986

1258554630979546

Property 152 145 145 145CommoditiesCustomsExcise dutyService tax

13261244852823094122

15525649350967918000

15092949350923798300

1736995300010719913500

Taxes of UT 573 557 594 624Gross tax revenue 216266 251527 254922 300323

State’s share 56122 63757 65784 78591Net tax revenue 160144 187769 189138 221731Section-II 174

Non tax revenue 72323 69766 75488 75416Capital receipts 182414 184860 211228 168507Total receipts 414162 438795 474255 477829

Analyzing the estimate of receipts presented for 2004-05, setting it against the actuals of 2002-03 and BE & RE of 2003-04 one notices that compared to 2003-04 corporation taxes are estimated to increase by 41% and income tax by 27% and excise duties by 18%. Even granting an inflation rate of 5% and growth in nominal GDP of 12%, these estimates appear to be of a very high order. These estimates imply that the states share of central taxes will increase from the actuals Rs. 56122 crores in 2002-03 to Rs.65784 crores in 2003-04 and an increase of Rs.9662 crores and further to Rs. 78591 crores in 2004-05, marking an increase of Rs. 12807 crores. While the interim budget estimates were themselves considered very optimistic, the further increases in the regular budget appears to be some what over optimistic.

In macro terms the ratio of gross tax revenue to GDP is expected to increase from 8.23 in 2001-02, 8.80 in 2002-03, 9.26 in 2003-04 to further 10.17 in 2004-05. Whether such an increase can materialize only on the expectations of buoyancy without upward revision of tax rates is a moot point. The facile assumption that collection of arrears and imposition of 2% cess on direct taxes and 0.15% of turn over tax will lead to this increase, may not be borne out in practice. Given the long term trend in tax buoyancy, and fluctuations in GDP growth. One can argue that the revised estimates of 2003-04 and the budget estimates of 2004-05, may not be a dependable base for the Finance Commission to estimate, in realistic terms the resources likely to be available to the Central Government during its award period.

Need for careful Review of Tax Reforms Strategy

The successive years of lower tax realizations as compared to budget estimates presented along with announcements of simplifications and lower rates, to encourage better compliance, makes one wonder whether it is not time for taking stock of the Tax Reforms of the Nineties, commencing from the recommendation of Tax Reforms Committee of 1991 to the recent exercises of the Task Force on Direct Taxes and Indirect Taxes 2002, both setup by Ministry of Finance, as also of the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan set up by the Planning Commission and the tax related recommendations of the Expert Committee to Review the systems of Administered Interest Rates set up by the Reserve Bank of India (2001).

While the first two advocated simplification and rationalization of tax structure,

both direct and indirect tax, and moderation of and reductions in the number of tax slabs

and rates, there has been a persistent recommendation of most of these committees to

Section-II 175

delete a member of tax exemptions and deductions. Though the Govt. of India did not

readily accept all the recommendations of these committees, and groups of experts, there

has been more than a seachange in tax administration, marked by lowering of rates and

simplification of procedures the changes are significant, viewed in the long-term

perspective, and these include:

(i) Reduction in personal Income Tax from 60% in 1980-81 to 30% and surcharge of 10% in 2003-04. (ii)Expansion of tax base with adoption of six economic criteria for submission of tax return for Residents in Urban Areas and Taxation of Services. (iii)Reduction in the level of Corporate Tax on domestic companies from 65% to 35% now and on foreign companies from 70% to 40% between 1980-81 and 2003-2004. (iv)Rationalization of capital gains and dividends tax. (v)Reduction in peak rate of customs duty on non-agricultural products. (vi)Reduction in the number of excise duties from 11 to 3 and rationalization of rates.

Advisory Group Forecast

While doing this, the Twelfth Finance Commission may also like to take note of the report of the Advisory Group on Tax Policy and Tax Administration, (2001) set-up by the Planning Commission. In its report of 2001 the Group has made projections for various fiscal variables for the period upto 2006-07, on the assumption of GDP growth rate of 15% in nominal terms and 9% in real terms, and Inflation Rate of 5.5%. It has derived aggregate Tax Revenues consistent with tax GDP rates set by the Eleventh Finance Commission. On the expenditure front, the Group had projected growth of expenditure on Defence, Pensions and explicit subsidies @ 10% and made projections for expenditure on General, Social and Economic services with different growth rates for salary and non-salary components. The salary component growth is taken @ 5.5%, the same as that assumed for inflation and the non-salary component growth rates are the same as those applied by the Eleventh Finance Commission 7% for General Services, 15% for Social Services and 11% for Economic Services. The non-plan grants to the states are also assumed to grow on the rates assumed by the Eleventh Finance Commission. The Advisory group has projected between 1999-2000 and 2006-2007, increase in Gross Tax Revenue from Rs.16,997 crores to Rs.5,59,088 crores, states share of taxes from Rs.43,510 crores to Rs.1,53,607 crores and Centre’s net Tax Revenue from Rs.1,26,469 crores to Rs.4,05,487 crores, non-tax revenue from Rs.53,035 crores to Rs.1,59,299 crores and Revenue Receipts from Rs.1,79,504 cores to Rs. 5,64,786 crores. The total expenditure is projected to grow from Rs.3,03,738 crores in 1999-2000 to Rs.8,01,030 crores of which Revenue Expenditure will grow from Rs.2,53,036 crores to Rs.5,64,786 crores. The projections were made in a such a manner

Section-II 176

that the revenue deficit will become zero in 2006-07.Assessing these projections in light of the actuals of 2001-02, 2002-03 and 2003-04 one finds that the projections are way off the mark compared with realization.

As mentioned earlier, the projections of the Tenth and the Eleventh Finance Commission were also off the mark and Finance Ministry’s estimates presented to the Parliament turned out to be overestimation. It is necessary to take into account the recent experiences in revenue realization, and pay close attention to the methodology of forecast and inject realism in the under lying assumptions. Since recommendations on the devolution of taxes and grants are to be made by the Twelfth Finance Commission on the basis of its assessment of the resources of Central Government for five years commencing on 1st April 2005 on the basis of levels of taxation and non tax revenue likely to be reached by end of 2003-04.

It may be desirable for the Twelfth Finance Commission to attempt construction of alternative scenarios based on different assumptions of growth rates of variables. It may be mentioned that international oil companies had resorted to such techniques of technological and economic forecasting when faced with violent price fluctuations in the global oil market. Even the Indian experience of demand forecast for what were once considered sunrise industries like Petrochemicals and Electronics appear to suggest a move away from linear forecast. It is also seen that the growth rates assumed for forecast are close to and some times even higher than the targeted growth rate set in the Five Year and Annual Plan Documents. Though some authorities distinguish growth rates in real and nominal terms, this distinction gets lost in transmission to implementing agencies. What is desirable as a target from the point of view of planning may not necessarily be realistic from the point of view of resource forecasts, which need to take into account changes in the behaviour of the production and other systems on account of unpredictability of monsoon, crude oil prices and power fluctuations and their impact on output of different sectors. In such cases, the construction of scenarios with alternative assumptions may be helpful.

This suggestion is made keeping in view that the Finance

Commission’s recommendations on revenue transfer are in the

nature of an award, and considered almost binding on the Centre,

and arouse not only expectations in the states but also influence

their budgetary estimates. Given the changing political

complexions and compulsions of the Central and State

Governments and the continuous exposure of the Indian

Section-II 177

Economy to systemic weaknesses, there is need for an

improved method of forecasting revenues with an element of

conservatism built into it.

Section-II 178

C. Demands From Expenditure Needs

The Twelfth Finance Commission has been required to take into account the demands on the resources of the Central Government on account of expenditure on a) Civil administration (b) Defence (c) Internal and border security (d) Debt servicing and (e) other committed expenditure and liabilities.

We have already brought out that the Tenth and Eleventh Finance Commissions had in their forecasts over-estimated revenue and under-estimated the non-plan revenue expenditure of the Central Government. For a proper estimate of the requirements for the period 2005-10, there is need to take into account the expenditure trends of the 1990’s and the recent years.

Table 1.15 brings out the recent trends in expenditure of the Centre and in particular the increase of total expenditure in absolute terms from Rs. 1,05,298 crores in 1990-91 Rs.1,78,275 crores in 1995-96 and the fall in terms of proportions to GDP from 18.5 to 15.0 in the same period, indicating careful regulation of expenditure following the economic crisis of the early 1990s. The table also brings out that the lid could not be kept tight on expenditure which started rising again to reach Rs.362453 crores (15.8 % of GDP) in 2001-02. In 2002-03 as against BE of Rs.410309 crores (16% of GDP) and RE of Rs. 404013 crores, the actuals were Rs.400396 crores, a saving of Rs.9913 crores. In 2003-04, the rising trend resumed with the total expenditure rising to Rs.474255 crores in the revised estimates as against BE of Rs.438795 crores (16.1% of the GDP). The Finance Minister indicated that this level of expenditure, an increase of 8.6 % over the previous year will be met by revenue receipts of Rs.253935 crores (tax revenue Rs.184169 crores and non tax revenues Rs.69766 crores) and capital receipts of Rs.184860 crores mainly made up of higher borrowings and other liabilities placed at Rs.153637 crores.

Table –1.15 : Trends in Expenditure of the Centre (Rs. in Crores)

1990-91 1995-96 2000-01 2001-022002-03

(BE) (RE) (AC)2003-04

(BE)Total 105298 178275 325594 362453 410309 404013 400396 438795 (18.5) (17.0) (15.47) (15.8) (16.0) (16.3) (16.1)Revenue 73516 139861 277839 301611 340482 341648 339627 366227 (12.9) (11.8) (13.1) (13.1) (13.3) (13.8) (13.4)Capital 31782 38414 477753 60842 69827 62365 60769 72568 (5.6) (3.2) (2.3) (2.7) (2.7) (2.5) (2.7)Plan 28365 46374 82669 101194 113500 114089 111445 120974 (5.0) (3.9) (3.9) (4.4) (4.4) (4.6) (4.4)Non Plan 76933 131901 242293 261259 296809 289924 288942 317821 (13.5) (11.1) (11.5) (11.4) (11.6) (11.7) (11.6

Section-II 179

The budget for 2003-04 assumes revenue growth of 7.2% over the previous year and expenditure growth of 8.6 % , with a clear indication of the realization at the policy making level that the expenditure control measures of the 1990s had been marked by compression of capital expenditure and reduction in public investment with some adverse effect on effective demand for goods and services in the economy and that the economy required a stimulus by way of step up of capital expenditure . It must however be noted that the budget estimates for 2002-03 had also projected a growth of 15.2 % in capital expenditure and 14.1 % in revenue expenditure but the revised estimates show a marginal increase of 0.3 % in revenue expenditure and a fall of 10.7 % ( Rs.7462 crores ) in capital expenditure . The total reduction of Rs.6296 crores was mainly on the non plan side with defence spending lower than budget estimates by Rs.9000 crores and a slight reduction in interest payments due to the softening of interest rates on government securities. There was however increase in expenditure on subsidies to the extent of Rs.4800 crores. There was poor utilization of funds earmarked as incentive for fiscal reforms in the state.

Table 1.16 Major items of Expenditure (Rs.in Crores) / (% of Total)

1990-91 1995-96 2000-01 2001-022002-03

(BE)2002-03

(RE)2003-04

(BE)A. Total 105298 178275 325594 362453 410309 404013 438795B. Non Plan 76933 131901 242293 261259 296809 289924 317821 (73.1) (74.0) (74.6) (72.1) (72.3) (71.8) (72.4)

i. Interest 21498 50045 99314 107460 117390 115994 123223 (20.4) (28.1) (30.5) (29.6) (28.6) (28.7) (28.1)ii. Defence 15426 26856 49622 54266 65000 56000 65300 (14.6) (15.1) (15.2) (15.0) (15.8) (13.9) (14.9)iii. Subsidies 12158 12666 26838 31207 39801 44618 49907 (11.5) (7.1) (8.2) (8.6) (9.7) (11.0) (11.4)iv. General Services 6849 12593 28120 28760 31550 30440 31867

(6.5) (7.1) (8.6) (7.9) (7.7) (7.5) (7.3)(i+ii+iii+iv) 55931 102160 203894 221693 253741 247052 270297 (53.1) (57.3) (62.6) (61.2) (61.8) (61.1) (61.6)

The assessment can be made in a different manner by

looking at the centre’s total revenue receipts and net revenue

receipts,as also major items of expenditure in terms of their

proportions to GDP to gauge the extent of preemption these items

of expenditure make on the resources of the centre. This is shown

Section-II 180

in Table 1.17. While the Table 1.16 indicate the trends in major

expenditure items, in terms of absolutes and proportion to GDP,

and the pattern emerging can be further embellished with the

details of actuals under various heads of expenditure like civil

administration, defence, internal and border security, debt

servicing and other committed expenditure and liabilities during

the 1990s, the basic purpose of the analysis could well be served

by noting that, while these four items accounted for 61.2 % of the

total expenditure in 2001-02 , interest payments alone preempted

29.4% of the total receipts , 53.34 % of the revenue receipts and

80.4% of net tax revenue of the Centre. Subsidies like-wise

accounted for 8.61% of the total receipts , 15.49% of revenue

receipts and 23.35% of centre’s net tax revenue .Defence like-wise

accounted for 14.97 % of total receipts, 26.9% of revenue receipts

and 40.6 % of net tax revenue. Given this frame , the demand of

general services whether taken in the larger context or some what

more limited context of administrative expenses will entail lower

levels of draft on centre’s resources. The darkness of the picture

gets determined by the denominator one chooses for analysis .

Analysing the picture in terms of gross tax proceeds

Sri.B.P.R.Vithal observes , “to get some perspective on the various

claims made regarding the share of the states, we may note the

current liabilities of the Central Government. Net interest payment

Section-II 181

comes to 31 % of gross tax proceeds , defence is 19 % and

subsidies 13 % making a total of 63 % , that leaves only 37 %

without taking into account any other expenditure of the Central

Government. Reduction of interest liability requires fiscal deficit to

go down and the reduction of subsidies requires political will both

at the centre and the states” (Fiscal Federalism in India , pg 259)

Table : 1.17:Receipts and Expenditure (As percentage of GDP)

1990-91 1999-00 2000-012001-02

(BE)2002-03

(BE)

A.Revenue Receipts 9.7 9.4 9.2 10.1 10

(i) Tax Rev Net to Centre 7.6 6.6 6.5 7.1 7.1

(ii) Non Tax Revenue 2.1 12.9 13.2 13.5 13.9

B.Capital Receipts 5.6 6 6.3 6.2 6.7

C. Total Exp 17.3 15.4 15.5 15.6 16.7 (i) Rev Exp 12.9 12.9 13.2 13.5 13.9

a) Interest Payment 3.8 4.73 4.7 4.9 4.8

b) Defence 1.9 1.8 1.8 1.8 1.8 c) Subsidies 1.7 1.2 1.2 1.2 1.6

Since the Twelfth Finance Commission is required to take into account the revenues at the end of 2003-04, we may take a quick look at the expenditure projections of budget 2003-04. Of the total expenditure of Rs. 4,38,795 crores projected for 2003-04, non plan expenditure accounts for Rs. 317821 crores (72.4% of total expenditure with Plan expenditure claiming the balance of Rs.120974 crores. ) Of the non plan expenditure four major items claim Rs.270297 crores (61.6 % of the total expenditure) and these are Civil Administration and General Services Rs. 31867 crores (7.3 % of TE) Subsidies Rs.49907 crores(11.4% of TE), Defence: net of receipts but including capital expenditure Rs.65300 crores (14.9% of TE) and the most striking of all Interest Payments Rs.123223 crores (28.1% ) .The respective draft of these items on the revenues in 2003-04 is shown below (Table 1.18.). It emerges that the net tax revenue of centre will not cover the

Section-II 182

proposed outgo on these three major items of expenditure and that gross tax revenue and revenue receipts will barely cover these items.

Table 1.16b Major items of Expenditure (Rs.in Crores) / (% of Total)

1990-91 1995-96 2000-01 2001-022002-03

(AC)2003-04

(BE)2003-04

(RE)A. Total 105298 178275 325594 362453 400396 438795 474255B. Non Plan 76933 131901 242293 261259 288942 317821 352748 (73.1) (74.0) (74.6) (72.1) (72.4)

i. Interest 21498 50045 99314 107460 117804 123223 124555 (20.4) (28.1) (30.5) (29.6) (28.1)ii. Defence 15426 26856 49622 54266 55662 65300 60300 (14.6) (15.1) (15.2) (15.0) (14.9)iii. Subsidies 12158 12666 26838 31207 43515 49907 44707 (11.5) (7.1) (8.2) (8.6) (11.4)iv. General Services 6849 12593 28120 28760 30327 31867 31731

(6.5) (7.1) (8.6) (7.9) (7.3)(I+ii+iii+iv) 55931 102160 203894 221693 247308 270297 261293 (53.1) (57.3) (62.6) (61.2) (61.6)

Table :1.18 Items of Expenditure and Revenueinterest payment subsidies defence

Absolute (Rs.crores) 123223 49907 65300(as percentage of )

Rev Receipts 253935 49 20 26Gross Tax Rev 251527 49 20 26Net Tax Rev 184169 67 27 35

The rising trend of expenditure and the predominance of non-

Plan expenditure items like the interest, defence, subsidies and

general services continued to show in the budget and the revised

estimates of 2003-04 and the budget for 2004-05.

Section-II 183

Table 1.19 Major items of Expenditure (Rs.in Crores) / (% of Total)

2000-01 2001-02 2002-03 2003-04

(BE)2003-04

(RE)2004-05

(BE)A. Total 325594 362453 400396 438795 474255 477829B. Non Plan 242293 261259 288942 317821 352748 332239 (74.6) (72.1) (72.4)

i. Interest 99314 107460 117804 123223 124555 129500 (30.5) (29.6) (28.1)ii. Defence 49622 54266 55662 65300 60300 77000 (15.2) (15.0) (14.9)iii. Subsidies 26838 31207 43515 49907 44707 43516 (8.2) (8.6) (11.4)iv. General Services 28120 28760 30327 31867 31731 35186

(8.6) (7.9) (7.3)(i+ii+iii+iv) 203894 221693 247308 270297 261293 285202 (62.6) (61.2) (61.6)

The estimates of expenditure in indicated in the budget 2004-

05 have been justified in terms of the common minimum

programme, which promised a change in priorities to correct the

inadequacies felt during the previous years when, as part of

economic reform, emphasis was on expenditure containment. The

doubts have been expressed over the revenue projections made in

the budget, and similar doubts have also been expressed regarding

the expenditure estimates. As a ratio of GDP total expenditure had

moved up from 15.35 in 2000-01 to 15.94 in 2001-02, 16.84 in

2002-03 and 17.23 in 2003-04, and is now projected at 15.30 for

2004-05. Component wise analysis of expenditure trend shows that

the budgeted increase in Plan expenditure and capital expenditure

Section-II 184

have not been materializing to the full, and there have been serious

short falls. To cite an instance as against a budget estimate of Rs.

20953 crores for defence capital, the revised estimate is only

Rs.16906 crores a short fall of Rs.4047 crores and in spite of this

an additional provision of Rs.12500 crores has been made for

2004-05 which is nearly double the revised estimates for 2003-04.

Infrastructure sector like Coal and Mines, Power, Road transport

and Shipping have, in the revised estimates show expenditure well

below the budget estimate. This short falls are nearly made up by

higher expenditure in petroleum and natural gas and Ministry of

Rural development and Department of atomic energy.

What is striking is that the non-Plan expenditure like debt

servicing and interest payments, subsidies continue to show an

increase. The total non-Plan expenditure which stood at Rs.302708

crores in 2002-03 was expected to increase to Rs.317821 crores as

per BE 2003-04, but showed a steep jump to Rs.352748 crores

mainly on account of capital expenditure which stood at Rs.34634

crores in 2002-03 (AC), was provided Rs. 28437 crores in 2003-04

(BE) but increased to Rs.67947 crores mainly on account of

repayments to national small saving funds. The provision for non-

Plan expenditure in 2004-05 budget shows a reduction of Rs.20500

crores mainly on account of lower provisions for capital

Section-II 185

expenditure. The inadequacy of revenue receipts to cover

expenditure of the Central Government, can be seen from table

1.19 showing the divergence of budget estimates of deficits from

revised estimates and the actuals.

Table :1.19 Deficit Indicators (Rs.Crores) / (% Of GDP) Primary Revenue Gross Fiscal

2000-2001BE 10009 (0.5) 77425 (3.6) 111275 (5.1)RE 11305 (0.5) 77369 (3.6) 111972 (5.1)Actuals 19502 (0.9) 85234 (4.1) 118816 (5.6)

2001-2002BE 4014 (0.2) 78821(3.2) 116314(4.7)RE 24464 91733 131721Actuals 33495 (1.5) 100162 (4.3) 140955 (6.1)

2002 -2003BE 18134 (0.7) 95377 (3.8) 135524 (5.3)RE 29803 (1.2) 104712 (4.3) 145466 (5.9)Actuals 27268 (1.1) 107880 (4.4) 145072 (5.9)

2003-2004 BE 30414 (1.1) 112292 (4.1) 153637 (5.6)RE 7548 (0.3) 99860 (3.6) 132103 (4.8)

2004-2005 BE 7907 (0.3) 76171 (2.5) 137407 (4.4)

Of particular significance is the notification of the Fiscal

Responsibility and Budget Management Act to be effective from

July 2004. This Act requires the Union Government to reduce its

revenue deficit by an annual minimum target of 0.5%. Fiscal

Responsibility and Budget Management Bill introduced in the

Parliament in December 2000 had envisaged the reduction by

2006-07, As against this, the Act indicated elimination of revenue

deficit by 2007-08. The Common Minimum Programme released

on May 28th 2004 has indicated that “the UPA Government

commits itself to eliminate the revenue deficit of the Center by Section-II 186

2009 so as to release more resources for investments in social and

physical infrastructure. All subsidies will be targeted sharply at the

poor and truly needy like small and marginal farmers, farm labour

in the urban poor”. There is definite indication of the target dates

sliding away from what was proposed earlier.

The Medium Term Fiscal Policy Statement placed by the Union

Finance Minister on the table of the Parliament on July 8th 2004

indicated the following targets

As % of GDP 2003-

04

RE

2004-

05

BE

Targets of

2005-06

2006-07

1 Revenue

Deficit

3.6 2.5 1.8 1.1

2 Fiscal Deficit 4.8 4.4 4.0 3.6

3 Gross Tax

Revenue

9.2 10.2 11.1 12.1

4 Outstanding

Liabilities

67.3 68.5 68.2 67.8

Section-II 187

D. Major Items of Expenditure

Recent trends in expenditure and important items of non-plan

revenue expenditure for the period 1995-96 to 2004-05 are shown

in Tables 1.21 and 1.22. Major items of expenditure, covered in the

category of General Services Civil Administration, Internal and

Border Security, Defence, Debt Servicing and other committed

expenditure and liabilities as also subsidies are examined in the

following pages.

a. General Services

The general services account for 78% of aggregate expenditure

and about 10% of non-Plan expenditure. This category covers

1. Organs of state (Parliament, President/Vice President, Council of Ministers, Judiciary and The Comptroller and Auditor General).

2. Tax collection machinery (Income Tax, Central excise and Custom Departments).

3. Elections (Election Commission and Conduct of Elections)4. Secretariat – General services (Home affairs, External affairs,

Revenue, Economic affairs, Defence Ministry, Defence Accounts and Defence Estate)

5. Police (Central Reserve Police, BSF, Indo-Tibetan border Force, Central Industrial Security Force, Assam Rifles and Delhi Police)

6. External affairs (Embassies and Consulates)

Section-II 188

7. Pension (Civil and Defence)8. Other services (Public works, Intelligence Bureau etc)

The total expenditure on general services has risen studily from

Rs.6849 crores in 1990-91 to Rs. 12593 crores in 1995-96 and

after a major jump of Rs. 4500 crores to Rs. 1866 crores in

1997-98, it further increased to Rs. 22952 crores in 1998-99 and

Rs. 28128 crores in 1999-2000. After staying around this level it

resumed its rise to touch Rs. 28760 crores in 2001-02. The

break up of general services expenditure is shown below:-

Expenditure on general services

Rs.Crores

Year Total Organs of

state

Tax

collection

Police Pensions

1995-96 12593 839 1077 3082 4277

1996-97 13736 890 1247 3855 5094

1997-98 18266 1444 1674 4903 6881

1998-99 22952 1367 1875 5619 10057

1999-

2000

28128 1544 1976 6361 14286

2000-

2001

28120 1582 2118 6759 14379

2001- 28760 1453 2214 7248 14436Section-II 189

2002

2002-

2003

30327 1716 2366 8163 14496

2003-

2004 BE

RE

31867

31731

1356

1509

2697

2754

8318

8331

15466

15366

2004-

2005 BE

34772 1463 2669 9629 15928

Source Budget Documents of Government of India

General services constitute an important non-Plan

expenditure, accounting for Rs.34772 crores, while social services

account Rs.6838 crores and the economic services account for Rs.

12054 crores. These three items of non-Plan revenue expenditure,

will be the third in the nature and size of demand on the resources

of the Central Government, with debt servicing (Rs. 129500 crores,

and defence expenditure Rs.66000 crores) taking a larger chunk of

the total non-Plan expenditure of Rs. 322363 crores provided in the

interim budget for 2004-05.

b. Civil Expenditure

Section-II 190

The civil expenditure of the Union Government consists of

expenditure on (i) general services (ii) social and community

services (iii) economic services. Expenditure on general services

covers organs of state fiscal services, debt servicing and interest

payments , administrative services , pension and miscellaneous

general services. The expenditure on social services covers

education, public health welfare schemes of workers etc . which

have acquired importance in the Indian context. The expenditure

on economic services cover those on agriculture and allied

services, industries , multi purpose irrigation projects , public

works , transport and communication , export promotion (see notes

on classification Annexure-B ).The classification of expenditure,

as presented in the budget, and as analysed in the Economic

Survey of the Ministry of Finance and in the Reports of the RBI

differ , in presentation of plan , and non plan expenditure and

developmental and non developmental expenditure.It is mainly on

account of the inclusion of the results of transactions of

departmental, commercial under takings in the Ministry of Finance

presentation. The distinction that requires to be kept is some times

lost while making trend analysis particularly in terms of GDP ratio.

Examination of the trends in the expenditure of Central

Government shows that expenditure under all major heads have

Section-II 191

been increasing over the decades. This should not cause any

surprise as the population has been increasing and the Central

Government has been taking responsibilities for various

developmental and welfare activities. What is significant is that

between 1950-51 and 1980-81 the total revenue expenditure had

increased nearly 40 times and a matter of particular interest to

Finance Commission is that the grants in aid to the states had

increased by more than 100 times between 1950-51 and 1980-

81.Total revenue expenditure which was only Rs.346 crores in

1950-51 has grown to Rs.3179 crores in 1970-71 Rs.14410

crores in 1980-81 and Rs.73516 crores in 19990-91 Rs,277839

crores in 2000-01 , with further increases to Rs.301611 crores

in 2001-02 and Rs.339628 crores in 2002-03. As against budget

estimates of Rs.366227 crores in 2003-04, the revised estimates

are Rs. 362887 crores and the BE for 2004-05 is Rs.385493

crores.

Of this Civil expenditure accounted for Rs.157 crores in

1950-51 Rs.1516 crores in 1970-71 and Rs. 8131 crores in 1980-

81. Further increases in this area particularly during the nineties

have attracted serious discussion, particularly in view of an

impression that there has been a serious and avoidable sharp

explanation in the salary bill and pension payment for those borne

Section-II 192

on central government establishment, on account of the Fifth Pay

Commission. It has been argued that the salary bill and pension

outgo of the Central Government, Civil Ministries and departments

including defence services but excluding post telecom and

railways, increased sharply in 1997-98. While expenditure on

salaries were indicated as 12.5 % of the revenue expenditure in

1997-98 , pension outgo was 3.8%.BY 1998-99 the proportions

had increased to 16.3 % and 4.5 % respectively . In absolute

numbers, the salary bill of Central Government establishment had

increased from Rs.1489 crores in 1995-96 to RS.26484 crores in

1998-99 while pension out go had increased from Rs.4300 crores

to Rs.7356 crores during the same period. The impact of the Fifth

Pay Recommendations on the salary bill of the Central public

sector and of the state governments has also been debated at great

length. In one respect it should be remembered that the Fifth Pay

Commission had kept in view, certain international trends, and

had, specified a reduction in the size of the staff. But the

acceptance of the recommendations had only meant an immediate

increase in the pay bill and pension outgo without any sizeable

relief from reduction in the size of the establishment.

An even more important element pointed out by public

finance analysts is the improvement in tax GDP ratio in respect of

Section-II 193

direct taxes is attributable to the pay revision of the central

government , state government and public sector employees.

Analysis of the buoyancies of central taxes show that the buoyancy

of total tax to GDP had declined from 1.07 for the period 1981-

1993 to 0.96 for the period 1981-2001, while the buoyancy for

direct tax to GDP had increased from 1.07 to 1.119 and personal

tax to GDP from 0.92 to 1.23. This lends credibility to the above

argument of the analysts.

The Eleventh Finance Commission had indicated that “ there

is no need to appoint pay commission as a routine at the intervals

of ten years. As the recommendations of the central pay

commission have a bearing on the states, its terms of reference, if

and when appointed should be determined in consultation with the

states. The level of salaries and allowances should bear a

relationship with the revenue expenditure of the states to be laid

down by an Expert Committee.” It also recommended that “

consideration needs to be given to evolving a system under which

pensions do not become an unsustainable burden on the state’s

exchequer .A large share of the pensions goes to the defence

sector. A suitable scheme to absorb the retirees from the armed

forces in other government department may be devised” (para 3.57

of the XI FC report).

Section-II 194

The recommendations appear to have been made, purely with a

view to reducing central government expenditure may pose

practical problems in implementation. There is need for adequate

appreciation of the structural issues involved in the early

retirement of armed forces officials, and the increasing longevity

as a demographic feature of the population. Provision for pension

have no doubt been showing an increase from year to year. Budget

2004-05 indicates a provision of Rs.15928 crores for pensions and

other retirement benefits, of retired personnel of defence (Rs.11250

crores) and other civil departments (Rs.4678 crores). This does not

include the pension charges of the Railways and the Department of

Posts which has been treated as part of their operational charges.

What is necessary for the XII FC to note is that the expenditure on

this item has reached a plateau, and attention should be

concentrated on improving the performance efficiency of the staff

and officials and not on merely reducing the outgo on salary and

pensions.

Section-II 195

c. Police, Internal and Border Security

The budgetary data relating to expenditure on central police

establishments, are part of the Home Ministry Demands and

Expenditure and for analytical purposes , this should be taken as

part of General Services. The Central Government expenditure on

Police was Rs.1297 crores in 1989-90 increasing to Rs.3082

crores in 1995-96 , and Rs.5619 crores in 1998-99 Rs.6361 crores

in 1999-2000 Rs.6759 crores in 2000-01 and Rs.7249 crores in

2001-02. The budget for 2002-03 was Rs. 8342 crores and the

revised estimate Rs.8237 crores but the actuals is only Rs.8163

crores. For 2003-04 the revised estimate is Rs.8331 crores and the

BE for 2004-05 is Rs.9940 crores.

The budgetary provisions cover Central Reserve Police,

Border Security Force, central industrial security force which

account for substantial part of expenditure. Provisions for other

agencies like National Security Guard, Indo-Tibetan Border Police,

Assam Rifles and Delhi Police are also included in the above

provisions, facilities like inter-state police wireless scheme, and

housing for central police organizations are also included in this

expenditure. The erection of wire fencing on the Indo-Pak border,

Indo-Bangladesh border are also included in this provisions. An

Section-II 196

important element of the budgetary provisions for police is the

provision of Rs. 650 crores in 2003-04 and Rs.800 crores in 2004-

05 for modernization of police force. Under this scheme assistance

is provided in cash and kind to the State Governments as 100%

grants in aid to be utilized for expenditure of non recurring nature

on purchase of vehicles, wireless equipment, computers and other

equipments. As the efficiency of police can improve only if there is

a proper balance between men, facilities for movement and

communications, the central scheme of modernization is an

important contribution to the States. The Central police

organization are often deployed in different parts of the country to

take care of law and order situations. The expenditure is recovered

from the State Governments.

The expenditure on police works out to 2.16 % of total non

plan expenditure and 1.89 % of aggregate expenditure of the

central government. Taking into account the treats to internal

security, and those on the border, and the fact that central police

establishments are moved to different parts of the states for

assistance to civil administration in times of disturbances and for

conduct of elections, and the provisions include traveling and other

allowances, the expenditure cannot be considered high. There is

perhaps a case for increasing this expenditure, on residential and

Section-II 197

other facilities for the families of personnel borne on Central

Police Establishments. In 2003-04 the budgetary provisions for

construction of residential accommodation for central police

organizations was about Rs.239 crores (Plan 101 crores and non-

Plan 138 crores, and this has been increased in 2004-05 to Rs.338

crores (Plan Rs.120 crores and non-Plan Rs.218 crores). The Delhi

police also secures a substantial allocation of Rs. 55 crores in

2004-05.

The XII FC could obtain and examine the data on percentage

satisfaction achieved in these establishments, and if need be

provide for additional expenditure, taking care to see that the

location of residential and other facilities are distributed in

different states across the country.

Section-II 198

d. Defence

Defence expenditure of the central government is on the

armed forces, and it includes pensions given to the retired army

personnel. Budgetary data generally shows defence salary and

pension expenditure as part of revenue expenditure, and

expenditure on defence procurement and works as capital

expenditure. There is a mistaken impression that defence

expenditure in India is very high and needs to be reduced. This

impression has to be corrected in the interest of national security.

According to World Economic Indicators 2000, India’s

defence spending is only 14.3 % of government expenditure

whereas in the neighbourhood Pakisthan spends 24.9 % and South

Korea 28.5%, Syria 26.2 % and UAE 46.5 % and United States

16.3% . There is no denying that total defence expenditure which

was Rs.189 crores in 1947-48 fell to Rs.136 crores in 1948-49,

Rs.161 crores in 1949-50, and Rs.170 crores in 1950-51 before

rising again to Rs.193 crores in 1951-52 , Rs.276 crores in 1957-58

and Rs.315 crores in 1961-62 . The impact of the Chinese war

could be seen in the rise of defence expenditure to Rs.474 crores in

1962-63 Rs.816 crores in 1960-64. The steady rise in expenditure

saw a jump in 1971-72 after the Indo-Pak war when defence

Section-II 199

expenditure moved up from Rs.1199 crores in 1970-71 to Rs.1525

crores in 1971-72. Thereafter there has been steady increase in

nominal terms, with the total defence expenditure picking up pace

in the eighties rising to Rs.14416 crores in 1989-90 and Rs.35278

crores in 1997-98. In other words between 1947-48 and 1997-98,

the five decades has seen defence expenditure rise by 186 times.

If this appears staggering, one should look at defence

expenditure as percentage of Central Government expenditure and

as percentage of GDP at current market prices. Between 1961-62

and 1999-2000, the defence expenditure increased from Rs.3149.2

crores to Rs.47071 crores, But as percentage of central government

expenditure, it had fallen from 21.33 % to 16.0%, with

expenditures in some of the intervening years touching 13.92 %

in1994-95, 13.58 in1996-97 . As percentage of GDP (1993-94

prices) defence expenditure was 1.83% in 1961-62, 3.30 % in

1971-72 and 2.91 % in 1981-82 and 2.65% in 1991-92 and

estimated 2.67 % in 2001-02.

The recent trends in defence expenditure are shown below :-

Year Total

expenditure

Capital

expenditure

Receipts

Section-II 200

1996-1997 29605 8508 981

1997-1998 35278 9104 1128

1998-1999 39897 10036 1338

1999-2000 47071 11855 1416

2000-2001 49622 12384 1638

2001-2002 54266 16207 1734

2002-2003 55622 14953 1976

2002-2003

(BE)

(R

E)

65300

60300 16906 2079

2004-2005 77000 33483 2131

Budgetary provisions for Defence Ministry include revenue

and capital expenditure on defence services net of recoveries and

revenue receipts spread on army, navy, air force, ordinance

factories and defence (R&D). The break up is shown below :-

Component 2003 – 2004

(BE)

(RE)

2004 – 2005

(BE)

General

services

632.59 697.34 886.35

Defence 11000 11000 11250Section-II 201

pensions

Army 28921 28277 27629

Navy 4950.54 4910.54 5343.82

Air Force 8324.08 7847.29 8618.40

Ordnance

factory

582.61 340.02 417.22

R & D 2734.11 2699.20 2343.16

Capital outlay 20952.76 16906.32 22482.85

One should also take into account that the defence budget

includes expenditure on several defence production units which

have made a significant contribution to not only build up of

defence capability but also growth of small and medium scale units

in the private sector supplying components to the defence

production units.In his book India 2020 , A vision for the new

millennium, Dr.A.P.J.Abdul Kalam has indicated that indigenous

production of defence equipment and supplies is about 30 % and

that this figure ought to be brought up to 70 % in the long terms

interest of our defence needs. In his view , this needs several steps

towards development of technological processes in the country ,

and an approach to sourcing out defence equipment and products

from many assemblies and sub assemblies drawn from the civilian

sector. The spin off from defence research laboratories into other Section-II 202

sectors like engineering plastics bio technology etc, have a value

that cannot be measured only in monetary terms.

While these have to be mentioned on the positive side, there

is on the other hand a need to look at the shortfalls in utilization of

budgetary provisions in the defence sector on account of the

procedures involved. Defence procurement attracts criticism often

misplaced and sensationalized in the media. There is an elaborate

procedure for testing of equipment in the field before approve of

the purchase. This involves time lag, which is justifiable from the

point of ensuring efficiency but posing problems for estimating

budgetary provisions and ensuring utilization. The budget

estimates for 2002-03 provided Rs. 65000 crores for defence and

the revised estimate places it at Rs.56000 crores , a shortfall of

Rs.9300 crores. (16.6 % ). Similar shortfalls have occurred in

previous years. Earlier Finance Commissions had looked into

defence expenditure, with outside expertise and a degree of

confidentiality. With a former Defence Secretary as a Member, the

XII FC is better equipped to conduct an in-depth examination of

the defence needs.

Adoption of a concept of a rolling budget, with medium

terms non lapsable provisions, can improve utilization of the

Section-II 203

budgetary provisions and ensure timely availability of equipment

and materials to the defence forces.

Section-II 204

e. Debt Servicing and Interest Payment

As per the budget document 2004-05 the outstanding internal

and external debt and other liabilities of the Government of India

at the end of 2004-05 will amount to Rs. 19,85,866.91 crores as

against 17,24,198.82 crores at the end of 2003-04. The manner in

which the outstanding liabilities have grown can be seen from the

following table

Outstanding Liabilities of Central Government (Rs. Crores at the end

of )

1950-51 2000-01 2001-02 2002-03 2003-04

RE)

2004-05

(BE)

A. Public Debt 2054.33 869642.86 984606.91 1080300.85 1181427.75 1346711.70

Internal Debt 2022.30 803697.63 913061.12 1020688.79 1134020.35 1291627.77*

External Debt 32.03 65945.23 71545.79 59612.06 47407.41 55083.93

B.Other

Liabilities

811.07 298898.16 381801.51 478900.50 543071.06 639455.21

Total Liabilities 2865.40 1168241.02 1366408.42 1559201.35 1724498.82 1986166.91*

* Includes markets stabilization scheme Rs. 60,000 crores.

The sharp increase in public debt during the recent decades

can be seen from the fact that the total outstanding liabilities of

Central Government has increased from Rs. 59749 crores (41.6%

of the GDP) in 1980-81 to RS.314558 crores (55.3% of GDP) in Section-II 205

1990-91 and further to Rs.1163635 crores (55.7% of GDP) in

2000-01. The share of Internal Debt stood at Rs.30864 crores

(21.5% of GDP), Rs.154004 crores (27.1 % of GDP) and

Rs.804528 crores (38.5% of GDP) in the respective years.

The RBI in its analysis of the debt position of the central

government in its Annual Report 2002-03 has observed, “the

widening fiscal gap has led to a steep rise in the outstanding

liabilities of the government. Of the outstanding debt of the Central

Government, internal debt alone accounted for 66.4 % and other

liabilities which comprise of small savings and provident funds

account for 29.9 % at the end of March 2003 .The sharp increase in

the debt GDP ratio since mid 1990s is reflected in burgeoning

interest payments despite a decline in interest rates. This

essentially represents the over hang of out standing liabilities

contracted at high interest costs in the past. This has created a

vicious circle of high debt leading to higher interest payments

which in turn leads to higher deficit higher borrowings and higher

debt” (RBI Annual Report 2002-03 pg 65).

Looking specifically at the outgo on interest payments, one

notices that in 1989-90, it claimed Rs.17757 crores, 19.1 % of the

aggregate expenditure of the Central Government and by 1999-

Section-II 206

2000 it had risen to Rs. 88000crores, 30 % of aggregate

expenditure. In 2000-01, the outgo was Rs. 100667 crores 30.5 %

of aggregate expenditure, and thereafter this kept increasing in

absolute terms to Rs. 107257 crores in 2001-02.

Section-II 207

The details of debt servicing are shown in the following table

Year Total

Debt

Servicing

Debt

repayment

Interest

payment

(IP)

IP as

% of

GDP

IP as %

of

Revenue

Receipts

1996-

97

125045 66545 58500 4.3 47.1

1997-

98

147470 81770 65700 4.3 49.0

1998-

99

193195 115947 77248 5.3 49.0

1999-

00

195128 107128 88000 5.4 48.1

2000-

01

228955 128288 100667 5.6 48.8

2001-

02

230554 123297 107257 5.2 50.5

2002-

03

(BE)

258005 140615 117390 5.7 55.2

2002-

03

277808 162145 115663 5.2 48.8

Section-II 208

(RE)

2003-

04

(BE)

288599 165376 123223 5.5 48.5

Provision for Interest payment was Rs.123223 crores in

2003-04(BE) signifying a decline to 48.8% of Revenue Receipts

and 28.1 % of aggregate expenditure. The revised estimates for

2003-04 is placed at Rs. 124555 crores including prepayment

premium for reduction of debt to the extent of Rs. 4079 crores. The

BE for 2004-05 provides Rs. 129499.86 crores for interest

payment and debt servicing. The initial rise in the early 1990s and

the more recent decline reflect the trend in the interest rates on

dated securities. In 1980-81 the interest rate on government

securities ranged between 5.98 to 7.50 % per annum and the

weighted average 7.03 % . It had steadily climbed to reach a range

of 12 to 13.4 % with weighted average of 12.63 % in 1993-94

falling thereafter to reach a range of 9.47 to 11.70 % and weighted

average of 10.95 % in 2000-01.While the burden of debt servicing

and interest payments will continue to be significant in the budget

formulation, it is significant that between 1998-99 and 2002-03

debt GDP ratio fell from 23.62 to 20.0, and debt-service ratio from

17.8 to 14.6.Section-II 209

There is however need for continuous vigilance on this front.

An important issue in debt management is the proposal for

separation of debt and monetary management while ensuring close

coordination of monetary and fiscal operations. The Committees

on Capital Account Convertibility (1997), the Advisory Group on

Transparency in Monetary and Financial Policies, (2000), have

dealt with this issue. While the first recommended the separation

of debt management from monetary management, the second felt

that this is a necessary but not sufficient condition for effective

Monetary policies. Expert opinion is that the separation of the two

functions would be dependent on the fulfillment of three

preconditions, the development of financial markets, reasonable

control over fiscal deficit and necessary legislative changes. Some

of these conditions appear to be getting fulfilled but there is as yet

no final decision on this.

Section-II 210

f. Subsidies

The increase in budgetary provisions and outgo on subsidies

on account of food, fertilizer, petroleum products and interest,

from Rs. 140 crores in 1971-72 to Rs. 1941 crores in 1981-82 Rs.

12253% (1.9% of the GDP) in 1991-92 and further to Rs. 31207

crores (1.4% of the GDP) in 2001-02 has been a major area of

concern for the policy makers, and a favourite theme for fiscal

reformers. It was at one stage felt that the volume of subsidies,

estimated at 14% of the GDP, was unduly large. The discussion

paper on “Government Subsidies” (1997) issued by Ministry of

Finance sparked a debate, which helped in crystallising the issues

involved. The National Institute of Public Finance Policy made an

analysis of explicit, implicit subsidies emanating from the Central

budget, and estimating them at Rs.43000 crores in 1995-96 and

Rs.48000 crores in 1996-97.

The NIPFP publication “Central budgetary subsidies in

India” by Dr. D.K.Srivastava and H.K.Amarnath,2001, revisited

the area and provided reclassification of subsidies within the merit

and non merit categories, proposed modifications in the

methodology of calculating depreciation costs, estimated implicit

and explicit central subsidies, quantification of the scope for

Section-II 211

subsidy reduction under alternative assumptions and identification

of the ways and means for subsidy reduction. The publication is a

useful contribution to informed debate on the need for subsidies

and the scope for reduction. It has been estimated that explicit

subsidies in central budget on account of various items had

increased from Rs.140 crores in 1971-72 to Rs. 1941 crores in

1981-82 and Rs.12253 crores in 1991-92 and Rs.23838 crores in

1999-2000. The further increases in the provisions as could be

gleaned from recent budgets involve outgo of Rs.26838 crores in

2000-01 Rs.31207 crores in 2001-02 Rs.44618 crores in 2002-03

revised estimates and Rs.49907 crores in 2003-04 budget

estimates. The breakup on account of various items are as follows.

Table 1.20 : Central Subsidies (Rs.Crores)

Yea

r

Foo

d

Fertilis

er

Intere

st

Export

Promoti

on

Petroleu

m

Othe

rs

Tota

l

197

1-72

47 5 54 34 140

198

1-82

700 381 102 477 281 1941

199

1-92

2850 5185 316 1758 2144 1225

3Section-II 212

199

5-96

5377 6735 34 318 908 1337

2

199

9-00

8560 13250 73 630 1325 2448

7

200

0-01

1206

0

13800 111 867 2683

8

200

1-02

1749

9

12595 210 903 3120

7

02-

03R

E

2420

0

11009 765 6265 2379 4461

8

AC 2417

6

11025 756 5225 2799 4351

5

03-

04B

E

2780

0

12720 179 8116 1092 4990

7

02-

03R

E

2520

0

11796 207 6573 984 4470

9

03-

04B

E

2580

0

12662 463 3559 1302 4351

6

Note : Others include items like subsidy for janata cloth,Section-II 213

While food subsidy, as part of public distribution scheme was

the major item of outgo along with export promotion in the early

seventies, the introduction of fertilizer subsidy in 1976-77, subsidy

on railway fares in 1979-80 and petroleum products in 2002-03,

have increased the budgetary impact of subsidies. Whether this in

itself is among major factors in the emergence of deficit is a

matter for debate.

The Expenditure Reforms Commissions devoted its First

Report (July 2000) to food subsidy and a the Second Report

(September 2000) to ferlilizer subsidy. These report are analysed

separately. In more recent years, the government has moved in the

direction of revising the issue price of food grains and reducing the

outgo on food subsidy, rationalization of the Retention Price

scheme and enhancement of the maximum retail price of fertilizers

has reduced the outgo on fertilizer subsidies .On the other hand ,

the dismantling of the Administered Prices Mechanism for

petroleum products has resulted in provision of subsidy for

petroleum companies.

The debate on subsidies has brought, economists and fiscal

pundits on one side, and social and political activists on the other

Section-II 214

side, with the central issue shifting from the quantum of subsidy

and its fiscal implication to the rising inequalities and social

pressures in the wake of economic reform and withdrawal of the

state from certain sectors. The outgo on subsidies in 1990-91 was

only Rs.12158 crores which as a ratio to GDP was 2.1 %. In 2000-

01, the outgo was Rs.26838 crores which as a ratio to GDP was

only 1.3 %. Even with the introduction of the subsidy on petroleum

products pricing, which takes the total outgo to Rs.49907 crores,

the ratio to GDP is only 1.8 %.

Given the structure of the Indian Economy and the socio

economic disparities, it is difficult to take a harsh view on these

outgoes purely on budgetary grounds. Wisdom may lie in keeping

the total outgo on subsidies to a maximum of 2 to 2.5 % of the

estimated GDP and leaving it to the policy makers to have their

play within these limits.

The Medium Term Fiscal Policy Statement laid by the Union

Finance Minister before the Parliament, as required under the

Fiscal Responsibility and Budget Management Act, on July 8th

2004, has indicated that the “major subsidies are assumed to

decline in 2005-06 and 2006-07, consequent upon the

Government’s commitment under National Common Minimum

Section-II 215

Programme to control inefficiencies that increase to food subsidy

burden and to sharply target all subsidies at the poor and the truly

needy, like small and marginal farmers, farmed level and the urban

poor”.

The Fiscal Policy strategy Statement, also laid before the

Parliament on the same day as indicated Governments

commitment “to restructure the subsidies so that the benefits are

not usurped by those not intended to be the beneficiaries of these

subsidies”. The statement indicated Governments intention to take

up an intensive review of the operational aspects of the subsidies,

as part of its expenditure policy.

Section-II 216

Table 1.21 Trends in Expenditure

(In Crores of Rupees)Actuals1995-96

Actuals 1996-97

Actuals 1997-98

Actuals 1998-99

Actuals 1999-00

Acutals 2000-01

Acutals 2001-02

Actuals2002-03

Revised2003-04

Budget2004-05

A. Non Plan Expenditure

131901 147473 172976 212522 221871 242923 2661116 302708 352748 332239

1 Interest Payments and Debt Servicing*

50045 59478 65637 77882 90249 99314 107460 117804 124555 129500

2 Defence Expenditure **

26856 29505 35278 39897 47071 46922 54266 55662 60300 77000

3 Subsidies 12666 15499 18540 23593 24487 26838 31210 43515 44709 435164 Grants to

States & UT.Govt

5967 6230 4420 4923 6238 14717 15327 12930 15669 19470

5 Grants to Foreign Govts.

240 251 335 387 368 361 402 981 712 844

6 Other Non-Plan Expenditure

22445 24140 29220 38262 44573 47083 46048 50733 54185 55144

7 Non-Plan Capital Expenditure @

1148 -478 990 435 2769 1374 2815 13328 48833 3317

8 Loans & Advances to State & U.T Govts. @@

10538 10606 15817 23893 2719 -14 -394 2491 181 106

9 Loans to Foreign Govts

84 50 130 92 74 152 150 533 277 144

10 Other Loans 1276 1485 1768 2117 2163 2456 2595 3385 1804 159811 Non-Plan

Expenditure of UTs without Legislature

636 707 841 1041 1160 1146 1237 1346 1523 1600

On Revenue Account

627 703 835 1033 1147 1211 1305 1402 1578 1659

On Capital Account

9 4 6 8 13 -65 -68 -56 -55 -59

B Plan Expenditure

46374 53534 59077 66818 76182 82669 1011194 111455 121507 145590

On Revenue Account

29021 31635 35174 40519 46800 51076 61657 71554 78086 91843

On Capital Account

17353 21899 23903 26299 29382 31593 39537 39901 43421 53747

Total Expenditure

178275 201007 232053 279340 298053 325592 362310 414162 474255 477829

On Revenue Account

139861 158933 180335 216461 249078 277839 301468 339627 362887 385493

On Capital Account

38414 42074 51718 62879 48975 47753 60842 74535 111368 92336

Source: Government of India Expenditure Budget 2004-05, July 2004

Section-II 217

Table 1.22 - Details of Other Non-Plan Revenue Expenditure (In Crores of Rupees)

Actuals1995-96

Actuals 1996-97

Actuals 1997-98

Actuals 1998-99

Actuals 1999-00

Acutals 2000-01

Acutals 2001-02

Actuals2002-03

Revised2003-04

Budget2004-05

1 General Services 12593 13736 18266 22952 28128 28120 28760 30327 31731 351861.01 Organs of State 839 890 1444 1367 1544 1582 1453 1716 1520 14691.02 Tax Collection 1077 1247 1674 1875 1976 2118 2214 2366 2754 27531.03 Police 3082 3855 4903 5619 6361 6759 7248 8163 8331 99401.04 Pensions 4277 5094 6881 10057 14286 14379 14436 14496 15367 159281.05 Charges payable

to IMF528 298 287 249 104 2 - - - -

1.06 Wrote off of Loans

293 201 751 950 934 63 -8 20 - -

1.07 Other Expenditure 2497 2151 2326 2835 2923 3217 3417 3566 3759 5096

2 Social Services 3325 3433 4314 5373 6956 7357 7677 7530 7063 68402.01 Education, Sports,

Youth Affairs1221 1287 1510 2336 2389 2521 2676 3017 3114 3151

2.02 Health and Family Welfare

456 491 595 780 906 969 907 1111 1204 950

2.03 Water supply, Housing etc

165 183 218 254 269 278 306 344 338 326

2.04 Information & Broadcasting

509 484 816 957 987 1066 1031 1074 1109 1017

2.05 Labour & Employment

435 496 516 641 763 799 737 654 721 771

2.06 Welfare of SC/ST & OBC

9 8 10 10 10 9 10 12 20 21

2.07 Other Social Services

530 484 649 395 1632 1715 2010 1318 557 604

3 Economic Services

5883 6283 5666 8365 7913 10077 8224 11517 14054 11763

3.01 Agriculture and Allied Activities

529 477 539 627 1266 1151 1067 993 1081 1784

3.02 Rural Development

2 1 6 7 9 10 8 21 9 9

3.03 Irrigation & Flood Control

88 93 122 139 146 152 158 155 165 170

3.04 Energy 519 735 812 31 663 -176 -157 60 -209 -733.05 Industry &

Minerals453 330 313 299 434 418 268 723 3155 1630

3.06 Transport 582 622 868 1119 1341 3733 2585 2177 1271 12543.07 Communications 45 34 43 28 36 41 66 334 237 2353.08 Science Tech. &

Environment934 1057 1334 1584 1720 1870 1948 2063 2176 2258

3.09 Dividend relief to Railways

388 468 536 602 685 812 896 1046 1228 1362

3.10 Export Promotion 318 397 429 574 520 621 616 628 932 9023.11 Other Economic

Services2025 2069 664 3355 1093 1445 769 3317 4009 2232

4 Postal Deficit 644 688 974 1572 1576 1529 1387 1359 1337 1355Total –Other Non-Plan Expenditure

22445 24140 29220 38262 44573 47083 46048 50733 54185 55144

Source: Government of India Expenditure Budget 2004-05, July 2004

Section-II 218

E. Expenditure Reforms Commission Recommendations and their implementation

Member Secretary of the Fourth Finance Commission has in his letter of April 27th 2004 sought supplementation of the study report with analysis of 3 issues including the quantification of savings that can be effected by implementing the recommendations of the Expenditure Reforms Commission and by curtailing some of the activities which neither fall within the Union or Concurrent list nor serve any National Policy, as such an analysis could be useful to the Commission in considering whether any normative approach could be applied to the Union Finances as well.

Expenditure Reforms Commission Reports –The Expenditure Reforms Commission was appointed after an

announcement in the budget speech of the Finance Minister for 1999-2000. The Commission submitted 10 reports in all between July 2000 and September 2001 covering various subjects as indicated below :-

First report (10th July 2000)Food SubsidySecond report (20th September 2000)Rationalising Fertilizer Subsidies: Optimising Government Staff

Strength :Rationalising of the Functions Activities and Structure of the Ministry of Information & Broadcasting: Rationalising of the Functions:Activities and Structures in the Ministry of Coal.

Third report (23rd December 2000)Department of Economic AffairsFourth report (20th September 2000)Ministry of Small-Scale Industries and Agro & Village Industries:

Department of Heavy Industry:Department of Public EnterprisesFifth report (7th March 2001)Department of Posts:Department of Supply:Autonomous InstitutionsSixth report (20th June 2001)Ministry of Steel:Ministry of Petroleum and Natural Gas:Department of

Chemicals and Petrochemicals:Department of FertilizersSeventh ReportEighth report (18th September 2001)Department of Agriculture and Cooperation :Ministry of Rural Development

:Ministry of External AffairsNinth report (18th September 2001)Ministry of Road Transport and Highways : Ministry of Shipping : Ministry

of Human Resources Development : Ministry of Youth Affairs and Sports : Ministry of Environment and Forests : Department of Culture : Department of Commerce

Tenth Report (25th September 2001)Ministry of Urban Development & Poverty Alleviation : Ministry of

Personnel, Public Grievances and Pensions :Ministry of Tribal Affairs :Ministry of Civil Aviation :Department of Tourism :Department of Industrial Policy & Promotion :Department of ExpenditureSection-II 219

Savings – Expected and Actuals

The ten reports of the Expenditure Reforms Commission covered various aspects, and the likely savings can be assessed if the recommendations in respect of three areas which have large budgetary implications. A. Food Subsidy. B. Fertilizer Subsidy and C. Optimisation of Government Staff Strength are examined.

While the ERC has done a pains taking job and deserves to be complimented for completing its task in a time bound manner, with clarity, one should in retrospect mention that the commission took on some of the intractable issues of expenditure management namely size of the official machinery, food subsidy and fertilizer subsidy all of which have political and other sensitivities attending on them. If the recommendations are sincerely implemented, they could make a qualitative difference to the structure of public expenditure if not to its size. While the excercise has been useful in instilling a measure of caution in various Ministries in respect of additions to the staff strength, the savings expected from reduction has barely been achieved. The experience of the Austerity Drive in the 1970’s showed that prescription of a percentage cut in expenditure, across the board did not achieve any useful purpose from the point of view of expenditure control but in some cases turned out to be counter productive, involving enormous official effort in scrutiny and approval, disproportionate to the eventual savings. The ERC did well to trace, the policy and programme imperatives of sensitive items of expenditure like food and fertilizer subsidies and with a disaggregated analysis cull out the elements that could be modified in a manner to ensure some qualitative impact of expenditure. Judging the effort of the ERC from only the monetary point of budgetary savings may not be appropriate. The ERC reports did serve a useful purpose, not necessarily from the savings point of view.

Food Subsidy –

Food subsidy is a sensitive theme and discussion of this as generated considerable heat without emitting adequate light. While the discussion paper on Government Subsidies released by the Ministry of Finance in 1997 sparked a debate, leading to consideration of the issues involved by the Parliamentary Committee attached to the Ministry Finance, the subsidies on food and fertilizers attracted attention, as they were considered “Explicit Subsidies” in the analysis made by economists. It was pointed out that the growth rates of food subsidies were 16.67% between 1971-72 to 1999-00, and fertilizer subsidy 20.87% between 1976-77 to 1999-00 (Central Budgetary Subsidies in India by D.K.Srivastava and Shri. H.K. Amar Nath, NAPFP page 17). There were arguments that these subsidies should be reduced and phased out. It was in this context that the Expenditure Reforms Commission turned its attention to Food Subsidy in its first report, (July 2000) and Fertilizer Subsidy in the second report, (September 2000).

Section-II 220

Pointing out that in the first full year budget after Independence presented on 28-2-1948, the expenditure on “ Food Subsidies including the bonus to provinces on the internal procurement of grain under the new food policy” was placed at Rs. 19.91 crores representing 14.6% of the total civilian budget, the ERC proceeded to point out its increase to Rs. 9,200 crores in the revised estimate for 1999-2000.

The ERC also took note of the fact that in 1999-2000 the overall food grain production reached 200 million tons mark, procurement level touched 29 million tons, food grain stocks reached 44 million tons and Public Distribution System had 4.5 lakh outlets with off take of food grains touching 19 million tons. The ERC felt that “The Food Policy pursued in the last five decades could definitely be considered a success story though there is room for arguing that the results achieved could have been much better”, (Paras 2 & 3 of ERC Report) and proceeded to argue that if a part of foreign exchange reserve had been utilized to import food grains, supply through PDS could have been at much lower price than the economic costs of the FCI and that the minimum support price for wheat itself was in excess of the FOB price of imported wheat.

The ERC conducted its analysis in a disaggregated manner, indicating (a) Consumer Subsidy incurred in the supply of food grains through PDS at below FCI’s economic costs (b) Cost of Buffer operations sub divided it into the cost required to maintain food security buffer and cost of holding stocks in the excess of the food security and PDS requirements and (c) The inefficiency of FCI attributable to the full cost reimbursement for its operations. The ERC took into account change in the PDS, in 1992 when the general entitlement scheme was converted into a Revamped PDS, with geographical area targeting, covering drought prone, desert, tribal, hilly and urban slum areas and the further change in 1997, when the Targeted PDS was introduced providing differential prices for those below poverty line and those above poverty line. The ERC also took note of the unevenness in the reach of PDS among the states as evident from the differences between allotment and off take.

After analyzing the various issues involved the ERC recommended that,

1. National Food Security – Buffer stock of 10 million tons, (4 million tons of wheat and 6 million tons of rice) should be maintained at all times.

2. The cost of buffer stocks held in excess of the above requirements should be treated as “producers subsidy” and action taken to phase it out over the next three years through (a) Moderate increase in the Minimum Support Prices (b) moving towards procurement of single variety of paddy/rice as in the case of wheat and making a suitable adjustment in the pricing mechanism to reduce procurement of paddy and incerease procurement of rice through a levy system (c) encouraging state governments and private sector to enter procurement trade and export of food grains through an assurance of continuity of policy for the next 15 years, with the declared objective of procurement policy being the maintanance of a food security buffer of 10

Section-II 221

million tons and availability of 21 million tons per annum for distribution through the PDS. ERC felt that the average stocks to be maintained for distribution and buffer stock should not be more than 17 million tons as against 24 million tons reached in 2000-2001.

3. Efforts should be made to minimize FCI’s overhead charges and the methodology for allocation of FCI’s overheads as between distribution and buffer stocks should be modified to ensure that the consumers particularly those below the poverty line are not made to pay for the cost attributable to excess stocks or FCI’s inefficiencies

4. Efforts should be made to ensure that the quantities allocated for the BPL Population reached them at the prices at which the Government of India releases the stocks and to ensure that BPL population is identified in a transparent manner.

5. In those states where the total distribution under the PDS is in excess of the quantities earmarked for BPL population and prices are below the price at which sales are to be made to the BPL population the Government of India could provide subsidy amounts directly to the state governments leaving it to them to procure the food grains required for the BPL population.

Assessment of ERC Suggestions

ERC felt that the suggestions made would lead to reduction in the economic costs thus benefiting the APL and BPL population alike. The ERC’s recommendation should be set against the background of the important role played by the MSP Scheme for boosting food grain production, the rationale for setting up Food Corporation of India for procuring stocks in the grain producing states and transporting them to the deficit states and establishment of vast distribution net work, across the villages and towns to cater to rural and urban consumers.

While the rationing system was in force in pre-independence days and the budgetary outgo was only Rs. 19 crores in 1948-49, Several stated faced serious problems of food shortage and near food riots during 50’s and early 60’s. This lead to the establishment in the 60’s, of the Food Corporation of India, in the Public Sector to take up procurement, transport and storage of Food Grains. Enabled by this, a network of Fair Price Shops were also established in many states to sell food grains at reasonable prices. The growth of this vast network of procurement transport and distribution of food grains implied increased budgetary out go on food subsidies reaching 47 crores in 1971-72, 700 crores in 1981-82, Rs. 2850 crores in 1991-92 and Rs. 17499 crores in 2001-02. Increase in the budgetary out go prompted the Comptroller and Auditor General to come up with a special report on the PDS operation between 1992 – 1999 and point out that between 1992 and 1999 food, sugar and kerosene oil subsidy aggregated to Rs. 77,379 crores and that in addition Andhra Pradesh, Kerala, Karnataka and Gujrat provided the subsidy of Rs. 8696 crores on their own schemes of food distribution. After a reported sample check covering 4664 fair price shop in 172 districts in 25 states and union territories

Section-II 222

conducted through a private agency the CAG Report had comments on poor targeting of beneficiaries, poor quality of grains and absence of vigilance.

The Planning Commission in its Mid Term Appraisal of the Ninth FYP, published in October 2000 reviewed the PDS and Food Security Schemes and commented that “huge as it may seem on paper, all is not well with the PDS in India. A large subsidy each year keeps the system going. A close look would show that the level of subsidies has risen from 2450 crores in 1991 to Rs. 8100 crores in 2001 and as a proportion of total governmental expenditure it went up from 2.5% at the beginning of the nineties to about 3% towards the end of the decade. The appraisal referred to a study conducted by TATA Economic Consultancy Services of diversion of stocks, according to which 36% of wheat supplies, 31% of rice and 23% of sugar were diverted and the estimated diversion were very high in the Northern, Eastern and North Eastern States and less in the Southern and Western region. Diversion of Stocks was less in the case of sugar as compared to wheat and rice. The Appraisal Report came up with suggestions for streamlining the Targeted PDS scheme and also suggested certain changes in the Essential Commodities Act.

The Administrative Staff College came up in 2001 with a study of the costs of acquisition and distribution of food grains by FCI for the Ministry of Food and followed it up in 2002 with a study of Fiscal and Monetary implications of excess stocks of food grains, for the Reserve Bank of India. The report pointed out, the Minimum Support and Procurement Prices were regularly increased for both paddy and wheat, often to a level higher than a recommended by the Agricultural Prices Commission, later redesignated as Commission for Agricultural Costs and Prices. (CACP), as indicated below

Rupees per Quintal1979-80 1989-90 1990-91 1995-96 1999-

2000Paddy 95 185 205 360 490Wheat 115 185 215 360 550

The Study also do attention to a details of procurement, offtake and stocks remaining with the FCI for the years 1990-91 to 2000-2001, which indicate that while the procurement levels fluctuated between 17.16 million tons 1991-92 to 36.46 million tons the offtake was marked by year to year fluctuations leading to gradual increase stocks as a mach end each year. The stocks level were a low of 11.07 million tons in 1991-92 and high of 28.91 million tons in 1999-2000. During 2000-01 the procurement was 36.46 million tons, (rice 20.10 mt, Wheat 16.3 mt. ) the offtake was only 70.95 million tons (Rice 10.22 mt, Wheat 7.73 mt) leaving a very large stock of 44.98 million tons (Rice 23.19 mt, Wheat 21.50 mt.). The study pointed out that the level of stocks of 60 million tons at the time of study is unsustainably high and that if the future offtake did not increase, the level of stocks could go up to nearly 75 million tons. The increasing stocks and holding costs resulted in the increase of food credit, both outstanding and incremental. A shown below

Section-II 223

(Rs. Crores)As of March end Outstanding Incremental 1980-81 1759 -1101990-91 4569 27021995-96 9791 -24841996-97 7597 -21941997-98 12485 48881998-99 16816 43311999-00 25691 88752000-01 39991 14300

Section-II 224

The study also pointed out that the fiscal burden was essentially on account of the growing food subsidy with a large section of the consumers not gaining the benefit of the subsidy. While suggesting a menu of options that could be considered in order to reduce the overhang up of stocks, the study was cautious in pointing out that in the search for a proper short to a medium policy share for reduction of excess stocks, it would be idle to pretend that any one measure of those mentioned in the study will help to achieve the desired results. “It would be necessary to work out a multi pronged approach where in the combination of measures may have to be undertaken.”

In the light of such studies and concerns the Government of India appointed a Committee on Long Term Food Policy. This Committee submitted its report in July 2002 covering issues relating to Minimum Support Price, Price Support Organizations, FCI operations and functioning of the Public Distribution System and the Requirement of Long Term Food Grain Policy covering buffer stocks, open market introductions, policy for import and export of grains.

While critics were pointing out the mounting food grains stock and their fiscal implication other observers were pointing out that the piling up of stocks and increase in food credit could also attributed to the scheme of differential issue prices for BPL and APL categories. What is required to be noted is that while the food management system was periodically refined and retuned by changes in buffer stock norms made in 1975, 1981, 1992 and 1998. The 1998 policy norm specified stocks of 15.8 mt on April 1st , 24.3 mt on July 1st, 18.1 mt on October 1st

and 16.8 mt on January 1st. The ERC came up with a different norm. A review of procurement shows that the quantum increased from 24.16 million tons in 1991 to 36.46 tons, but the off take fluctuated, rising from 16.49 million tons in 1991 to 25.63 million tons in 1996-97, falling thereafter to 17.95 million tons in 2000-01. The stocks available also fluctuated reflecting the fluctuations in off take. Food grains stock on 1st May 2004 was 33.7 million tones as against the buffer stock norms of 15.8 million tones. The off take in 2003-04 was 47.93 million tones. Export of food grains had also picked up and the outstanding food credit registered a sharp fall.

The budgetary provisions for food subsidy increased from Rs.5377 crores in 1995-96 to Rs.6066 crores in 1996-97 Rs. 7900 crores in 1997-98 Rs.9100 crores in 1998-99 Rs. 9434 crores in 1999-2000 Rs.12060 crores in 2000-01 Rs.17497 crores in 2001-02 Rs.24176 crores in 2002-03 and Rs.25200 crores in 2003-04. The budget for 2004-05 makes a provision of Rs.25800 crores for food subsidy. Analysis of financial implications have to take into account the fluctuating food production, depending on the behaviour of the monsoon, the distribution of rain fall in different states across the country and the possibility of some state or other being affected by draught and the need for movement of stocks into those areas. The Economic Survey of 2003-04 for instance pointed out bright prospects for agriculture production in 2004-05 based on the forecast of a normal monsoon by the Indian Metrological Department and came up with a suggestion that their should be Section-II 225

a freeze on the cost based minimum support price (MSP) and increase in the Central issue prices of food grains sold through PDS, in line with the economic cost to contain the subsidy bill. During 2003-04 a good monsoon helped to increase food grain production from 174.2 million tones in the previous year to 2010.8 million tones. While this helped in containing the inflation, there was increase in procurement, and high MSP, introduced with the previous years low production in mind. As the Survey put it “during 2000-01 and 2001-02, there were excessive build up of public stock support grains, much above the minimum buffer stock norm. Large volumes of unsold public stocks pushed up carrying cost and pushed the subsidy bill. The carrying cost accounts for 25% of the subsidy”. It is in the light of such an assessment that the survey suggested freeze of minimum support price. It was also argued that increasing MSP had not only distorted domestic prices but also eroded export competitiveness. As an exporter of food grains India cannot have its domestic grain prices out of sink with FOB export prices. It was also argued that high levels of MSP tend to disturb inter crop price parities leading to a shift in cultivable area towards cereals even while there are huge stock of food grains and oil seed production needs to go up to reduce imports of edible oils. What needs to be noted is that while fluctuations in food production and prospect of drought conditions, dictate programme for procurement and increase in stock holding pressures of budget exert the contrary pull. In some years the burden of carrying cost gets moderated by regular increases in the Central issue prices of wheat of rice and wheat as shown below.

Central Issue prices of Rice and Wheat (Rs. Per Quintal)Year Rice Wheat1990-91 289 2341991-92 377 2801992-93 377 2801993-94 437 3301994-95 537 4021995-96 537 4021996-97 537 4021997-98 BPL 350 250

APL 700 4501998-99 BPL 350 250

APL 905 6501999-2000 BPL 350 250

APL 905 6822000-01 BPL 565 415

APL 1130 8302001-02 BPL 565 415

APL 830 610Source: Ministry of Food, Consumer Affair and Public Distribution

Section-II 226

The Indian Institute of Economics conducted a seminar on the New Food Grain Policy in October 2002, in which the senior officials of the Government of India and the State Government participated. While there was no consensus, the emphasis of most participants were on the need for a multi dimensional view of the food management system and for continued intervention by Government and Public Bodies, as Indian agriculture was still vulnerable to weather fluctuation despite improvement in production technology and the evident need for shock absorbers in the economy to meet the fluctuations in the availability and prices of food grains. Some senior officials felt that constitutionally, Food is a subject of the Centre and that Union Government cannot abandon its responsibilities for managing the food system mainly to control budgetary deficit. The present system has evolved over a period of nearly 40 years with FCI taking it into account the specific conditions in the each state and accordingly trimming its operations. Any redefinition of the role of the FCI should take into account the need for Government intervention to balance the interest of all groups, the producer and the consumers. It was suggested that excessive stock could be depleted by a policy of exports. The Discussion Paper of the Indian Institute of Economics had concluded that “while PDS had some weaknesses, it also acts as a moderator of the market mechanism which, when left to itself, can manipulate the demand-supply situation to its advantage and to the detriment of the consumer both in terms of price and availability” and that “those critical of the PDS appear to forget that the scheme with the universal coverage as provided regular supply to 20 crores consumers while the back up of procurement operation of FCI and state agencies had extended to 11 crore operational farm holdings”.

Concern with the increasing subsidy and criticism of FCI operations has made the Government to devise various measures covering buffer stock norms level of procurement, steps to increase offtake and regulate food credit. These measures appeared to have been affective between April 2002 to March 2003. As against opening stock of 51.0 million tons in April 2002, regulation of procurement to 38.2 million tons and increase in offtake to 47.6 million tons (20.1 mt) under PDS. Issue of 11.7 mt. for Jawahar Rozgar Yojana and other welfare schemes, issue of 5.8 mt. for Open Market Sales and 11 mt for exports ) Brought down the closing stock level to 32.8 m.t in March 2003. The outstanding food credit was brought down from 52483 crores in April 2002 to Rs. 49479 crores in March 2003. Between April and November 2003, the procurements was restricted to 27.1 mt. and offtake covered 11.7 mt for PDS, 9.1 mt. for Welfare schemes, 1.1 mt. for Open Market Sales and 7.4 mt for Exports. The Closing Stock in September 2002-03 was only 23.7 mt as against the buffer stock norm of 18.1 mt for September. The Outstanding Food Credit was brought down further 36020 crores by October 2003. The Economic Survey 2003-04 has observed that the comfortable supply situation and remarkable price stability in respect of food grains in different parts of the country despite poor monsoon in 2002 have demonstrated the relevance of our food security system. The total offtake of food grains from Central pool was 47.93 million tons, with export of food grains accounting for more than one fifth. Food Credit fell by 27.3 % in 2003-04 because Section-II 227

of lower procurement and higher offtake of grains still left a stock of 33.7million tons on 1st May 2004 as against the buffer norm of 15.8 million tons.

The comfortable stock position has given a measure of confidence up. While the ERC focused on food subsidy from the point of view of expenditure containment reducing the outgo from the budget, the issues need to be settled in terms of both the philosophy of an elected government whose major responsibility is to not only moblise resources and manage expenditure but also be answerable to the vast multitude of farmers in rural areas and consumers in rural and urban areas.

Section-II 228

Fertilizers Subsidy –

In its second report submitted in September 2000 the ERC came up with the recommendations on Rationalizing Fertilizers of Subsidy. The report reviewed the dramatic increase in Fertilizers Subsidy outgo from Rs. 505 Crores in 1980 – 81 to Rs. 12000 Crores in 2000 – 01 and felt that the need to subsidize fertilizers to induce farmers to increase their usage has gone down as Green Revolution Technology as been widely accepted. While recognizing that the Retention Price Scheme introduced by the Government of India has contributed to the development of domestic fertilizer industry, the ERC felt that the unit wise cost plus approach, has resulted in high cost fertilizers, excess payments to industry and did not provide any incentive to manufacturing units to be cost efficient. The ERC suggested a reform of fertilizer policy to bring the price of fertilizers to the level of import parity and to promote balanced use of nitrogen, potassium and phosphates.

The package suggested by the ERC to rationalize fertilizer subsidies in a gradual and phased manner over a period included the following steps.

1. To protect small and marginal farmers who consume a large part of their output from a loss in their real incomes arising out of increase in farm gate prices of fertilizers, two options could be considered (a) Introduction of dual price scheme under which all cultivator house holds are given 120 kgs of fertilizers at subsidized prices and (b) expansion of Employment Guarantee Scheme and rural Works programmes to provide additional incomes to small farmers.

2. Dismantling of the controlled system in a phased manner leading to a decontrolled fertilizer industry which can compete with imports albeit with a small protection and a feedstock cost differential compensation to naphtha/LNG based units to self sufficiency.

3. A 7% increase in the price of urea in real terms every year from01-04-2001,so as to bring the open market price of fertilizers to a level of Rs. 6903 by 01-04-2006, a level at which the industry can be freed from all controls and be required to compete with imports with variable levy ensuring availability of such imports at the farm gate at Rs. 7000 per ton of urea. This would mean that no concessions will be necessary from that date onwards for gas based, fuel oil/ Low Sulphur heavy stock (LSHS) and mixed plants, existing naphtha plans converting to LNG. New plants and additions to existing plants will be entitled to a feed stock differential with that for LNG plants serving as a ceiling.

4. The farm gate prices of nitrogenous, phosphatic and potassic fertilizers should be set to promote a desired balance of fertilizer use. To enable this, the prices of potassic and phosphatic fertilizers should be suitably adjusted, to the re-determined urea price every six months. The Government should announce in advance the formula to be adopted for fixing the prices of P & K fertilizers with reference to a given urea price.

Section-II 229

While the above is a summary of the recommendations of the ERC as provided in the Economic Survey of the Ministry of Finance, a study of the report of ERC shows that the Commission had applied its mind to the details of cost of manufacture, in different plants based on various feed stocks, the origin and logic of the fertilizer policy, the unit wise retention price scheme and its consequences, the options for reforming the fertilizer policy and the calibration of the move from control regime to competitive self reliance. It had also applied its mind to the relative uses of urea, phosphatic and potassic fertilizers usage. The ERC also suggested a reference to the Tariff Commission, on the issue of DAP based on imported ammonia and phosphoric acid. The report has referred to procedural delays in the disbursement of subsidy and suggested that the arrangements for administration of the subsidies should be modified by making it subsidies the responsibility of Ministry of Chemical and Fertilizers while continuing to give to the Ministry of Agriculture a major role in the fixation of the maximum retail or indicative prices.

Assessment of ERC recommendationThe ERC recommendations for phased reduction of subsidies

and decontrol, has to be examined in relation to the need to monitor the relative handicaps Indian fertilizer industry face vis-a-vas global fertilizer suppliers and international prices of petroleum feed stocks. The fertilizer industry was set to acquire a certain degree of self sufficiency, not withstanding the relative disadvantages of alternative feed stocks like gas, naphtha and fuel oil. But with a view to controlling the increasing subsidy bill the Government announced partially control of the fertilizer industry in August 1992, releasing phosphatic and potassic from control on the ground there were consumed less than nitrogenous fertilizers. As a result the subsidy bill dropped from Rs. 5796 crores in 1992-93 to Rs. 4399 crores in 1993-94. The experienced however was rise in the prices of phosphatic nutrients and resultant drop in consumption from 28.4 lakh tons to 26.7 lakh tons in one year, which was significantly below the peak consumption of 33 lakh tons in 1991-92. This forced Government to announce an ad hoc subsidy in 1994-95 with a budgetary provision of Rs. 528 crores. The element of ad hoc affected the Industry, which also faced the threat of imported fertilizers. The subsidy on imported fertilizers showed a steep increase from Rs. 114 crores in 1987-88 to Rs. 1,933 crores in 1995-96. The Industry continue to protest against ad hocism in policy resulting in increased imbalance of nutrient consumption, higher dependence on imports, with fluctuating impact on subsidy out go. It was argued by many in 1997 that any move to remove pricing and subsidy support may effect and introducing the Indian units to global competition may lead to large scale closure of domestic plants, resultant loss of indigenous production leading in turn to heavy dependence on imports and the consequent likelihood of exploitation of our predicament by suppliers in the global market (See Economic Times 13th Dec 1997 and The Hindu Business Line Dt. 26th /12/1997).

Section-II 230

In January 1997, the Government appointed an High Powered Fertilizer Pricing Committee (HPC) to examine the various issues faced by the industry, and to help it overcome the uncertainty it was facing. The Government was obliged to look beyond the subsidies. It has subsequently transpired that between 1997 and 2003 six plants have been shut down.

The implementation of the recommendations of the ERC commenced from Feb’02 when modest increases were announced in the issue prices of urea, DAP and MOP with effect from 28-02-2002 (see the statement on implementation of Budget Announcements made by the Minister of Finance Feb 28th

2003). The Ministry of Chemical and Fertilizers announced vide its letter (No 12019–5–98 FPP dated January 30th 2003), a new pricing policy for urea manufacturing units to be effective from 01-04-2003 and to be implemented in 3 stages, stage 1 from 01-04-2003 to 31-03-2004, stage 2 From 01-04-2004 to 31-03-2006 and stage 3 to commence after a review of stage 1 & 2. The new pricing policy divided the fertilizer plants into six groups based on age and feed stock use, with differential concessions to be determined with reference to a group retention price, providing for escalation in variable cost. The announcement also referred to the phased decontrolled of urea distribution and movement, and the manner in which freight equalization will be worked out. In July 2003 the Ministry also followed with the prescription of energy norms to be enforced on manufacturing units to ensure efficiency in operations. In August 2003 the Ministry announced reduction in capital related charges for units in 3 categories. For 2003-04 Finance division of the Fertilizer Ministry had indicated a likely saving of Rs. 538 Crores on the then prevalent feed stock prices.

The budget provisions for fertilizer subsidy commenced 1976-77 with Rs. 60 Crores, increasing there after to Rs. 1898 Crores in 1986-87, Rs. 7578 Crores in 1996-97, Rs. 9918 Crores in 1997-98, Rs. 11388 Crores in 1998-99, Rs. 13250 Crores in 1999-00 and Rs 13800 Crores in 2000-01. There after the outgo began to come down to Rs. 12595 Crores in 2001-02 and Rs. 11015 Crores in 2002-03. The outgo can be analysed in terms of the three components of subsidy.

Fertilizer Subsidies Breakup(Rs. Crores)

Year Indigenous Urea

Imported Urea

Sale of De-Controlled

Total

1995-96

4300 1935 500 6735

1996-97

4743 1163 1672 7578

1997-98

6600 722 2596 9918

1998-99

7473 333 3790 11388

1999-00

6670 74 4500 13250

2000- 9480 1 4319 13800Section-II 231

012001-

028044 47 4504 12595

2002-03

7790 - 3225 11015

2003-04 (RE)

8139 1 3656 11796

2004-05

8143 473 4046 12662

What needs to be noted is that between 1995-96 to 1998-99, while import of urea was considered an option, in the latter years this has come down and there is increase on subsidy on sale of decontrolled fertilizers with concessions to farmers. The budget for 2004– 05 has a provision of Rs. 12662 Crores, with Rs. 8143 Crores towards subsidy on indigenous urea fertilizers, Rs. 473 Crores on imported urea fertilizers, and Rs. 4046 Crores for sale of decontrolled fertilizers with concession to farmers with a view to enable them to maintain a healthy N:P:K ratio.

The issues involved in determining the effectiveness of the new pricing policy are somewhat complex, as the Indian Fertilizer Industry still continues to be based on various feed stocks, gas, naphtha and fuel oil/LSHS both indigenous and imported. The plants are also of different vintage. The new pricing scheme grouped fertilizer units in two age categories pre 1992 and post 1992 and further grouped them according to feed stock used in manufacture. As on 01-04-2003 the grouping was as follows :-

Pre 1992 Post 1992 TotalGas 6 7 13Naphtha 6 2 8Fuel

oil/LSHS4 - 4

Mixed 3 - 3Total 19 9 28

In the light of the earlier experiences, one could argue that the linkages built between feed stock availability, fertilizer manufacture, distribution network, the soil and cropping patterns in different areas, preferences of farmers and food crop and commercial crop production need to be maintained in the interest of food security and welfare of farming community. This chain of links may have its weak spots, and one can find scope for cost savings. It may be more worthwhile to pay close attention to removing these weaknesses than by concentrating on budgetary savings through segmented approach to fertilizer manufacture and farming economics. There is at the moment, some discussion on who secures the benefit of the subsidy, the fertilizer manufacturer or the farmer, and there are even imputations that the fertilizer manufacturers have benefited more and farmers have been deprived of the intended benefits. Such arguments are often based on sectional analysis of the large chain of linkages mentioned above.

Section-II 232

One can even argue that the Fertilizer Subsidy is not solely a concession to the fertilizer manufacturer or the farmer but also benefits the rural and urban consumers with the linkage to the minimum support price for grains in procurement operations to support the Public Distribution Scheme. What is important is the appreciation of the concatenation of policy and programme elements which had evolved over a period. One can at the same time also argue that the interplay of vested interests, at the base of the political pyramid have pushed the burden of subsidies. The ERC’s disaggregated analysis of Farmer Subsidy, Retention Price Scheme for the Industry and Consumer Subsidy should be considered as a useful contribution to rationalizing the Governmental support for Fertilizer Industry, farmers and the consumers. To understand the importance and budgetary impact of subsidies, one should examine food and fertilizer subsidy together and view the benefit for the ultimate consumer. While the total subsides in 2004-05 amounts to Rs. 43516 crores, Food and Fertilizers account for Rs. 38462 crores and petroleum subsidy Rs. 3559 crores and other subsidies Rs. 1495 crores. The inputs for farmer and food for consumers all over and their prices are important for the nation. A multi-disciplinar approach, may enable a holistic view of fertilizer subsidy schemes and their implications for the efficiency of fertilizer manufacture and farmgate price advantage and efficiency of input use for the farmers.

Section-II 233

Optimisation of Staff –

ERC recommendations in the Ten Reports covered 36 Ministries and were mainly as follows :

1. A cut of 10% on the Staff strength as on 1st January 2000 to be carried out by the year 2004 – 05 besides an Annual direct recruitment plan for all cadres should be prepared by a screening committee.

2. There should be a total ban on creation of new posts for 2 years.3. Staff declared surplus should be transferred to the surplus cell to be re-

designated as the division for retraining and deployment which will pay their salaries and retirement benefits etc.

4. Surplus staff should be made eligible for a liberal Voluntary Retirement Scheme recommended by the Fifth Central Pay Commission, with the exception that the commutation entitlements will be as at present and the ex-gratia amount will be paid in monthly instalments over a five year period.

5. Those who do not opt for Voluntary Retirement and are deployed within one year will be discharged from service.

The ERCs report covered 36 Ministries that had total sanctioned strength of 8.65 Lakhs of the identified surplus manpower of 42,200 in those Ministries 12,200 posts were expected to be abolished by the end of March 2002. Examination of the recommendation in respect of certain Ministries were still continuing. The decision to limit fresh recruitment to 1% of total civilian staff is to be implemented over a four year period. As per reports 2003, 23,901 posts were identified for abolition by various Ministries and out of these, 12,898 posts were abolished. It is seen that while the civilian strength was estimated at 8.65 Lakhs, the abolition of posts were family touched 13,000. Even this level of abolition of posts would have meant some savings in the salary out goes.

Far more significance should however be attached to steps like the Ninety First Amendment to the Indian Constitution, limiting of the size of the Council of Ministers in the Centre and the States to 15% of the legislative strength. This is likely to result in enormous savings on account of this in the expenditure on salaries of the Ministers and their staff, even more in their traveling bills and security arrangements. Since the amendment has become effective from 7 th July 2004, the implementation has commenced and the savings will be reflected only in the budgets of the next year.

The notification of the Fiscal Responsibility and Management Act and the rules framed under it to become effective from July 4th 2004, with a stipulation of reduction in revenue deficit and fiscal deficit, along with capping the level of guarantees and total liabilities that Government can assume can also be considered a significant landmark in fiscal consolidation expenditure containment. It is significant that the Expenditure Reforms Commission itself was allowed to expire at the end of its tenure. A similar time bound approach to various Commissions of enquiry, could also result in savings. There could be a moratorium Section-II 234

on appointment of retired Civil Servants and Judicial Officers to Commissions and Committees. Any extension of the term should be with the approval of the Parliament.

Normative Approach -

It has been suggested that the scope for expenditure control by curtailing some activities which neither fall within the Union or Concurrency list nor serve any national policy should be examined as such an analysis could be useful to the Finance Commission in considering whether any normative approach could be adopted for the Union Finances. While as a conceptual preposition, adherence to the Constitutional allocation of subjects to the Union and the States make a significant difference to their finances, the difficulty appears to be in securing this operationalised. The need for restructuring Centrally sponsored schemes has been debated for a long time and recommendations of the National Developmental Council have been on no avail.

Even advocates of fiscal consolidation and votaries reforms seem to falter at the altar of political power and patronages that the Union Government functionaries can wield over the State Governments. The Common Minimum Programme drafted, among others by some known to be advocates of fiscal reform, has advocated thrust in areas which are the responsibilities are those of the states. Budget 2004-05 brings out once again the political reluctance for adherence to the Constitutional allocation of subjects to the Union and the States, by creating the Backward States Grants Commission, without the recommendation of the Finance Commission or Discussion in the NDC. In these circumstances one can say that while an normative approach can be formulated reasonable prospect for its adoption appear remote.

It may be noted that in the Ninth Finance Commission was required to “adopt a normative approach in assigning the receipts and expenditures on the revenue account of the states and the center and in doing so keep in view the special problems of each state, if any, and the special requirements of the Center such as refunds, security, debt servicing and other committed expenditure or liabilities” (Para 4.1 of Terms of Reference dated 17th June 1997). The Commissions report mentioned that “ Adoption of a normative approach and incorporation of the plans side of the revenue account, however, rise to some important operational difficulties. As comprehensive norms have to be developed for Central and the State Governments for the first time, several conceptual and methodological issues have to be resolved. We are also aware that norms prescribed by the Finance Commission would have to be realistic so as to be capable of being adhered to by the Central and State Governments. In undertaking this task, it is also necessary that the exiting institutions and the developmental process initiated through the planned programme should not be hampered in any way but instead, that the conducive fiscal environment should be created for economic planning” (Report of the Ninth Finance Commission Para 2.38).

Section-II 235

The Ninth Commission also felt that the normative approach should not only satisfy the criteria adopted regarding equity, efficiency and fiscal responsibilities but should also lead to the phasing out of the revenue deficits and then in due course to the generation of surplus for Capital Investment. The Commission had also felt that translation of normative approach into a practicable plan could take considerable time, would mark a radical departure from the basis on which Finance Commissions have been operating and it would not be fair to the parties concerned to adopt it without giving them sufficient notice. Keeping in view the problems this approach would pose in plan implementation, the Ninth Finance Commission opted for a selective adoption of norms in the assessment of revenue and expenditures.

It is significant that the states had protested against some of the formulations of the Ninth Finance Commission, since it involved commission dictating expenditure norms which were the prerogative of the State Governments. This lead to the Commission clarifying that the prescription of norms implied “ No interference in the rights of the State Governments to raise resources and incur expenses at such levels and in such a manner as desired by its people and its legislature. The norms are relevant only in arriving at the relative entitlement to Central transfers and are so designed as to insure inter state equity in working out such entitlements” (Para 2.17 Ninth Finance Commission report). We may need to note that the Tenth and Eleventh Finance Commissions that followed were not required to adopt a normative approach nor did their approach have elements of such a methodology. The previous experience in adoption of normative approach to assessment of revenues and expenditure, whether in respect of the Finances of the Union or of the States is still relevant. It is also necessary to make a distinction between what is desirable as a goal and objective and what is practicable within the constitutional and legal frame work in position. There are obvious limitations in the Federal Frame work, flowing from the distribution of functional responsibilities and resource mobilization powers as between Centre and the States, and the past practices and conventions that have grown around the mechanism evolved for transfer of resources from Center to the States. Foremost of these is the political environment and legislative authority. Prescription of norms for expenditure, has the past faced counter questions regarding legal competence. In view of this it is necessary to also consider alternative approaches for achieving the desirable goals.

While adopting norms for expenditure, it may also be necessary to note that while the total expenditure of the Central Government as increased in absolute terms from Rs. 105298 Crores in 1990 – 91 to Rs. 400396 Crores in 2002 – 03, and further to Rs. 474255 Crores as per R.E 2003 – 04, and the rate of growth of aggregate expenditure as been higher than the rate of growth in revenue during the 90’s. However judged by another indicator, total expenditure as a percentage of GDP, it is seen that there is a fall from 18.5 % in 1990 – 91 to 16.2 % in 2002 – 03. As for 2003 – 04, the budget estimates place it at 16 % and revised estimates at 17.2 %, and 2004 – 05 Budget Estimates indicate the ratio at 16.6 %. Arguing for a rationalization of the Centre State revenue transfer system adopting a Section-II 236

normative approach, Amaraesh Bagchi and Pinaki Chakraborty point out that need for a radical review of the practices of planning, plan financing and Central Assistance and the necessity for taking a holistic view and doing away with plan and non-plan distinction in revenue expenditure, which is a source of distortions in the expenditure priorities of the centre and the states and conclude that “Until that happens rationalization of the transfer system will not be possible. However, the way fiscal reforms are proceeding in our country, such a radical departure from the past practices would seem to be a distant goal”. (NIPFP Seminar September 2003)

Section-II 237

There should be attempts to improve the operations within the existing Constitutional framework. As A.Premchand and S. Chattopadhyay point out “the design of expenditure management frame work should pay adequate attention to the changing portfolio of expenditures. To the extent that a growing share of expenditures is in the form of transfers to local governments, complementary efforts need to be made to improve their operational effectiveness”. (see Fiscal Policies and Sustainable Growth in India, Oxford University Press 2004 P.252) Attention to the design and delivery systems with a clear understanding of the need and scope for COST CONTAINMENT in respect of all items of expenditure can make substantial difference. Even given the existing budgetary structure, and the conventions relating to classification of expenditure into Plan and Non Plan, and the relative functions of the Finance and Planning Commissions such an approach is possible. It may be of advantage to examine whether the cost of execution of schemes, and the outgoes in respect of staff and programmes could be better controlled by imposing cash management approach and expenditure control related to the budgetary provisions. This implies a certain measure of detailed scrutiny of schemes and projects, and proper attention to time phasing of implementation before provisions are made in the budget. It was invariably the practice, in the past to make budgetary provisions only after verification of the details of administrative and financial sanctions obtained after securing the approval of the competent authorities, and to make only token provisions where administrative sanctions had been given but financial approval has not been obtained. Such financial discipline is not observed now either at the pre-budget or the post-budget stages. Timing and quantum of release of funds often bear no relation to the time phasing of schemes and projects indicated at the time of approval, resulting in cost and time overruns, with consequent delays in the flow of expected benefits.

One often hears Ministerial level, announcements of schemes and projects, without budgetary provisions and legislative approval “for new items of expenditure”, as required under the rules. It then becomes the responsibility of official machinery to set in motion the process for formulation and approval of schemes. Given the environment of such fiscal laxity and indiscipline, and lack of respect for constitutional prescriptions, expenditure control and budgetary priorities become difficult. Lack of respect for audit by the CAG and the legislative requirements of scrutiny by the Public Accounts Committee, have also become common. These basic flaws need to be addressed and removed before adoption of normative approach, is considered by the Finance Commission.

Section-II 238

F. Inter Sectoral Priorities

Member Secretary Twelfth Finance Commission has indicated that norms for desirable levels of public expenditure in different sectors based on inter sectoral prioritization and inter sectoral efficiency parameters would facilitate proper monitoring of public expenditure, and that an attempt to relate public spending to productivity and overall achievements against targets particularly in respect of developmental expenditure would help focus attention on improving that quality of expenditure.

We must at the outset take note of the following points (a) Given the Constitutional division of functions and responsibilities, reflected

in the allocation of subjects in the Union list, the states list and the concurrent list, criteria for prioritization of expenditure for the two tiers of Government will have to be different, and that the Parliament, and Union Council of Ministers, as also the State Legislatures and Councils of Ministers should be the ultimate authority for deciding inter sector priorities.

(b) Given the wide variations in resource endowment, the levels of development and the administrative and technical infrastructure available in the different states, setting priorities may not be an easy task. The need to take into account the cultural differences should also be kept in view. In the areas of developmental programme, over the years the Planning Commission, has acquired experience and built up some measure of expertise required to set inter sector priorities in Plan Expenditure, while discussing the Five Year and Annual Plans of the States. The Finance Commission may have to take this into account, and decide whether it would like to confine its attention to the non-Plan Expenditure. While this may seem some what less of a responsibility, as the vital need is to take an holistic view of public expenditure, one should not lose sight of the fact that within the non-Plan, and non developmental sector there is a need to consider and set reasonable limits for various items of expenditure. The Finance Commissions have also the advantage of visiting the various states and holding discussions with the State Governments and various organizations representing industry, trade and commerce as also public finance experts, and are therefore in a position to guide the states in fine tuning their priorities.

One must however note that it has been argued by the Fifth Finance Commission and much later by the State Governments before the Ninth Finance Commission that a norm prescriptive approach infringes on the rights of the State Governments and Legislatures and restricts their authority and discretion to Finance activity as their deem appropriate. Perhaps the Twelfth Finance Commission can choose to tender advice without appearing to give a mandatory prescription.

(c) It should also be noted that the budgetary and accounting classifications of allocations and expenditure some times conceal and some times cut across the flow of funds for activities in different sectors. This emerged in an in-

Section-II 239

house exercise relating to the Union Finances in the late 70’s, carried out by me at the instance of the then Finance Minister Shri C.Subramaniam. It is well known that the classification of expenditure into developmental and non developmental, and also into Plan and non-Plan has its weaknesses even while serving some purposes. In view of their limitations, in providing a basis for inter sectoral priorities, what can emerge is only a broad view. In the common view there is much hype regarding developmental and plan expenditures, but this overlooks the fact that some parts of non-plan expenditure can be developmental expenditure.

(d) Total developmental expenditure can be both direct developmental expenditure on social and economic services as also by way of loans and advances such as a housing, crop production, power projects and small industries. Nov-developmental expenditure can include Capital Expenditure.

At the Union level, concern regarding improvement in patterns of expenditure has centered on the (a) decline in the share of developmental expenditure (b) decline in capital expenditure in the relative shares of revenue and capital expenditure and (c) decline in plan expenditure in the relative shares of plan and non-plan expenditure. Analysis of time series data indicate that at the centre between 1980-81 and 2000-2001. Total expenditure, as a proportion of GDP had decline of 3.03 % from 18.5 to 15.47, with revenue expenditure increasing by 0.2 % from 12.9 to 13.1 and capital expenditure showing a steep fall by 2.9 % from 5.6 to 2.7. Development expenditure, as a ratio to GDP declined from 9.3% to 6.6% while non-development expenditure increased from 6.9 to 9.38%. This seems to lend strength to the argument that fiscal consolidation measures involving in expenditure compression had effected capital expenditure and developmental outlays. Across the sectors it has become common knowledge that social sector bore the brunt of expenditure deduction.

As regard the states, since deterioration commenced in the later eighties, a look at the relative position, every five years is shown in the table below.

Analysis of States Expenditure (as % of GDP)1989-90 1994-

951999-

2000Total Expn. 15.8 16.0 16.6Revenue Capital

12.43.4

12.73.3

13.92.7

Plan Non-plan

4.711.1

4.411.3

4.012.0

Development 10.9 10.3 10.1Economic Services 4.7 4.7 5.5Social Services 5.2 4.9 4.0General Services 1.0 0.8 0.6Non-Development 4.0 4.9 5.6Others 0.9 0.8 0.9

Section-II 240

Section-II 241

The quantum and shares of developmental and non-developmental expenditure in the total expenditures of the Centre and the States and combine can be seen from the table below

DEVELOPMENT AND NON DEVELOPMENT EXPENDITURE (Rs.Crores)

Centre States State and centre

Combined

Years Dev N.Dev Total Dev N.Dev Total Dev N.Dev Total

1980-1981 13327 9867 23194 15961 4289 22770 24480 12738 37879(9.3) (6.9) (16.2) (11.1) (3.0) (15.8) (17.0) (8.9) (26.3)

1990-1991 58645 49349 107994 63370 22600 91242 96686 63397 163673(10.3) (8.7) (19.00) (11.1) (4.0) (16.00) (17.4) (11.1) (28.8)

1999-2000 129151 177928 307079 187297 110206 313889 273604 258053 545813(6.7) (9.2) (15.85) (9.67) (5.69) (16.21) (14.13) (13.3) (28.18)

2000-01 139386 197470 336856 210543 118887 347198 309053 272906 592429(6.6) (9.38) (16.00) (10.0) (5.65) (16.5) (14.7) (13.0) (28.15)

2001-02 159364 215456 374820 236384 143625 401571 350624 315197 677729(6.9) (9.38) (16.32) (10.3) (6.26) (17.5) (15.27) (13.73) (29.52)

2002-03(RE) 190630 237008 427638 246150 160391 430934 377866 375861 766981(7.71) (9.59) (17.3) (9.9) (7.5) (17.4) (15.3) (15.2) (30.5)

Note: 1. Total in the case of states includes ‘Others’ comprise discharge of internal debt, repayment of loans to the center and compensation and assignments to local bodies and Panchayati Raj Institutions.

2. Total in the case of Centre and State combined includes ‘Others’ which relate to state governments and are adjusted for repayment of loans by State Governments to center as given in Central Government Budget Document.3. Figures for Centre and States do not add up to the combined position due to inter-Governmental adjustment.4. Figures in brackets indicate Percentage of GDP(at market prices).

Data given in Economic Survey of Govt. of India differ as they cover internal and extra budgetary resources of the Public Sector undertakings.

The aggregation of expenditure at the sectoral and state levels conceals an important aspect of relevance to quality of expenditure namely the ability to make a rupee go the farthest. Given the intra district, intra state, and inter state differentials, assessment of budgetary ratios alone may not be adequate to ensure proper inter sectoral priorities or utilization of funds. Decentralisation of developmental decision can be more useful in linking expenditure to the local needs. The constitution of District Planning Committees and empowerment of local bodies can make a difference, to the quality of expenditure and better public services, if only, the pattern of flow of funds and sectoral priorities are indicated, leaving the

Section-II 242

choice of individual schemes to the district and local levels. The nation and the developmental decision makers, have not been able, as yet, to evolve a proper blend of planning of allocations from the top and scheme formulation and execution at the local levels.

The issues involved in sectoral priorities emerged sharply, particularly after the experience of economic reforms in the nineties. It has been argued by many that importance to fiscal consolidation, and expenditure contraction have affected inter sector priorities in expenditure programmes with adverse effect on social sector . Dr. Sanjaya Baru (New Economic Policy, Economic and Political Weekly April 10, 1993) had drawn attention to the likely deflationary and high costs of social adjustment bound to be faced by the poor in the process of macro level fiscal consolidation and pointed out that in the budgets of early nineties, “share in total government expenditure of important sectors like education, health, small scale industries and public distribution scheme was not very significant. While the aggregate expenditure increased, the budgetary increase for the social sector was less than one percent”. In its analysis of the finances of the State Government and of the Government of India published in April & May 2001, the Economic and Political Weekly Research Foundation, pointed out that “the budgetary trends during the reform period show that actual performances has not been even remotely comparable to the Five Year Plan target and goals and that objective of fiscal consolidation, resulted mainly in sever compression of plan expenditure in general and investment in particular”. A study of Management of Public Expenditure by State Governments in India, conducted by the Indian Institute of Economics for the Planning Commission drew attention to the impact of budgetary conservatism on the social sector and pointed out that between 1993-94 and 2000-01, while the aggregate expenditure of Government of India increased from Rs. 143872 crores to Rs. 335522 crores, the allocations for social services and poverty alleviation, also increased from Rs. 17851 crores to Rs. 42455 crores, both showing increase in absolute numbers. However, while aggregate expenditure had continued to remain at about 12% of GDP social sector allocations came down from 2.08% to 1.87%.

The important role played by state finances in the macro economy can be assessed from the fact that the total expenditure of State Governments (Rs.3,25,634 crores or 16.6% of GDP) over took the total expenditure of Centre (Rs. 315258 crores or 16% of GDP) in 1999-2000. While the overall developmental expenditures of the state has always been higher than that of the Centre. It is note worthy that in total governmental expenditure on social services the share of the state government constituted over 86%. This is of great significance to the deliberations and recommendations of the Finance Commissions. It may be necessary to take note of the composition of revenue expenditure. As per an analysis of the budgets of the State Governments, the total revenue expenditure of the states had increased from Rs. 71776 crores (12.6 % of the GDP) in 1990-91 to Rs. 290622 crores (13.3% of GDP) in 2000-01. Of these share of developmental expenditure had increased from 48855 crores to Rs. 161966 crores in absolute terms, but as a percentage of GDP there was a fall from 8.6% to 7.4% and as a share of total revenue expenditure there Section-II 243

is a fall from 68.8 % to 56.7 %. The relative shares of social services and economic services have also shown a fall. While the share of non-developmental expenditure increased from 3.9 % to 5.7 %, in terms of GDP, its increase as a share in total revenue expenditure was 31.2 % to 43.3 %, this was mostly in the category of general services. Expenditure on debt servicing and interest payments, administrative services and pensions explain this increase. Setting inter sector priorities in expenditure may require the Finance Commission to go well beyond its traditional role, which can no doubt be justified by the terms of reference which seeks a plan for restructuring the public finances.

The inter state variations in the relative rates of growth of expenditure between 1990-2000 shown in table below may need the attention of the Twelfth Finance Commission.

Table : 3.4 Average Annual Growth of Expenditure States/Territories 1990-2000 Dev Non Dev1.Andhra Pradesh 14.6 18.72.Arunachal Pradesh SC 12.3 13.33.Assam SC 15.0 20.14.Bihar 14.8 17.15.Chhattisgarh6.Goa SC 14.7 36.37.Gujarat 15.6 18.48.Haryana 14.6 26.19.Himachal Pradesh SC 15.6 20.710.Jammu& Kashmir SC 13.5 2211.Jharkhand12.Karnataka 13.5 17.513.Kerala 15.6 18.914.Madhya Pradesh 13.2 17.815.Maharashtra 14.0 19.516.Manipur SC 18.0 19.017.Meghalaya SC 15.2 17.518.Mizoram SC 13.5 19.819.Nagaland SC 9.4 14.520.Orissa 15.3 17.821.Punjab 16.1 26.522.Rajasthan 15.9 20.923.Sikkim SC 15.2 78.124.Tamil Nadu 13.2 20.225.Tripura SC 12.9 16.926.Uttar Pradesh 12.8 17.827.Uttaranchal28.West Bengal 16.9 20.2Section-II 244

Delhi (NCT) 48.7 67.4All States 14.1 19.2Source : RBI State Finances 2000-01 pg 28 and 29

There is need to reduce the disparities in the levels of expenditure and even more in the levels of coverage and standards of public services among the various states. Set against this context, the need to formulate norms for desirable levels of public expenditure in different sectors becomes fairly clear but the question will still remain as to who should set this levels?. Should the Finance Commission suggest to each state for its adoption or whether this should be for the Union Government to make it part of the guidelines for utilization of grants is to be settled or for the states themselves to review and reset the priorities? This needs to be settled.

What are the desirable levels of spending for various sectors. The United Nations Development Programme had in 1991 suggested four ratios for comparing and monitoring social sector expenditure

The Public Expenditure Ratio: The percentage of national income that goes into public expenditure. The recommendations is to keep this ratio around 25%.

The social allocation ratio: the percentage of public expenditure earmarked for social services. This ratio, according to the UNDP, should be more that 40%.

The social priority ratio: the percentage of social expenditure devoted to human priority concerns. This ration has to be more than 50%.

The human expenditure ratio: the percentage of national income devoted to human priority concerns. This ration is the product of the above three ratios and the UNDP recommends that it should be about 5%.

According to the Human Development Report 1991, India had public expenditure ratio of 37% social allocation ratio of 20% and social priority ratio of 34% and Human Expenditure ratio 2.5%. This has been disputed by Sri. S.Mahendra Dev and Jos Mooij, whose calculations indicate the public expenditure ratio was 25.4%, social allocation ratio 27.4%, social priority ratio 40% and human expenditure ratio 2.78% (Social Sector and Budgeting, S. Mahendra Dev and Jos Mooij, Centre for Economic and Social Studies, Hyderabad, January 2002).Both in working out the ratios of the past expenditures, and those to be adopted in the future there is need to bear in mind the budgetary classifications of expenditure and indicate the specific items that will be taken into account in working out these ratios.

Relating public spending to productivity and overall levels of achievement against targets is a desirable approach. What is important is not setting targets or productivity norms but the more mundane task of monitoring and matching the progress of physical work and ensuring availability of men, materials and money at the appropriate time. At the moment the budgetary releases from the state government are done by fits and starts, and the field agencies often complain about non release of funds during the working Section-II 245

season. The system need to be tuned for operational efficiency and not setting new norms. There is a mismatch between announcement and action.

Section-II 246

Assessment of Expenditure Management by Government of

India

More than a decade after the Economic Reforms were

launched elevating fiscal consolidation as a major objective, the

Union Government still appears to be grappling with the basic

problems of managing its own finances, even while burdened with

the responsibilities of motivating and guiding the states to effect

improvements in their fiscal health. Even while appreciating the

efforts made by the Government of India to improve its fiscal

position, an objective assessment will be marked by more than a

tinge of disappointment even if not of disapproval.

The Reserve Bank of India in its Annual Report 2002-03 had

observed that expenditure management strategies put in place by

the Centre in the early 1990s have begun to yield room for fiscal

maneuvers in recent years. (pg 53). But it appears that it is too

early to express satisfaction over the management of public

expenditure in recent years and therefore a closer look at the

composition, and reorientation of budget is an urgent need.

While the Reserve Bank has expressed its satisfactions over the expenditure management, there have been voices of dissent from other circles .For instance, in May 2003 the Economic and Political Weekly while publishing the Special Statistics on the Finances of Government of India for the period 1989-90 to 2003-04 observes that “ there Section-II 247

is no doubt that the Central Government Budget for 2003-04, particularly when judged against the political discourses that took place around the budget time , has further widened the gulf between promise and reality….. an impression imported by the overall budgetary operations of the government is that, despite so much of hype and pretence of budgetary dynamism every year , the broad budgetary heads have remained static in relation to the size of the national economy during the past 10 to 12 years. Revenue receipts have ranged between 9 to 10 % of GDP and total expenditure has remained around 16 %. Within total expenditure non plan expenditure has stubbornly remained between 11.1 to 12.1 % of GDP and plan expenditure between 3.9 to 4.7 %. Even the fiscal deficit has remained static at around 5.6 % . It is only the revenue deficit that has shown a creeping rise from 2.5 % to 4.1 % . The radical changes that one expected in the role of Fisc in the national economy as a result of reforms are no where to be seen” (Economic and Political Weekly, May 10th 2003, pg 1887). This is perhaps an angrier version of the admission made by the Finance Ministry in the Economic Survey for 2002-03 that, “Fiscal consolidation a key element in the package of Economic Reforms remains an un-finished task.” (Economic Survey 2002-03, pg 22).

The implications of fiscal management for the national economy have been brought out succinctly by the Asian Development Bank’s assessment in its Country Strategy and programme 2003-06–India, published in August 2002. Presenting the relevant numbers in the changing dynamics of growth and highlighting the deceleration in growth rate of the Indian Economy, the Bank has observed “ the deceleration has been attributed to external shocks such as the Asian Crisis of 1997, the events of September 11, 2001, or the poor monsoon of 2002. However reduced growth of 5 to 6 years cannot be attributed to transient factors alone. Systemic factors have been at work driven primarily by fiscal imbalances. Growth was earlier led by public investment. However the situation has changed significantly , especially in the late 1990s . Servicing of the burgeoning public debt , the burden of large subsidies and a sharp increase in government salaries in the late 1990s following the recommendations of the Fifth Pay Commission Report have crowded out Public Investment .It declined from 11.2 % of GDP in FY 1986 to 8.2 % in FY 1993 6.6 % in FY 1998 and 6.3 % in FY 2002. Unfortunately private investment failed to fully replace public investment as an engine of growth since the private sector was constrained by large government draft from the total savings pool and the low level of business confidence. The consolidated fiscal deficit of central and state governments together is estimated at 9.3 % of GDP in 2002. Private savings amount to 26.5 % of GDP, Private investment only 16 %. Thus almost 40 % of private saving are transferred through the financial sector to finance government deficit. The effect of this crowing out of private investment is compounded by low progress of policy reforms and by policy uncertainties in some sectors. Reduced rates of public and private investments , inturn constrain expansion of capacity and especially the development of infrastructure thereby reducing the economy’s growth potential. Consequently after a brief period of acceleration in the mid 1990s, growth has decelerated in recent years.”

The ADB report further stated that “ While government has no control over monsoons and external shocks, it can embark on an aggressive fiscal adjustment Section-II 248

programme to reduce the chronic revenue deficit and implement reforms to reduce policy distortions and policy uncertainty. These measures will revive business confidence as well as public and private investment and shift the economy to a high growth path. (ADB, Country Strategy and Programme 2003-06, India, August 2002, pg-2)

While it is perhaps natural for financial institutions to advocate “ aggressive” approach to fiscal reform, elected governments such as the one at the Centre-one multi-party coalition replaced by another, have to manage the economy as also the nation, and may therefore opt to be circumspect, preferring pragmatism and political consensus weighing the policy options on the scales of feasibility and popular acceptability. The heroic declarations of the last decade on the reduction of revenue and fiscal deficits have now been moderated, as evident from the Union Finance Minister’s statement in his budget speech, “under the FRBM Act, I am obliged to wipe out the revenue deficit by 2007-08. However, the National Common Minimum Programme has proposed that we do so by 2008-09. In my view, 2008-09 is a more credible terminal year: it will also coincide with the term of this Government. Hence I proposed to move an amendment to this effect through the Finance Bill” (Para 7, Budget Speech, July 8th 2004)

The rationale for this can be found in the Statement on Macro Economic Frame Work, laid by the Minister of Finance before the Parliament as required as in Sec. 8 of the Fiscal Responsibility and Budget Management Act. 2003. It states that “after some improvement in the early nineties, the fiscal situation started worsening from 1997-98,with the pay revision of Government employees and economics slowdown. Fiscal deficit of the central government after declining from 6.6% of GDP in 1991 to 4.1% of GDP in 1996-97 started rising from 1997-98 to reach 6.2% of the GDP in 2001-2002. The deterioration in revenue deficit of the central government was sharper. The cumulative effect of high fiscal deficits has been an increase in the debt GDP ratio, with outstanding liabilities of the central government declining from 55.3% of GDP in 1991 to 51.2% of GDP in 1998-99. Before starting to rise again to reach 62.1% of GDP” (Para 11 of Macro Economic Framework Statement).

The Twelfth Finance Commission is expected to have regard to the resources of Government of India for five years commencing on 1st April 2005 on the basis of levels of taxation and non-tax revenues likely to be reached by the end of 2003-04 and demands on the resource of central government on account of its own functional responsibilities. The emerging picture from the revised estimates of 2003-04 and budget estimates of 2004-05 are as follows

Fiscal Indicators – Rolling Targets (% of GDP)2003-04 RE 2004-05

BE2005-06Targets

2006-07Targets

Revenue Deficit 3.6 2.5 1.8 1.9Fiscal Deficit 4.8 4.4 4.0 3.6Gross Tax Revenue /GDP 9.2 10.2 11.1 12.1Total Outstanding Liabilities 67.3 68.5 68.2 67.8

Section-II 249

For 2003-04, the budget indicated gross tax revenue of Rs. 251527 crores and the revised estimates Rs. 254923 crores and the net tax revenue to the centre are Rs. 184169 crores and Rs. 187539 crores respectively. The net tax revenue indicated in the revised estimates mark an increase of 17.63% of the actuals of Rs. 159425 crores in 2002-03. The Union Budget 2004-05 projects a gross tax revenue of Rs. 317733 crores and the net tax revenue of Rs. 233906 crores. The net tax revenue projection is an increase of 24.72% over the revised estimates for 2003-04. The projections have assumed an average annual nominal growth rate of 12% in GDP, 22% per annum in Gross Tax Revenue, 26% in Direct Taxes and 19% in In-Direct Taxes.

It is difficult to be confident about the realization of this projection, as the experience of past three years 2000-01, 2001-02, 2002-03 have shown, the budget estimates have been over optimistic. Such optimism on the part of the Union Finance Ministry may provide the Twelfth Finance Commission an easy way out for in the resource forecast. The Tenth and the Eleventh Finance Commissions forecasts of revenue and expenditure of both the Union and the States have turned out to be way off the mark when compared to the realizations. Dr. Amresh Bagchi has argued that “doubts about the the value or even the credibility of the Finance Commissions’ projections of revenue and expenditure of the states and the centre are based on a misperception of the role of the commission. The FC is not supposed to anticipate how the states will frame their budget; their task clearly is to adjudicate the sharing of revenue between the centre and the states and their allocations among the states in their judicious manner. So their projection cannot be faulted if they turned out to be vide of the actuals. Dr. Bagchi attributes it to the inability of Finance Commission to free itself from the tyranny of the base year (paper NAPFP Seminar on Issues before the 12th Finance Commission, September 2003).One must submit that the nation can ill afford to be so casual about such a major responsibility, and the Chairman of the 12th Finance Commission had in this inagural address not only pointed out that a good transfer system should serve the objectives of equity and efficiency and should be characterized by predictability and stability but also referred to the problem arising on account of the practice of recommending devolution of taxes in terms of shares of central taxes. While such a practice provides for automatic sharing of the central tax buoyancies, they may also need to a genuine problems for the states, if growth in central taxes falls short of expectations.

The Twelfth Finance Commission may therefore recommend the shares of states as a percentage of the Union Budgets estimates as the minimum, and a proportionate share flowing to the states in the subsequent year if the collections exceed the budget estimate. Since the states frame their expenditure programmes, duly factoring the tax devolution, the Centre should take some responsibility for the shortfalls if any in the realization. This is important, as the constitutional amendment to give effect to the Tenth Finance Commission alternative scheme of devolution chose specifically to define the shares as percentage of net proceeds, giving due credit to the administrative and other needs of central missionary for collection of taxes and duties.

Budget Support of the Tenth Plan

Section-II 250

There are two major areas which also need attention from the Twelfth Finance Commission in assessing the resources of the Centre for the period 2005-2010.The Tenth Five Year Plan approved by the Planning Commission in October 2002 and by the National Development Council in December 2002 envisages a total outlay of Rs. 15,92,300 crores (Central Plan Rs.9,21,291 crores and State and Union Territories Plans Rs.6,79,009 crores) calling for a steep increase over the Ninth Five Year Plan outlay of Rs. 8,75,000 crores (Central Plan Rs.5,05,165 crores and states and UTs Rs.3,66,979 crores ).This calls for an increase in budgetary support from Rs. 3,74,000 crores in the Ninth Plan to Rs. 7,06,300 crores in the Tenth Plan. It must be noted that the proposed outlay amounts to an increase of 67.4 % over the Ninth Plan realization and that the gross budgetary support realized during the Ninth Plan was only Rs.3,16,286 crores about 84.6 % of the projected level of Rs. 3,74,000 crores. The Tenth Five Year Plan document draws attention to the deterioration in balance from current revenues caused by stagnant level of revenue receipts and substantial growth in non-plan revenue expenditure. The current assessments made in the Planning Commission showed that during the IX Plan period Central assistance to the states was only Rs. 1,38,394 crores as against the projection of Rs.3,74,000 crores. In other words, the realization of budget support for plan was 87.2 % of projection for the Central Plan and 81.4 % in terms of Central assistance to the States and UTs . Planning Commission’s assessment for the X Plan assumes Central assistance to the States and UTs at 42.5 % of Gross Budgetary Support as against 43.8 % realized in the IX plan.While the budget support requirements for the X Plan may be outside the immediate frame of reference of Twelfth Finance Commission, the demand from this cannot be ignored if a holistic view should be taken of the Finances of the Union and the States.

Section-II 251

Demands of the States

The other major question which the Twelfth Finance Commission has to grapple with emerges from the demands of the States for increasing their share in the resources of the Centre. This demand has been made before the earlier Commissions. The Tenth finance Commission had come up with an alternative scheme of devolution according to which 29 % of the total tax revenue would be transferred to the states and this share would be in operation for a period of five years. The third meeting of the inter state council held in July 1997 had reached consensus in this issue , but the scheme could not be given effect to as it required Constitutional Amendment. Though the required change was made in the Constitution, through the 80th Constitution Amendment Act 2000, it was with the modification that the proportion in which the states will share not the gross proceeds but the net proceeds of all central taxes and duties and that the share will not remain frozen for 15 years as proposed by the Tenth Finance Commission but will be reviewed by successive Finance Commissions. The Eleventh Finance Commission had recommended that 28 % of the net proceeds of all shareable Central Tax and Duties be transferred to the states and had further suggested that Tax devolution and Plan and Non Plan transfers should not exceed 37.5 % of the gross revenue receipts of the Centre.

In the Note on Action Taken submitted to the Lok Sabha along with the report of the Eleventh Finance Commission in July 2000 , the Finance Minister has indicated that the Union Government has accepted this ceiling on total revenue account transfers from Centre to the States, with a rider, “ however the acceptance does not imply the establishment of a principle of mandatory sharing of a fixed percentage of Centre’s revenue receipts with the States.

In a Memorandum submitted to the Prime Minister , Eight state governments had however argued that there should be no such ceiling and that the total transfers to the states had ranged from 38.72 % to 44.06 % during the period 1990-1995 and this share began to decline only in the recent period. Suggesting that this trend should be reversed in order to meet the increasing developmental responsibilities , the states urged that 37.5 % should be treated as a minimum share to be transferred to the states.

It would appear from our analysis, that while the previous Finance Commissions had in the course of their re-assessment , under estimated the revenue expenditure and over estimated the revenue receipts , and imposed on Centre the obligation of meeting their recommendations for higher levels of resource transfer, there is no finality on the specific share of the states, either viewed as a floor or as a ceiling.

Plan and Non-Plan

While academics appear to feel that issues involved in transfer of resources could be competently dealt by doing away with the distinction between Plan and Non Plan ,

Section-II 252

Dr.Ajit Mozoomdar , who has held positions as Secretary in the Finance Ministry and the Planning Commission has offered a different view while dealing with India’s Federal Future, with the observation “ in the past some states and academics have proposed that Plan and Non Plan transfer of resources should be merged into a single stream or atleast that the two kinds of transfers should be decided by a single agency, preferable the Finance Commission which is a quasi-judicial body. It has been argued that the elimination of discretionary transfer would strengthen Federal Governance . This idea was rejected by the Sarkaria Commission for good reasons which still remain valid. Resource allocation between states should not be completely formulae bound . Plan and Non Plan allocation are rightly decided on different principles” (See India’s Federal Future, Dr.Ajit Mozoomdar, in ‘Political Reforms:Asserting Civic Sovereignty’ Edited By V.A.Pai Panandikar and S.C.Kashyap, Centre for Policy Research , Konark Publishers , Delhi, 2001 pg:222).

Calibrated Change

The Twelfth Finance Commission , may therefore have to deal with the complex issues of resource sharing , with a open and fresh mind, keeping a reality check on the prescriptions made by academicians , and demands, a la Oliver Twist , made by state Governments. Radical suggestion are offered by some more with a view to strike a different path than with the intent or responsibility for implementing the suggestion. Indian experience has relevant examples of moderation succeeding where aggression may have failed. The calibration shown for instance in the financial sector reforms following the two reports of Committees headed by Shri.M.Narasimham has much to commend itself for adoption and implementation in the fiscal sector for bringing about changes in fiscal balances and sustainability. A review of the secular trends show that the strengthening of the monetary and banking infrastructure and the softening of the interest rates have thrown positive signals. The interest liability of the centre during the Ninth Plan period increased only at an annual average rate of 12 % as against the annual rate of 17.5 % during the Eighth Plan. However there is the question of differences in the burdens cast on the centre and the states which needs to be tackled and necessary corrective action brought about. Even in the area of tax reforms, there is need to strike a balance between the resource needs of government and simplification of the system.

The Twelfth Finance Commission in its exercise for drawing up a fiscal restructuring plan may consider making a change in the manner of prescribing targets for operational convenience of those implementing budgetary and fiscal reforms. The Eleventh Finance Commission’s plan for restructuring of public finances with targets in terms of GDP ratios has made no significant impact on the implementing agencies including the Finance Ministry as the estimates of GDP , appear to be not so readily accessible for those who need to be not only clearly focused on the composition and growth of revenues and expenditure but also have to make mid course corrections during the year. The Central Statistical Organisation, generally publishes initially, Advance and Quick Estimates, follows up with Provisional Estimates and then comes up with the Revised Estimates. The time lag can be justified in view of the time taken for collection Section-II 253

of data from different sectors and the responsibility cast on the organization for ensuring reasonable accuracy and consistency in its presentation. This however can be an handicap for authorities charged with the task of monitoring and guiding the course of fiscal and financial operations as also for others at the implementation level. The publications (Indian Public Finance Statistics of the Ministry of Finance, the Department of Economic affairs, which has the Budget Division) and the Reserve Bank of India(Annual Report, Report on Currency and Finance and the Hand Book of Statistics) all indicate the time lag in collection and analysis of data, though the Ministry of Finance is directing and monitoring flow of budgetary funds and the Reserve Bank of India has hands on experience in monitoring credit and banking system operations and access to current data on the economy. It is also worth noting that the estimates of growth rates on the basis of which the Reserve Bank formulates its credit policies are marked by changes within an year.

All these appear to indicate, that the GDP data while serving as a useful reference point for analysis of sectoral performance, in retrospect, do not necessarily provide a convenient frame work for fiscal policies and operations and mid season corrections. It is to be seen whether Finance Departments of the state governments and the Union Ministry of Finance, will respond better to a simpler system of prescription of fiscal and budgetary targets in terms of percentage variations from budget estimates over the previous years and the actuals of the corresponding periods of previous years.

Chapter - II

Finances of State Governments – A macro view

The Twelfth Finance Commission has been required in the Terms of Reference to have regard among other considerations to : (i) the resources of the states government for five years commencing on first April 2005 on the basis of levels of taxation and non tax revenues likely to be reached at the end of 2003-04. (ii) the objective of not only balancing the receipts and the expenditure on revenue account of all the states but also generating surpluses for capital investment and reducing fiscal deficit and (iii) taxation efforts of each state government as against targets if any and the potential for additional resource mobilization in order to improve the tax GSDP ratio. This study is required to focus only on the expenditure side with analysis of the quality and efficiency of state government expenditure, identification of structural and process related sources of inefficiency, and assessment of the fiscal performance using various budgetary variables and ratios as criteria, as also to indicate the norms of expenditure on the basis of which the objective of balancing receipts and expenditure on revenue account, of generating surpluses for capital investment and of reducing fiscal deficit can be met.

Section-II 254

Overview of State Finances

The continuing distress on the fiscal front and implacable fiscal imbalances, that emerged in the late 80s and assumed grim proportions in the nineties, will be evident from the snap shot pictures of budgetary transactions over the last five decades given below. The marginal revenue deficit in 1950-51 had continued to be so even in 1970-71 and had turned into revenue surplus of Rs.1486 crores (0.13 % of GDP) in 1980-81, but this was followed by a large revenue deficit, of Rs.5,309 crores (0.93 % of GDP) in 1990-91, and further to Rs. 53,569 crores (% of GDP) by 2000-01. The capital account with fluctuating balances gave a different picture, and made difference to the overall surplus .

Table: 2.1 Budgetary Transactions of the States (Rs.crores) Revenue Account Capital Account Aggregate Rec Exp Diff Rec Exp Diff Rec Exp Diff1950-51 396 392 +4 164 189 25 460 581 -1211970-71 3371 3390 -19 1662 1784 -122 5033 5174 -1411980-81 16294 14808 +1486 5473 7856 -2383 21767 22664 -8971990-91 66467 71776 -5309 24693 19312 + 5381 91160 91088 + 722000-01 237953 291522 -53569 111591 55677 +55914 349544 347198 +23452001-02 255599 314833 -59234 124507 62722 61785 380106 377555 +255102-03BE 306844 355159 48314 118811 75683 43128 425655 430842 -5187 RE 293873 355175 -61302 143419 87434 55985 437292 442609 -531703-04BE 334290 382616 -48326 146935 105744 41191 481225 488360 7135Source :Compiled from GOI Documents and RBI Reports

Expenditure Management by the States 1951-52 to 1999-2000

A study of Management of Public Expenditure by State Governments in India covering the period upto 1999-2000, carried out by the India Institute of Economics, Hyderabad for the Planning Commission, summarized the findings as follows A perspective view of the State’s Finances reveal enormous

increase in transactions on both the Revenue and Capital Accounts .

(a) The total receipts on Revenue Account increased from Rs. 396.4 crores in 1951-52 to Rs. 64842 crores in 1990-91, and Rs. 214810 crores in 1999-2000 .Revenue expenditure increased from Rs. 392.6 crores in 1951-52 to Rs. 70993 crores in 1990-91 and Rs.271611 in 1999-2000.

(b) The Capital Receipts increased from 164.64 crores in 1951-52 to Rs. 21868 crores in 1990-91 and Rs. 101612 crores in 1999-2000 and capital expenditure increased from Rs. 189.47 crores to Rs. 18025 crores and Rs.54023 crores during the same period.

Section-II 255

State Budgets recorded more revenue surpluses than deficits during the first six five year plans and deficits if any during this period was relatively small, but from the mid eighties onwards, the revenue deficits became regular feature of the State Budgets increasing from Rs. 4582.4 crores in 1989-90 to Rs. 56801 crores 1999-2000.

Capital Account depicted fluctuations between small surpluses and deficits uptill the fourth plan period but from the mid-eighties, the capital account started recording increasing surpluses.

This trend of revenue deficits and capital surpluses continued in the nineties. The Revenue deficit increased from Rs. 5651 crores in 1991-92 to Rs. 56, 801 by 1999-00(RE). and capital surplus increased from Rs. 5495 crores in 1991-92 to Rs. 47589 crores in 1999-00(RE). With the revenue deficit increasing at a much faster pace than capital surpluses, overall deficit also increased.

During the nineties, Gross Fiscal Deficit increased from 3.30 percent of GDP in 1990-91 to 4.13 percent of GDP in 2000-01 (BE). The primary deficit decreased first, from 1.78 percent in 90-91 to 0.93 in 97-98 and then increased to 2.52 percent of GDP in 1999-00(RE) and on the other hand, Revenue Deficit increased steadily from 0.93 percent of GDP in 1990-91 to 2.91 percent of GDP in 1999-00(RE)

The Tenth Finance Commission also noted that an increasing part of Capital Receipts was used for financing revenue deficits leading to growth of public debt and interest burdens . With further expansion of Revenue expenditure and spiraling deficits, the GFD of the States increased from Rs. 3713 crores in 1980-81 to Rs. 18787 crores. In 1990-91 and to Rs. 56802 crores in 1999-2000 (RE)

While the emerging picture of state finances as seen from the main fiscal indicators ,showed weaknesses in the late eighties , culminating in signs of stress in the nineties but as pointed in the RBI study the key deficit indicators, like revenue deficit, GFD etc. while serving as useful information variables do not depict a vital aspect of the States resource gap in the context of inter institutional transactions and constitutional restraints on the borrowing powers of the State contributing to the ‘artificial’ stagnancy of GFD.

In the financing of GFD of the states , loans from the Centre, market loans and small savings and other (including PR fund etc) increased significantly from the eighties to the nineties . Loans from the centre increased from Rs. 1567 crores in 1980-81 to Rs. 9978 crores in 1990-91 and to Rs. 39879 crores in 1999-2000 (RE) Market Borrowing (net) increased from Rs. 198 crores in 1980-81 to Rs. 2556 crores in 1990-91 and to Rs. 11829 crores in 1999-2000 (RE).Small savings and others increased from Rs. 1948 crores in 1980-81 to Rs. 6253 crores in 1990-91 and further to Rs. 43031 crores in 1999-2000 (RE).Consequently, the total out standing liabilities of the States increased from Rs. 23959 crores in 1980-81 to Rs. 110289 crores in 1990-91 and further to Rs. 41852 crores in 1999-2000 (RE) and Gross interest payments increased from Rs. 1225 crores in 1980-81 to Rs. 8655 crores in 1990-91 and further to Rs. 45526 crores in 1999-2000 (RE)

Expenditure on Administrative Services increased from Rs. 1562 in 1980-81 to Rs. 7018 in 1990-91 and further to Rs. 24424 crores in 1999-2000 (RE) and pensions increased from Rs.

Section-II 256

375 crores in 1980-81 to Rs. 3593 crores in 1990-91 and further to Rs. 24750 crores in 1999-2000 (RE). The constricting nature of non-plan expenditure, reduced the availability of resources for investment and also maintenance expenditure leading to a structural weakness in the state finances. Eight state governments show a persistent and growing revenue deficit.

Bihar (Since 89-90), Kerala (Since 83-84) , Maharashtra (Since 88-89), Orissa (Since 84-85) , Punjab and Tamil Nadu (Since 87-88) , West Bengal (Since 86-87) , Uttar Pradesh (Since 88-89)

Tenth Finance Commission reported that (a) All the States had almost identical ‘turning points’ on their financial deterioration(b) This was indicative of ‘Systemic’ factors, rather than ‘State Specific’ factors.

Other analysts have pointed out that the financial and institutional weaknesses at the State level emerged as major constraints on the provision of social and infrastructural services, and that the impact of structural adjustment policies in the nineties, affected expenditure patterns in various sectors with consequences for different economic and social groups to the detriment of basic objectives of Indian Planning like growth with social justice and equity . There has been a deceleration in social sector expenditure in thirteen major states, including those with low levels of Human Development since the mid 1990’s. The social costs of transition are felt mainly by the marginalised sections of society, with decreasing plan expenditure on social services.

Overview of finances at the centre and the states indicate fiscal deterioration marked by fiscal deficits of various kinds, with the state finances also deteriorating in the nineties on account of systemic factors and that the economic reforms and the structural adjustment policies led to compression of public investment at the Centre and lower social sector expenditure in the states.

Aggregate Budgetary Picture 1980-81 to 2000-2001

With a view to facilitating a rapid view of the states aggregate budgetary picture , the numerical values of the transactions are presented for the years

1980-81 , 1985-86 1990-91, 1995-96 and 2000-01 in Table 2.2 Table : 2.2 Overall Budgetary Position Of All States Governments

(Rs. In Crores)Items 1980-81 1985-86 1990-91 1995-96 2000-01

1 Aggregate Receipts

21872 46557 91313 180433 349544

A. Revenue Receipts

16293 33424 66466 136803 237953

1 Tax Receipts 10405 21810 44586 99912 168715A States' own 6616 14551 30344 63865 117981

2 Non Tax receipts

5888 11613 21880 43890 69238

a States' own 3265 5290 9237 22895 31456B Capatal Receipts 5579 13133 24847 43630 111591

a States'own 2257 4765 10872 24030Section-II 257

b Central loans

3022 8368 13974 19599 18966

2 Aggregate Disbursements

22770 44868 91242 177583 347198

A. Developmental Expenditure

15961 31732 63369 114819 210543

1 Social Services

6601 14540 29960 57835 113690

2 Economic Services

9360 17192 33409 56984 96853

B Non Dev Exp 4289 9617 22600 55379 118887C Repayment of

Loans to Centre1458 2611 3996 4798 10570

D. Discharge of Internal Debt

178 503 337 1055 2246

E Others 884 404 938 15313 Overall balance -897 1688 71.6 2849 2345.6

The Table– 2.2 reveals the shifting patterns of receipt and

disbursements, overall balances in the state finances during this

period. The broad trend one notices, is that the overall resource gap

of the states began to increase mainly on account of worsening

deficit on the Revenue account in the late eighties and a closer look

at the budgetary positions show a turning point in 1986-87.During

the eighties revenue expenditure of the states grew at an average of

17.6 % per annum much faster than the growth of revenue receipts.

The budget constraint at the state level appears to have been

hardened by the introduction of the Overdraft Regulation Scheme

(ORS) and the regulation of market borrowing. There is view that

the ORS by limiting the extent to which states could incur

overdrafts during a financial year translated into a cut in the

expenditure of the state budgets and a marked deceleration in the Section-II 258

growth of capital expenditure at the state level from 8.8 % to 3.9 %

between 1980 and 1987. The states also began to resort to

financing resource gap through loans from Central Government,

Market Borrowings and state provident funds .

The continuation of this trend in the early nineties led

Reserve Bank of India to observe in its Report “Finances of State

Government 1995-96,” that “the aggregate consolidated budgetary

position of State Government in –95-’96 reflected an acceleration

of the structural weakness in their finances. A matter of particular

concern is the deficit of the revenue account which persists for the

ninth year in succession and is estimated to increase by nearly 36

percent to Rs. 10,461.7 crores in 1995-96”. Seven State

Governments show a persistent deficit in the revenue accounts viz.

Bihar (Since ‘89-’90), Kerala (‘83-‘84) Maharashtra (‘88-’89),

Orissa (‘84-’85), Punjab (‘87-’88), Tamilnadu (‘87-’88), Uttar

Pradesh (‘88-’89) and West Bengal (‘86-’87)”.( State Finances

1995-96, RBI Bulletin, Dec. 1995 page 1000). Deficit Indicators of

Centre and the states are presented below for a comparative

understanding.

Table 2.3. Deficit Indicators (in Rs.Crores) Centre All States 1980-81 1990-91 2000-01 1980-81 1990-91 2000-01

Section-II 259

RevenueDeficit

2037 18562 85234 -1486 5309 53569(1.41) (3.47) (4.1) (0.11) (1.0) (2.5)

Gross Fiscal Deficit

8299 44632 111275 3713 18787 89532(5.75) (8.33) (5.1) (2.73) (3.5) (4.3)

Net FiscalDeficit

5110 30692 111972 NA 14532 84698(3.54) (5.73) (5.1) (2.7) (4.1)

Primary Deficit

5695 23134 17473 2488 10132 37830(3.94) (4.32) (0.46) (1.83) (1.9) (1.8)

Structural Weakness

Presenting an analytical overview of Centre and State

Finances The Tenth Finance Commission in its report of 1994 had

noted that , “the change in the fiscal regime from 1982-83 has

meant that what was earlier a non debt creating source of financing

has become a source of rising internal indebtedness. In the other

words, while Revenue Receipts used to cover a part of Capital

Expenditure, an increasing part of the Capital receipts are used to

finance revenue expenditure. The consequent build up of public

debt and interest burden which is now the largest and fastest

growing them of expenditure further fuelled the growth of revenue

expenditure. This lead to a spiral of growing deficits, rising debt,

escalating interest costs and further expansion of deficit” (Report

of the Tenth Finance Commission 1994 page 4). The implications

of this spiral for the State Finances were manifold.Between 1990-

Section-II 260

91 and 2000-01 the expenditure on Administrative Services,

increased from Rs.9225 crores to Rs. 29219 crores, and on

pensions from Rs.3593 crores to Rs.23810 crores. This increase

enhanced the constricting nature of non plan expenditure and

implied meagre availability of resources for new projects,

particularly in the infrastructural sector and even for maintenance

expenditure.

The TFC also pointed out that “the structure of expenditure

had imparted a downward rigidity and inflexibility to its level.

Interest payment and wages and salaries emerged as the major

components of expenditure as a direct result of the mode of

financing of expenditure and expansionary policies. These items of

“committed expenditure could be curtailed only in the medium

term. This had made expenditure more income elastic than revenue

receipts, thus generating an inbuilt tendency towards deficits. As a

result, the economy moved away from resource based fiscal

management to expenditure based Budgeting.”

The details of deficit indicators in state government finances for the 1990s show that Gross Fiscal Deficit increased from Rs. 3713 crores in 1980-81 to Rs. 18787 crores in 1990-91 and further to Rs. 94739 crores in 1999-2000. With the Revenue Account turning from a surplus of Rs. 1486 crores in 1980-81 to a deficit of 5309 crores in 1990-91 and Rs.56802 crores in 1999-2000. In the financing of Gross Fiscal deficit loans from centre increased from Rs. 1567 crores in 1980-81 to Rs.9978 crores in 1990-91 and Rs. 39879 crores in 1999-2000. While market borrowings (net) increased relatively gradually from Rs.198 crores to Rs. 2556 crores and further to Rs.11829 crores during the same period small savings and others contributed an increasing share from Rs. 1948

Section-II 261

crores in 1980-81 to Rs. 6253 crores in 1990-1991and further to Rs. 43031 crores in 1999-2000.

The total outstanding liabilities of the State Governments (as a sum of internal debt, outstanding loans and advances from the Centre , Provident Funds etc) on March 31st of the year increased from Rs. 23959 crores (16.7 % of GDP) in 1980-81 to Rs. 110289 crores (19.4 % of GDP) in 1990-91 and further to Rs. 418582 crores (21.4 % of the GDP) in 1999-2000. As a consequence of the steep increase in the outstanding liabilities of the state, the gross interest payments, which stood at Rs. 10944 crores in 1991-92 increased to Rs.45526 crores in 1999-2000, and from 13.6% to 21.2% as a percentage of the revenue receipts of the states.

The structural deterioration in the state finances was

diagnosed by the Tenth Finance Commission, as being marked by

“a pattern in the transition from healthy revenue surpluses that the

system used to generate, to chronic deficits”. The Commission

identified a three phase deterioration in the revenue account

balance of all the States, by disaggregating the revenue account

into Plan and Non Plan as follows

1. First Phase Non Plan account surplus was larger than Plan deficit yielding upto 1986-87 an overall Revenue surpluses.

2.Second Phase The magnitude of Plan deficit increased sharply and became larger 1986-87 to 1991-92 than the Non Plan surplus which was declining.

3.Third Phase The Non Plan revenue account itself went into deficit. after 1991-92

The Tenth Finance Commission went on to observe that “the

fact that all the States have had almost identical turning points

seem to suggest that there are systemic factors underlying this

deterioration rather than State specific reasons….. for the first

time, not a single State has submitted a pre devolution surplus on

Section-II 262

the Non Plan revenue account. Thus the problem posed to us was

far worse than that faced by earlier Finance Commissions” .

Long Term Significance

The long term significance of the structural deterioration was

highlighted by the World Bank in its Report. (“India- Recent

Economic Development: Achievements and challenges” Country

Economic Memorandum, World Bank, May 30, 1995). The Bank

observed that “the financial and institutional weakness at the State

Level are becoming a major constraint to the provision of

infrastructure and Social Services.” State Governments account for

53% of the total combined expenditure of the Centre and the States

as also 56 % of the expenditure on Social Services and 85% of

total combined expenditure on economic services, :World Bank

also pointed out that discrete changes in the policy regimes by a

few Central Ministries and Departments (Finance, Commerce,

Industry and Telecommunication) can no longer profoundly

improve the enabling environment, and that there was need for

sustained reform efforts in several areas including ones in which

State Governments play a central role. Among the key areas cited

by the Report were Irrigation and Road Transport which are

constitutionally the responsibility of State Governments and Power

and Education which are constitutionally responsibilities shared

Section-II 263

with the Central Governments. In more recent years these have

come to be described as ‘economic and social infrastructure’.

Eleventh Finance Commission

At the turn of the Century, the picture was indeed very grim, and the terms of reference to the Eleventh Finance Commissions called for suggestions for a restructuring of the public finances both at the Centre and the States, The Eleventh Finance Commission in its report brought out the broad magnitudes and recent trends in Budget imbalances and commented that, “ the secular decline in the fiscal balance of the economy that had set in during the eighties, marking the transition of a revenue surplus economy to one of deficits, to which pointed attention was drawn by the Tenth Finance Commission, as not only persisted but got accentuated in the closing years of the 90s with some of the key deficit indicators climbing to unprecedented ‘highs’. The economic reforms programme launched in the wake of the balance of payment crisis of 1991 with fiscal reform as a key component, led to a number of corrective initiatives on the fiscal front producing some promising results in the first two years. Expenditure growth was reined in and the deficits were down, but only for a while . After remaining subdued at a relatively moderate level , the budget imbalances widened as the decade was coming to a close with fiscal stress turning acute in 1998-99……The fact of the matter is that , no sustained improvement can come about unless the root causes of the malice that affects our public finances are correctly diagnosed and addressed frontally with a careful designed plan of action.” (para2.5 of Eleventh Finance Commission Report).

Presenting the details of the fiscal deficit, revenue deficit and primary deficit in respect of Centre, States and combined , the Commission felt that “the deterioration in the fiscal situation of the states in the nineties , especially in the later half , has been more acute than what would appear from the consolidated deficit figures of all the states.” It presented the frequency distribution of the states according to size of revenue and fiscal deficits, and pointed out the increase in the number of states touching higher levels of deficit as also the spurt in post devolution deficits in all the states .It commented that “ although few among the states ever showed a surplus in the budget without the Central transfers , there were at least some states whose revenue budgets yielded a surplus even though small, with tax devolution.In 1998-99 none except Karnataka had a post devolution non plan revenue surplus. Even states which earlier showed handsome post devolution surplus regularly ( Gujarat, Maharashtra, Goa , Kerala and Tamilnadu) turned in revenue deficits even after tax devolution in 1998-99….. with the disappearance of post devolution surpluses in Non Plan account, combined with deficits in plan revenue account, the overall revenue deficit went up to levels never witnessed before.” The Commission identified the impact of pay revision at centre and the cyclical recession in economic activity retarding the growth of tax revenues as the factors leading to deterioration of fiscal situation in the states.

Section-II 264

The failure to register any significant success in the area of

public finance during the nineties emerges from the steady increase

in the magnitude of revenue deficit on the combined account of

Central and State Governments, with its increase from 4.16 % of

GDP in 1990-91 to 6.66 % in 1999-2000. Even more significantly

the fiscal performance of the states was marked by an unwelcome

trend. As pointed out by Dr.D.K.Srivastava, “individual states, first

the fiscally weaker ones and then, even the higher per capita

income states have successively slid into revenue deficit. These

revenue deficits embedded as they are in unsustainable fiscal

deficits are only visible manifestation of multiple and deeper

deficiencies in government finances.” (Inter Governmental Fiscal

Transfers , NIPFP, Nov 2001 , pg – 4)

The transfers from Central Government to the States on

account of the Finance Commissions had increased from Rs.5316

crores during 1969-74 to Rs.9609 crores during 1974-79, Rs.20843

crores during 1979-84 , Rs.39452 crores during 1984-89,

Rs.119698 crores during 1989-95 and to Rs.226643 crores during

1995-2000. The Finance Commission transfers do appear to have

made a difference to the balance between revenue and expenditure

of the state Governments, even though at the same time these

transfers caused a heavy dent on the Centre. Even while the Union

Section-II 265

Finance Ministers kept talking about fiscal consolidation and

reducing of budgetary deficits of different kinds. This did not

however deter the states from asking for higher levels of transfer

arguing that while the transfer have increased in absolute terms

there is decline in the assistance when viewed as a share of the

total revenue receipts of the centre or as a share of the aggregate

expenditure of the states. Analysis shows that between 1990-91

and 2000-01 , Gross Central transfers as a share of Centre’s total

receipts declined from 39.0 % to 31.0% and net transfers from 31.2

% to 22.0 % .As a share of the state’s aggregate expenditure , gross

transfers fell from 44.8 % to 39.8 % and net transfers from 34.8 %

to 28.5% .

An important aspect of the Indian experience in development

planning and programme implementation is the interactive roles of

the Union and the States, in mobilising resources for both regular

and developmental administration. The size and pattern of tax

devolution and transfer of resources from the Centre to the States

have to some extent influenced the Management of Public

Expenditure by the State Governments .In 1990-91 the gross

transfers from Centre to the states covering State’s share in Central

taxes, Grants and Loans, accounted for Rs. 40,859 crores (as much

as 44.8 % of the Aggregate Expenditure of the States). Net of

repayment from States to the Centre, the transfer was Rs.31685

Section-II 266

crores (meeting 34.8 % of the aggregate expenditure of states). By

2000-2001, the quantum of gross transfer had increased to Rs.

139661 crores and net transfer to Rs. 100035 crores, meeting only

a reduced share of 39.8 % and 28.5 % of the State’s Aggregate

Expenditure. This aspect came for specific attention, with the

Tenth Finance Commission suggesting an alternative scheme of

devolution in which 29% of the Total Central Tax Revenues would

remain the state’s share, frozen for a period of fifteen years,

instead of fluctuating from one Finance Commission to another.

The Eleventh Finance Commission on the other hand suggested

that the amount involved by way of tax devolution, Plan and Non

Plan Grants should not exceed 37.5 % of Gross Revenue Receipts

of the Centre.

The National Development Council in its meeting in February 1999 discussed the fiscal health of the states and suggested that urgent corrective steps must be taken. Following this the Union Finance Minister had a meeting with the Chief Ministers and Finance Ministers of seven states, and settled on a scheme for incentives for fiscal improvement through medium term fiscal reform programmes.A provision of Rs.2570 crores was also made available in the Union Budget towards this.

Fiscal Outlook in Recent Years

The Reserve Bank of India observed in its Annual Report (2001-02) that “the fiscal position of the State Governments has remained under pressure throughout the nineties “, (P.125), Its Report on Currency and Finance, 2002. P. IV.25) indicated that “four factors have been identified as responsible for the deterioration in the fiscal conditions of the states. These are rising interest payments, inadequate recovery of user charges, rising expenditure on wages and salaries and sluggishness in the central transfer of resources.” The Ministry of Finance, in its Economic Survey 2002-03, has drawn attention to “the near total stagnation in the growth of revenues, the rigidities in controlling expenditure on the revenue sides, bulk of which consists of wages and salaries and interest payments”

Section-II 267

and observed that, “the quality of expenditure has worsened over the years.” (Page 40 of Economic Survey). After an examination of Public Expenditure Management by State governments, a Study of the Indian Institute of Economics conducted for the Planning Commission, concluded that, “ the most important contribution to fiscal imbalances in the states have been on the Expenditure side.” The IIE study has also pointed out other problem areas in public expenditure management – like falling levels of budgetary marksmanship, declining standards of public accountability, leakage and wastage of funds in programme implementation, tardy devolution of funds to local bodies and continuing intra–state disparities.

It was in the context of continuing fiscal distress that in February 2001 , Sri Yashwant Sinha Union Finance Minister while presenting the Union Budget for 2001-02 stated that “ the most serious problem confronting the economy is the poor state of fiscal health of both the central and state governments . The combined fiscal deficit of the two together is in the region of 10 % of GDP.” The provocation for the statement can be seen from the deficit indicators over the previous two decades shown below

The overall budgetary position of the states in the recent years can

be seen in Table: 2.4. There does not appear to be any

significant turn around in the fiscal position of the states despite an

increasing trend in receipts.

Table : 2.4 Overall Budgetary Position Of All States GovernmentsItems 2000-01 2001-02 2002-03

(BE)2002-03

(RE)2003-04

(BE)1 Aggregate Receipts 349544 380106 425655 437292 469446

A. Revenue Receipts 237953 255599 306844 293873 3329191Tax Receipts 168715 180275 215049 202518 227094a. States' Own 117981 131710 152590 149358 169021

2Non Tax receipts 69238 75324 91795 91355 105825a. States' Own 31456 32276 37787 35954 41564

B Capital Receipts 111591 124507 118811 143419 136527a. States' Ownb. Central loans 18966 26959 31454 30260 33947

2 Aggregate Exp 347198 377554 430842 442609 476039A. Developmental Exp 210543 216629 246181 247873 260977

1Social Services 113690 113623 130046 127613 1377582Economic Services 96853 90817 102559 103449 109501

B Non Dev Exp 118887 138062 160296 160596 177025C Repayment of Loans to

Centre 10570 11539 12718 22122 22309

Section-II 268

D. Discharge of Internal Debt 2246

E Others 17767 22863 24365 34140 380373 Overall balance 2345.6 2552 -5187 -5317 -6593

Note: The figures given above compiled earlier in December 2003 differ from the figures given in R.B.I Study 2003-04 published in May 2004. RBI data include additional resource mobilization indicated in budgets of some states and in respect of expenditure includes compensation and assignments to local bodies.

Section-II 269

The deficit indicators continue to be grim though, at the budget estimate stage there appears to be intention to reduce the revenue and fiscal deficits. The actual deficits turned out to be much larger than those envisaged in the budget and revised estimates, despite some noticeable fall in the expenditure in the Centre and marginal increase in the expenditure in the states. (Table: 2.5).

The Finance Minister’s statement in the Parliament came after a decade of Economic and Financial Reform, with fiscal consolidation as the primary objective. As pointed out earlier, the momentum, which appeared to gather in the initial years of the nineties petered out in the later half with further decline in the early years of the present decade. The gross fiscal deficit as per accounts for 2001-2002 turned out to be Rs.1,40,995 crores (6.1 % of the GDP) for the Centre and Rs.95,986 crores ( 4.2% of the GDP) for all the states. Together, after accounting for inter government transactions, the combined gross fiscal deficit amounted to Rs. 2,26,418 crores, (9.9% of the GDP) . When this is set against the combined gross fiscal deficit of Rs.53,580 crores (9.4 % of the GDP) in 1990-91, the fiscal decline in the 1990s becomes evident and when we take into account that in 1995-96, the combined fiscal deficit had only been Rs.77,671 crores (6.5% of GDP), it will be evident that the fiscal consolidation measures which appeared to be yielding results in the early nineties had weakened in the later nineties and the early years of the present decade.

Table 2.5 (in Crores) Centre All States 2001-02 02-03(RE) 03-04 (BE) 2001-02 2002-03(RE) 03-04 (BE)RevenueDeficit

100162 104712 112292 59233 61302 49008(4.3) (4.3) (4.1) (2.6) (2.5) (1.8)

GFD140955 145466 153637 95986 116730 108861

(6.1) (5.9) (5.6) (4.2) (4.7) (4.0)

Gross Primary Deficit

33495 29803 30414 33497 42584 26573

(1.5) (1.2) (1.1) (1.5) (1.7) (1.0)

During 2002-03 the gross fiscal deficit at Centre increased

from Rs.1,35,524 crores (5.3% of GDP) at the budget estimate

stage to Rs.1,45,466 crores (5.9% of GDP) at revised estimate

stage.The Union budget estimates for 2003-04 present a further

increase to Rs. 1,53,637 crores (5.6% of the GDP) . The picture

presented by the state governments show that gross fiscal deficit

had increased from Rs.89,532 crores in 2000-01 to Rs. 95,986

Section-II 270

crores in 2001-02 , and that during 2002-03 the state governments

together could not hold on to the budget estimate of GFD of Rs.

1,02,882 crores 4% of GDP with RE placing GFD at Rs. 1,16,730

crores, 4.7% of GDP. Budget estimates for 2003-04 place the GFD

of all states at Rs.108,861 crores (4 % of GDP) but one should

keep fingers crossed as the recent experience has been, that the

budget estimates , whether of revenues or expenditure or the

deficits turn out to be more optimistic, and the actuals belying the

fond hopes of the budget maker. Reporting the major features of

the Finances of State Governments 2003-04,the RBI states that “

the fiscal outturn of states in 2002-03 witnessed deterioration with

GFD reaching 4.7 % of GDP” and indicates that “ the absolute

increase in GFD during 2001-02 was primarily driven by a revenue

deficit which accounted for about 88% of the increase. In

comparison the increase in GFD during 2002-03 was mainly on

account of higher capital outlay and net lending …. The large and

growing GFD of the states pushed up their outstanding debt to 25.7

% of GDP in 2001-02 to 28.1 % of the GFD.”(RBI Bulletin, Nov

2003)

The nineties has seen the changes in the relative

budgetary status of center and the states. In 1990-91, the total

expenditure of the state governments was Rs. 91,088 crores (16.0%

Section-II 271

of GDP) and the Centre’s was higher at Rs.105298 crores (18.5%

of the GDP) but during 1999-2000 the total expenditure of the

state governments, Rs.3,25,634 crores (16.6% of the GDP)

overtook expenditure of the Centre . Rs.3,13,258 crores (16 % of

the GDP). The 2002-03 RE, place the total expenditure of the

states at Rs.4,42,609 crores (17.9% of the GDP) while the

Centre’s total expenditure is only Rs.4,04,013 crores (16.3% of

GDP). As per 2002-03 RE the revenue receipts of the states was

Rs.2,93,873 crores including shareable taxes of Rs.53,160 crores

and centre’s receipts was Rs. 2,36,936 crores. Without the

shareable taxes, the revenue receipts of the states would have been

marginally higher than the centre’s. This assumes importance

since Central budget had shown revenue deficit during the

eighties. Revenue deficit of states stood at 3.26% of GDP in 1990-

91 rising to 3.8 % in 1993-94 and declining to 3.05% in 1997-98

before rising again to 3.8 % in 1998-99. In the recent years

Centre’s revenue deficit as percentage of GDP has been 3.7 in

1999-2000, 4.1 in 2000-01, 4.3 in 2001-02, 4.3 in 2002-

03(RE).The states on the other hand after receiving transfer from

Centre , in the form of tax devolution and grants had remained in

surplus until 1986-87 except for some isolated years but their

aggregate revenue deficit remaining below 1 % of GDP until

1995-96 began to rise reaching 2.7 % in 1999-2000, and hovering

Section-II 272

above 2 % in the succeeding years. This makes the states share of

central taxes a crucial balancing factor and the instrument of

devolution a vital one in ensuring balance between the receipts and

expenditure at the Centre and the States. (According to RBI study

2003-04, the states share in central taxes were Rs. 52215.3

crores in 2001-02, Rs. 62595.2 crores in 2002-03 BE and Rs.

57361.5 crores as per RE. BE 2003-04 place this at Rs. 62986

crores) Since Finance Commission devolutions are indicated as

shares of net tax collection of the centre, there is difference of Rs.

5,234 crores between the BE and RE for 2002-03, mainly on

account of lower collections in central taxes as compared to budget

estimates.

The budgetary figures of the states are greatly influenced by

the transfer of resources through the Finance Commissions as

envisaged in the Indian Constitution, and the Development

perspectives and plan assistance provided by the Planning

Commission. Public Expenditure management is however guided

by a framework of political objectives and growth targets of state

governments formulated with consideration of local needs, in

addition to those in the Central Plan, covering Central Sector and

Centrally Sponsored Schemes. Quality of fiscal management in

the future will rest on the balance to be maintained between the

requirements of resources of both the Centre and the States which Section-II 273

have come under increasing pressure from the Expenditure side

with Tax and Non Tax Revenue proving inadequate to meet their

respective needs. Nature of Resource Mobilisation and Quality of

Expenditure Management, both at the Centre and the States have

therefore become vital imperatives for sustained economic growth.

Section-II 274

Chapter-III

Trends in Expenditure Management

Patterns of Expenditure

By far the most important contribution to fiscal imbalance in

the states has been on the expenditure side marked by steep

increase in total expenditure of state governments over the last

several decades. If the increases in the total expenditure of the

states during the last two decades were staggering, the changes in

the composition of expenditure were rather distressing. Between

1970-71 and 2000-01, Revenue Expenditure increased, as

proportion of total expenditure from 65.52 % to 83.96%, while

capital expenditure sharply came down from 34.48% to 16.04%.

The revenue expenditure of Rs.71776 crores during one year

1990-91 equaled the entire revenue account expenditure for

three decades from the First Plan to the Fifth Plan periods.

Table- 3.1 : Expenditure PatternYear Total Exp Revenue Exp Capital Exp

Rs. crores Rs. crores Percent Rs. crores Percent1970-71 5174 3390 65.52 1784 34.481975-76 10281 6967 67.77 3314 32.231980-81 22664 14808 65.34 7856 34.661985-86 44868 32770 73.04 12097 26.961990-91 91242 71776 78.66 19466 21.341995-96 177583 145004 81.65 32579 18.351999-00 325633 271611 83.41 54022 16.592000-01 347198 291522 83.96 55677 16.042001-02(RE) 401571 331440 82.54 70131 17.46Section-II 275

2002-03(BE) 430934 355166 82.42 75768 17.58 (RE) 442609 355175 80.25 87434 19.752003-04(BE) 476039 381927 80.23 94112 19.77Note: Percentages are share in Total Expenditure

The growth of State expenditures over the decades revealed

increasing rigidities in the pattern highlighting (a) Increasing share

of Revenue Expenditure in total disbursements particularly of non

plan items like administrative services and meeting interest and

debt service obligations and decline in capital expenditure , with

implications for economic growth, by restricting the resources

available for capital outlays in major infrastructure sectors like

irrigation , roads and transport as also social services. (b) sluggish

growth in State’s economy, owing to state’s inability to invest

adequately in Economic infrastructure with a consequent impact

on the potential for growth of state’s own tax and non tax

revenues. The erosion in development momentum as reflected in a

declining share of capital and development expenditures in total

expenditure both at the Centre and State levels, in the 1990s,

appears to have been noted by the budget makers, who have made,

in the budgets for 2001-02 and 2002-03 a conscious effort to step

up capital expenditure and public investment to stir the economy

and set it on a revival mode,and help it recover from the recession.

Budget 2003-04 continues this trend.

Development and Non-Development

Section-II 276

Attention to the composition of expenditure has become important.

Disaggregation of expenditure in terms of development and non

development categories in respect of Centre , states and the

combined accounts, is presented in the table below. While

development expenditure of states increased in absolute terms,

from Rs.2428 crores in 1970-71 to Rs.15961 crores in 1980-81

Rs.63370 crores in 1990-91 and Rs.210543 crores in 2000-01,

with its share in total expenditure rising initially from 46.93 % in

1970-71 to 69.5 % in 1990-91 before coming down to 60.6 % in

2000-01 . There was a fall in development expenditure in terms of

the ratio to GDP both at the centre and in the states. The share of

non development expenditure rising through the eighties increased

from 24.8 % in 1990-91 to 34.20% in 2000-01. the category of

expenditure ‘others’ covering repayment of central loans etc also

increased from Rs.5272 crores in 1990-91 to Rs.17768 crores in

2000-01, hovering around 5.2 % of GDP.

TABLE: 3.2 DEVELOPMENT AND NON DEVELOPMENT EXPENDITURE

(Rs.Crores)

Centre States State and centre

Combined

Years Dev N.Dev Total Dev N.Dev Total Dev N.Dev Total

Section-II 277

1980-1981 13327 9867 23194 15961 4289 22770 24480 12738 37879(9.3) (6.9) (16.2) (11.1) (3.0) (15.8) (17.0) (8.9) (26.3)

1990-1991 58645 49349 107994 63370 22600 91242 96686 63397 163673(10.3) (8.7) (19.00) (11.1) (4.0) (16.00) (17.4) (11.1) (28.8)

1999-2000 129151 177928 307079 187297 110206 313889 273604 258053 545813(6.7) (9.2) (15.85) (9.67) (5.69) (16.21) (14.13) (13.3) (28.18)

2000-01 139386 197470 336856 210543 118887 347198 309053 272906 592429(6.6) (9.38) (16.00) (10.0) (5.65) (16.5) (14.7) (13.0) (28.15)

2001-02 159364 215456 374820 236384 143625 401571 350624 315197 677729(6.9) (9.38) (16.32) (10.3) (6.26) (17.5) (15.27) (13.73) (29.52)

2002-03(RE) 190630 237008 427638 246150 160391 430934 377866 375861 766981(7.71) (9.59) (17.3) (9.9) (7.5) (17.4) (15.3) (15.2) (30.5)

Note: 1. Total in the case of states includes ‘Others’ comprise discharge of internal debt, repayment of loans to the center and compensation and assignments to local bodies and Panchayati Raj Institutions.2. Total in the case of Centre and State combined includes ‘Others’ which relate to state governments and are adjusted for repayment of loans by State Governments to center as given in Central Government Budget Document.3. Figures for Centre and States do not add up to the combined position due to inter-Governmental adjustment.4. Figures in brackets indicate Percentage of GDP(at market prices).

Data given in Economic Survey of Govt. of India differ as they cover internal and extra budgetary resources of the Public Sector undertakings.

The year-wise decomposition of states expenditure during the

nineties and the recent years (Table below.) confirms that the trend

of the nineties has continued during the early years of the present

decade.

Table- 3.3 : States Aggregate Development, Non-Dev & Other Exp Year

Dev Non-Dev Others Total% of GDP

1990-91 63370.00 22600.00 5272.00 91242.00 16.00(69.50) (24.80) (5.70)

1991-92 74588.00 27143.00 6916.00 108647.00 16.60 (68.70) (25.00) (6.30)

1992-93 80566.90 32103.80 6664.00 119335.00 15.90(67.50) (26.90) (5.60)

1993-94 89387.60 38019.60 7241.00 134648.00 15.70

Section-II 278

(66.40) (28.20) (5.40)1994-95 104347.80 49556.00 7650.00 161554.00 16.00

(64.60) (30.70) (4.70)1995-96 114819.40 55379.90 7385.00 177584.00 14.90

(64.70) (31.20) (4.10)1996-97 132007.70 62095.40 8664.00 202767.00 14.80

(65.10) (30.60) (4.30)1997-98 145268.40 71766.90 11100.00 228135.00 15.00

(63.70) (31.50) (4.80)1998-99 164503.50 86474.40 15383.00 266361.00 15.10

(61.80) (32.50) (5.70)1999-00 187297.00 110206.00 16386.00 313889.00 17.97

(59.7) (35.1) (5.2)2000-01 210543.00 118887.00 17768.00 347198.00 18.27

(60.6) (34.2) (5.1)2001-02(RE) 236384.00 143625.00 21562.00 401571.00 17.5

(58.9) (35.8) (5.4) Accts 216629.00 138062.00 22563.00 377554.00

(57.4) (36.6) (6.0)2002-03(BE) 246150.00 160391.00 24393.00 430934.00 17.4

(57.1) (37.2) (5.7) (RE) 247873.00 160596.00 34140.00 442609.00 17.9

(56.0) (36.3) (7.7)2003-04(BE) 260977.00 177025.00 38037.00 476039.00 18.6

(54.8) (37.2) (8.0)As the RBI Study of State Finances (1999-00) observed

“Failure to contain expenditure has been accepted as a major

reason for the fiscal woes of the state governments. While the

development expenditure in absolute terms has been higher than

the non-development component, the latter has been rising faster

through out the eighties and the nineties. In the eighties non

development expenditure rose at an average rate of 18.7% as

compared with 14.9% for development expenditure, while in the

nineties the growth was even faster at 19.1% with a concomitant

Section-II 279

decline in growth in developmental expenditure at 13.7%. State-

wise picture is shown below.

Table : 3.4 Average Annual Growth of Expenditure States/Territories 1990-2000 Dev Non Dev1.Andhra Pradesh 14.6 18.72.Arunachal Pradesh SC 12.3 13.33.Assam SC 15.0 20.14.Bihar 14.8 17.15.Chhattisgarh6.Goa SC 14.7 36.37.Gujarat 15.6 18.48.Haryana 14.6 26.19.Himachal Pradesh SC 15.6 20.710.Jammu& Kashmir SC 13.5 2211.Jharkhand12.Karnataka 13.5 17.513.Kerala 15.6 18.914.Madhya Pradesh 13.2 17.815.Maharashtra 14.0 19.516.Manipur SC 18.0 19.017.Meghalaya SC 15.2 17.518.Mizoram SC 13.5 19.819.Nagaland SC 9.4 14.520.Orissa 15.3 17.821.Punjab 16.1 26.522.Rajasthan 15.9 20.923.Sikkim SC 15.2 78.124.Tamil Nadu 13.2 20.225.Tripura SC 12.9 16.926.Uttar Pradesh 12.8 17.827.Uttaranchal28.West Bengal 16.9 20.2

Delhi (NCT) 48.7 67.4 All States 14.1 19.2Source : RBI State Finances 2000-01 pg 28 and 29

Section-II 280

One needs to note in this regard that the size of overall

development expenditure of the states has always been higher than

that of the Centre and that the difference has widened significantly

in the 1990’s. EPW Research Foundations’ Review of State

Finances, 2001, observed that, in 1990-91 State Development

Expenditure exceeded that of the Centre by less than 10% but by

2000-01 it had exceeded by about 55%. What is more, in total

government expenditure on social services the share of the state

governments now constitutes over 86% while central expenditure

accounts for less than 14%.

Taking a closer view of the expenditure in Major Heads of

expenditure categorized developmental and non developmental, in

the more proximate period between 1990-91 and 1999-2000, one

notices that the total developmental expenditure of all the states

increased in absolute terms from Rs. 63370 crore in 1990-91 to Rs.

187297 crore in 1999-00 but as a percentage of GDP it came down

from 11.1% to 10.72% in the relevant period. This fall is common

to both direct developmental expenditure covering social and

economic services, as also to loans and advances by state

government in the various sectors. Between 1990-91 and 1999-

2000 direct developmental expenditure increased from Rs.57815

crores to Rs175711.7 crores, even while falling, as a percentage of

Section-II 281

GDP from 10.2% to 10.06%. Of this, the expenditure on Social

Services, which was declining slightly in the mid nineties picked

up in the later years of the nineties, where as expenditure on

Economic Services continued to decline as a proportion of GDP.

Loans and advances, given by the state governments in the areas of

housing, cooperation, crop husbandry, soil and water conservation,

village and small industry are covered in this category. While the

developmental advances to these sectors, were marked by nominal

increases from year to year, the advances to the power projects

showed a significant increase from Rs. 3585 crores in 1990-91 to

Rs. 5951 crores in 1999-00.

With direct development expenditure in Irrigation Sector

increasing from Rs. 7113 crores to Rs. 19871 crores and that in

Energy increasing from Rs. 1994 crores to Rs. 6914 crores during

the same period, it appears that infrastructural expenditure was on

the increase. The other areas of significant increase in

developmental expenditure between 1990-91 to 1999-00 were

water supply and sanitation from Rs. 1993 crores to Rs. 7782

crores Urban Development from Rs. 664 crore to Rs. 4033 crores

and welfare of Scheduled Caste from Rs. 1909 crores to Rs. 6900

crores. Similar increase has also been noticed in agricultural and

Section-II 282

rural development, which accounted for over 35% of the

expenditure on Economic Services.

Within the broad category of total Development Expenditure

the share of Social Services had gone up from 46.1% to 54.3%,

while the share of Economic Services had gone down from 45.1%

to 35.7%. This increases in budgetary attention to Social Services

within the Developmental Expenditure category does not appear to

be adequate to meet the continuing obligations of the State for

promoting equitable development among different regions and

sections of society. The formation of corporate financing and

development bodies, to cover the specific target groups like

Scheduled Castes, Scheduled Tribes, and the Minorities, appeared

to absorb more resources on Administrative Expenses, and there

by reduced the availability of funds for Development Schemes.

A surprising aspect of the state expenditure programmes is

that the provisions for and the expenditure on Science Technology

and Environment turned out to be very low. The Revenue

Expenditure on this was a bare Rs. 26 crores in 1989-90 and,

despite all the emphasis on modernising society and government,

the expenditure had just increased to Rs. 131 crores in 1999-00. In

contrast the expenditure on relief on account of natural calamity

has shown substantial increase from Rs.564 crores in 1989-90 to

Rs. 2503 crores in 1999-00. As should be expected, a major share

Section-II 283

of the expenditure on Social Services were accounted for by

Education, Sports, and Culture, and Medical and Public Health in

the Social Service Sector, and the Agriculture, Rural Development

and Irrigation and Flood Control and the Energy in the Economic

Services category. One conclusion that can be drawn is that, while

Social Services account for higher shares in Revenue Expenditure,

Economic Services account for higher disbursement on the capital

side.

Non Development ExpenditureAnalysis of the expenditure pattern of the states shows that

non developmental expenditure rose at an average rate of 18.7 %

in the eighties and 19.1 % in the nineties as against 14.9 % and

13.5 % in respect of development expenditure . This was mainly

on account of rise in interest payments, administrative services and

pensions which in 1980-81 , accounted for 14% of Total

Expenditure , 21.35 % of Total revenue expenditure and 73.7 % of

Total non development expenditure. evoted to organs of states,

fiscal services, interest payment and debt servicing, as will be seen

from Table given below

Table- 3.5 : Non Development Expenditure –Revenue Account

(Rs.crores)

1970

-71

1980-

81

1990-

91

1995-

96

2000-

01

2001-

02

2002-

Section-II 284

RE 03

BE

TE 5174 2266

4

9108

8

17758

4

34719

8

40157

1

43093

4

TRE 3390 1480

8

7177

6

14500

4

29152

2

33144

0

35516

6

NDE 1518 4289 2260

0

55380 11888

7

14362

5

16039

1

Int.

Pay

398 1225 8655 21932 51702 64502 72285

Adm.

Sr

455 1562 7018 13391 25399 28299 30100

Pensio

n MGS

165* 375 3593 12834 28484 31793 39155

Subsid

y

NA NA 42 338 493 551 777

TE-Total Expenditure, TRE- Total Revenue Expenditure. NDE-Non developmental expenditure,

Adm. Sr- Administrative services.

Note: The figures indicated have been taken from Handbook of Statistics on Indian Economy,

2002-03 of RBI. The Annual Report of RBI and Study of State Finances of 2002-03 and 2003-04

report different figures.

Examination of the nature and source of increase in

expenditure show that sharp increases have occurred in respect of

interest payment , administrative services and pensions as shown Section-II 285

above. The preemption of available expenditure on account of

increasing revenue expenditure, non developmental expenditure

and these unproductive items of expenditure can be seen from the

table below.

1980-

81

1990-

91

2000-01

Int.Pay+Adm.Sr+pension

(Rs.crores)

3162 19266 105585

As % of Total Exp 13.9 21.15 30.41

As % of Total Rev Exp 21.35 26.84 36.72

As % of NDE 73.7 85.25 88.81

TRE as % of TE 65.34 78.8 83.96

NDE as % of TE 18.92 24.81 34.24

While the emphasis in fiscal policy reform has been on

consolidation, downsizing government and reducing non

development expenditure, the trend appears to have been in the

other direction. Increase in administrative expenditure has been

mainly on account of the implementation of the award of the Fifth

Pay Commission for Central Government employees and their

effect on State Government employees. While the salaries bill has

been pushed up, it has been argued by Dr. Rakesh Mohan that the

growth of expenditure on Government servants has been at a lower

rate than the GDP growth rate and others have also argued that, the Section-II 286

improvement in the Tax/GDP ratio for direct taxes is attributable

to the pay rise for government and public sector employees. One

outcome should not be missed- the talk on downsizing of

government and privatisation of services has resulted in

uncertainty among government servants reducing their level of

commitment to public services, without significantly altering their

size in employment of the public sector, and providing relief to the

central exchequer.

Resources for Basic Services and Capital Investments.

The terms of reference for the study has sought an

examination of the availability of resources for provision of basic

services at minimum average national levels. As pointed out

earlier, the Eighties and the Nineties have been marked by

increasing revenue expenditure and non development expenditure,

reducing the availability of resources for capital expenditure and

development expenditure . A considerable share of the blame is

heaped on increasing administrative expenditure, while as shown

in the table, interest payments and other items have also

contributed to the reduction in the resources for capital investment.

There is need to appreciate the needs of a growing population

spread in different states, and the consequent demand for basic

Section-II 287

services in all the states. The TOR for the study has rightly

referred to the provision of basic services at minimum national

levels.

One approach to provision of better basic services is to take

the administration closer to the people, and our analysis shows that

there is some move in this direction. Between 1991 to 2001 the

number of districts in India increased from 466 to 593, the number

of new districts were 17 in Orissa , 16 in UP ,9 each in Tamilnadu

and Chattisgarh , 8 each in Delhi and Bihar, 7 each in MP and

Karnataka and 6 in Gujarat and 5 Maharashtra . In Tamilnadu the

number of districts increased from 21 to 30 and taluks from 167 to

201, town from 469 to 832, making decentralization of

administration more than a mere slogan. With demographic

factors changing in each state, and the creation of new states and

new districts carved out of existing ones, there is need to address

the requirements of operating staff at the field level through well

considered schemes for grants under Article 275. In areas where

administration has been taken closer to the people, the intra state

disparities appear to arouse less discontent. Otherwise they take

the form of regional separatism as seen in Andhra Pradesh

entailing increased expenditure on maintenance of law and order.

Section-II 288

What is required, in state governments is a proper

examination of man power requirements, at the various tiers of the

governments in relation to the need for performance of essential

services to the community. Macro level prescriptions of

Expenditure Reforms announced often overlook the vital

imperative of the need to increase basic services. In certain sectors,

and departments, increasing population implies increase in demand

for services, calling for adequate staffing in the departments

providing the services. In sectors like manufacture, trade and

Commerce from which the state can choose to withdraw, the

number of employees could perhaps be reduced at the state and

Central level, but at the district and lower levels, there is need for a

proper assessment of the staff needs, not only in relation to the

Government expenditure on social services, including health,

primary education as also regulatory arms of government like the

Collector, Police and judiciary but also in relation to the growing

demand from increasing population

In a study carried out for the Ministry of Rural Development

designed to assess the impact of rural development schemes in the

district of Nagapatinam, based on field surveys of beneficiaries

and utilization of funds, it was found that there was a strong need

for ensuring that supervisory posts remain continuously filled at

Section-II 289

the district level and that there were no frequent changes of

incumbents. Apart from this, one found at the field level posts

remaining unoccupied and curious mismatch of administrative and

technical staff at the level of Panchayat Unions. In block

development offices where engineering staff was in position,

administrative assistants and extension officers were not available.

In Thalanayar block, out of 50 sanctioned posts only 36 were filled

14 remained vacant, in Kilvelur block out of 51 sanctioned posts

only 42 were filled and nine were vacant. The study team was

given to under stand that the government orders were that

vacancies arising on account of retirement of serving personnel

should not be filled. This has meant that in backward blocks like

Thalanayar and Kilvelur the effects of mismatch between work

load and sanctioned posts were sharpened by vacancies arising out

of retirements and other reasons. The situation is typical of the

position in some districts of Andhra Pradesh where also a similar

impact study was carried out.(see Rural Development Schemes ,

Impact Assessment in Nagapatinam District of Tamilnadu for

Ministry of Rural Development , Indian Institute of Economics,

August 2002.)

Efficiency in performance of services is a function of a

proper combination of administrative and technical staff at the

Section-II 290

field level with finance being only a lubricating element for the

developmental machinery. Financial stringency had obliged the

Government of India and of the State Governments to take steps

for reducing administrative expenditure, and this has meant, in

most cases, imposition of an arbitrary measure of restriction,

without a clear analysis of the implications at the operating and

cutting edge levels. While successive Finance Commissions have

provided upgradation grants for strengthening the services at the

district and sub-ordinate levels n the departments of revenue,

police, judiciary and treasury, there has been, also a failure on the

part of state governments to complete a proper man power

planning exercise to ensure that the upgradation is of the standard

of standard of service to the public and not merely of the level of

expenditure. Twelfth Finance Commission may need to address

this area in far more specific terms than was done by earlier

Commissions.

Section-II 291

Plan and Non Plan Expenditure

As per the other classification of expenditure in terms of plan and

non plan categories, plan expenditure of the states increased in

absolute terms from Rs. 27433 crores in 1990-91 to Rs. 78616

crores in 2000-01, their share has a percentage of total expenditure

came down from 30.10% to 22.6% during the same period. This

trend was common to both the states and centres. As a percentage

of total expenditure of the states the share of non plan expenditure

increased from 69.9% in 1990-91 to 77.4% in 2000-01.

Table – 3.6 : States Aggregrate Expenditure% of GDP % of Total Exp

Year Plan Nonplan Total Total Plan Non Plan Plan Non Plan

1990-91 27432.90 63809.10 91242.00 16.00 4.80 11.20 30.10 69.90

1991-92 31084.50 77561.00 108645.50 16.60 4.80 11.80 28.60 71.40

1992-93 33391.50 85943.10 119334.60 15.90 4.50 11.40 28.00 72.00

1993-94 36730.00 97918.50 134648.50 15.70 4.30 11.40 27.30 72.70

1994-95 44513.70 114892.50 159406.20 15.70 4.40 11.30 27.60 72.40

1995-96 48450.00 129133.80 177583.80 14.90 4.10 10.80 27.30 72.70

1996-97 53045.60 149723.10 202768.70 14.80 3.90 10.90 26.20 73.80

1997-98 59260.00 168874.80 228134.80 15.10 3.90 11.20 26.00 74.00

1998-99 64870.60 201490.20 266360.80 15.10 3.70 11.40 24.40 75.60

1999-00 70320.6 243695.9 313888.8 17.97 4.02 13.95 22.4 77.6

2000-01 78615.6 268582.5 347198.2 18.27 4.13 14.13 22.6 77.4

01-02 B.E 96373.3 304961.1 401334.4 17.40 24 76Accts 80138.9 297172.8 377311.6 16.40 21.2 78.8

02-03 BE 107699.5 323234.4 430933.8 16.80 25 75

Section-II 292

RE 105344.9 337296.8 442641.8 17.90 23.8 76.22003-04

BE118452 369908 488360.4 24.3 75.7

Source: Compiled by IIE

In this connection it is necessary to clear one misconception

that all non plan expenditure are per se bad. It has been clarified

by a note in the Expenditure Budget of Government of India that

“non plan expenditure is a generic term which is used to cover all

expenditure of government not included in the annual plan

programmes.” It must be noted that this could cover both

developmental and non-development expenditure as also capital

and revenue expenditure. It must be recognised that non-plan

expenditure category covers transactions on the Revenue and

Capital Accounts, and some items of non-plan expenditure are

actually developmental in character. A detailed scrutiny of the

accounts of Central Government Departments as also the States

will show that some of the direct development expenditure in

Economic and Social Services are booked under non-plan. For

instance scrutiny of the 1998-99 accounts show that of the total

developmental expenditure of Rs. 164503 crores, plan expenditure

accounts for 63326 crores and non plan expenditure account of Rs.

101178 crores. This non plan expenditure further divided into

direct development expenditure of Rs. 98949 crores and indirect

Section-II 293

expenditure of loans and advances for developmental purposes Rs.

10388 crores.

EPW Research Foundation’s Study of State Finances

indicates that “for all States together over 97% of plan expenditure

are under developmental heads and that 55% of such plan

expenditure are under revenue account and 45% are under capital

account.” It must be noted that vital items of expenditure like those

involved in maintenance of law and order as also maintenance

expenditure of Projects are included in the non plan category.

Further even expenditure on continuing services and activities of

levels already reached in a plan period (like continuing Research

Projects and operating expenses of Power Stations) is classified as

non-plan expenditure in the next plan period. Given this

clarification, the pejorative inferences regarding non-plan

expenditure could be eschewed, and analysis proceed on rational

lines.

The Tenth Five Year Plan document has observed that, “ the

close observation of the states’ budgets during the past decades

reveal a blurring of plan and non plan distinction of Government

expenditure . Although inadvertent, this resulted in

misrepresentation of non plan as plan expenditure. Some of the

Section-II 294

new schemes which states implemented during a new five year

plan period took longer than five years to get commissioned.

Ideally these should have been considered as non plan in the

following five year plan however this did not happen as states

considered a larger plan size as a positive reflection on their

economic performance. For this very reason, even those plan

schemes which were completed and commissioned within the five

year plan period were not booked under non plan budget in the

following five year plan.” The document further analyses the

implications of this misrepresentation for resource assessment for

plan investments and maintenance expenditure as also for transfer

of Central funds.

The Tenth Finance Commission had expressed the view that

“the present artificial distinction between plan and non plan

expenditures …. shall be replaced by the simpler and

conventionally well recognized distinctions between revenue and

capital. Future Finance Commissions may be required to examine

the aggregate requirements on revenue accounts and recommend

means to bridge the revenue gaps.” Sri B.P.R.Vithal has examined

“ the plan non-plan conundrum” , and clarified that while plan

expenditure is incremental expenditure it is not synonymous with

developmental expenditure and explains the mechanics of

Section-II 295

budgetary formulation and treatment of expenditure.(Fiscal

Federalism in India, Pgs 264-277). His discussion leads to the

respective roles of the Planning and Finance Commissions and a

clarification that “the real distinction between these two bodies

arises out of the nature of the tasks”

Section-II 296

The clarity that academics advocate,has not yet been achieved

because the practitioners continue to see the Finance Commission

as a Constitutional Body of experts with a measure of objectivity

and the Planning Commission as a politically appointed body of

experts capable of discretionary developmental decisions with

political dimensions.

Sectoral Distribution

The fiscal imbalances had an adverse impact on plan efforts

to promote growth with Social Justice and Equity as also on Social

services sector expenditure. Equity consideration which have been

a pillar of the planning process in India with dominant objective of

growth with social justice appears to have received a set back in

the pursuit of fiscal stabilization and structural adjustment

programme.

The sectoral distribution of expenditure incurred by the state

governments can be analysed, for comparative purposes by looking

at expenditures in Social, Economic and General Services for

1991-92, 1997-98 to 1999-00 .

Table : 3.7 Sectoral Distribution -All States

Revenue Expenditure Capital Expenditure1991-92 (Accts)

Expenditure Items Plan Non Plan Total Plan Non Plan TotalTotal Expenditure 1593362 7025283 8618645 1515084 659216 2174300Social Services 635963 2473282 3109245 156776 7965 164741Section-II 297

Economic Services 927254 1814022 2741276 825098 -3703 821395General services 30145 2636427 2666572 22010 1426 23436

1997-98 (Accts)

Total Expenditure 3047642 15615729 18663371 2878359 1271748 4150107Social Services 1664799 5166366 6831165 340571 2501 243072Economic Services 1328073 3219297 4547370 1695583 145287 1840870General services 34443 695696 6989139 86562 9697 96259

1998-99 (Accts)


1999-2000 (AC)


Taking the year 1990-91 the total expenditure incurred by the states was of the order of Rs. 91242 crores (16% of the GDP), which comprised of a plan expenditure of Rs. 27433 crores (4.8% of GDP) and a non-plan expenditure of Rs. 63809 crores (11.2% of GDP). In terms of application, developmental expenditure accounted for Rs. 63370 crores (69.45% of total expenditure), non-development expenditure accounted of Rs. 22600 crores (24.77% of total expenditure) and others like inter governmental transfers, Rs. 5272 crores (5.78% of total expenditure).

Sectorally, Social Services absorbed Rs. 29220 crores and Economic Services Rs. 28596 crores, each working to about 5% of GDP. The loans and advances by state governments which amounted to about Rs. 5,555 crore was deployed almost entirely on Economic Services. The non-developmental expenditure of Rs. 22600 covers was mostly on general services covering fiscal and administrative services.

Tracing the trend of expenditure, one finds the total expenditure, while increasing in size has been hovering around 15% to 16 % of the GDP in the nineties. The total expenditure in 1999-2000, is placed at Rs. 325634 crores (16.6% of GDP) comprising a Plan expenditure of Rs. 78156 crores (4% of GDP) and a Non Plan expenditure of Rs. 247478 crores (12.6 % GDP) implying an increase in Non Plan expenditure, as compared to Plan expenditure.(0.8 % ) as percentage of GDP. Section-II 298

In terms of applications, Development Expenditure, in 1999-00, accounted for Rs. 198322 crores, (60.90% of total expenditure), Non Development Expenditure for Rs. 1,10,137crores (33.80% of total expenditure) and others Rs. 17,175 crores (5.27% of total expenditure). Of the Development Expenditure, Social Services accounted for Rs. 1,07,680 crores on direct development expenditure and Rs. 2,984 crore on loans and advances. Economic services accounted for Rs. 78,812 crores on direct expenditure and Rs.8,847 crores on loans and advances and General Services accounted for Rs. 1,07,309 crores. Non Development Expenditure has increased from 4% of GDP in 1990-91 to 5.6% on 1999-2000.

Analysis of the sectoral distribution of expenditures in the states, their spread into Revenue and Capital accounts and their split under Plan and Non Plan categories, it was found that while Social Services and General Services dominated by Revenue expenditure, Economic Services have a high proportion of Capital Expenditure.

Analysing the impact of the structural adjustment

programmes in the nineties, Dr.Sanjaya Baru (The New Economic

Policy and the Budget: Efficiency, Equity and Fiscal stabilization”

EPW, April 10, 1993.) pointed out that while the new economic

policy was seeking to improve the level of efficiency in the

economy by promoting efficiency gains to be attained through

privatisation and deregularisation of the economic system, it did

not address the problem of inequity and inequality as an explicit

goal and that even the efforts to meet the social dimensions of

structural adjustment programmes were limited to compensate for

the macro economic and micro economic losses that marginalised

economic and social groups were likely to encounter as

consequence of the new policies

Dr.Geeta Gouri (Towards Equity, New Economic Policy,

Oxford 1995 Pg .11) had however pointed out that “ Reactions to

Section-II 299

New Economic Policy display a common tendency with the

Stabilisation and Structural Adjustment Programme, towards

obfuscation of existing social costs of poorly designed

governments interventions or lack of government action and

transitional costs attributed to changes in economic policy.” She

further argued that, “Unfortunately, more often than not both sets

of costs tend to converge on the same groups and classes of people.

Transitional costs then cease to be transitional and instead tend

towards the long run. ….While the sustainability of the SAP

package depends on the minimisation of transitional costs, the

structural transformation of the economy depends on the

minimisation if not elimination of all social costs. Design of policy

however has to be sensitive to the different dimensions of social

costs.”

Examination of the Budgetary trends do reveal the extent to

which expenditure Programmes have been sensitised to different

Social costs. S.P.Gupta and A.K. Sarkar (Fiscal Correction and

Human Resource Development’ EPW, March 26, 1994, pp. 741-

751) had also drawn attention to the possibility of fiscal

consolidation measure affecting the expenditure on social services

particularly those catering to the poorer sections of the society.

They had argued that as activities on social services are mostly

Section-II 300

undertaken by the State Government, which account for 85% of

the total expenditure on social services, with a break up of 94% of

non-plan expenditure and 68% of plan expenditure going towards

social services, structural adjustment and fiscal consolidation were

likely to have a contractionary role leading to high social cost of

adjustment. This apprehension was more or less confirmed by

other studies. The contraction in Plan expenditure was highlighted

by Dr. Montek Ahluwalia(Economic Performance of States in

post-reform period”, EPW, May 6, 2000 pp. 1637 to 1648.) who

pointed out that in respect of 14 states the average plan expenditure

as a percentage of SDP for the period 1980-81 to 1990-91 was

5.69% and that it had come down to 4.5% during the period 1987-

88 – 1997-98 .

Taking a longer view and estimating Trend Growth of

Government Expenditure in Social Services, particularly on

Education and Health in 15 major Indian States, P.C. Sarkar and K.

Seethaprabhu(Financing Human Development in Indian States-

trends and implications 1974-75 to 1995-96”, Asian Economic

Review, April 2001, pp.36-60), pointed out that there was a

deceleration in social sector expenditure in 13 Indian States,

including those with low levels of human development since the

mid 1990’sand that 14 out of 15 states registered a deceleration, in

Section-II 301

respect of health sector with 9 States recording negative growth

rates and further that the deceleration was noticed only in 6 States

in respect of education.

Dr. N.J.Kurien, (Advisor, State Plans,Planning Commission)

pointed out (State Government Finances – A Survey of Recent

Trends EPW May 1999 pages 1115 to 1123) that while the overall

impact of Fiscal Reforms initiated at the Centre since 1991were

not encouraging with the Tax /GDP ratio in the nineties dropping

lower than that in the eighties, and that pay revision of Central

Government employees had nullified what ever gains that were

achieved in the expenditure management by the Centre, the States

Finances were marked by a sharp deterioration on account of the

failure of State Governments to contain wasteful expenditure,

reluctance to raise additional resources, competitive populism

practised by different political parties, substantial and still growing

explicit and implicit subsidies passed on to influential segments of

the society through State Budgets and the continued losses of the

State Electricity Board and other public undertakings.Presenting

data on demographic indicators, State domestic product,

development and non development expenditure of State

Governments, sectoral shares in plan outlay, banking activities and

infrastructural development, Dr. Kurien concluded that the

Section-II 302

“ongoing economic reforms since 1991, with stabilization and

deregulation policies as their prime instruments and a very

significant role for the private sector seem to have aggravated the

inter state disparities.”

Analysts have been drawing attention to the relative responsibilities of the Centre and the States in financing sectoral programmes and to the large role played by the states in the fields of Health and Education. The problems of prioritisation and management of expenditure have been highlighted in the context of fiscal stress of the states by Dr. A.K. Lahiri, (Sub National Public Finance in India, EPW April 29, 2000) Dr. Lahiri has also drawn attention to “the intrusion of the centre in many areas of expenditure. For example, dissatisfaction with the states performance and a desire to pursue a uniform policy through out the country led to the shifting of population control and family planning, forests, education and trade and commerce in several essential items from the state list to the concurrent list through Constitutional Amendments. In many areas, the centre has also intruded in the allocation decisions under the purview of the states through centrally sponsored schemes”. (EPW April 29, 2001 p.1543).

Whichever way one looked at the finances of the Union and the States, it emerges very clearly that while the Centre sought to cope with fiscal stress in the eighties, and faced a major crisis in early nineties, the states, one after the other slipped into fiscal imbalance nearly imperceptibly. The Reserve Bank of India study of State Finances (1999-2000), had observed that,“ the overall budgetary position of the 26 state governments for 1999-2000 highlights, that the basic structural weakness in state finances is yet to be addressed.”

(It can now be said that the structural weaknesses were sought to be addressed by the Union Government following the discussions in National Development Council in February 1999. The Fiscal Reforms facility of 1999 and a State Fiscal Reform Facility set up in 2000 are discussed in chapter XIII of the this report) The RBI study of State Finances 2003-04 reports that “2000-01 stands out as the first year when the study deterioration of State Finances witnessed in the second half of the 1990’s was arrested. This process of improvement was strengthened at least in part in 2001-02” and reports that both GFD and Revenue Deficit in 2001-02 were higher than the previous year. But showed an improvement in terms of GDP, with a decline in primary deficit both in absolute and GDP terms becoming a note worthy development. “the gains in containing fiscal deficit in the previous two years dissipated in 2002-03, with GFD and Primary Deposit increasing sharply and revenue deficit marginally. Budget Estimates for 2003-04seek to contain the deficit indicator both in absolute terms and in terms of the GDP. It remains to be seen whether this will be realized.

Chapter-IV

Section-II 303

Debt Burden, Other Liabilities and Interest Payment

The Presidential Notification of 1st November 2002 indicates

that, “the Commission may after making an assessment of the debt

position of the states as on 31st March 2004, suggest such

corrective measures, as are deemed necessary, consistent with

macro economic stability and debt sustainability. Such measures

recommended will give weightage to the performance of the states

in the fields of human development and investment.”

The Indian Constitution permits under Articles 292 and 293,

the Union and the State Governments respectively to borrow on

the security of their respective consolidated funds to meet their

financial requirements. The Constitution authorizes the Parliament,

and the State legislatures to fix limits on the total borrowings of

the Union and the state governments respectively but no such

limits has been prescribed.

It may be useful, at the outset to keep in view the distinction

between public debt and outstanding liabilities. While Public Debt

is raised on the security of the Consolidated Fund of India or of the

state and are repayable from out of the Fund, the other liabilities

like compensation and other bonds, special securities issued to the

Section-II 304

National Small Savings fund etc, are payable out of the Public

Account.

The Reserve Bank of India has in its Annual Report 2002-03

indicated that over the period between 1990-91 to 2002-03 the

outstanding liabilities of central and state governments shot up by

almost 15 % per annum,” and that the combined liabilities of the

Centre and the States grew as shown below.

Table : 4.1 Combined Liabilities and Debt-GDP Ratio

Year

end

March

Outstanding liabilities

(Rs crores)

Debt-GDP Ratio (%)

Centre States Combi

ned

Centre State

s

Combin

ed

1980-81 59749 2395

9

66728 41.6 16.7 46.4

1990-91 31455

8

11028

9

350957 55.3 19.4 61.7

1999-

2000

10210

29

42013

2

120434

2

52.7 21.7 62.2

2000-01 11685

41

49809

2

138805

1

55.5 23.7 66.0

01-02 13664 58979 163208 59.5 25.7 71.1Section-II 305

08 7 4

02-03

RE

15618

75

69428

9

186662

6

63.2 28.1 75.5

03-04

BE

17800

64

79070

2

211068

1

64.9 28.8 76.9

Note: Data regarding states are provisional

While taking note of the debt stock, one needs to remember

that the effect of changes in the systems of accounting in the

treatment of short term treasury bills (91 days) in 1997-98 and of

conversion into Central Government Securities of small savings,

deposits, public provident funds etc are reflected in the rise or fall

of numerical values from year to year.

The Asian Development Bank in its latest Economic Bulletin

on India (Nov 2003) has drawn attention to the worsening debt

profile of India with its total Public Debt inclusive of External

Public Debt accounting for 75.5 % of GDP. It has drawn attention

to the deterioration in the debt GDP ratio of the centre from 59.5 in

2001-02 to 63.2 in 2002-03 as also to the increase in the

Debt/GDP ratio and variations over a large range of Debt/GDP

ratio across the states, with 60 % for Himachal Pradesh and Orissa

and 17.3 % and 20.9 % for Maharashtra and Tamilnadu. The ADB Section-II 306

study also points out, as was done by the Reserve Bank of India a

few years back that the total liability of the states will be much

higher if the contingent liabilities on account of outstanding

guarantees get devolved on the state governments

The Planning Commission has, in the context of assessment

of the availability of resources for the Tenth Five Year Plan

recently examined the fiscal sustainability of the Centre and the

States, against the backdrop of the existing high debt to GDP Ratio

and raised the question of crowding out effect of Government

borrowings on private investment. The Commission has mentioned

that in the Indian context “investment has to primarily rely on

borrowing”, and that “a sizable part of which would continue to

finance government consumption expenditure” and gone on to

emphasise that “It is important in this context to under stand the

long term implications of continued dependence on borrowing.

Conventional wisdom justifies the borrowing so long as the return

from investment financed by such borrowings exceeds the cost of

borrowing. But India’s public finance inherits the consequence of

fiscal mismanagement the past , as reflected in the already existing

high debt/GDP ratio .” (Tenth FYP, para.2.83 etc)

Public Debt of the State Governments

Section-II 307

As has been pointed out earlier, the increasing revenue gap

had obliged state governments to resort to loans from the Centre

and to Market Borrowing to meet their rising expenditure

requirements from the mid eighties onwards. The steepness of the

increase in the eighties and the nineties can be seen from the

relatively small stock of debt the state governments had in 1961

and 1971. (see Table : 4.2)

Table 4.2 - Outstanding liabilities of the State

Governments

196

1

197

1

198

1

1991 2001 2002 2003 2004

Market

Loans

410 114

3

298

8

1561

8

8546

6

1015

40

1133

84

1448

94

Banks

& FIs

50 230 914 2906 3223

5

4564

3

5791

5

7196

7

Centre 201

4

636

5

169

80

7411

7

2245

90

2393

96

2581

31

2514

92

State

PF

112 471 218

5

1400

2

7644

6

8628

0

9581

5

1023

80

258

6

820

9

230

67

1066

43

4187

37

4748

61

5272

48

5707

33Section-II 308

Other

Liabiliti

es

153 540 892 3646 79355 1143

57

1559

20

2206

67

273

9

874

9

239

59

1102

89

4980

92

5892

18

6831

68

7914

00

% to

GDP

16.0 19.0 23.7 25.7 26.7 28.8

A grim indicator of the prodigality of the states is the

startling fact that while the states accumulated additional total debt

of Rs. 55,922 crores in the Five Year Period between 1986 and

1991, they doubled, in the next five years, the quantum of

addition- by increasing the total debt by Rs. 104023 crores from

Rs.106643 crores in March 1991 to Rs. 212226 crores in March

1996. The annual increases thereafter were also very striking The

total debt increased by Rs. 60,769 crores during one year 1998-99,

by Rs. 76,606 crores during 1999-00 and Rs. 80,257 crores during

the single year of 2000-01. The end product of fiscal laxity is seen

in growing outstanding liabilities of state governments which

began in the second half of the nineties when revenue growth

suffered a set back. The debt/GDP ratio of all the states together

which had remained stable at around 19% in the second half of the

Section-II 309

1980’s, and had in fact declined in the first half of 1990’s to less

than 18%, began rising later and touched 23.7% by March 2001.

The analysis of the burden of outstanding debt , other

liabilities and interest payments indicate the dimension of the

deterioration in the fiscal health of the states during the nineties.

The predicament was the combined result of the aggregate

expenditure of the state government staying around 15 %, while

states own tax revenues were marked by a stubborn sluggishness,

and non tax revenues by continuing poor returns from past

investments, and the congenital apathy towards revenue

augmenting measures like appropriate user charges. The Reserve

Bank of India presented its analysis of relative average growth in

revenues and in public debt of the state governments for the period

1990-99 and observed that, when the consolidated outstanding

debt of states as ratio to GDP stood in the range of 17.3 % to 20.6

% , the nominal debt stock grew at 15.4 % per year exceeding the

average revenue growth of 14.4 %. (RBI, State Finances 1999-

2000, pg 20).The state-wise position is shown below.

Table : 4.3 Public Debt of States - Average Rate of Growth

1990-99

States Revenue DebtSection-II 310

Andhra Pradesh 15.0 17.5

Arunachal Pradesh 14.1 15.7

Bihar 11.6 12.9

Himachal Pradesh 15.9 19.9

Karnataka 15.5 16.2

Kerala 16.6 17.7

Madhya Pradesh 13.8 14.5

Maharshtra 12.8 15.3

Manipur 12.6 14.2

Meghalaya 13.7 16.6

Mizoram 11.8 18.3

Nagaland 13.2 17.5

Orissa 13.1 16.1

Rajasthan 14.7 16.5

Tamilnadu 14.6 17.5

Tripura 15.8 15.0

Uttar Pradesh 12.5 16.4

West Bengal 12.4 19.0

The details of outstanding liabilities as on March 31st of

1998,1999, 2000,2001 and 2002 and the estimates for 2003 are

presented in Table below.

Section-II 311

Table –4.4 All States Outstanding Debt on March 31st of Each Year (Rs. Crores)

States 1998 1999 2000 2001 2002(RE) 2003 (BE)Tot Debt % GSDP Tot Debt % GSDP Tot Debt Tot Debt Tot Debt Tot Debt

A.P 19969 20.8 23905 20.9 29114 35651 43246 50638Arp 779 57.6 866 56.2 906 973 1092 1205Assam 6212 26.9 6836 26.9 8573 10199 12008 13252Bihar 20164 30.4 23193 35 28353 33818 39325 44649Goa 1409 - 1681 - 1921 2258 2684 3060Gujarat 15061 16.3 18561 18.2 22984 29786 38102 46689Haryana 7632 20.1 9495 21.7 11556 13179 15551 17526H.P 3965 48.5 5714 61.7 6473 7871 9286 11101J & K 5857 68.8 6335 - 7743 8760 9708 10590Karnataka 12945 16.9 15444 17.1 18725 22158 26893 32597Kerala 12868 24 15700 25 20176 23919 26559 30008M.P. 16040 19.8 19268 21.2 23089 26282 30431 34099Maharastra 25870 12.1 31176 12.4 38300 44680 53578 61324Manipur 865 35.6 1150 44.2 1422 1692 1901 2065Meghalaya 561 21.4 711 23.7 874 1047 1312 1538Mizoram 594 52.9 730 - 883 1100 1297 1488Nagaland 1187 - 1378 - 1644 1908 2234 2526Orissa 12403 38 15057 42 18309 22015 25509 29207Punjab 17216 35.2 20877 38 23661 27830 33300 37950Rajasthan 16430 27.8 21108 - 26683 30641 35390 40890Sikkim 357 - 505 - 677 731 786 834T.N. 16282 23 19582 16.7 23838 28686 33808 40947Tripura 1125 36 1389 40.4 1780 2210 2745 3330U.P. 40008 26.6 48624 28.3 59969 66401 76451 87106W.B. 22041 23 28617 26 37007 47249 57351 68111NCT Delhi 3370 9.6 4077 - 5472 7048 8675 10440

All States 281209 18.5 341979 17.5 420133 498092 589218 683168

Section-II 312

Growth of debt individual state wise reveals that the rate of

debt accumulation exceeded the revenue growth in the case of as

many as 18 states, and that five among the special category states,

and nine from non special category states had recorded debt

growth at a rate higher than the all states averages. In its analysis

of State Finances 2001-02, the RBI also presented the Debt/NSDP

ratios and interest burden represented by interest payment as a

ratio of revenue receipts as shown in the table below

Table : 4.5 Burden of Debt and Interest Payment

States Debt/NSDP ratio Interest Burden-

IP/RR

1990-95 1995-

000

1990-

95

1995-

2000

Andhra Pradesh 22.0 23.2 12.1 16.9

Assam 37.6 32.8 13.8 15.0

Bihar 41.6 41.1 20.2 30.4

Gujarat 22.4 18.6 15.4 17.4

Haryana 22.2 23.9 12.4 15.7

Jammu and

Kashmir

98.6 65.1 18.3 14.1

Section-II 313

Himachal

Pradesh

47.7 58.1 15.4 17.3

Karnataka 20.7 20.4 11.4 13.6

Kerala 33.3 27.9 16.5 19.5

Madhya

Pradesh

23.9 22.5 12.1 14.8

Maharshtra 15.5 17.0 11.5 15.1

Orissa 44.2 48.1 19.7 26.1

Punjab 39.9 41.4 19.3 32.6

Rajasthan 30.6 33.4 15.2 22.9

Tamilnadu 19.3 18.3 10.1 13.8

Uttar Pradesh 30.2 31.3 18.2 27.2

West Bengal 24.3 25.8 18.1 28.9

RBI State Finances , 2001-02 January 2002, pg 24

Analysis of Recent Data between 2001-02 to 2003-04 showed that

as many as 13 states had rates of growth in debt between 15 to

20%, and 8 states between 10 and 15% as can be seen from the

Table below

General Category Special Category

Below 10% - Arunachal, Mizoram,

Sikkim

Section-II 314

(3 States)

10 to 15% Bihar, Kerala,

Haryana & Punjab

(4 States)

Assam, J&K, Manipur,

Nagaland

(4 States)

15 to 20% Andhra Pradesh,

Goa, Karnataka,

Madhya Pradesh,

Maharashtra, Orissa,

Rajasthan, Tamil

Nadu, Uttar Pradesh

and W.Bengal

(10 States)

Himachal, Mizoram,

Meghalaya

(3 States)

Above 20% Gujarat, NCT-Delhi

(2 States)

Tripura

(1 State)

The Reserve Bank of India has also examined the sustainability of

debt of the states in terms of their ratio to the net state domestic

product at current prices for which year the estimates are available

for 2001-02.

Debt NSDP Ratio 2001-02

General Category Special

Category

Below 30% Karnataka, Maharashtra & NoneSection-II 315

Tamil Nadu

30 to 40% Andhra Pradesh, Goa, Gujarat,

Haryana, Kerala, Madhya

Pradesh

Meghalaya

40 to 50% Rajasthan, U.P and W.Bengal Assam, Tripura

Above 50% Bihar, Orissa, Punjab Arunachal,

Himachal,

Manipur,

Mizoram,

Sikkim

Note : M.P includes Chattisgarh, U.P Uttaranchal and Bihar

Jharkand

Indebtedness to Centre

While concern has been shared by all over the rapid growth

of the aggregate liabilities of the state, there is need to analyse the

composition and ownership pattern of the debt of the state

governments. It is significant that out of the outstanding debt of

Rs. 4,98,092 crores remaining in March 2001, loans and advances

from the central governments accounted for Rs.224590 crores,

45.1% of the total outstanding debt. We need to note that, while

the loans and advances from centre to the states increased in Section-II 316

absolute terms from Rs. 2014 crores in 1960-61 to Rs.6365 crores

in 1971, Rs. 16980 crores in 1981, Rs.74117 crores in 1991 and

very sharply to Rs. 216194 crores in 2000 , this component as a

share of outstanding liability declined accounting for 73.5% in

1961, 72.8 % in 1971 , 70.9 % in 1981, 67.2 % in 1991, 51.5% in

2000. This has since decline to 37.77 % as per Budget Estimates

2004. (See table below) Part of the decline can be attributed to the

changes in regard to small savings collections, out of which

Government of India used to transfer 80% to the states till end

1999. From 1st January 2000, the entire net collections are

transferred to the states. Recent position is shown below

(Rs.

Crores)

Year Total Liabilities of

the States

Central Loans

and Advances

National Small

Saving Fund

2000 420132 216194 26416

2001 498092 224590 59022

2002 586687 235564 94670

2003 688421 243698 143739

2004

BE

791400 251492 193935

Section-II 317

The states have been provided further relief by the introduction by

centre of a Debt Swap Scheme in the Union Budget for 2003-04.

Under this the states can pre pay the high cost debt to the centre

from the proceeds of additional market borrowings and small

savings States are allowed to retire loans amounting to Rs.

1,00,000 crores from the centre bearing rates in excess of 13% .

During 2002-03 the states pre paid central loans of Rs. 13766

crores, utilizing Rs. 10,000 crores from additional market

borrowings and the balance through small savings proceeds.

During 2003-04 the central government had provided for Debt

Swap of Rs. 46602 crores. The Reserve Bank of India indicate the

additional market borrowings under the Debt Swap Scheme

amounted to Rs. 26,623 crores during 2003-04. What is significant

is that while additional market borrowing at interest rates below

6.5%, of the rate at which the states had borrowed from centre and

the proceeds of small savings involved interest rate of 9.5%. This

enable the state governments to reduce the burden of interest

payments. While on the surface Debt Swap Scheme involves only

change in the composition of debt, and can be considered debt

neutral from the point of view of budget presentation, and

estimates of gross fiscal deficit, the relief to the state governments

is on the decline in interest payment burden.

Section-II 318

Market Borrowings

The outstanding liabilities on account of market borrowings

of the state government has increased from Rs. 2988 crores by

March 1981 to Rs. 15618 crores by March 1991and rapidly rising

through the nineties to Rs. 85466 crores by March 2001. The

recent budget estimates indicate that this will reach Rs. 144894

crores by March 2004. Analysis of year wise details show that

gross market borrowings of state government has increased from

Rs. 2565 crores in 1990-91 to Rs. 13300 crores in 2000-01, Rs.

1870 crores in 2001-02, Rs. 30853 crores in 2002-03 and a likely

Rs. 50521 crores in 2003-04. The net borrowings after repayment

stood at Rs. 29064 crores in 2002-03 and Rs. 46376 crores in

2003-04.

It is to be noted, the cost implication of market borrowings

had initially risen during the nineties only to start declining from

1999-2000 onwards. While earlier loans from the Centre met

substantial part of the overall borrowing requirements of the states,

centre’s own constraint became evident in the nineties. In view of

this market borrowing as a source of finance became more

important increasing their share of outstanding liabilities and

meeting 16.4% of the state fiscal deficit in the nineties as

Section-II 319

compared to 11% during the eighties. With the deregulation of the

interest rate, the cost implication of market borrowings became

serious for the states. The weighted average of interest rates for

loans of state governments increased from 11.50% in 1990-91 to

12.35% in 1998-99. The aggregate gross interest payments of all

states increased from Rs. 10944 crores in 1991-92 to Rs. 54271

crores in 2000-01 and increase, as a percentage of revenue receipts

of the states was from 13.5% in 1991-92 to 22.20% in 2000-01.

The Reserve Bank of India, in its study of Finances of State

Governments, 1996-97 explained the inter relation between the

nature of increase in Capital Receipts of States, increasing share of

Central Loans, and the rising interest payment obligations of the

states and observed, “ Since the Central Government has been

resorting to market related interest rates, the interest rates on the

loans extended by the Centre to the States have also been increased

by Centre. As a result the average interest rate charged by Central

loans to states has been rising .In 1980-81 , the average interest

rate charged by Centre on the on-lent funds was 5.50 % , which

rose to 8.86 % in 1991-92 . Since then it has grown steadily to

reach 11.39 % in 1995-96 and 11.74 % in 1996-97. Loans for State

Plan schemes are the single largest component of Central loan to

states which have an average maturity of 20 years. Interest rates on

Section-II 320

these loans have been revised to 13.5 % with effect from June 1,

1995, which is close to the yield rate on longest maturity central

loan presently offered. On the other hand, the average borrowing

cost to the Centre from market has increased from 10.43 % in

1991-92 to 12.05 % in 1995-96 and further to 12.09 % in 1996-97.

With the result, the interest rate subsidy from the Centre to the

States has come down from 1.57 % in 1991-92 to 0.66 % in 1995-

96 and further to 0.35 % in 1996-97. Thus rising share of Central

loans in the borrowing requirements of the states while obviating a

need for states access to other borrowing sources on a large scale

also implies some cost to the Central Budget and subsidy to the

states to the extent that the interest costs on Centre’s borrowing is

higher than the interest rates charged by it to the states.” (pg 8 of

1996-97, RBI Study Finances of State Governments 1996-97). It

needs to be noted that, the weighted average of interest rates on

Central Government Securities rose from 7.03 % in 1980-81 to

13.75 % in 1995-96 , and thereafter started declining gradually to

11.77 % in 1999-2000 and that in the case of state governments

there was a similar gradual increase each year from 6.75 % in

1980-81 to 14 % in 1995-96 and a fall thereafter to 11.89 % in

1999-2000. There has been further decline to 10.99% in 2000-01,

9.20% in 2001-02, 7.49% in 2002-03 and 6.13% in 2003-04. The

RBI has since 1998 made significant changes in the management

Section-II 321

of public debt of the state governments with alternative approaches

to the market. It is evident that the Ministry of Finance the

Planning Commission and the Reserve Bank of India who

formulate the market borrowing programmes have fine tuned the

operations, keeping in view the implication of interest rate and

maturity profile for the fiscal position of the Centre and the States,

and in particular the outgo on interest payments. The year wise

increase in Gross and net payments for all the states are shown in

Table 4.5.

Table- 4.6 States Aggregate Interest PaymentsYears Gross Net1990-91 9225.00 (13.88) 6821.00 (10.26)1991-92 10944.40 (13.50) 5624.00 (6.98) 1992-93 13210.10 (14.50) 9272.00 (10.20) 1993-94 15800.50 (15.00) 11075.10 (10.50) 1994-95 19413.30 (15.90) 14048.80 (11.50) 1995-96 21932.10 (16.00) 16139.60 (11.80) 1996-97 25576.40 (17.70) 17405.50 (12.00) 1997-98 30112.80 (17.10) 22203.10 (27.60) 1998-99 35873.50 (20.30) 28395.60 (16.10) 1999-00 RE 45525.90 (21.20) 36884.50 (17.20) Accts 45171.00 35878.002000-01 BE 54270.90 (22.20) 45303.10 (18.50) RE 54031.00 43912.00 Accts 51702.00 40264.00

Note: Figures in brackets represent Percentage of Revenue Receipts

Section-II 322

Interest Payment – Statewise

Between 1991-92 and 2000-01, gross interest payment

liabilities of all the states increased from Rs.10944 crores to

Rs.51702 crores. As a percentage of the revenue receipts of the

states the increase was from 13.5 % to 21.73 % . Net interest

payment had increased from Rs.5624 crores to Rs.40264.3 crores

and from 10.26% to 18.2 % Individual state wise liability for

interest payment in gross and net terms are shown in the Tables 4.7

and 4.8. Eleventh Finance Commission had observed that the

proportion of interest payments to revenue receipts including

devolution and grants should be about 18 % but the states appeared

to be carrying higher interest burden till 2001-02, and the position

may change somewhat, in the years to come on account of the debt

swap scheme introduced by the Centre.

Table 4.7 Gross Interest Payment -All States

State 1991-92 97-98(AC) 98-99(AC) 99-00(AC) 00-01(AC) 01-02(RE) 02-03(BE)

Andhra 695.00 2153.30 2643.80 3101.10 3792.60 4853.50 Arp 21.40 59.90 71.20 79.80 120.70 111.90 127.90 Assam 92.70 638.90 520.70 955.60 865.10 1288.20 1575.40 Bihar 1004.30 1536.00 1872.30 2861.40 2374.10 2752.30 2863.90 Goa 57.30 118.10 143.90 178.20 212.20 267.20 292.40 Gujarat 716.80 1884.20 2261.90 2808.20 3131.40 4238.50 4900.00 Haryana 321.90 820.30 997.00 1357.40 1491.90 1709.20 1998.20 H.P 147.90 372.10 498.00 597.30 798.30 1030.40 1224.40 J & K 385.70 592.70 664.70 844.50 844.50 1086.30 1181.50 Karnataka 514.50 1393.80 1616.60 2012.30 2387.60 2838.50 3291.20 Kerala 483.40 1286.10 1446.30 1952.30 2257.60 2273.70 2416.90

Section-II 323

M.P. 607.70 1659.90 1834.80 2138.70 2410.80 2359.70 2417.10 Maharastra 1159.60 2903.60 3673.10 4883.60 5224.50 6283.70 7286.10 Manipur 31.10 78.90 91.30 132.00 177.10 177.20 186.40 Meghalaya 21.50 60.90 69.40 95.70 113.70 158.20 162.30 Mizoram 13.20 65.80 73.70 93.70 101.20 124.60 145.90 Nagaland 53.50 113.40 136.50 163.10 194.00 222.50 256.00 Orissa 481.00 291.70 1484.80 1237.70 2286.80 3019.90 2915.30 Punjab 360.50 1848.80 2316.80 2636.70 2343.30 3149.20 3211.00 Rajasthan 615.70 1896.70 2242.90 2825.20 3339.30 3913.00 4372.90 Sikkim 14.90 40.90 52.50 67.90 78.70 83.50 84.50 Tamil Nadu 557.30 1763.40 2121.90 2711.50 3123.80 3559.90 3970.70 Tripura 50.10 120.00 140.60 185.20 226.00 277.80 334.20 U.P. 1710.30 4689.30 5516.60 6553.10 7455.40 8913.30 9736.40 W.B. 827.00 2410.00 2949.90 4169.00 5249.50 6747.40 7487.60 NCTDelhi NA 314.10 432.30 530.70 716.80 910.60 1108.00 All States 10944.40 30112.80 35873.50 45171.70 51702.00 64502.30 72285.30

(13.50) (17.10) (20.30) (25.90) (21.73) (23.81) (23.55)

Section-II 324

Table : 4.8 Net Interest Payment All States (Rs. Crores)

State 97-98(AC) 98-99(AC) 99-00(AC) 00-01(AC) 01-02 (RE) 02-03(BE)Andhra 1249.80 1498.30 1681.00 2327.00 3263.40 4524.80 Arp 54.60 65.10 75.60 111.70 101.90 118.90 Assam 636.80 518.50 953.10 860.80 1283.70 1570.00 Bihar 1448.20 1736.30 2532.80 2241.30 2663.20 2834.90 Goa 115.40 139.40 173.10 209.30 262.20 286.90 Gujarat 677.00 669.20 1043.70 1201.60 2560.80 3150.00 Haryana 583.30 813.30 1155.20 1255.70 1333.50 1573.90 H.P 359.10 488.60 437.80 783.30 1022.10 1213.50 J & K 492.60 576.60 742.00 739.50 962.20 1047.80 Karnataka 831.30 946.90 1210.60 1666.40 2694.50 3165.20 Kerala 1232.60 1375.30 1915.00 2220.80 2237.30 2377.60 M.P. 1436.70 1687.30 1881.60 2226.20 2088.00 2253.60 Maharastra 1209.50 2019.20 3159.40 2062.90 5350.30 6149.60 Manipur 78.00 90.50 131.30 176.40 176.50 185.60 Meghalaya 56.80 63.50 87.30 104.40 152.40 160.50 Mizoram 65.40 73.10 92.90 98.10 123.40 143.80 Nagaland 111.40 134.00 160.10 191.00 219.40 252.70 Orissa 1273.10 1465.20 1218.20 2273.70 2999.90 2885.30 Punjab 865.90 2211.90 2101.70 1637.20 2597.50 2496.60 Rajasthan 1298.50 1614.10 2154.80 2749.70 3318.40 3761.10 Sikkim 40.90 52.20 67.40 74.20 78.00 84.00 Tamil Nadu 1277.10 1736.90 2364.70 2720.20 3018.50 3567.50 Tripura 117.80 137.00 173.60 207.50 259.30 314.00 U.P. 4205.00 5088.60 6076.40 6930.20 8457.10 9289.00 W.B. 2305.10 2901.20 4058.90 4575.90 6116.50 6600.40 NCTDelhi 181.20 293.30 230.00 239.50 88.40 655.40 All States 22203.10 28395.60 35878.00 40264.30 55297.70 62922.40

The more recent picture of gross and net interest payment of all the states are shown in the following table

Years Gross Net20001-02 BE 64875.00 56183.00

RE 64498.00 52298.00Acct. 62506.00 53300.00

2002-03 BE 72285.00 62922.00RE 74187.07 65318.08

Acct NA NA2003-04 BE 82920.00 73630.10

Section-II 325

Table : 4.9 Gross and Net Interest Payment All States (Rs. Crores)Gross Net Gross Net

State 02-03(BE) 02-03(BE) 03-04

Andhra 4524.80 6923.6 5072.5Arp 127.90 118.90 150.6 143.1Assam 1575.40 1570.00 1737.2 1732.8Bihar 2863.90 2834.90 3416.8 3386.9Goa 292.40 286.90 300.9 294.8Gujarat 4900.00 3150.00 5542.2 3568.4Haryana 1998.20 1573.90 2220.6 1726.3H.P 1224.40 1213.50 1875.7 1865.2J & K 1181.50 1047.80 1150.0 1022.1Karnataka 3291.20 3165.20 3630.6 3592.7Kerala 2416.90 2377.60 2738.1 2702.8M.P. 2417.10 2253.60 3000.1 2888.3Maharastra 7286.10 6149.60 8306.5 7767.7Manipur 186.40 185.60 214.3 213.3Meghalaya 162.30 160.50 182.8 180.0Mizoram 145.90 143.80 158.5 156.9Nagaland 256.00 252.70 270.7 268.7Orissa 2915.30 2885.30 3250.0 3217.0Punjab 3211.00 2496.60 3473.1 1901.6Rajasthan 4372.90 3761.10 4793.1 4114.2Sikkim 84.50 84.00 94.0 91.0Tamil Nadu 3970.70 3567.50 4546.3 4132.4Tripura 334.20 314.00 336.9 332.0U.P. 9736.40 9289.00 11004.4 10565.4W.B. 7487.60 6600.40 9426.2 9202.2NCTDelhi 1108.00 655.40 1393.0 835.5All States 72285.30 62922.40 82920.0 73630.0

Section-II 326

Off Budget Borrowings and Contingent Liabilities

An important dimension to sustainability of state finances

was added in 1999 by the Reserve Bank which pointed out that, “ a

growing trend in guarantees at the state level has been witnessed in

the recent past on account of demand for extending guarantees for

setting up basic infrastructure”. It was noted that the state

government guarantees outstanding at the end of the financial year

increased from Rs. 40,159 crores in 1992 to Rs. 83,075 crores in

1999. This has since risen to Rs 168712 crores in 2001. The

increase in off budget borrowings and contingent liabilities is

examined in detail in chapter XII of this report.

Though the outstanding state government guarantees in

respect of 17 major states as a ratio to GDP came down from 6.5%

in 1992 to 4.7% in 1999, RBI felt that this had serious implications

for the risk associated with loans from financial institutions, and

therefore set up a Technical Committee on State Governments

Guarantees which in its Report February 1999 recommended

prescription of limits and ensuring greater selectivity and

transparency in providing and reporting government guarantees.

This has been followed by a Group to Assess the Fiscal Risk of

State Government Guarantees, which has recommended that the

Section-II 327

guarantees to be met out of budgetary resources should be

identified and treated as equivalent to debt and that for other

guarantees appropriate risk weights should be assigned to the

projects. The Group also recommended that the state level tracking

unit for guarantees should be set up and that atleast one percent of

the outstanding guarantees should be transferred to the Guarantee

Redemption Fund each year specifically to meet the additional

fiscal risk.

In view of the serious concern over the rising liabilities of the

states, Government of India and the Reserve Bank of India took

several measures to contain the seriousness of the problem. The

Reserve Bank of India organized conferences of state financial

secretaries to discuss the issues and problems relating to debt

management and for evolving measures relating to Ways and

Means advances for the Reserve Bank of India, Market Borrowing

Programmes, proposals for Sinking Fund, Extension of guarantees

for state governments, Guarantee Redemption Fund and measures

for enhancing transparency in fiscal operations. The traditional

system of open market borrowings by the states involved

finalisation by and approval of the programmes by the Ministry of

Finance, and the Planning Commission in consultation with the

Reserve Bank of India and the RBI as Debt Manager completing

Section-II 328

the combined borrowing programme of all the states in two or

three tranches through issue of bonds with a pre determined

coupon and pre-notified amounts for each state. In the context of

financial sector reforms, some significant changes have come in

public debt management. The RBI now offers options to the states

to enter the market individually and raise resources through the

auction method or the market tap method. This has prodded the

states to improve their image as managers of Public Finance, the

effect is yet to be fully felt. What is significant is that of the three

states i.e Karnataka, Maharashtra and Tamil Nadu whose debt

NSDP ratio below 30% in 2001-02, Maharashtra and Karnataka

has resorted to heavy off budget borrowings for their infrastructure

projects in irrigation, Power and Housing

Section-II 329

Debt Relief by Finance Commissions

On a different plane the State governments were also relying

on the Finance Commissions to provide relief in respect of loans

from Central Government .The Sixth Finance Commission had

indicated that the problem now of the indebtedness of the states

was not the size of the debt stock but the repaying capacity of the

states and recommended against writing off of any debt and

suggested categorization of state loans with different degrees of

reliefs in terms and conditions of repayment , the total relief

offered to 21 states amounted to RS.1969.62 crores. The Seventh

Finance Commission also did not favour write off of loans and

recommended relief to the tune of Rs.2155.80 crores. The Eighth

Finance Commission did not favour any change in the loan

repayment terms and conducted an exercise by taking the

percentage of central loans outstanding on 31st March 1984 to the

average of State Domestic Product for the period 1976-79 to

categorise the states into four groups to determine the debt relief

to be given to them .The major exercise however resulted only in

the relief of Rs.2285.38 crores to the states . The Ninth Finance

Commission was also asked to review the entire debt position of

the states as at the end of March 1989, After a detailed

examination of the total outstanding of Rs. 89,461 crores of which

Section-II 330

Rs.56,052 crores were due to the Centre , the Ninth Commission

recommended relief to the extent of Rs.975.62 crores , a small

proportion of the sum of Rs. 15,529 crores the states were due to

repay to the Centre during the period 1990-95. The Tenth Finance

Commission reviewed the debt position of the states, diagnosed

the aggravation of the problem due to diversion of funds and use

for non productive purposes and felt the effective solutions to the

problem could come only by prudent use of borrowed funds by the

state and limited scheme of debt relief with preference for states

under severe fiscal difficulties. Its scheme of relief was limited to

Rs. 1266.07 crores.

The Eleventh Finance Commission, was required to make an

assessment of the debt position of the states as on 31st March 1999,

and suggest, “ such corrective measures as are deemed necessary

keeping in view the long term sustainability for both the Centre

and the states.” The Commission in its report has discussed

conceptual and practical issues relating to sustainability of debt

and examined the debt profile of individual states which indicated

that as a proportion to GSDP the long term debt in 1998-99

varied from 13.08 % for Maharshtra to 55.87 % for Himachal

pradesh 58.39 % for Mizoram and 64.24 % for Sikkim. Analysing

the out standing Central loans of Rs. 2,03,786 crores from the

Section-II 331

states in 1998-99, the Commission noted that repayments due

during the period 2000-05 amounted to Rs.51369 crores

comprising of plan loans , Rs.30,947 crores and non plan loans of

Rs. 20,422 crores, and recommended a scheme of relief which

was nothing more than a continuation of the Tenth Finance

Commission, with some change in the formula. The relief scheme

in its essence linked the relief to improvement in the ratio of

revenue receipts to revenue expenditure with enhancement of

incentives suggested by the Tenth Finance Commission. The

bottom line implications for the states on account of the

recommendations of the successive Finance Commissions have not

been significant and the states continue to clamour for debt relief.

Relief appears to have come from some other quarters

namely the market, with the softening of the interest rate

regime.The coupon rates and state government security which had

increased from a range of 11.5 to 12 % per annum in 1991-92 to

14 % in 1995-96, started climbing down to a range of 10.5 to 12 %

in 2000-01, and thereafter in response to policy forced direction

further to 6.67 to 8 % per annum during 2002-03.As the Reserve

Bank of India has indicated, “the declining interest rates on market

borrowings by state governments has some positive implications

on the states debt serving costs. (Study of State Finances 2002-03,

Section-II 332

pg 27) .It is however important to note that the burden of

repayment of market borrowings will be significant for some more

years to come as will be evident from the repayment schedule for

market loans (Table 4.10) , marked by a sharp rise from Rs. 1789

crores in 2002-03 to Rs.21807 crores in 2011-12. It appears that

the relief by way of low interest on new securities may not make a

significant difference to the burden of repayment of loans earlier

raised .

Table:-4.10 Repayment schedule of market loans by

state Governments

Year Rs. Crores Year Rs. Crores

2002-03 1789 07-08 11554

03-04 4145 08-09 14400

04-05 5123 09-2010 16261

05-06 6274 10-11 15870

06-07 6551 11-12 21807

The Central Government has introduced a debt swap scheme

between the Central Government and the states under which all

state loans from Government of India bearing coupons in excess of

13 % interest rate would be swapped over a three year period

ending in 2004-05. The state governments are expected to save Section-II 333

Rs.81,000 crores in interest and deferred loan repayments. This

scheme has been welcomed by the state governments.

It is clear that while the state governments have been

prodded into moving towards establishment of consolidated

sinking funds and take other measures to ease their debt burden

and interest payments, the Twelfth Finance Commission may need

to note that the latter part of its award period, will involve heavy

repayment liability for the states, and there may be need to take

this into account in the fiscal restructuring plan.

Section-II 334

Chapter-V Deficit Indicators

An important aspect of Indian Public Finance emerging in

the nineties is the critical dimensions of the state finances, with the

expenditure of the state government outstripping that of the Centre

in 1999-2000, and the predominance of the state government’s

share in development expenditure. As the Reserve Bank of India

pointed out in its Annual Report 2002-03, “ It is increasingly

recognized that it is the state finances where the Government

sectors interface with the public is most significant. Issues in the

reform of fiscal policy have a direct bearing on the quality of life.”

But the steep dive into deficits witnessed in state finances have

been a major source of worry for policy makers at the Centre and

in the states.

The increasing size of Revenue, Gross Fiscal and Primary

Deficits of the states during the last two decades. (see table below),

and the decomposition and financing of Gross fiscal deficit have

presented a rather distressing picture. The individual state wise

details of growing Revenue and Gross Fiscal Deficits show that

fiscal distress has spread to all the states and that while the

diagnosis of structural and operational is clear, fiscal reform

Section-II 335

strategy formulated in recent years have not yet begun to yield

noticeable results.

Table : Deficit Indicators of States (Rs.Crores)

70-71 1980-81 1990-91 00-01 01-0202-03 (BE)

02-03 (RE)

03-04 (BE)

RevenueDeficit

19 -1486 5309 53569 59233 48223 61302 48326(0.11) (1.0) (2.5) (2.6) (1.9) (2.5) (1.8)


901 3713 18787 89532 95986 102848 116730 116175

(1.9) (2.73) (3.5) (4.3) (4.2) (4.0) (4.7) (4.2)Primary Deficit

503 2488 10132 37830 33947 30629 42584 33251(1.83) (1.9) (1.8) (1.5) (1.2) (1.7) (1.2)

Revenue Deficit

Analysis of the Aggregate figures show that all the states had

a marginal revenue deficit of Rs. 19 crores in 1970-71 which

turned into a surplus in the second half of the seventies reaching

Rs.1486 crores in 1980-81 and thereafter surplus declined from

year to year and turned into a deficit of Rs.1088 crores in 1987-88

. For about a decade up to 1997-98, revenue deficit remained

below one percent of GDP and began to rise in the Nineties from

about Rs. 5309 crores in 1990-91 to Rs. 8200.50 crores, in 1995-

96 and steeply increasing thereon to Rs. 16113 crores in 1996-97 ,

Rs. 16333 crores in 1997-98 and even steeper to Rs. 43641 crores

in 1998-99, Rs.53797 crores in 1999-2000 and Rs.53569 crores in

2000-01. The rise since 1997-98, from 1.2% to 2.5% in 1998-99

Section-II 336

and 2.91% in 1999-00, has been attributed to the salary and wage

pressures from a state government employees following the

implementation of the recommendation of the Fifth Pay

Commission in respect of Central Government employees.

While the Revenue Deficit increased as above Capital Outlay

of the State Government increased from Rs. 556 crores in 1970-71

to Rs.3201 crores in 1980-81 Rs.9223 crores in 1990-91, and

increasing further to Rs 31130 crores in 2000-01 and Rs.38333

crores in 2001-02 and Rs.43684 crores in 2002-03.The Loans and

Advances by State Governments had increased from Rs.491

crores to Rs.2447 crores, Rs. 5756 and Rs.11732 crores in the

respective years. Further increases have been indicated for 2001-

02 and 2002-03. The budgets of the recent years plan for a

lower revenue deficit at the estimate stage, only to end up with

higher deficit by the close of the financial year. In 2002-03 the

budget estimates indicated the revenue deficit of Rs. 48079

crores (1.9% of the GDP) and the revised estimates indicated

Rs. 61240 crores (2.5% of the GDP). The budget estimate for

2003-04 once again indicated revenue deficit at Rs. 48326

crores (1.18% of the GDP).


Section-II 337

The increase in the expenditure on the revenue and capital

side began to get reflected in the increase in Gross fiscal deficit of

the state. The GFD of all the states rose from Rs. 901 crores in

1970-71 to Rs. 3713 crores in 1980-81 and Rs.18787 crores in

1990-91and by 1999-2000, the year in which states expenditure

outstripped the centre, it had risen to a astounding level of Rs.

91480 crores. The G.F.D. of all States which was only 1.96% of

GDP in 1970-71 had risen to 2.57% in 1980-81, 3.30% in 1990-

91, before sharply rising to touch a level of 4.72% in 1999-

2000.The next year there was a reduction to 4.25 % .The Table

indicates the extent to which State Finances have deteriorated in

the second half of nineties.

Increase in First half

of the nineties

(Rs.Crores)

Increase in Second

half of the nineties

(Rs.Crores)

Gross Fiscal

Deficit

12,639 58,691

Revenue Deficit 2,892 43,117

Outstanding

liabilities

1,01,936 3,79,607

Section-II 338

With both the Centre and the States struggling to improve

their fiscal make up, the Union Government decided in 1998-99 to

make a change in the classification of small savings, shifting them

to the category of States’ borrowings through special securities.

The result of this accountancy tactic was that the Centre’s deficit

came down and that of the States rose, without any material

improvement in the overall fiscal health.

It also served to increase the share of Revenue Deficit in Gross

Fiscal Deficit of all the States from 29.90% in 1991-92, to 37.00 in

1997-98, and further to 58.80% in 1998-99 and 60.1% in 1999-

2000, and 61.1 in 2000-01. Manner of financing the Gross Fiscal

Deficit also underwent change, with the loans from the Centre

meeting smaller shares of GFD, coming down from 53.11% in

1990-91, to 47.10% in 1995-96, and 42.10% in 1999-

2000.Thereafter thanks to the change in accounting system

mentioned earlier, loans from Centre is indicated to have financed

GFD to the extent of 13.6 % in 1999-2000, 9.4 % in 2000-01 and

13.9 % in 2001-02. The role of market borrowings became more

prominent rising from 13.6 % in 1990-91 to 18.7 % in 1995-96

and thereafter declining gradually to reach 14 % in 2000-01. from

and resort to tapping small savings, provident funds, loans from

financial institutions, Reserve funds and Deposits etc accounted

for the rest. Special securities issued to the National small savings

Section-II 339

fund increased from 28.9 % in 1999-2000 to a likely 38.5 % in

2002-03

It is rather interesting to note that in 1980-81, when the GFD

of all States was only Rs. 3,713 crores, loans from Centre was

providing Rs. 198 crores and the rest came from small savings etc.

In 1990-91, the GFD of Rs. 18,787 crores was covered by central

loans to the tune of Rs. 9,978 crores (53.11%) market borrowings

Rs 2,556 crores (13.61%) and other Rs. 6,253 crores (33.28%).

The relative shares of these sources fluctuated during the nineties.

In 2000-01 GFD of Rs. 89,532 crores being covered by central

loan of Rs.8,396 crores (13.9%), Net Market Borrowings Rs.

16,074 crores (15.1%) and small savings Rs.32,606 crores

(36.4%), P.F., others Rs.36,011 crores (40.2%).

The fluctuating shares appear to indicate that there has been

no firm and steady strategy of fiscal management to cope with the

deficits, revenue or fiscal, and that a predominant element of

adhocism was clearly discernible. Analysis of the State wise

details of decomposition of and financing of GFD during the

nineties show that some of states like U.P., West Bengal, Punjab,

Orissa and Kerala had consistently high level of revenue deficits,

because of high revenue expenditure.

Section-II 340

EPW Research Foundation Review, 2001 has drawn

attention to a complex set of inter state scenario in the comparison

of absolute sizes of gross fiscal deficits of states and

decomposition in the sources and financing patterns. “in 2000-

01(BE) U.P. had the largest amount of GFD (Rs. 12,358 crores)

followed by West Bengal (Rs. 10,339 crores), Andhra Pradesh (Rs.

8,460 crores) and Maharashtra (Rs. 7,030 crores). But their capital

outlay figures, which are an important purpose for which

borrowings are made are unrelated to their GFD size. Where

capital outlay figures are low, the borrowings are used to finance

revenue deficit, which is comparatively high. West Bengal is a

case in point, having a relatively lower level of capital outlay (Rs.

1,402 crores) but a higher level of revenue deficit (Rs. 7,525

crores) then U.P. (Capital Outlay Rs. 5,885 crores) and revenue

deficit Rs. 4,130 crores. Capital outlays of Andhra Pradesh (Rs.

3,419 crores) and Maharashtra (Rs. 3,071 crores) are closer to the

revenue deficits. Andhra Pradesh (Rs. 3,841 crores) and

Maharashtra (Rs. 3,601 crores).” and further observed that,

“circumstances faced by individual states as much as differences in

the governance explain the differing fiscal outcomes” (EPW May

19th 2001, Page 1751).

Section-II 341

The preference of Finance Commissions to continue to come

to the rescue of states facing revenue deficits needs to be reviewed.

A comparison of the relative data of revenue deficit and gross

fiscal deficit in 1991-92 and 1998-99, in respect of four states UP,

West Bengal, Bihar and MP which have received preferential

treatment by way of increased devolution and transfer from the

award of the Eleventh Finance Commission and five states

(Karnataka, Andhra Pradesh, Kerala, Tamilnadu and Maharashtra),

which complained of receiving a raw deal (Table 5.1)

Table-5.1.Comparative Growth Of RD& GFD (Rs. Crores)1991-92 1998-99

RD GFD RD GFDAll States 5650.70 18900.10 56801.60 94738.00U.P. 724.60 2836.60 8696.20 11632.50W. Bengal 646.10 1143.70 4856.20 7109.10Bihar 885.00 1617.00 1350.50 2378.90M.P 43.80 984.00 2871.80 4126.70

Karnataka 178.70 917.80 1215.20 3112.10Andhra 169.60 1125.30 2684.10 5705.60Kerala 364.30 803.40 2030.00 3012.20Tamil Nadu 1903.40 1299.90 3436.60 4777.10Maharashtra 276.10 1656.90 3925.90 7462.40

The horizontal devolution recommended by the Eleventh

Finance Commission appears to have not been consistent with its

prescriptions for fiscal management by states. While pursuing a

Section-II 342

laudable idea of reducing the disparities in the levels of

development of the states, through their gap filling approach, the

successive Finance Commissions appear to have allowed some

states to receive props from the Centre to fill the revenue gaps,

even while evidence was available that their fiscal management,

had many things to be desired.

Current Status

The State wise details of revenue deficits for the years,

1999-2000, 2000-01, 2001-02(RE) and 2002-03(BE) are indicated

in Tables 5.2. The crucial indicator of GFD as a ratio to net state

domestic product in respect of 15 major states is indicated in Table

5.3 and the state wise details of gross fiscal deficit are shown in

Table 5.4.

Gross Fiscal Deficits of all the States has risen from Rs.

18787 crores (3.3% for GDP at current market prices) in 1990-91

to an estimated Rs. 102848 crores (4.2% of GDP) in the budgets

for 2002-03. Revenue deficit has also risen from Rs. 5309 crores

(0.9% of GDP) to Rs. 48223 crores (2.0% of GDP) during the

same period. The persistent fiscal deficits of the States had led to a

steady accumulation of debt with the outstanding debt estimated to

Section-II 343

reach Rs. 683168 crores (27.9% of GDP) by end of March 2003,

marking a five fold increase in a decade from a level of Rs. 110289

crores (19.4 % of GDP). (Ratios of GDP at current prices for 2002-

03 (BE) are based on CSOs Advances Estimates released in

February 2003). In view of the persistence of the problems of

revenue and fiscal deficits, unaccompanied by any evidence of

sincere attempt for fiscal improvement, The Twelfth Finance

Commission, will be justified in evolving criteria for horizontal

devolution that pays equal attention to efficiency in fiscal

management as to equity in distribution.Table : 5.2 Revenue Deficit1999-2000

2000-01

2001-02(RE)

2002-03(BE)

Andhra 2724.60 3595.5

0 2992.90 2481.80 (45.50) (49.20) (40.80) (33.10)

Arunachal (151.30) -51.90 -223.60 -220.50(-109.4) (-24.7) (-127.8) (-282.1)

Assam 1366.30 779.50 2206.80 777.40 (59.10) (50.60) (67.60) (37.80)

Bihar 3549.70 2960.70 2341.90 1517.60 (58.10) (60.60) (58.40) (42.40)

Goa 242.20 226.00 130.80 88.60 (63.00) (54.70) (35.00) (19.30)

Gujarat 2759.20 6302.20 8325.30 5815.90 (45.80) (78.90) (89.40) (59.60)

Haryana 1291.10 607.50 1170.50 1056.20 (52.40) (26.80) (43.60) (40.40)

H.P 241.80 1330.60 831.30 1186.10 (55.30) (72.10) (56.60) (63.80)

J & K 118.40 1258.60 -735.50 -77.00(9.50) (58.10) (-98.5) (-4.8)

Karnataka 1573.20 1862.2 3006.2 2605.2(52.10) (44.10) (58.40) (44.60)

Section-II 344

Kerala 2481.30 3147.1 1886.4 1916.8(70.70) (81.20) (67.10) (71.80)

M.P. 2615.40 1319.3 3698.7 -6.1(65.80) (48.60) (73.90) (-0.2)

Maharastra 9484.00 7834.0 6244.8 4401.7

(68.20) (87.30) (55.60) (55.00)Manipur 261.10 86.30 9.60 42.70

(40.70) (36.80) (2.60) (14.90)Meghalaya 14.50 -52.70 -2.00 -67.60

(4.40) (-21.1) (-0.6) (-24.8)Mizoram 21.40 193.40 41.20 -15.90

(8.10) (51.50) (16.10) (-11.6)Nagaland 36.30 0.40 -44.90 -89.60

(14.60) (0.10) (-12.3) (-34.1)Orissa 2176.50 1926.80 2114.30 1754.80

(66.70) (57.90) (59.30) (49.20)Punjab 3104.40 2336.00 3842.00 3017.60

(72.30) (59.80) (73.10) (60.70)Rajasthan 3860.00 2633.60 3510.00 3851.90

(66.90) (61.10) (61.00) (55.40)Sikkim (0.30) -99.30 -210.30 -230.80

(-0.2) (-196.6) (-650.3) (-826.4)Tamilnadu 3700.70

3435.80 3432.40 5543.20

(74.40) (67.70) (59.80) (67.60)Tripura 137.80 96.00 -1.10 -95.60

(30.80) (21.60) (-0.1) (-15.2)U.P. 7923.00 6289.30 7756.80 5275.60

(64.60) (61.80) (62.40) (54.10)W.B. 8056.10 7581.30 7985.50 7791.50

(74.10) (69.30) (68.90) (68.90)

NCT Delhi (786.30)-

1747.50 -1380.80 (2139.20)(-46.3) (-108.6) (-68.7) (-121.2)

All States56801.6

0 53568.

60 60539.90 48222.90 (60.00) (59.80) (56.80) (46.90)

Note : Figures in bracket are % of GFD

Section-II 345

Table 5.3 Gross Fiscal Deficit as a ratio in NSDP: Major

States

SL States 1997-

98

1998-

99

1999-

00

2000-

01

2001-

02

1 Andhra

Pradesh

2.8 5.5 4.4 5.8 5.0

2 Bihar 3.2 6.9 9.5 11.7 8.7

3 Goa 3.0 5.2 5.9 6.4 6.1

4 Gujarat 4.1 6.3 7.5 8.7 6.2

5 Haryana 3.3 5.8 5.0 4.7 5.2

6 Karnataka 2.5 4.0 5.0 4.5 6.0

7 Kerala 5.4 5.9 8.0 6.1 4.7

8 Madhya

Pradesh

3.4 6.7 5.7 4.2 5.1

9 Maharashtra 3.8 3.9 5.4 4.2 5.1

10 Orissa 6.4 9.3 10.9 9.8 10.5

11 Punjab 5.7 7.6 5.9 6.7 7.9

12 Rajasthan 4.5 7.9 7.7 6.1 7.3

13 Tamil Nadu 2.3 4.5 4.8 4.0 3.6

14 Uttar Pradesh 6.3 8.7 7.6 6.7 6.0

15 West Bengal 4.5 6.7 10.0 8.5 8.2

Section-II 346

Coefficient of

Variation

33.1 25.6 34.7 34.4 29.3

Source : RBI, State Finances A Study of Budgets of 2003-04,

April 2004

Section-II 347

Table : 5.4 Gross Fiscal Deficit (All States)1999-

2000(AC) 2000-012001-02(RE) 2002-03 (BE)

Andhra 5993.10 7305.90 7336.00 7499.30 Arp 138.20 210.10 174.90 78.20 Assam 2313.60 1540.00 3262.70 2054.20 Bihar 6107.70 4884.30 4010.30 3576.70 Goa 384.20 412.90 373.80 458.60 Gujarat 6030.80 7987.60 9312.40 9752.50 Haryana 2463.70 2265.20 2685.60 2617.70 H.P 437.20 1844.80 1467.60 1859.90 J & K 1248.10 2166.40 748.10 1612.80 Karnataka 3020.70 4219.2 5150.8 5839.1Kerala 3510..3 3877.8 2812.5 2669.5M.P. 3973.20 2712.1 5005.6 3148.1Maharastra 13913.30 8975.8 11238.5 7997.4Manipur 642.00 234.40 373.70 287.00 Meghalaya 325.30 249.60 334.40 272.20 Mizoram 270.20 375.30 255.60 137.10 Nagaland 249.00 358.80 366.10 262.80 Orissa 3260.80 3325.30 3566.40 3570.00 Punjab 4293.80 3903.80 5257.10 4969.80 Rajasthan 5772.60 4313.20 5753.30 6956.50 Sikkim 148.00 50.50 32.30 27.90 Tamilnadu 4975.00 5076.00 5735.90 8205.00 Tripura 447.00 445.20 739.60 631.80 U.P. 12256.30 10179.50 12431.30 9744.20 W.B. 10865.40 10920.20 11585.70 11315.20 NCT Delhi 1698.20 1609.70 2009.30 1764.60

All States 94738.50 89532.0

0 106594.7

0 102847.60

Budgetary Balance 2003-04 and Beyond

Section-II 348

The Twelfth Finance Commission is required by its Terms of Reference to have regard to the resources of the central government and the state governments for five years commencing on 1st April 2005 on the basis of levels of taxation and non tax revenues likely to be reached at the end of 2003-04 , and keep in view the objective of not only balancing the receipts and expenditure of all the states and the centre but also generating surpluses for capital investment and reducing fiscal deficit. The Twelfth Finance Commission in its Terms of Reference for the study has sought indication of norms on the basis of which the objective of balancing receipts and expenditure on revenue account can be met.While analysts have commented on the distortions wrought by the tyranny of the base year , we may bear with that and take a look at the picture emerging from the budgets of the Central Government and the states for 2003-04 as shown below.

Table : BB -1 Union Finances 2003-04 Rs. Crores2001-02 2002-03(BE) 2002-03

(RE)2003-04 (AC)

2003-04 (BE)

2003-04(RE)

Tot Rec 362453 410309 404013 414162 438795 474255Revue 201449 245105 236936 231748 253935 263027Capital 161004 165204 167077 182414 184860 211228Tot Exp 362453 410309 404013 414162 438795 474255Revenue 301611 340482 341648 339628 366227 362887Capital 60842 69827 62365 74535 72568 111368Rev Deficit

100162 95377 104712 107880 112292 99860

Fiscal Deficit

140955 135524 145466 145072 153637 132103

Table : BB -2 State Finances -2003-04 Rs. Crores 2001-02 2002-

03(BE) 2002-03 (RE)

2003-04 (AC)

2003-04 (BE)

2003-04(RE)

Tot Rec 375886 425888 437452 481225Revue 255675 307076 294009 334290Capital 118211 118812 143443 146935Tot Exp 377312 430919 442642 488360

Revenue 314863 355156 355248 382616Capital 62448 75763 87394 105744Rev Deficit

59188 48079 61240 48326

Fiscal Deficit

95994 102700 116636 116175

A quick comparison of accounts 2002-03 and 2003-04(RE) in respect of Union Finances show

Section-II 349

1) increase in total receipts of 14.51 %, revenue 15.50% and capital 15.80%, (Tax revenue 17.63, non tax revenue 4.38 % , loan recoveries 89.01 % and borrowings 8.94 %.)2) Increase in total expenditure by 14.51% (revenue 6.55 %, capital 49.42, Non plan 16.53% , plan 9.02%)A. Similar analysis of state Finance Accounts 2002-03 RE and 2003-04 BE show 1) Increase in Aggregate Receipts by Rs. 43773 crores 2.4 % (revenue Rs. 402813 crores 13.7 % , capital Rs. 34923 crores 2.4 %)2) Increase in Aggregate Disbursement by Rs. 45718 crores 10.3 % (revenue Rs. 273680 crores 7.7 % , capital Rs. 18350 crores 21.0% )

Scrutiny of recent documents reveals that both the Union and state finances accounts reveal under estimation of deficits at the budget and even revised estimate stages and balance between revenue and expenditure on the revenue account..

Revenue Deficit and Quantum of Transfers Rs. CroresCentre States Tax Devolution Grants from

Centre2001-02 100162 59188 52215 430832002-03 95367 61240 RE 57361 555502003-04 BE 112292 48326 62986 63422

The mere numbers do indicate that between the Union and the states , fiscal transfers make a significant difference to the deficit indicators and that the mechanism of federal transfers can be an effective lever in balancing the Revenue and Expenditure of both Union and the States.

While this appears a fairly convenient mechanism there are influences at work which make the task of balancing a nightmare for even the most composed of experts. It is perhaps time that Finance Commission and the Planning Commission got beyond mere exhortations on fiscal discipline and utilized the instruments at their disposal to introduce some order and focus. As per Budget Estimates for 2003-04 , the states expect Rs. 62980 crores by way of share in central taxes , Rs. 63420 crores by way of plan and non plan grant, Rs.33703 crores by way of loans totaling in all Rs.160111 crores by way of Gross Transfer. After accounting for Repayment of loans to the tune of Rs. 25909 crores and payment of interest of Rs. 31593 crores to the centre , the states were expecting to receive Rs.102609 crores by way of net devolution and transfer from centre.

The Union Budget 2003-04 placed revenue deficit at Rs. 112292 crores , which is Rs.9683 crores more than the net devolution and transfer. The Debt Swap Scheme involving higher loan repayment of loans by the states to the Centre during 2003-04, making a significant difference to the net resources transferred to the states and UTs which as per revised estimates of Union Budget came down from Rs.126623 crores to Rs. 80078 crores .This shows that fine tuning of federal transfers as seen in the Debt Swap Scheme do make a qualitative difference to the finances of the states. This should encourage the Section-II 350

utilization of the instruments of tax devolution , non plan grants and plan grants , for bringing greater order and neatness in the present scheme of federal transfer, which appears dominated by the dependency syndrome of the states.

One approach could be to shift the focus of the state fiscal reform facility from measuring improvement in terms of percentage reduction in the revenue deficit to the positive aspect of revenue mobilization measured by the contribution of the states own revenue receipts as a share of revenue expenditure and total expenditure. Analysis of recent data (Table BB – 1 and 2 ) show not only variation between nine states grouped as special category and seventeen states grouped as General Category but also between individual states within each category. There is vast difference between these two categories in the contribution made by states own receipts to the expenditure (see Table below)States own revenue receipts as percentage of

Spl Category General Category All states Rev Exp Tot Exp Rev Exp Tot Exp Rev Exp Tot Exp

2001-02 22.4 18.4 56.7 46.4 50.9 42.52002-03 RE

22.3 17.5 57.9 44.9 51.0 40.9

2003-04 BE

22.9 18.2 61.1 47.4 54.3 42.3

Statewise analysis made in Table BB-1 and 2 indicate that nine states in general category make a contribution well above the average for the category and two are close to the average . In the special Category states only two states are above the average for the category. Similar is the picture when analysis is made of revenue deficit as a percentage of gross fiscal deficit and capital outlay as a percentage of gross fiscal deficit.

It is worth considering whether the average for the category in the base year should be fixed as a target to be reached by the laggard states by specified a date to make a state eligible for central transfers in subsequent years. If such eligibility is a difficult condition to introduce and enforce it could be considered whether quantum of federal transfers should bear a specific relation to the contribution states own revenues makes in meeting the revenue expenditure and total expenditure . The Tenth Finance Commission assigned weight of 10 % for tax efforts of the state, the Eleventh Finance Commission reduced it to 5 % and introduced fiscal discipline as additional criteria with a weightage of 7.5 % . While earlier Commissions recognized contribution as a criteria for allocation of the states’ share of income tax proceeds, this was given up by the Tenth Finance Commission. It is desirable to bring contribution to either the central revenues or states’ own revenues in meeting states expenditure as a criteria in federal transfers with a significant weightage. Such moves can in the ling run enable the states to balance their revenue and expenditure.The other aspect that deserves attention is whether fiscal reform should be rewarded by incentives within the scheme of Finance Commission transfers or should be an additionality to the tax devolution and grants recommended by the Commission. There is a strong case for keeping this as an additionality and increasing the corpus to about Rs.25,000 crores and bringing positive elements as criteria.Section-II 351

Table : States Own Revenue Receipts, All States

As a Percentage of

Revenue Expenditure

As a Percentage of Total

Expenditure

2001-

02

2002-

03

(RE)

2003-

04

(BE)

2001-

02

2002-

03

(RE)

2003-

04

(BE)

Andhra

Pradesh

62.6 63.2 63.0 49.8 49.4 48.9

Assam 30.7 28.9 27.2 24.6 23.0 22.6

Bihar 22.3 22.0 27.6 18.9 17.4 21.4

Delhi 114.4 131.1 130.1 66.9 59.6 70.0

Goa 81.2 87.6 89.8 72.5 74.3 75.9

Gujarat 57.3 56.4 61.0 50.7 45.3 49.3

Haryana 76.7 75.8 77.9 61.9 63.9 64.8

Karnataka 58.8 59.6 65.1 49.9 48.6 52.9

Kerala 55.5 61.0 61.5 49.2 52.7 54.6

Madhya

Pradesh

43.9 47.3 53.1 37.2 37.0 41.2

Maharashtra 67.8 68.4 76.6 61.1 57.6 66.3

Orissa 32.0 35.4 32.6 26.2 27.4 26.6

Punjab 61.2 63.8 68.5 49.6 52.5 54.0

Rajasthan 45.0 46.2 47.4 37.8 36.3 37.0

Tamilnadu 67.6 60.4 66.8 58.7 52.6 55.9Section-II 352

Uttar

Pradesh

38.1 37.9 40.0 31.8 30.6 27.3

West

Bengal

31.1 33.3 39.5 25.9 27.5 30.0

Average

GC States

56.7 57.9 61.1 46.4 44.9 47.4

Special

Category

Arunachal 10.2 15.3 14.3 7.6 10.4 10.3

Himachal 24.3 21.0 21.6 19.6 18.0 17.2

J&Kashmir 18.9 20.4 22.9 14.4 15.0 17.2

Manipur 6.0 8.0 11.7 3.8 5.1 7.8

Meghalaya 19.9 18.8 19.9 16.5 14.3 15.2

Mizoram 5.7 6.9 7.7 4.8 5.4 6.5

Nagaland 6.9 7.2 9.0 5.0 5.1 6.5

Sikkim 72.6 72.3 74.3 63.3 61.9 64.8

Tripura 14.1 13.4 14.5 10.4 9.8 10.2

Average

SC States

22.4 22.3 22.9 18.4 17.5 18.2

Chattisgarh 55.3 50.3 59.1 48.3 42.0 39.5

Gharkhand 50.6 41.8 50.3 38.3 33.0 37.4Section-II 353

Uttaranchal 37.3 32.7 29.0 32.0 24.1 21.7

All States 50.9 51.0 54.3 42.5 40.9 42.6

Section-II 354

Table : Quality of Expenditure Management, All States

Revenue Deficit/Gross

Fiscal Deficit

Capital outlay/Gross

Fiscal Deficit

2001-

02

2002-

03

(RE)

2003-

04

(BE)

2001-

02

2002-

03

(RE)

2003-

04

(BE)

Andhra

Pradesh

42.9 43.1 46.0 49.4 65.3

Assam 60.9 43.8 35.4 49.2 37.5

Bihar 58.4 50.0 27.9 33.7 42.4

Delhi -69.8 -78.9 35.3 37.5 63.5

Goa 55.4 25.0 44.7 74.0 86.6

Gujarat 103.4 58.0 27.0 25.5 38.7

Haryana 38.5 49.3 53.6 40.6 51.4

Karnataka 56.0 59.1 35.9 48.7 59.0

Kerala 79.7 66.7 17.1 28.2 17.9

Madhya

Pradesh

86.8 33.1 40.3 59.4 75.9

Maharashtra 75.1 56.6 27.1 29.3 41.0

Orissa 71.4 45.9 22.4 34.8 30.4

Punjab 76.2 69.4 19.8 22.9 39.7

Rajasthan 66.0 62.6 31.6 33.9 46.4

Section-II 355

Tamilnadu 57.8 73.0 37.5 21.3 39.2

Uttar

Pradesh

62.5 60.6 35.9 33.6 59.3

West

Bengal

75.0 77.6 10.7 10.0 8.4

Average

GC States

30.6 32.7 46.0

Special

Category

Arunachal -10.2 -187.6 109.7 286.6 561.8

Himachal 56.9 74.3 43.0 25.5 28.9

J&Kashmir -98.3 -52.4 189.1 147.7 268.2

Manipur 47.4 2.2 51.6 94.1 93.7

Meghalaya 15.2 10.8 72.4 72.2 99.4

Mizoram 61.7 13.4 32.8 79.4 45.2

Nagaland -12.3 -25.0 109.9 122.2 175.0

Sikkim -213.9 -447.2 315.3 548.4 540.2

Tripura -10.1 10.1 109.0 88.6 124.6

Average

SC States

75.5 66.3 68.1

Chattisgarh 50.8 33.1 44.9 62.3 77.3

Section-II 356

Gharkhand -6.1 15.1 84.6 70.3 122.1

Uttaranchal 23.5 64.7 58.9 21.2 33.3

All States 33.6 35.6 48.0

Chapter -VIChanging Profile of Federal India

The commendable endeavour to strike a balance between Equity and efficiency in fiscal devolution with a study of structural and process related sources of inefficiency in the expenditure programmes of the Union and the State Governments in India and examination of the scope for using federal grants as a lever in promoting greater efficiency in expenditure management by the states and achieving a quicker realization of public services across the states, has to contend with major factors like – (a) The changing political map with the number of states to be considered increasing from 16 for the First Finance Commission( I FC) to 28 for the Twelfth Finance Commission( XII FC) (b) the vastness of sub-continental India and the diversity of physical conditions and differences in the levels of resource endowment and development of the states that are the constituent units of federal India and (c) varying rates of growth of economy and levels of fiscal performance by state governments.

A. Changing Political Map of Indian Union

The Major task of Finance Commission is to recommend the distribution between the Union and the States, as also among the States. The proceeds of Tax Revenue and grants in aid. It is in a way, interesting to recall the way in which the Indian Union has retained its total integrity except for the areas occupied by Pakistan and China, even while the states have changed in area, jurisdiction and nomenclature. Between the First and the Twelfth Finance Commissions all the states except Rajasthan and West Bengal have been reorganised with changes in area and in some cases in names too.

Section-II 357

The First Finance Commission- 16 states1)Assam2)Bihar3)Bombay4)Hyderabad5)Madhya Bharat6)Madhya Pradesh7)Madras8)Mysore9)Orissa10)Patiala , East Punjab states Union11)Punjab12)Rajasthan13) Sourashtra14) Travancore Cochin15) Uttar Pradesh16) West Bengal

Second Finance Commission -14 states1) Andhra Pradesh*2) Assam3) Bihar4) Bombay5) Kerala*6) Madhya Pradesh7) Madras8) Mysore9) Orissa10) Punjab11) Rajasthan12) Uttar Pradesh13) West Bengal14) Jammu and Kashmir**new states

The First Finance Commission dealt with 16 state entities the second Finance Commission had to deal with only 14 state entities, due to Reorganization of the States on Linguistic Basis. The Third Finance Commission dealt with 15 entities because of the split of Bombay into Maharashtra and Gujarat. The Fourth Finance commission dealt with 16 entities with the addition of Nagaland.The Fifth Finance Commission dealt with 17 entities since Haryana State was created. The Sixth Finance Commission dealt with 21 entities since Himachal Pradesh, Manipur, Meghalaya and Tripura were given state status. With the addition of Sikkim to the list of states to be considered, Seventh Finance commission dealt with 22 entities and the number did not change for the Eighth Finance Commission. Three more states, Arunachal Pradesh, Goa and Mizoram had to be considered by the Ninth Finance Commission, taking the tally up to 25.The Tenth and Eleventh Finance Commission had to deal with the same number of states. The Twelfth Finance Commission will be required to consider the needs of Chattisgarh, Jharkhand and Uttaranchal states which were carved out of Madhya Pradesh, Bihar and Uttar Pradesh respectively. This reorganization made in November 2000 involved not only bifurcation of the area of three states but also redistribution of natural resources like minerals and forest areas and consequent changes in the revenue potential of the states. A special assessment in respect of the states involved in the reorganization may be needed.

B. Diversity of Physical Conditions

To enable an adequate appreciation of the diversity of natural resources endowments and handicaps, that India’s sub continental dimension and its varied physiographic details are set out below. It must be however mentioned that state boundaries delineated in India do not necessarily follow the natural divisions like water sheds and the catchment areas of various rivers and the relative advantages and disadvantages flowing from natural resource endowments and handicaps cannot be precisely weighted and allotted to the states.

Section-II 358

Indian peninsula lying to the north of the Equator between 8o4’ and 37o6’ latitude and 68o7’ and 97o25” east longitude, is spread over a geographical area of 3,287,263 sq kilometers. This includes 78114 sq km occupied by Pakistan, 37555 sq km by China and 5180 sq km. of Indian land handed over by Pakistan to China. Measuring 3214 km from North to South, 2933 km East to West, India has a land frontier of 15200 km from north West to North and a coastline of 7516.5 km from the East to the West. This land mass has seven physiographic regions -i) The northern mountains including the Himalayas and the North Eastern mountain regions (ii)the Indo-Gangetic plains (iii)the Thar Desert (iv) The central High lands and Peninsular Plateau (v)The East Coast (vi)West Coast and (vii) Bordering Seas and Islands of Andaman and Nicobar in the Bay of Bengal and Lakshadweep in the Arabian Sea.

India has seven mountain ranges-a) the Himalayas in the North, (b)The Patkai and allied mountain ranges on the Eastern border,(c)the 1050 km long Vindhyas which cleave the Indian Peninsula separating the Indo Gangetic plains on the north and the Deccan Plateau on the South (d) the 900km long Satpura range, with two sides running parallel to the Narmada and Tapti rivers (e) the Aravalli ranges in the North West considered as a remnant of an ancient gigantic system (f) the 1600km long Sahyadris on the Western Ghats which separates the west Coast plains from the Deccan Plateau and (g) the rather discontinuous Eastern Ghats bordering the East Coast.

Water ShedsThree main watersheds sustain the Indian land mass, with Twelve major rivers

originating in them(a) The Himalayan Range with its Karakoram branch in the North with three main rivers, The Indus, The Ganga and the Brahmaputra and their tributaries(b)The Vindhyas and Satpura ranges in the central India with Narmada and Tapti and (c)The Western Ghats from which emerge the rivers of Godavari,Krishna, Cauvery, The Pennar, the Mahanadi, Sharavathi, Netravathi, the Periyar and the Pampa.

The catchment areas of the twelve major rivers is indicated as 252.8 million hectares, of which the Ganga-Brahmaputra-Meghana systems, with about 110 million hectares catchment is the largest. Indus with 32.1 million hectares, the Godavari with 31.3 million hectares, Krishna with 25.9 million hectares and the Mahanadi with 14.2 million hectares account for a major part of the remaining catchments.

Water being such a vital resource, it is worth noting, that (i) India has 16% of World’s population, only 2.45% of World’s land resources and 4% of World’s fresh water resources. (ii) Out of average annual prescription in volumetric terms estimated at 4000 billion cubic meters and owing to tropical constraints only 690 b.c.m is said to be utilized. (iii) out of the estimated ultimate irrigation potential of 139.89 million hectares 58.46 m.ha from major projects and 81.43 m.ha from river irrigation) the potential created are covered by facilities is only 93.98 m.ha (37.06 mha from major irrigation) 56.92 m.ha on minor irrigation) and potential utilized is only 80.11 m.ha (31.027 mha from major irrigation and 49.04 mha from minor irrigation. (iv) that the flood prone areas is estimated at 40mha of which 32 mha can be given a reasonable degree of protection and that about 7.56 mha of which 3.55 mha is cropped area, is said to be regularly affected by floods.( The Tenth Plan, (vol. II p872))Section-II 359

The state wise distribution of ultimate irrigation potential, potential created by projects and potential actually utilized as also of flood prone areas could be taken into consideration for devising a financial support scheme for increasing potential utilization and water use efficiency in addition to the determination of maintenance grants.

Desert and Drought Prone AreasIndia has fortunately a limited area in the North West in

Rajasthan and Gujarat that are desert areas.Proneness to drought ,

and vulnerability to vagaries of monsoon is more wide spread. It

has been estimated that 69% of our geographical area falls within

Dry Zone (Tenth Plan.vol II.p.58).The document acknowledges

‘given the inter linkages of crop production, livestock economy

and the environment, land degradation has a major impact on the

livelihoods of people in the rural areas.”

The schemes for transfer of Central Funds to the states, have

taken into account the diversity of physical conditions, classifying

the states into special category and non special category for Central

assistance with varying proportions of loans and grants. While the

Finance Commission and Planning Commission have taken into

account population, per capita income, area, tax and fiscal

performance, the plan transfers have in addition taken into account,

special problems and national objectives.

C. Fiscal Performance of the States

Section-II 360

The changes in the political map of Indian Union, since

independence, marked by increased in the number of states, the

persistent diversity of physical conditions and natural resources

endowments of the states, varying levels of economic development

of the states, juxtaposed with the asymmetry of functional

responsibilities and revenue raising powers of the states and the

Union, as also the more recent political dimensions introduced by

fractured electoral verdict and compulsions of coalition

government have severally and individually given rise to issues of

significance to the scheme of federal fiscal transfers envisaged in

the Constitution. Over the years, a spirit of accommodation

characteristic of Indian social and political communities has

enabled the federal system survive the stress and strains, inherent

in the efforts to raise the economic performance of the states and

simultaneously seeking to even out the regional and inter-state

disparities and social and economic inequalities among different

classes of people. But the emerging issues of macro economic

stability and fiscal sustainability continue to pose problems.

The experience over the past five decades or more have led to

the general acceptance of a basic proposition that a good system of

federal fiscal transfers should “serve the objectives of equity and

efficiency and should be characterized by stability and

Section-II 361

predictability”. The translation of this preposition into practice has

not been easy. Equity has been advocated on two different plains

of fiscal transfer system. The vertical dimension of transfer

between the Union and the States posed problems for the earlier

Finance Commission, and all their endeavors in formulating

principles for allocation of resources between the Union and the

States, could culminate recently in the alternative scheme of

devolution proposed by the Tenth Finance Commission assigning a

specific share of 26% of all tax proceeds of centre to the states and

in the other approach advocated by the Eleventh Finance

Commission, marked by a cap of 37.5% of the gross revenue

receipts of the centre on the total quantum of transfers, on account

of devolution plan and non-plan grants, to the state. Even though

this is yet to reach finality, the heat over central transfer to the

states has dissipated. On the horizontal dimension of fiscal

transfer, there is still no consensus on the principles that should

guide the inter se allocation of resources between different states.

There is some degree of near unanimity of opinion that the

objective should be the equalization of levels of public services

across the states, and that to achieve these fiscal transfers should

take into account the different needs of the states, the varying

cost disabilities imposed on account of lack of resource

endowment and the fiscal performance efficiencies of the states.

Section-II 362

While “equity”, as an objective has received attention in the

past, “efficiency”, as posed problems in both conceptual and

operational terms, because of the inherent difficulties in the

measurement of efficiency in performance of public services and

even more in the evaluation of fiscal performances. “Economy”,

“Efficiency” and “Effectiveness” have at different points of time

been set as the objective to be pursued in the performance in the

Public Services and utilization of Public Funds. What needs to be

appreciated is that conceptual elegance is more easily achieved in

bringing out the nuances involved but operationally their

translation into measurement of performance and using these

measures for comparative evaluation pose innumerable problems.

Keeping this at view one may at the few of the several

indicator of fiscal performance of the states, relevant to a design

of fiscal transfer. The ability of the states to moblize resources for

financing their expenditure on performance of services can be

gauged by the share of States Own Revenue Receipts as a

percentage of Revenue Expenditure and as a percentage of Total

Expenditure. The federal fiscal transfer system, has over the years

accepted the cost disabilities imposed by disadvantages of location

and differences in resource endowment to classify states into

Special Category States and others, which we will refer as General

Section-II 363

Category States. In 2001-2002, the General Category States

financed from their own revenues 56.7% of revenue expenditure

46.4% of total expenditure. The Special category states on the

other hand could finance from their own revenue receipts only

50.9% of revenue expenditure and 42.5% of total expenditure.

Within the two categories there is a considerable variation among

the various states, as brought out in Table 6.1.

When the states are not able to finance their revenue

expenditure from their revenue receipts they run into revenue

deficits, which is considered an important fiscal indicator. In order

to meet their needs for development and capital expenditure the

state government resort to borrowing to meet their total

expenditure needs. This involves repayment of debts incurred.

When there is a difference between aggregate disbursements net of

debt repayment and recovery of loans and the total revenue

receipts and non-debt capital receipts it is referred to gross fiscal

deficit. The borrowings are expected to be utilized in creation of

assets by incurring capital expenditure. The quality of expenditure

management by the states can be assessed not only the revenue

deficits in absolute terms or their proportion to gross domestic

product or net state domestic product but also by the share of

revenue deficits in the gross fiscal deficits. The share of capital

Section-II 364

outlays in gross fiscal deficits indicate the extent to which

borrowings have been utilized for capital expenditure. The inter-

state variations in these indicators are brought out in Table 6.2.

The size and composition of debt and burden of interest

payment also give an indication of the prudence with which the

governments have managed their finances. While the aggregate

debt of the states as a proportion of GDP has risen from 16.0

percent in March 1981 to 19% in March 1991, the nimieties were

marked by an higher increase to 23.7% by March 2001 and the last

three years have shown an even sharper increase to touch 28.8% in

March 2004. That nearly all the states have been drawn into the

vortex of increasing debt with varying degrees of liabilities has

been brought out by our analysis in our earlier section.

What is significant is that during the last three years as many

as 26 out of 29 states have witnessed average annual rate of growth

in debt of over 10% and that 16 of these have shown growth rate of

over 15%. In 2001-02 only three states had debt NSDP ratio of

below 30% and even these states are marked by high degree of off

budget borrowings. While deterioration in financial performances

is common to all the states, the growth rates achieved by them

seem be markedly different, posing a dilemma in devising federal

Section-II 365

fiscal formulae - whether to encourage economic growth and better

utilization of resources or continue to lend assistance to the poorer

states for improving their economic levels.

Section-II 366

D. Growth Performances of the States

The inter-state disparities in levels of development and

varying rates of economic growth, and different levels of fiscal

performance of the states, have been an important factor in the

determination of criteria for fiscal devolution. While a study of this

nature may help in monitoring trends in resource mobilization,

expenditure containment and debt management, assessment of the

quality of fiscal performance may need to draw into its fold, the

contribution to developmental effort as measured by plan

investments and capital expenditure. Analysis of ratios like that of

plan expenditure to GSDP and gross fiscal deficit to plan

expenditure, may help in assessing the quality of financing plan

expenditure by the state, the GSDP data indicate the extent and

degree of success of the efforts to widen the production base in the

economy and reduce interstate disparities.

The Approach paper to the Ninth Five Year Plan had drawn

attention to the evidence of deterioration in the relative rates of

growth of states and pointed out that some of the populous and less

developed states have experienced growth rates which are lower

than the national average(Approach paper to the Ninth Five Year

Plan ,1997 pg 7). The Mid-Term Appraisal of the Ninth Plan

Section-II 367

pointed out that plan expenditure (at constant prices) during the

entire Eighth Five Year Plan fell short of the outlay by 22.4% .

States which spent substantially less than the plan outlay included

Bihar (-67.8 %), Orissa (-46.9%) , West Bengal (-35.9 %) ,

Uttar Pardesh (-26.3%) and Meghalaya (-21.1 %) and that these

states continue to show substantial reduction in Plan expenditure

compared to the approved annual outlay even during the Ninth

Five Year Plan. The Appraisal observed that, “the most striking

feature of India’s development is the persistence of wide spread

disparities across states, within states, and across communities and

gender” and drew attention to the fact that in the mid nineties,

Punjab ‘s NSDP was 5 times that of Bihar, that Kerala reported a

literacy rate of 90% while Bihar and Rajasthan reported 38.5%,

that Kerala reported life expectancy of 72 years while Assam

reported only 52 years and that the population below poverty line

was 49 % in Orissa as against 12 % in Punjab. The Appraisal

concluded that while the performance of the Indian states is

nothing to be ashamed of, there were also many dark spots and that

a disaggregated view may help in defining problems more

precisely.

The Tenth Five Year Plan Document has drawn attention

to the fact that while the gross domestic product of the country as a

Section-II 368

whole has grown steadily over all the five year plans, the growth

rates achieved were lower than the targeted growth rates from the

First to the Fourth Five Year Plan and were higher than the

targeted rate from the fifth to the Eighth Five Year Plan. The Ninth

Five Year Plan has once again been marked by the achieved

growth rate of 5.3 % falling below the targeted rate of 6.5 %. The

Plan document states that, “the adoption of planning and a strategy

of state led industrialization was intended to lead to a more

balanced growth in the country. It was expected that, over time

inter state disparities would be minimized. Plans and Policies were

designed to facilitate more investments in the relatively backward

areas. Nevertheless social economic variations across states

continue to exist even today.” The Plan document also indicates

that overall disparity in inter state growth of NSDP and per capita

NSDP of states has increased considerably during the nineties as

compared to the eighties and seventies. (see Chapter 3, Tenth Five

Year Plan, Planning Commission, December 2002). The Plan

document has indicated the constraints of consistency and

comparability of data in presenting comparable trends in the

development of the various states in terms of available and

generally accepted development indicators.

Section-II 369

Turning to pattern of financing the plans, the document has

observed that the mobilization of Plan resources, during the Eighth

and the Ninth Five Year Plan, has been associated with three

features of considerable fiscal concern i)falling share of plan

resources and expenditure to GSDP ii) rising level of net debt

receipts (GFD) to plan expenditure, reflecting the growing debt

component of state expenditure and iii) rising share of revenue

expenditure in net debt receipts ( GFD) indicating inappropriate

use of borrowing. The first two features can be gleaned from the

state-wise details presented in Table 1.1.

Grouping the states into four categories, of a) High Income

(Goa, Punjab, Maharashtra, Haryana and Gujarat b) Middle

Income (Tamilnadu, Kerala, Karnataka, Andhra Pradesh and

Rajasthan c) Low Income (West Bengal, Madhya Pradesh, Orissa,

Uttar Pradesh, ) d) All Special Category States, the Planning

Commission reports a fall in plan expenditure in all the states

except the special category states, during the Ninth Five Year Plan

as compared to the Eighth Five Year Plan . A point of significance

for the Finance Commission is that the burden of carrying the

liability of non plan expenditure is largest for low income states,

despite large transfer of Central Funds. Planning Commission

Section-II 370

indicates that the requirement of pruning and consolidating non

plan expenditure is felt most in this category.

While the Eleventh Finance Commission had considered the

flow of center’s revenue to the states in three segments as “the

most serious flaw in the current system of federal transfer in India”

and formulated its strategy of restructuring to rectify the

deficiency, the Planning Commission has, in the Tenth Plan

document, drawn attention to the blurring of plan and non plan

distinction of Government expenditure and its adverse implications

for financing development plan. In devising the scheme of

transfers for the period 2005-10 the Twelfth Finance Commission

may like to keep in mind not only plan performance of the states -

during the Ninth Plan but also the targets of growth rates and

projected outlays for the states and Union territories for the Tenth

Plan period finalized by the NDC.

The SDP growth rate during 1991-2001 and the Tenth Five

Year Plan target are indicated in Table 1.2. The projected outlay,

states own resources and Central assistance area indicated in Table

1.3. Set against the experience of the states during the Ninth Plan,

the Tenth Plan calls for a significant step up of outlay and

improvement in sectoral performance, which can be ensured only

Section-II 371

by ensuring balance and efficiency in both plan and non plan

expenditure of the state governments. Monitoring mobilization of

revenues raised by way of taxes and loans and their utilization, and

resources received from centre by way of tax devolution and

grants will be an important aspect of federal finance system

between 2005-10.

Table : 6.1 States Own Revenue Receipts, All States

As a Percentage of

Revenue Expenditure

As a Percentage of Total

Expenditure

2001-

02

2002-

03

(RE)

2003-

04

(BE)

2001-

02

2002-

03

(RE)

2003-

04

(BE)

Andhra

Pradesh

62.6 63.2 63.0 49.8 49.4 48.9

Assam 30.7 28.9 27.2 24.6 23.0 22.6

Bihar 22.3 22.0 27.6 18.9 17.4 21.4

Delhi 114.4 131.1 130.1 66.9 59.6 70.0

Goa 81.2 87.6 89.8 72.5 74.3 75.9

Gujarat 57.3 56.4 61.0 50.7 45.3 49.3

Haryana 76.7 75.8 77.9 61.9 63.9 64.8

Karnataka 58.8 59.6 65.1 49.9 48.6 52.9

Kerala 55.5 61.0 61.5 49.2 52.7 54.6Section-II 372

Madhya

Pradesh

43.9 47.3 53.1 37.2 37.0 41.2

Maharashtra 67.8 68.4 76.6 61.1 57.6 66.3

Orissa 32.0 35.4 32.6 26.2 27.4 26.6

Punjab 61.2 63.8 68.5 49.6 52.5 54.0

Rajasthan 45.0 46.2 47.4 37.8 36.3 37.0

Tamilnadu 67.6 60.4 66.8 58.7 52.6 55.9

Uttar

Pradesh

38.1 37.9 40.0 31.8 30.6 27.3

West

Bengal

31.1 33.3 39.5 25.9 27.5 30.0

Average

GC States

56.7 57.9 61.1 46.4 44.9 47.4

Special

Category

Arunachal 10.2 15.3 14.3 7.6 10.4 10.3

Himachal 24.3 21.0 21.6 19.6 18.0 17.2

J&Kashmir 18.9 20.4 22.9 14.4 15.0 17.2

Manipur 6.0 8.0 11.7 3.8 5.1 7.8

Meghalaya 19.9 18.8 19.9 16.5 14.3 15.2

Mizoram 5.7 6.9 7.7 4.8 5.4 6.5

Nagaland 6.9 7.2 9.0 5.0 5.1 6.5Section-II 373

Sikkim 72.6 72.3 74.3 63.3 61.9 64.8

Tripura 14.1 13.4 14.5 10.4 9.8 10.2

Average

SC States

22.4 22.3 22.9 18.4 17.5 18.2

Chattisgarh 55.3 50.3 59.1 48.3 42.0 39.5

Gharkhand 50.6 41.8 50.3 38.3 33.0 37.4

Uttaranchal 37.3 32.7 29.0 32.0 24.1 21.7

All States 50.9 51.0 54.3 42.5 40.9 42.6

Section-II 374

Table : 6.2 Quality of Expenditure Management, All States

Revenue Deficit/Gross

Fiscal Deficit

Capital outlay/Gross

Fiscal Deficit

2001-

02

2002-

03

(RE)

2003-

04

(BE)

2001-

02

2002-

03

(RE)

2003-

04

(BE)

Andhra

Pradesh

42.9 43.1 46.0 49.4 65.3

Assam 60.9 43.8 35.4 49.2 37.5

Bihar 58.4 50.0 27.9 33.7 42.4

Delhi -69.8 -78.9 35.3 37.5 63.5

Goa 55.4 25.0 44.7 74.0 86.6

Gujarat 103.4 58.0 27.0 25.5 38.7

Haryana 38.5 49.3 53.6 40.6 51.4

Karnataka 56.0 59.1 35.9 48.7 59.0

Kerala 79.7 66.7 17.1 28.2 17.9

Madhya

Pradesh

86.8 33.1 40.3 59.4 75.9

Maharashtra 75.1 56.6 27.1 29.3 41.0

Orissa 71.4 45.9 22.4 34.8 30.4

Punjab 76.2 69.4 19.8 22.9 39.7

Rajasthan 66.0 62.6 31.6 33.9 46.4

Section-II 375

Tamilnadu 57.8 73.0 37.5 21.3 39.2

Uttar

Pradesh

62.5 60.6 35.9 33.6 59.3

West

Bengal

75.0 77.6 10.7 10.0 8.4

Average

GC States

30.6 32.7 46.0

Special

Category

Arunachal -10.2 -187.6 109.7 286.6 561.8

Himachal 56.9 74.3 43.0 25.5 28.9

J&Kashmir -98.3 -52.4 189.1 147.7 268.2

Manipur 47.4 2.2 51.6 94.1 93.7

Meghalaya 15.2 10.8 72.4 72.2 99.4

Mizoram 61.7 13.4 32.8 79.4 45.2

Nagaland -12.3 -25.0 109.9 122.2 175.0

Sikkim -213.9 -447.2 315.3 548.4 540.2

Tripura -10.1 10.1 109.0 88.6 124.6

Average

SC States

75.5 66.3 68.1

Chattisgarh 50.8 33.1 44.9 62.3 77.3

Section-II 376

Gharkhand -6.1 15.1 84.6 70.3 122.1

Uttaranchal 23.5 64.7 58.9 21.2 33.3

All States 33.6 35.6 48.0

Table 6.3All States : Plan

exp/GSDPAll States : GFD /plan

Expas % of GSDP as % of Plan Exp

Eighth Ninth Difference Eighth Ninth DifferenceAndhra 5.0 5.3 -0.3 62.9 68.1 5.1Arp 38.3 37.0 -1.3 10.0 12.1 2.2Assam 6.5 6.3 -0.2 28.7 36.3 7.6Bihar 4.0 4.0 - 75.0 95.5 20.5Goa 6.2 5.5 -0.7 43.5 70.3 26.8Gujarat 3.6 4.0 0.4 61.1 87.5 26.4Haryana 4.4 4.3 -0.1 61.5 82.3 20.8H.P 14.1 15.9 1.8 54.8 59.2 4.4J & K 14.4 14.2 -0.2 10.5 35.1 24.5Karnataka 5.9 5.3 -0.6 49.4 59.6 10.2Kerala 4.3 4.6 0.3 77.6 96.4 18.8M.P. 5.1 4.8 -0.3 45.1 61.2 16.1Maharastra 4.1 3.5 -0.6 60.4 89.8 29.4Manipur 20.4 20.2 -0.2 22.3 42.4 20.1Meghalaya 14.8 13.7 -1.1 23.0 33.5 10.4Mizoram 31.5 31.6 0.1 23.6 29.5 5.9Nagaland 19.8 18.8 -1.0 61.9 55.6 -6.3Orissa 7.5 7.4 -0.1 69.1 86.2 17.1Punjab 3.8 3.3 -0.5 113.1 153.1 40.0Rajasthan 6.7 5.8 -0.9 67.2 90.8 23.6Sikkim 36.5 33.8 -2.7 25.7 33.8 8.1Tamilnadu 3.8 3.5 -0.3 63.9 84.8 20.9Tripura 18.1 16.4 -1.7 21.5 28.7 7.2U.P. 4.5 4.2 -0.2 94.0 121.6 27.6W.B. 3.5 3.5 - 96.6 148.1 51.5NCT DelhiSection-II 377

All StatesSource X Five Year Plan pg-15

Section-II 378

Table : 6.4

States/Territories Per capita NSDP at

1993-94 prices SDP Growth Rate2000-01(P) 1991-2001 10th FYP Target

1.Andhra Pradesh 9982 5.4 6.82.Arunachal Pradesh SC 9013 5.3 83.Assam SC 5867 2.5 6.24.Bihar 3345 2 6.25.Chhattisgarh NA - -6.Goa SC 26106 7.2 9.27.Gujarat 12975 6.3 10.28.Haryana 14331 4.8 7.99.Himachal Pradesh SC 10942 6.1 8.910.Jammu& Kashmir SC 7383 4.5 6.311.Jharkhand NA - -12.Karnataka 11910 7.7 10.113.Kerala 10627 5.7 6.514.Madhya Pradesh 7003 4.4 715.Maharashtra 15172 6.5 7.416.Manipur SC 7955 6.2 6.517.Meghalaya SC 8460 5.3 6.318.Mizoram SC NA - 5.319.Nagaland SC NA - 5.620.Orissa 5187 3.9 6.221.Punjab 15390 4.9 6.422.Rajasthan 7937 4.4 8.323.Sikkim SC NA - 7.924.Tamil Nadu 12779 6.2 825.Tripura SC 8372 6.8 7.326.Uttar Pradesh 5770 2.8 7.627.Uttaranchal NA - -28.West Bengal 9778 6.7 8.8Delhi (NCT) 24450 6.8 10.6Union Territories1.Andaman&Nicobar Is2.Chandigarh3.Dadra&Nagar Haveli4.Daman & Diu5.Lakshadweep6.Pondicherry 18500 7.3 10.7All India 5.6 8Chattisgarh, Jharkhand,and Uttaranchal were formed in 2000, carving in territories

Section-II 379

out of Madhya Pradesh,Bihar and Uttar Pradesh Table : 6.5

States/Territories Tenth Plan Outlay SORCentral

Assistance

1.Andhra Pradesh 46614.00 24372.11 22241.892.Arunachal Pradesh SC 3888.32 492.07 3396.253.Assam SC 8315.23 -1212.37 9527.604.Bihar 21000.00 9278.59 11721.415.Chhattisgarh 11000.00 6896.43 4103.576.Goa SC 3200.00 2547.60 652.407.Gujarat 40007.00 26850.66 13156.348.Haryana 10285.00 7105.00 3180.009.Himachal Pradesh SC 10300.00 4760.00 5540.0010.Jammu& Kashmir SC 14500.00 2679.45 11820.5511.Jharkhand 14632.74 10566.33 4066.4112.Karnataka 43558.22 25565.40 17992.8213.Kerala 24000.00 13161.45 10838.5514.Madhya Pradesh 26189.33 16021.80 10168.1315.Maharashtra 66632.00 56861.61 9770.3916.Manipur SC 2804.00 -362.42 3166.4217.Meghalaya SC 2299.44 -23.71 2323.1518.Mizoram SC 2052.51 -346.93 2399.4419.Nagaland SC 2227.65 -366.82 2594.4720.Orissa 19000.00 4392.28 14607.7221.Punjab 18657.00 14678.00 3979.0022.Rajasthan 27318.00 17677.44 9640.5623.Sikkim SC 1655.74 95.50 1560.2424.Tamil Nadu 40000.00 24993.87 15006.1325.Tripura SC 4500.00 491.55 4008.4526.Uttar Pradesh 59708.00 24297.88 35410.1227.Uttaranchal 7630.00 1003.50 6626.5028.West Bengal 28641.00 14295.50 14345.00Delhi (NCT)Union Territories1.Andaman&Nicobar Is2.Chandigarh3.Dadra&Nagar Haveli4.Daman & Diu5.Lakshadweep6.Pondicherry All states 560615.78 306771.77 253844.01SOR:States own resourcesSource : Planning Commission

Section-II 380

Chapter-VII

Criteria for Devolution

As is well known, the federal fiscal transfer system in India

has a vertical dimension in which the Central Tax Revenues are

shared between the Union and the states, and horizontal Dimension

in which the respective shares of individual states in the aggregate

share of the states are determined. The successive Finance

Commissions have, in their pursuit of objectivity in resource

distribution, sought to evolve, what they considered to be reasoned

formulae for determining the horizontal and vertical sharing of

resources.

A retrospective analysis shows that the Commission have

trod a veritable mine field in their pursuit of formulae and that the

criteria adopted have been marked by changes from one

Commission to the another. One may recall the forcible words of

Justice P.V.Rajamannar, Chairman, Fourth Finance Commission,

“As regards distribution inter se among the several states,…. There

has been a great divergence in the suggestions put forward by the

states before the Finance Commissions. Population, contribution,

collection, relative financial weakness, social and economic

backwardness, per capita income are some of the different criteria

urged by one or the other of the states.In respect of such an

Section-II 381

important matter as the determination of the resources which will

be available to each state as a result of a scheme of devolution,

there should not be a gamble on the personal views of five persons

or a majority of them.” ( Minute appended to the Report of the

Fourth Finance Commission, August 1965)

As was pointed out by Sri.S.Guhan way back in 1984, “ the

strength of the Indian Centre State fiscal system is that it provides

mechanisms in the Finance and Planning Commissions which can

redistribute national resources between the Centre and the States

and amongst the latter in the light of twin considerations of ability

and need. The weakness has been that in the actual working of the

two Commissions there has been a lack of both clarity and

coordination in regard to ways in which each Commission could

address itself to upgrading ability while responding to needs and

concurrently and conversely compensate for backwardness while

upgrading ability” Guhan also argued that, “it is important to give

undivided attention to devolution criteria for two main reasons.

Devolution accounts for the very large bulk of transfers made by

the Finance Commissions under all heads, an estimated 85 %

under the Eighth Commission, Secondly while broad common

sense considerations have been found sufficient to deal with tax-

rental arrangements relief expenditure, debt accommodation and

Section-II 382

upgradation of standards, a long term frame work is necessary to

settle devolution criteria and coordinate such criteria with the

operation of the Planning Commission in the federal planning

context of India. Over more than three decades (1952-1984) eighth

successive Finance Commissions have failed to develop such a

framework” (Devolution Criteria of Finance and Planning

Commissions: from Gamble to Policy, EPW Dec 1 1984). There

has since been a serious attempt by the later Finance Commissions,

to refine the transfer scheme, by changing the criteria as also

weightage assigned to various criteria.

Analysts have pointed out that the fiscal transfer formulae

have evolved in three phases, starting with separate criteria for

income tax and Union Excise duties from the First to the Seventh

Commissions, and followed by a move towards convergence of

criteria seen in the recommendations of the Eighth, Ninth and

Tenth Finance Commissions and emergence of full convergence,,

with the recommendations of the Eleventh Finance Commission

after the Eightieth Amendment to the Constitution. The devolution

formulae adopted by the Finance Commissions have been guided

by the principles of capacity equalization, efficiency promoting

incentives and allowance for cost disabilities. The formulae thus

evolved have been classified into those based on a) Income

Section-II 383

Distance , reflecting fiscal deficiency b) Inverse Income, reflecting

relative fiscal deficiency c) population size, seeking equal per

capita transfers d) geographical area and availability of

infrastructure, reflecting cost disadvantages in performance of

services e) fiscal performance, reflected in tax effort and fiscal

discipline. (see D.K.Srivastava, Inter governmental Fiscal

Transfers, NIPFP, Nov 2000, pg 34-48).

It should be noted that the successive Finance Commissions

have been guided by considerations that were directed towards equity and progressive character of distribution process, in which the transfers were so adjusted that the poorer states were provided with resources to enable them close the gaps in their revenues and further, with assistance of the grants provided move towards standards of public service available in the states with higher incomes. The transfer whether of shares of divisible taxes or of specific grants were guided more by objectives of equalization than considerations of efficiency in the performance of public services in all the states.

It may be mentioned that, as many as Eleven FCs have sought to establish a workable system of resource sharing between Centre and the States and among the states. Between 1952 and 2000 Ten Finance Commissions had recommended the transfers of sums totaling Rs.4,26,079 crores, (Rs.3,76,235 crores by way of devolution of taxes and duties and Rs. 49,844 crores as grants-in-aid) and the Eleventh Finance Commission recommended transfer of Rs. 4,34,905 crores ( Rs.3,76,318 crores by way of devolution and Rs.5,87,587 crores as grants.) for the period 2000-05. It is significant that the transfer during 2000-2005, will be higher than what was done during the previous five decades. In all eleven Finance Commissions have so far recommended a total transfer of Rs.8,60,984 crores of which Rs. 7,52,553 crores, 87% of the total has been by way of devolution, and the states not only keep asking for more from the Centre but have also begun to make competitive claims, which makes the choice of criteria for vertical and horizontal devolution, a critical one.

Vertical Sharing

Section-II 384

In the area of vertical sharing there have been debates raised

over the relative tax powers and functional responsibilities

assigned to the Centre and the States, over the relative buoyancy of

the taxes leviable by the Centre and the States and over the

perceived pre-emption of more buoyant taxes by the Centre, over

centre’s resort to levy of surcharges which are not shareable as

against increase in the basic rate of tax or duty and the like. The

shares of income tax and Excise duties allocated to the center and

the states by the First to the Tenth Commission is shown in Table

7.1. It emerges from the table that the proportions were changing

from Finance Commission to Finance Commission, denying an

element of continuity to the tax devolution. Some quietus should

have descended on these debates, with the Alternative Devolution

Scheme proposed by the Tenth Finance Commission, suggesting

that the share of the states should be fixed at 26% of the gross

proceeds of all Central taxes and duties with a further share of 3%

of gross tax receipts in lieu of additional excise duties thus totaling

29 % of gross receipts of the Centre and that this should be

provided in the Constitution and reviewed once in fifteen years.

Even though a consensus emerged on this issue in the Inter-State

Council meeting in 1997, the translation of the recommendation

into constitutional amendments, could take place only in 2000 with

Section-II 385

two important changes firstly that the share will be of the net

proceeds of the Central taxes and duties and secondly that the

matter will be reviewed every five years. The Amendment got

couched in such terms that it did not bury the issues once for all.

Horizontal Devolution

Even in the area of horizontal division, there has been a

continuing debate, over the criteria adopted by successive Finance

Commissions. While size of population, contribution to the total

yield, per capita income, indicators of backwardness, poverty

levels, needs for revenue equalization, tax efforts and fiscal

discipline have been among the criteria adopted by one or the other

of the Commissions for deciding the shares of the states and the

weightage given to the chosen factors have also varied from

Commission to Commission. The criteria adopted for allocation of

the proceeds of income tax and basic excise duties among the

various states are shown in Tables 7.2 and 7.3. The frequent

changes in the criteria for distribution among the states have also

resulted in some controversy or other after each quinquennial

exercise of Finance Commissions. The changes in terms of

quantum of transfers made by Seventh to Eleventh FCs are shown

in Table: 7.15 (placed at the end of the chapter)

Section-II 386

Geographical and Demographic Factors

As the geographical area and the size of population of a state

are factors that affect the quality of delivery and cost of public

services, and impact on efficiency of public expenditure, there is

continuing need to keep them in view along with the weights

assigned to them by the previous Commissions. State-wise details

of geographical area, size of population and rank and density in

1991 and 2001, are set out in Tables 7.4 and 7.5

AreaA tacit recognition of geographical area or size of the state as a physical factor

was only recently made by the Tenth Finance Commission while dealing with the request of some states to use ‘Area’ as one of the distribution criteria and in deciding to assign, what it called a small weight of 5% to area.(Para 5.42) p.24 of the Report. Eleventh Finance Commission increased the weightage given to Area to 7.5%. ‘Area’ is only one among the physical factors that impacts on the efficiency of delivery of public services. There are other factors like the quality of soils, nature of the tract and the like which influence the rate of development given the same level of application of human and financial resources. While the geographical area of a state may be one of the convenient criteria for deciding the sharer of a state in horizontal devolution, it is necessary to keep in view these physical factors, while assessing efficiency of public expenditure.

Population

The size of population in the states has been one of the most important criteria adopted by all the Finance Commissions, though the weight assigned to this factor in horizontal distribution has varied not only between income tax and union excise duties but also from Commission to Commission. It should also be noted that while the first seven Commissions gave to population a high weightage 80 to 90 % for distribution of income tax and the first six Commissions gave similar weightage to population for distribution of Union excise duties, the Seventh Finance Commission proposed reduction of weightage for population for distribution of excise revenues from 75 to 25 % and this was adopted by the Eighth and the Ninth Finance Commissions. The Eighth Finance Commission proposed reduction in the weightage to population for income tax allocation from 90 to 22.5 %, and the Ninth Finance Commission also adopted this. The Tenth

Section-II 387

Finance Commission gave a weightage of 20 % for both income tax and excise duties but the Eleventh Finance Commission reduced weightage to 10%.

Sri B.P.R.Vithal has pointed out, that “the strength of this criterion has been the perception that it is objective…. Population has the advantage of being an undisputed factor without any statistical bias …..The most populous states like UP and Bihar, and sparsely populated states like Rajasthan and Orissa are all backward… When we are looking for a criterion, which would represent entitlement and need, population as a factor might appear to have advantages.”

The Terms of Reference from the Seventh to the Twelfth Finance Commissions stipulate that “the commission shall adopt the population figure of 1971 in all cases where population is regarded as a factor for determination of devolution of taxes and duties and grants in aid”. It is rather significant that this is though a) the population has increased from 361.08 millions in 1951 to 439.23 millions in 1961, 548.16 millions in 1971,684.33 millions in 1981, 846.30 millions in 1991 and further to 1027.01 millions in 2001, b) the number of states have increased from 16 to 28 between the First Finance Commission to the present and c) after 1971 census, and the recommendations of the Fifth Finance Commission for the period ending with 1973-74, as many as eleven new state entities have come into existence.

An important factor that affects the quality of public services is the density of population which has, at the all India level increased from 117 (per Sq.Km) in 1951 to 324 in 2001. State wise data on density of population indicate huge variations in density, with a possibility that the pressure on public services like health, education and transport can vary from state to state on this account. Census reports published by the Registrar General of India also indicate the number of statutory and Census towns as also the percentage of distribution of population according to village size categories. This become relevant in the context of allocations for decentralization of administration and grants to urban and rural local bodies.

Table : 7.4 Geographical Area States/Territories Area (Sq Km) Rank 1.Andhra Pradesh 275,045 52.Arunachal Pradesh SC 83,743 143.Assam SC 78,438 164.Bihar 94,164 125.Chhattisgarh 135,237 106.Goa SC 3,702 287.Gujarat 196,024 78.Haryana 44,212 209.Himachal Pradesh SC 55,673 1710.Jammu& Kashmir SC 222,236 611.Jharkhand 79,261 1512.Karnataka 191,791 8

Section-II 388

13.Kerala 38,863 2114.Madhya Pradesh 308,144 215.Maharashtra 307,713 316.Manipur SC 22,327 2317.Meghalaya SC 22,429 2218.Mizoram SC 21,081 2419.Nagaland SC 16,579 2520.Orissa 155,707 921.Punjab 50,362 1922.Rajasthan 342,239 123.Sikkim SC 7,096 2724.Tamil Nadu 130,058 1125.Tripura SC 10,492 2626.Uttar Pradesh 294,000 427.Uttaranchal 53,566 1828.West Bengal 88,752 13Delhi (NCT) 1,483 2Union Territories 1.Andaman&Nicobar Is 8,249 12.Chandigarh 114 53.Dadra&Nagar Haveli 491 44.Daman & Diu 112 65.Lakshadweep 32 76.Pondicherry 492 3SC means Special Category StateSource : Census of India 2001

Section-II 389

Table 7.5 : States -Population and Rank

States/Territories Total Population Rank Rank % to Total population

Density of population per sq km

1991 2001 1991 2001 2001 1991 20011.Andhra Pradesh 66,508,010 75,727,541 4 5 7.37 242 2752.Arunachal Pradesh SC 864,558 1,091,117 27 27 0.11 10 133.Assam SC 22,414,320 26,638,407 13 14 2.59 286 3404.Bihar 86,374,470 82,878,796 5 3 8.09 497 8805.Chhattisgarh 20,795,956 16 17 2.03 0 1546.Goa SC 1,169,739 1,343,998 26 25 0.13 316 3637.Gujarat 41,309,580 50,596,992 10 10 4.93 211 2588.Haryana 16,464,000 21,082,989 16 16 2.05 372 4779.Himachal Pradesh SC 5,170,877 6,077,248 21 20 0.59 93 10910.Jammu& Kashmir SC 7,718,700 10,069,917 19 19 0.98 NA 9911.Jharkhand 26,909,428 14 13 2.62 - 33812.Karnataka 44,977,200 52,733,958 8 9 5.14 235 27513.Kerala 29,098,520 31,838,619 12 12 3.1 749 81914.Madhya Pradesh 66,181,170 60,385,118 7 7 5.88 149 19615.Maharashtra 78,937,190 96,752,247 2 2 9.42 257 31416.Manipur SC 1,837,149 2,388,634 23 23 0.23 82 10717.Meghalaya SC 1,774,778 2,306,069 24 24 0.22 79 10318.Mizoram SC 689,756 891,058 29 30 0.09 33 4219.Nagaland SC 1,209,546 1,988,636 25 25 0.19 73 12020.Orissa 31,659,740 36,706,920 11 11 3.57 203 23621.Punjab 20,281,970 24,289,296 15 15 2.37 403 48222.Rajasthan 44,005,990 56,473,122 9 9 5.5 129 16523.Sikkim SC 406,457 540,493 31 31 0.05 57 7624.Tamil Nadu 55,859,000 62,110,839 6 6 6.05 429 47825.Tripura SC 2,757,205 3,191,168 22 21 0.31 263 30426.Uttar Pradesh 139,112,300 166,052,859 1 1 16.17 473 68927.Uttaranchal 8,479,562 20 19 0.83 - 15928.West Bengal 68,077,970 80,221,171 3 4 7.81 767 904Delhi (NCT) 9,420,644 13,782,976 18 18 1.34 6352 9294Union Territories 1.Andaman&Nicobar Is 280,661 356,265 32 32 0.03 34 432.Chandigarh 642,015 900,914 29 30 0.09 5632 79033.Dadra&Nagar Haveli 138,477 220,451 33 33 0.02 282 4494.Daman & Diu 101,000 158,059 34 34 0.02 907 14115.Lakshadweep 51,707 60,595 35 35 0.01 1616 18946.Pondicherry 807,785 973,829 28 28 0.09 1642 2029SC means Special Category StateSource : Census of India 1991 and 2001

Section-II 390

Criteria of Backwardness

Examination of the reports of the successive Finance Commissions and evolution of criteria for tax sharing and determining grants, brings out their recognition of the differences in the resource endowments and, levels of development of the States and even a search for proxy parameters like the calculated poverty ratio and index of infrastructure. But one gains the impression that FCs have paid greater attention to population and contribution of the states than to the disadvantages and constraints emerging from natural factors, like vulnerability to flood, proneness to chronic drought, and the hilly and rugged terrain, which characterized one state or the other and contributed to continuing backwardness. These factors continue to need attention and central assistance from Plan and Non plan dispensations as they have not emerged completely out of their state of disadvantage.

The differences in the natural resource endowments and physical disadvantages of states have been dealt by the various Finance Commissions by using state income or poverty ratio as proxy, taking per capita State Domestic Product, as an income criteria and calculating shares on the basis of three year averages to eliminate erratic changes. Variations of the income formulae have also been used by the different Commissions to assess the fiscal deficiency of the state and the cost disadvantages in provision of services. Some specially constructed infrastructure indices combining economic and social infrastructure data have also come into reckoning.

The Fourth Finance Commission had expressed the opinion that the scheme of

inter-se distribution among states should be on the basis of “ascertainable factors” than on the basis of “uncertain factors” While recognizing,like previous Commissions, population as a major factor in distribution and giving it 80% weightage, IV FC felt that “relative economic and social backwardness should also be taken into account” and gave this 20% weightage in distribution using seven indicators to determine backwardness. The V FC came up with an integrated index of backwardness on the basis of six indicators. The VII FC used criteria like Income adjusted Total population, Poverty Ratio and Revenue Equalization factor. Ninth Finance Commission came up with an Index of backwardness in its second report giving it a weightage of 11.25% in distribution of Income Tax proceeds and 12.5% in respect of Excise Duties. The Tenth Finance Commission gave a weightage of 5% on the basis of an Index of Infrastructure. The Eleventh Finance Commission gave a weightage of 7.5% to this factor.

Income Criteria

While the Fifth Commission gave a weightage of 13.34% to states with per capita income below the all states average and the Sixth gave a weightage of 25% for allocation Section-II 391

of excise duties, the Seventh adopted a different formula. The Eighth Finance Commission assigned a weightage of 25% for per capita income, for excise duties and 22.5 for income tax.The Ninth Finance Commission increased the weightage to per capita income (distance method) to 50% in the first report and 33.5% in the second report. The Tenth Finance Commission increased it to 60% and the Eleventh to 62.5%. Assigning such high weightage to income factor as done by the Tenth and the Eleventh Finance Commission appear to have ignited some controversy. One point of statistical importance is that the data on net state domestic product in total or per capita terms for different states and Union Territories are not strictly comparable owing to the differences in the source material used. While the data compiled by Directorates of Economics and Statistics of the various State Governments are not comparable the Finance Commissions have used the computations of the CSO and this may have been normalized before their adoption as a basis for inter-state allocation of resources. While NSDP data can be taken into account, the weightage assigned, 60 % by the Tenth Finance Commission and 62.5 % by the Eleventh Finance Commission for per capita income distance, appears to be far too high needing downward adjustment.Twelfth FC may like to take into account, the data on NSDP, and per capita NSDP at current prices and 1993-94 prices for the latest three years and their average. (Tables 7.6 and 7.7)

Table. 7.6 : Net State Domestic Product (Total and Per Capita- Current Prices ) States/Territories NSDP at CP Per capita NSDP at CP

1998-99 1999-002000-01(P) Avg 1998-99 1999-00

2000-01(P) Avg

1.Andhra Pradesh 103915 111753 124443 113370 13993 14878 16373 15081.32.Arunachal SC 1369 1427 1591 1462.33 13129 13352 14587 13689.33.Assam SC 22710 26273 27600 25527.7 8826 10080 10467 97914.Bihar 34680 38326 41825 38277 4474 4813 5108 4798.335.Chhattisgarh 20313 31331 NA 25822 10056 10405 NA 10230.56.Goa SC 5212 5862 6022 5698.67 40248 44613 45105 433227.Gujarat 88932 89606 93601 90713 18815 18685 19228 18909.38.Haryana 38288 42488 47474 42750 19716 21551 23742 21669.79.Himachal SC 9507 10657 11536 10566.7 16144 17786 18920 17616.710.J Kashmir SC 11128 12182 12423 11911 11591 12373 12399 1212111.Jharkhand 22565 23227 NA 22896 9129 9223 NA 917612.Karnataka 78874 86296 94635 86601.7 15420 16654 18041 1670513.Kerala 51061 56926 63094 57027 16029 17709 19463 17733.714.Madhya Pradesh 61099 67778 64063 64313.3 10682 11626 10803 1103715.Maharashtra 188331 213151 227893 209792 20356 22604 23726 22228.716.Manipur SC 2308 2858 2945 2703.67 10504 12721 12823 1201617.Meghalaya SC 2580 2904 3230 2904.67 11090 12083 13114 12095.718.Mizoram SC 1139 1288 NA 1213.5 13479 14909 NA 1419419.Nagaland SC 2184 2330 NA 2257 12408 12594 NA 1250120.Orissa 29458 31195 30795 30482.7 8324 8733 8547 8534.6721.Punjab 49588 55470 60890 55316 21184 23254 25048 2316222.Rajasthan 65535 71020 66949 67834.7 12348 13046 11986 1246023.Sikkim SC 702 758 827 762.333 13158 14751 15550 14486.324.Tamil Nadu 107123 114309 123140 114857 17613 18623 19889 18708.325.Tripura SC 3473 4193 4580 4082 11012 13195 14348 12851.726.Uttar Pradesh 135262 149352 159408 148007 8633 9323 9721 9225.67

Section-II 392

27.Uttaranchal NA NA NA NA NA NA NA NA28.West Bengal 106170 117507 128387 117355 13641 14894 16072 14869Delhi (NCT) 42785 47846 52793 47808 33870 36515 38864 36416.3Pondicherry (UT) 2677 2783 3030 2830 28761 29348 31358 29822.3

Table. 7.7 : Net State Domestic Product (Total and Per Capita- 1993-94 prices) States/Territories NSDP(1993-94 prices) Per capita NSDP (1993-94) prices

1998-99 1999-002000-01(P) Avg 1998-99 1999-00

2000-01(P) Avg

1.Andhra Pradesh 68036 71031 75868 71645 9162 9457 9982 9533.672.Arunachal Pradesh SC 921 917 983 940.333 8829 8580 9013 8807.333.Assam SC 14574 15078 15470 15040.7 5664 5785 5867 57724.Bihar 24917 26461 27383 26253.7 3215 3323 3345 3294.335.Chhattisgarh 13882 13719 NA 13800.5 6873 6692 NA 6782.56.Goa SC 3285 3601 3485 3457 25364 27405 26106 26291.77.Gujarat 63777 62450 63161 63129.3 13493 13022 12975 13163.38.Haryana 25251 27028 28655 26978 13003 13709 14331 136819.Himachal Pradesh SC 5966 6300 6672 6312.67 10131 10514 10942 1052910.Jammu& Kashmir SC 7005 7270 7397 7224 7296 7384 7383 7354.3311.Jharkhand 16334 16750 NA 16542 6608 6651 NA 6629.512.Karnataka 54225 58313 62477 58338.3 10607 11254 11910 1125713.Kerala 30644 32716 34451 32603.7 9619 10178 10627 10141.314.Madhya Pradesh 43526 46328 41530 43794.7 7609 7947 7003 7519.6715.Maharashtra 128976 142217 145734 138976 13941 15082 15172 14731.716.Manipur SC 1555 1830 1827 1737.33 7076 8147 7955 772617.Meghalaya SC 1846 2002 2084 1977.33 7935 8333 8460 8242.6718.Mizoram SC NA NA NA NA NA NA NA19.Nagaland SC 1605 1614 NA 1609.5 9118 8726 NA 892220.Orissa 18280 18809 18690 18593 5165 5265 5187 5205.6721.Punjab 33412 35733 37413 35519.3 14274 14980 15390 14881.322.Rajasthan 46459 47402 44335 46065.3 8754 8707 7937 846623.Sikkim SC 516527 NA NA 516527 9666 10250 NA 995824.Tamil Nadu 71871 75790 79121 75594 11817 12348 12779 12314.725.Tripura SC 2333 2532 2672 2512.33 7396 7967 8372 7911.6726.Uttar Pradesh 85344 91027 94612 90327.7 5447 5682 5770 563327.Uttaranchal NA NA NA NA NA NA NA28.West Bengal 68598 73609 78108 73438.3 8814 9330 9778 9307.33Delhi (NCT) 30484 31875 33213 31857.3 24133 24327 24450 24303.3Pondicherry (UT) 1796 1887 2018 19278 18680 18500

Choice of Criteria – A comparison of Tenth and Eleventh Finance Commissions

Attention was drawn earlier to the three phases of evolution of devolution formulae and to the differences in the criteria for allocation of proceeds of income tax and excise duties adopted by the First to the Eighth Finance Commission and the move towards convergence of criteria made by the Eighth,Ninth and Tenth Finance Commissions.The Section-II 393

Ninth Finance Commission adopted a Normative Approach for the first time, but this faced evoked criticism from the states though the Commission clarified that its methodology implied not interference with the right of the states to decide the manner of taxation and expenditure.

The Tenth Finance Commission not only made an effort to give some stability to the vertical sharing of tax proceeds but also, while determining horizontal devolution moved into the areas of cost disadvantages in performance of public services, emerging from geographical area and availability of infrastructure giving a weightage of 5% each to area and a newly constructed infrastructure index. The Eleventh Finance Commission increased the weightage to geographical area and infrastructure index from 5 to 7.5 % each and added fiscal discipline as a criteria, giving it a weightage of 7.5 %.The importance of these criteria flowed from the fact, that the geographical size of a state, and the population spread, influenced the per capita cost of providing public services. The index of infrastructure constructed for the consideration and adoption by the Twelfth Finance Commission was a weighted combination of indices of economic infrastructure, ( covering agriculture, communication, banking electricity roads and transportation) and social infrastructure covering health and education facilities. Deficiency in infrastructure entailed additional cost in provision of public services and called for additional resources for schemes to improve delivery systems, the financial implications could be both by way of revenue and capital expenditure. The attempts made by the Tenth and the Eleventh Finance Commission to reduce weightage to population as a criteria further than the Seventh, Eighth and the Ninth Commissions and bring in area and infrastructure availability should be considered as a move in the direction of seeking improvement in efficiency by provision of adequate resources to compensate for cost disadvantages, emerging out of natural and socio economic conditions.

It must however be noted that the criteria for performance incentives adopted by the Tenth and the Eleventh Finance Commission differed somewhat both in the choice of criteria and the assignment of weights. The Tenth Finance Commission introduced tax effort as a criteria and giving it a weightage of 10 %. The Tax effort of the state was estimated by a per capita tax as a ratio to square of per capita state domestic product. The share of the state was the ratio of its tax effort to the total for all states multiplied by their respective poputation.Thus, the share for Andhra Pradesh will be =

[per capita tax of AP/ (per capita SDP of AP)2 X (Population of AP)

(sum of similar products for all states )

Eleventh Finance Commission, adopted a different formula for

calculating tax effort by taking the average of the tax/GDP ratio for

three years of 1994-95, 1995-96 and 1996-97 and assigned it a

Section-II 394

lower weight of 5% to calculate the share of the states. It also

introduced an Index of fiscal discipline to measure improvement in

fiscal self reliance by calculating the ratio of states own revenue

receipts to its total revenue expenditure and relating this to similar

ratio for all states and gave a weight of 7.5 %. While its intention

was to provide some incentive for fiscal performance, by

introducing a new criterion like fiscal discipline, many State

Governments argued that the approach of the Eleventh Finance

Commission favoured fiscally imprudent states in both tax

devolution and grants, in comparison with states having better

records of fiscal performance. This is examined, in Table 7.8

showing state-wise Tax/GSDP ratio and their shares in tax

devolution as per Tenth and Eleventh Finance Commission’s

recommendations. The data establish that, the largesse conferred

on some states did not bear any relation to tax/GSDP ratios, and

the EFCs recommendations did not appear to respect past fiscal

performance of various states.

Table. 7.8 : Tax performance of states and share in the tax devolution

State Tax/GDP ratio Avg of

1994-95 to 1996-97

Tax devolution share as per

TFC EFC Diff

Tamilnadu 8.47 6.12 5.38 -0.74Karnataka 8.43 4.86 4.93 0.07Kerala 8.33 3.50 3.06 -0.44Goa 7.77 0.25 0.21 -0.04

Section-II 395

Gujarat 7.29 3.88 2.82 -1.06Haryana 6.72 1.24 0.94 -0.3Punjab 6.52 1.53 1.15 -0.38Maharashtra 6.55 6.23 4.63 -1.6AP 5.45 7.91 7.70 -0.21

0West Bengal 5.39 6.84 8.12 1.28Rajasthan 5.33 4.97 5.47 0.5MP 4.94 7.40 8.84 1.44UP 4.66 16.25 19.80 3.55Orissa 4.16 4.26 5.06 0.8Bihar 3.83 11.29 14.60 3.31

Relative shares of the states

It appears from the Table 7.9 below and Tables

7.12,7.13,7.14 (placed at the end of the chapter) that the EFC

awards as compared to TFC’s have resulted in reduction in total

transfers and tax devolution in respect of special category and high

income states, marginal reduction in middle income states while

low income states have gained enormously. The only exception has

been West Bengal which is a middle income state. It was perhaps

only a coincidence, that the states that benefited belonged to

certain geographic and linguistic configurations.

Table 7.9 DISTRIBUTION AMONG STATES

Tax Devolution Total Transfer

TFC EFC TFC EFC

Section-II 396

High income 13.14 9.75 13.06 9.62

Middle Income 29.23 29.19 28.53 27.56

Low Income 44.17 53.76 43.25 49.34

Special Category 13.46 7.30 15.17 13.48

100.00 100.00 100.00 100.00

High Income : Gujarat, Haryana, Maharashtra, Punjab and Goa

Middle come : Andhra Pradesh, Karnataka, Kerala, Tamilnadu and West Bengal

Lower Income : Bihar, Madhya Pradesh, Orissa, Rajasthan, and Uttar Pradesh

Special Category States : Arunachala Pradesh, Assam, Himachal Pradesh, Jummu and Kashmir, Manipur,

Meghalaya, Mizoram, Nagaland, Sikkim and Tripura

The criteria adopted and weightage assigned by the Tenth

and the Eleventh Finance Commission and the implications of the

changes in the weightages assigned to different criteria, for the

various states, in terms of the end product- the quantum of resource

transfer are brought out below.(Table 7.10)

Table 7.10 : Gainers and losers from EFC award

CriteriaWeightage given

by Gainers LosersTFC EFC in 2000-05 2000-05

Population 20.0* 10.0 - UP,Bihar, AP, Maharashtra, West Bengal,

Income (distance) 60.0 62.5 Bihar,UP, MP,Orissa, Maharashtra, Gujarat,Tamilnadu, Kerala

Area 5.0 7.5 MP,Rajasthan, Gujarat, Orissa UP,Bihar, Tamilnadu, KeralaIndex of Infrastructure 5.0 7.5 Rajasthan, MP,Bihar,Orissa Punjab,Kerala,Tamilnadu,

Haryana,Gujarat

Tax Effort 10.0 5.0 Tamilnadu,Karnataka, Kerala,Gujarat, Maharashtra, Bihar,Orissa,UP,West Bengal,AP

Fiscal discipline 0 7.5 Kerala,Karnataka,Bihar, Tamilnadu,Maharashtra

West Bengal, Rajasthan, MP, Haryana, AP

Note : * for population TFC adopted a weightage of 20 % for I.T and 16.84 % for excise duties

Section-II 397

The Economic Times (31st July 2000), captioned its analysis

of the EFC recommendations as “ The states turned upside down”

and presented in tabular column its analysis of the Gainers and the

Losers, indicating the gainers Bihar, Haryana, HP,MP Rajasthan

and UP as belonging to the Hindi belt and the losers, AP,

Karnataka, Kerala, and Tamilnadu as southern states and Gujarat

and Maharashtra as western states. Its analysis was restricted to the

impact for 2000-01.

The Hindu, even with its reputation for sobriety, captioned its

analysis of EFC’s recommendations, as “ Winners and Losers from

the EFC” (August 3rd, 2000)and pointed out that “usually the

criticism is about how much or rather how little of its resources the

Centre is asked to transfer to the states, this time around though the

controversy seems to be more about how the resources devolved to

the states will be distributed among them. In the jargon of

Economists the controversy over horizontal transfers has taken

precedence over that of vertical transfers. This is so because the

result of EFC recommendations will be a substantial change in

2000-05 in the relative shares of almost all the states in their

resources that will devolve from the Centre.This follows from a) a

change in the formula in the inter states distribution of the states

share in central tax revenue and b) a shift in the underlying

Section-II 398

principles of other transfers” The Analysis added “ what seems to

be a small change in percentage lead to some states receiving some

thousands crores more in 2000-05 and others losing out. The

differences in percentage points are not insignificant. Since the

share of the states in Central tax revenues in 2000-05 has been

estimated at Rs. 376318 crores, even 1% point difference can mean

a gain or loss of Rs. 3700 crores. Once all transfers are taken into

account, the shares in central tax revenues, non plan grants,

assistance for special problems and resources for the local bodies, -

there are fairly large changes in inter state shares between 1995-

2000 and 2000-05. UP and Bihar will each get Rs.9000 crores

more West Bengal Rs.6000 Crores more MP Rs.4000 crores more

… on the other hand Maharashtra will get Rs.7000 crores less

Gujarat Rs.5000 crores less, Tamilnadu Rs.4000 crores less, AP

Rs.3600 crores less (The Hindu, Aug,3rd 2000).

While this was the reaction of media analysts, the Eleventh

Finance Commission recommendations prompted a rather unusual

move among the states, with a Group of eight states, at the level of

Chief Ministers and Finance Ministers calling on the Prime

Minister and the Finance Minister and making representation on “

a raw deal” from the EFC, and seeking redressal. The Group of

Eight argued that if appropriate balance was not struck in using

Section-II 399

criteria of equity and efficiency for resource allocation, the

performing states may also turn out to be laggards. Their Ten Point

Representation sought increase in tax devolution from 29.5 % to

33.5%, non acceptance of the recommended ceiling of 37.5 % on

total transfers from center to the states, and treating this as a

minimum share to be transferred, retention of revenue deficit

grants only for special category states, and scrapping it for others,

excluding central tax devolution from debt relief computation and

evolving special schemes for debt rescheduling and taking 1991 as

the bench mark for measuring income disparities. Some of these

issues continue to figure in the memoranda presented by State

Governments to the Twelfth Finance Commission.

It appeared at one stage that the considered recommendations

of the Tenth Finance Commission for a definite share in the

Central revenues for the states for a period of fifteen years, would

place federal fiscal transfer on a stable footing, with a measure of

unanimity among the states. But this has not materialized due to

the time lag and nature of the 80th Amendment of the Constitution.

The recommendations of the EFC, suggesting a ceiling on central

transfers has not only revived the controversy over the vertical

sharing between center and the states, its formula for inter-se

distribution also appears to have disturbed the ambience in which

Section-II 400

the issues relating to horizontal devolution can be objectively

examined, and an acceptable formula evolved with due attention to

the continuing need for equity and the imperative need for

efficiency.

Recommendations

The Twelfth Finance Commission may consider whether

balancing considerations of equity and efficiency in transfer of

Central resources to the States call for attention to a) the differing

needs and multiple demands on resources faced by the states and

the Centre examined earlier in the study b) the need for separate

formulae for tax devolution, and grants-in-aid to the states in the

light of experience with the recommendation of the previous

Finance Commissions analysed earlier and c) the recognition,

whether explicit or not of the transfers made on plan account, as

per principles of Gadgil formula modified over the years as shown

below. (Table 7.11)

Section-II 401

Table : 7.11 Formulae for Plan AssistanceGadgil

FormulaFirst

RevisionSecond

RevisionThird

Revision1969 1980 1990 1991

Special Category states 30 30 30 30General Category states1. Population 60 60 55 602. On going irrigation power projects 10 0 0 03.Per capita income 10 20 25* 254. Performance 10 10 5 7.5**5. Special Problems 10 10 15 7.5**** 20% As per deviation method covering only states below national average and 5 % as per distance method covering all the states.** further divided into 2.5% for tax effort, 2.5 % for fiscal management and 2.5% for national objectives.(population control, Female literacy, ontime completion of externally aided projects and success in land reform)*** special problems of border, desert, flood prone, drought prone, and metropolitan areas, refugee settlements and high unemployment

It is clear that formulae for transfer of central resources to

states with equal emphasis on equity and efficiency call for care in

not only choice of criteria but also close consideration to the

weights to be assigned to each criteria. The changes in the criteria

and weightage made by the earlier Finance Commissions indicate a

shift from population and per capita income as the dominant

factors to consideration of performance of tax effort and fiscal

discipline. The need to bring, expenditure and debt management

within this fold is evident The formula for central assistance for

plans continues to give high weightage to population and per capita

income even after revisions in 1980 and 1990 and there is also fine

tuning of the criteria for judging performance. It must however be Section-II 402

recognized that, the weightage assigned to performance has been

relatively lower in comparison with the weightage given to

population and poverty.

Both Finance Commission and Planning Commission have

tried to improve the manner of application of the income criteria,

by considering different weightage to distance and deviation and

alternative formulae. Similarly, criteria for performance have also

been subjected to changes and refinement. While changing the

weightage of 10 % each given to performance and special

problems assigned by Gadgil Formula of 1969, the Planning

Commission in 1990 revision gave 5% to fiscal management and

15% for special development programmes. This has been

subsequently modified with weightage of 7.5% each for

performance and special problems, with the performance

weightage further subdivided into 2.5 % each for tax effort, fiscal

management and national objectives. While the Tenth Finance

Commission gave a weightage of 10 % to tax effort calculated as

per formula evolved by it, the Eleventh Finance Commission not

only reduced the weightage to 5 % but also changed the manner of

computing the states share on the basis of tax effort and further

introduced fiscal discipline as a criteria with 7.5 % weightage.

There is some degree of confusion in the State Governments

Section-II 403

resulting from these frequent changes in the choice of criteria,

assignment of weightage and method of computation of share of

individual states.

There is a felt need for not only care in the choice of criteria

and for balance in the assignment of weights, but also a measure of

stability and continuity regarding this. As pointed out earlier, while

the Eleventh Finance Commission mentioned tax effort and fiscal

discipline, past performance by way of tax effort, as computed by

the three year average of tax/GDP ratio adopted by the

Commission did not result in states with higher tax/GSDP ratios

getting reasonable shares in tax devolution.

The Twelfth Finance Commission may consider bringing

balance into the formula for horizontal devolution by not only

grouping the criteria according to their properties but also

assigning weightage to different groups in a manner so as to ensure

that both need for revenue as reflected in by size of population,

poverty and level of development and need for recognition of past

fiscal performance and provision of incentives for efficiency are

balanced. Some of the states have suggested to the Twelfth

Finance Commission that the size of the incentive fund should be

fixed as a percentage of the total devolution, and that the size of

Section-II 404

the fund should be such as to be meaningful enough to encourage

State Governments. Taking this into account, we suggest for the

consideration of the Commission the following grouping of criteria

and weights.

Group A- 30%

a)Population, 15 %

b) Geographical Area 7.5%

c) infrastructure index: 7.5%

Group B - Income/ poverty– 30 %

Distance method 15 %

Deviation methods 15 %

Group C -Fiscal performance 30%

Revenue mobilization, 15 %

Expenditure containment 7.5 %

Debt Reduction 7.5%

Group D – Incentive for improvement in performance(2005-10)

10%

The Commission may like to decide on the assignment of

weights in the light of its appreciation of the problems posed by the

State Governments in their memoranda submitted to the

Commission.

Section-II 405

TABLE – 7.1 SHARES OF STATES IN THE SHAREABLE TAXES

Finance Commissions Income Tax Basic Excise Duties

First (1952-57) 55 40 1

Second (1957-62) 60 25 2

Third (1962-66) 66.67 20 3

Fourth (1966-69) 75 20 4

Fifth (1969-74) 75 20 4

Sixth (1974-79) 80 20 4

Seventh (1979-84) 85 40 4

Eighth (1984-89) 85 45 5

Ninth I (1989-90) 85 45 5

Ninth II (1990-95) 85 45 6

Tenth (1995-2000) 77.5 47.5 7

Note : 1) Restricted to excise duties on Tobacco, Matches and vegetable products.

2) Restricted to excise duties on tobacco, matches vegetable products, sugar, coffee, tea, paper and

vegetable non essential oils

3) All commodities yielding Rs.50lakhs of excise revenue per year except minor sprits

4) All excisable commodities

5) 5 % earmarked for deficit states.

6) 7.425 % earmarked for deficit states

7) 7.5 % of net proceed of Union Excise duties

TABLE 7.2 CRITERIA FOR INTER STATE ALLOCATION OF INCOME TAX

Finance Commissions contri popul PC PC Specific poverty tax

bution ation income income indicators criterion effort

First (1952-57) 20 80

Second (1957-62) 10 90

Third (1962-66) 20 80

Fourth (1966-69) 20 80

Fifth (1969-74) 10 90

Sixth (1974-79) 10 90

Seventh (1979-84) 10 90

Section-II 406

Eighth (1984-89) 10 22.5 45 22.5

Ninth I (1989-90) 10 22.5 45 11.25 11.25

Ninth II (1990-95) 10 22.5 45 11.25 11.25

Tenth (1995-2000) - 20 60 - 10 10

TABLE 7.3 CRITERIA FOR INTER STATE ALLOCATION BASIC EXCISE DUTIES

Finance Commissions popul PC PC revenue specific poverty tax in

ation income income equali indicatirs criterion effort propor

distance inverse sation of back tion to

criterion criterion criterion wardness post –de

volution

First (1952-57) 100

Second (1957-62) 90 10

Third (1962-66) a.

Fourth (1966-69) 80

Fifth (1969-74) 80

Sixth (1974-79) 75 25

Seventh (1979-84) 25 25 - 25 2 - 25 - -

Eighth (1984-89) 22.22 44.44 22.22 - - - - 11.11

Ninth I (1989-90) 22.22 44.44 11.11 - - 11.11 - 11.11

Ninth II (1990-95) 25 33.5 12.5 - - 12.5 - -16.5

Tenth (1995-2000) 16.84 50.53 - - 8.42 - 8.42 15.79

Section-II 407

Notes : a. Exact proportion not specified but population used as major factor

2. In effect the revenue equalisation formula was the per capita income distance criteria

TABLE 7.12 QUANTUM OF TRANSFERS

Tenth Finance Commission Eleventh Finance Commission

(for 1995-2000) (Rs.Crores) (for 2000-2005) (Rs.Crores)

1. Share in Central taxes andDuties 206343-00 376318-01

2. Grants-in-Aid for variousPurposes 20300-30 58587-39

3. Total transfer 226643-30 434905-40

TABLE - DISTRIBUTION AMONG STATES

Tax Devolution Total Transfer

TFC EFC TFC EFC

High income 13.14 9.75 13.06 9.62

Middle Income 29.23 29.19 28.53 27.56

Low Income 44.17 53.76 43.25 49.34

Special Category 13.46 7.30 15.17 13.48

100.00 100.00 100.00 100.00

Section-II 408

TABLE 7.13 RELATIVE SHARES OF STATES IN RESOURCE TRANSFER –

State Tenth Finance Commission Eleventh Finance Commission

TD TT TD TT

Total for All States (Rs.Crores) 206343 226643 376318 434905

1. Andhra Pradesh 7.91 7.98 7.701 7.13

2. Arunachal Pradesh 0.66 0.78 0.244 0.53

3. Assam 3.42 3.67 3.285 3.05

4. Bihar 11.29 10.88 14.597 13.04

5. Goa 0.25 0.27 0.206 0.19

6. Gujarat 3.88 3.92 2.821 2.76

7. Haryana 1.24 1.23 0.944 0.97

8. Himachal Pradesh 1.81 2.10 0.683 1.72

9. Jammu and Kashmir 2.86 3.23 1.290 3.78

10. Karnataka 4.86 4.64 4.930 4.53

11. Kerala 3.5 3.41 3.057 2.83

12. Madhya Pradesh 7.4 7.10 8.838 8.05

13. Maharashtra 6.23 6.05 4.632 4.46

14. Manipur 0.82 0.94 0.366 0.74

15. Meghalaya 0.74 0.83 0.342 0.68

16. Mizoram 0.68 0.80 0.198 0.58

17. Nagaland 1.06 1.23 0220 1.02

18. Orissa 4.26 4.28 5.056 4.77

19. Punjab 1.53 1.58 1.147 1.25

20. Rajasthan 4.97 5.03 5.473 5.42

21. Sikkim 0.27 0.31 0.184 0.38

22. Tamilnadu 6.12 5.89 5.385 4.97

23. Tripura 1.13 1.27 0.487 1.00

24. Uttar Pradesh 16.25 15.95 19.798 18.05

25. West Bengal 6.84 6.61 8.116 8.10

Total All states 100.00 100.00 100.00 100.00

Section-II 409

Note : TD -Tax Devolution share TT – Total Resource Transfer share

TD for Tenth FC only of income tax and excise duty revenue TD for Eleventh FC is for all tax revenue

High Income : Gujarat, Haryana, Maharashtra, Punjab and Goa

Middle come : Andhra Pradesh, Karnataka, Kerala, Tamilnadu and West Bengal

Lower Income : Bihar, Madhya Pradesh, Orissa, Rajasthan, and Uttar Pradesh

Special Category States : Arunachala Pradesh, Assam, Himachal Pradesh, Jummu and Kashmir, Manipur,

Meghalaya, Mizoram, Nagaland, Sikkim and Tripura

Section-II 410

TABLE – 7.14 TOTAL TRANSFER TO STATES UNDER THE ELEVENTH FINANCE COMMISSION: 2000-05 (Rs.Crores)

Grants- in- Aid to local bodies

Sl No States Share in % to Non plan % to upgrada % to panchayats % to munici % to relief % to Total % to Total % toCentral total revenue total tion and total total palities total expdi Total (5+7+9+ total transfer totalTaxes and deficit special 11+13) (3+15)Duties problems

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

1. Andhra Pradesh 28980.25 7.70 0 0.00 285.23 5.74 760.24 9.50 164.66 8.23 820.8 9.94 2030.93 3.47 31011.18 7.132. Arunachal Pradesh 918.22 0.24 1228.02 3.47 90.59 1.82 27.84 0.35 0.68 0.03 49.83 0.60 1396.96 2.38 2315.18 0.533. Assam 12362.05 3.29 110.68 0.31 132.54 2.67 233.45 2.92 21.54 1.08 420.6 5.09 918.81 1.57 13280.86 3.054. Bihar 54934.9 14.60 0 0.00 401.6 8.08 785.04 9.81 93.9 4.70 512.46 6.21 1793 3.06 56727.9 13.045. Goa 775.22 0.21 0 0.00 27.28 0.55 9.27 0.12 4.64 0.23 5.15 0.06 46.34 0.08 821.56 0.196. Gujarat 10615.93 2.82 0 0.00 234.85 4.72 348.04 4.35 132.52 0.63 668.88 8.10 1384.29 2.36 12000.22 2.767. Haryana 3552.44 0.94 0 0.00 132.65 2.67 147.09 1.84 36.64 1.83 336.95 4.08 653.33 1.14 4205.77 0.978. Himachal Pradesh 2570.25 0.68 4549.26 12.87 91.16 1.83 65.67 0.82 3.89 0.19 180.2 2.18 4890.18 8.35 7460.43 1.729. Jammu and Kashmir 4854.5 1.29 11211.19 31.71 127.82 2.57 74.41 0.93 15.66 0.78 144.64 1.75 11573.7 19.75 16428.22 3.7810. Karnataka 18552.48 4.93 0 0.00 311.53 6.26 394.12 4.93 124.82 6.24 309.03 3.74 1139.5 1.94 19691.98 4.5311. Kerala 11504.04 3.06 0 0.00 129.14 2.60 329.63 4.12 75.25 3.76 278.66 3.38 812.68 1.39 12316.72 2.8312. Madhya Pradesh 33258.98 8.84 0 0.00 494.52 9.94 715.47 8.94 156.01 7.80 373.4 4.52 1739.4 2.97 34998.38 8.0513. Maharashtra 17431.05 4.63 0 0.00 331.97 6.68 656.73 8.21 316.25 15.81 651.49 7.89 1956.44 3.34 19387.49 4.4614. Manipur 1377.32 0.37 1744.94 4.93 58.59 1.18 18.77 0.23 4.4 0.22 11.89 0.14 1838.59 3.14 3215.91 0.7415. Meghalaya 1287.01 0.34 1572.38 4.45 57.39 1.15 25.61 0.32 2.7 0.14 16.32 0.20 1674.4 2.86 2961.41 0.6816. Mizoram 745.11 0.20 1676.3 4.74 89.84 1.81 7.86 0.10 3.84 0.19 12.32 0.15 1790.16 3.06 2535.27 0.517. Nagaland 827.9 0.22 3536.24 10.00 62.84 1.26 12.87 0.16 1.79 0.09 8.12 0.10 3621.86 6.18 4449.76 1.0218. Orissa 19026.64 5.06 673.6 1.91 215.05 4.32 345.59 4.32 39.96 2.00 453.66 5.50 1727.86 2.95 20754.5 4.7719. Punjab 4316.37 1.15 284.21 0.80 110.01 2.21 154.64 1.93 54.73 2.74 508.57 6.16 1112.16 1.90 5428.53 1.2520. Rajasthan 20595.88 5.47 1244.68 3.52 299.85 6.03 490.95 6.14 99.42 4.97 857.85 10.39 2992.75 5.11 23588.63 5.4221. Sikkim 692.43 0.18 840.58 2.38 66.78 1.34 5.29 0.07 0.21 0.01 28.63 0.35 941.49 1.61 1633.92 0.3822. Tamilnadu 20264.72 5.38 0 0.00 251.86 5.06 466.12 5.83 193.37 9.67 425.36 5.15 1336.71 2.28 21601.43 4.9723. Tripura 1832.67 0.49 2414.16 6.83 60.18 1.21 28.46 0.36 4.02 0.20 21.55 0.26 2528.27 4.32 4361.04 1.0024. Uttar Pradesh 74501.56 19.80 1026.74 2.90 669.91 13.47 1319.13 16.49 251.63 12.58 740.33 8.97 4007.74 6.84 78509.3 18.0525. West Bengal 30540.09 8.12 3246.09 9.18 239.45 4.82 577.73 7.22 197.49 9.87 419 5.08 4679.76 7.99 35219.85 8.10

TOTAL 376318.01 100.00 35359.07100.00 4972.63 100.008000.00 100.002000.00 100.008255.69100.0058587.4100.004341905.44100.00

Section-II 411

Table : 7.15 Total Transfer of Resources to States States/Territories VII FC VIII FC IX FC Rs.Crores % Rs.Crores % Rs.Crores %1.Andhra Pradesh 1522.49 7.31 2896.52 7.34 7239 6.82.Arunachal SC 835 0.83.Assam SC 518.65 2.49 1607.48 4.07 3956 3.74.Bihar 2212.87 10.62 4220.47 10.7 11176 10.55.Chhattisgarh 6.Goa SC 509 0.57.Gujarat 963.87 4.63 1489.05 3.77 3713 3.58.Haryana 308.57 1.48 439.22 1.11 1195 1.19.Himachal SC 325.07 1.56 774.37 1.96 1860 1.810.J&Kashmir SC 376.89 1.81 1120.43 2.84 3359 3.211.Jharkhand 12.Karnataka 1005 4.82 1727.97 4.38 4063 3.813.Kerala 770.34 3.7 1288.25 3.27 3448 3.314.Madhya Pradesh 1597.46 7.67 2957.68 7.5 7843 7.415.Maharashtra 1714.06 8.22 2635.42 6.68 6201 5.816.Manipur SC 194.03 0.93 469.05 1.19 1085 117.Meghalaya SC 134.15 0.64 581.86 0.97 822 0.818.Mizoram SC 1021 119.Nagaland SC 240.59 1.15 527.42 1.34 1244 1.220.Orissa 984.45 4.72 1909.66 4.84 5223 5.221.Punjab 419.53 2.01 646.15 1.64 1674 1.622.Rajasthan 902.81 4.33 1676.17 4.25 6526 6.223.Sikkim SC 36.85 0.18 104.45 0.27 252 0.224.Tamil Nadu 1503.6 7.21 2464.94 6.25 6198 5.825.Tripura SC 199.84 0.96 561.18 1.42 1434 1.426.Uttar Pradesh 3314.74 15.9 6105.03 15.47 17449 16.527.Uttaranchal 28.West Bengal 1597.11 7.66 3449.98 8.74 7409 7Delhi (NCT) Union Territories 1.Andaman&Nicobar 2.Chandigarh 3.Dadra&Nagar Haveli 4.Daman & Diu 5.Lakshadweep 6.Pondicherry Total:All States 20842.97 100 39452.01 100 106036 100Total Transfer as percent of total central revenue 26.01 24.1 (1) SC means Special Category State.(2) Chattisgarh, Jharkhand,and Uttaranchal were formed in 2000, carving in territories out of Madhya Pradesh,Bihar and Uttar Pradesh

Section-II 412

Table : 7. 15 Total Transfer of Resources to States (contd) States/Territories X FC XI FC Rs.Crores % Rs.Crores %1.Andhra Pradesh 18081 7.98 31011 7.132.Arunachal Pradesh SC 1768 0.78 2315 0.533.Assam SC 8328 3.67 13281 3.054.Bihar 24655 10.88 56728 13.045.Chhattisgarh 6.Goa SC 622 0.27 821 0.17.Gujarat 8876 3.92 12000 2.768.Haryana 2793 1.23 4206 0.979.Himachal Pradesh SC 4762 2.1 4760 1.7210.Jammu& Kashmir SC 7322 3.23 16428 3.7811.Jharkhand 12.Karnataka 10521 4.64 19692 4.5313.Kerala 7722 3.41 12317 2.8314.Madhya Pradesh 16094 7.1 34998 8.0515.Maharashtra 13709 6.05 19387 4.4616.Manipur SC 2137 0.94 3216 0.7417.Meghalaya SC 1889 0.83 2961 0.6818.Mizoram SC 1802 0.08 2535 0.5819.Nagaland SC 2793 1.23 4450 1.0220.Orissa 9706 4.28 20754 4.7721.Punjab 3589 1.58 5429 1.2522.Rajasthan 11401 5.03 23589 5.4223.Sikkim SC 699 0.31 1634 0.3824.Tamil Nadu 13361 5.89 21601 4.9725.Tripura SC 2873 1.27 4361 126.Uttar Pradesh 36159 15.95 78509 18.0527.Uttaranchal 28.West Bengal 14980 6.61 35220 8.1Delhi (NCT) Union Territories 1.Andaman&Nicobar Is 2.Chandigarh 3.Dadra&Nagar Haveli 4.Daman & Diu 5.Lakshadweep 6.Pondicherry Total:All States 226643 100 434905 100Total Transfers as % of total central revenue (1) SC means Special Category State.(2) Chattisgarh, Jharkhand,and Uttaranchal were formed in 2000, carving in territories out of Madhya Pradesh,Bihar and Uttar Pradesh

Section-II 413

Chapter –VIII

Grants-in-Aid to the States -

Principles, Quantum and Coverage

The Terms of Reference for the study has sought coverage

of the norms and performance parameters to achieve efficiency

in provision of specific essential services to ensure that the

Grants-in-Aid recommended by the Commission are well

targeted and do result in the states securing intended benefits. It

has also been specified that the states which are better of in

respect of such essential services could receive grants for special

problems to be indicated by them. The TOR seeks the manner of

identification of states and the specific problems for which

grants can be given as also norms for efficiency and

performance in this area.

Constitutional Provisions

The provision of grants in aid could be traced to the early

decades of the century, starting with provincial assignments in

existence before 1919 and more formally to the Government of

India Act of 1935 which gave a statutory form.

The Constitution of India originally provided for grant

from centre to the states under four Articles : Article 273 grants

for jute growing states of Assam, West Bengal, Bihar and Orissa

Section-II 414

in lieu of their share in export duty on jute products, for a period

of ten years. Article 275 grants in aid to states in need of

assistance for meeting gaps in their revenue or for upgradation

of standards of administration in non developmental sector.

Article 278 grants to cover the needs of princely states

(described as part-A states) on their amalgamation or on their

merger with part-B states. Article 282 discretionary grants for

any purpose not within the legislative powers of the parliament

or the state legislature, covering such transfers as Plan and Non

Plan grants from Centre to the States.

The federal fiscal system, as it evolved over the years, has

shed some of the above grants, particularly those under Articles

273 and 278, and the remaining two Articles have enabled the

Finance Commission, the Planning Commission, the Union

Ministries and the State Governments to operate schemes of

grants in aid for a wide variety of purposes. Of these,Finance

Commission has been mainly concerned with Grants under

Article 275 and to a much smaller extent grant under Article

282. Planning Commission and Union Ministries have been

making all their grants under Article 282.

A fine distinction has been made between the grants made

under Articles 275 & 282, and there has been considerable

discussion over the implications of these two articles for the

Section-II 415

Federal Fiscal Transfer Regime. It has been explained that

grants under Article 275 are in aid of the revenues of a state and

can be made by the Union to such states as the Parliament may

determine to be in need of such assistance and different sums

may be fixed for different states. Reading this article along with

Article 280(3), which specifies that “it shall be duty of the

Commission to make recommendations to the President as to

….. the Principles which should govern the grants in aid of the

revenues of the state out of the Consolidated Fund of India”, one

gathers that grants under Article 275 can be made only on the

recommendation of a Finance Commission. On the other hand

grants under Article 282 can be made by the Union or a State “

for any public purpose not withstanding that the purpose if not

one with respect to which Parliament or the Legislator of a State

may make laws”.

Dr.B.N.Rau who played an important role in the making of

the Indian Constitution, as drawn attention to the distinction

between “grants simpliciter “ and “grant in aid of the revenues

of a state”. According to him, “the expression grants in aid of

the revenues of states standing by itself suggest a recurring

grant. A single grant for any particular year or a particular

purpose can hardly, with propriety be called a grant in aid of

revenues of a state. Article 282 could cover any grant whether

single or recurring, while Article 275 appear to cover recurring

Section-II 416

grants in aid of the Annual Revenues of a State”. Ruling out any

other application in the use of a term grant in aid Dr. Rau refers

to the fact that the Constitution itself mentions various types of

grants (like Article 273 in respect of grant in aid for Jute

growing States of Assam, Bihar, Orissa and West Bengal in lieu

of export duty on Jute, and indicates that “ it would therefore

seem that a grant in aid of revenues of a state may be

conditional or unconditional” (India’s Constitution in the

Making,Dr.B.N.Rau with a foreword by Dr.Rajendra Prasad,

Orient Longmans 1960).

The First Finance Commission considered the question

“whether the terms ‘grants in aid of the revenues’ should be

construed as confining it to such grants as are intended for the

augmentation of the revenues of the receiving state without any

limitation as to how the money so made available should be

spent” and felt that “the problem has to be viewed in the larger

perspective of securing an equitable allocation of resources

among the states. It further observed that the scope of Article

275 or Article 280(3) should not be limited solely the grants in

aid which are completely unconditional” and that “grants

directed to broad but well defined purposes could reasonably be

considered as falling within their scope”.

Section-II 417

The First Finance Commission covered both general grants

and grants for broad purposes and enunciated certain principles

which should govern grants in aid of the revenues of a state

which included.

(i) Fiscal need of a state: Indicating that for determining

the eligibility of a state for a grant in aid as well as for the

assessment of the amount of grant in aid, the states budget

should be the starting point of an examination of fiscal need, the

First Finance Commission suggested (a) reduction of State

Budgets to a comparable basis by adjusting any abnormal or

unusual non recurring item of revenue or expenditure to arrive at

an normal budget and (b) avoidance of any impression that the

Central Government has the responsibility for helping the States

to balance their budget.

(ii) The State’s Tax effort : Indicating that the extent of

self help of a state should determine the eligibility for as well as

the amount of help from the Center, The First Finance

Commission suggested that the States Tax effort should be

assessed on the basis of potential for additional taxation in the

state and its actual tax effort.

(iii) Equalization of Standards of services : Suggested that

the grant in aid from Center should be such as to help in

Section-II 418

equalization of standards of basic social services in different

states by raising the level of such services in the poorer states.

(iv) Special obligations : The First Finance Commission

suggested that any burden or obligation of national concern,

even if with the states sphere should be taken into account to

determine the eligibility for and quantum of a grant.

(v) Services of importance : The First Finance

Commission suggested that grants may be given to states to

further any beneficent service of primary importance in regard

to which it is in National interest to assist the less advanced

states to go forward.

The principles suggested above where followed by

subsequent Finance Commissions, with varying emphasis on

one or the other of the principles, in making their

recommendations. The Seventh Finance Commission while

indicating that these principles where unexceptionable, pointed

out serious difficulties in application of some of them and

proceeded to lay down its own principles. These included (i)

Fiscal gap after Tax devolution (ii) States Tax effort (iii) The

need to reduce disparities, among the states, in the availability of

various administrative and social services and (iv) The burden

Section-II 419

cast on states finances on account of particular circumstance or

matters of national importance.

The Finance Commissions that followed did not make any

radical departure from these principles and are generally made

recommendations on grants in aid to meet the residuary fiscal

needs of the states after offsetting the estimated amounts to be

made available to the state by way of Tax devolution. Even

though the principles were fairly clear there were issues like

whether a grant should be recommended for states emerging

with a post devolution surplus and whether the plan revenue

requirements should be taken into account to determine the need

of a state. Finance Commissions dealt to these issues within the

frame work of their terms of reference, interpreting them in their

own light. The Tenth Finance Commission which was required

by its terms of reference to consider “ the objective of not only

balancing the receipts and expenditure on revenue account of

both the States and Central Governments but also generating

surplus for Capital investment and reducing fiscal need”, chose

to point out “practical difficulties” and confined its attention

specifically to the non planned revenue expenditure.

Shri B.P.R.Vithal drawn attention to the reference to “

Economic and social planning in Entry 20 in the Concurrent List

of the Constitution, and the distinction drawn between

Section-II 420

expenditure on revenue account and other expenditure, in the

Annual Financial Statements of the Union and States

Governments to be prepared as per Articles 112 and Article 202

of the Constitution, and mentions that in Article 275 were grant

in aid of revenues are related to the needs of assistance as

determined by a Finance Commission, no specific mention is

made, in the substantive clause, of schemes of development

though these are mentioned in both the provisos under the

article. Shri Vithal points out “ A plan has both revenue and

capital components. The capital outlay in the state plans is

financed by capital receipts, central loans and market

borrowings. The Finance Commissions have examined these

aspects only when a specific reference was made to them of the

non-Plan capital gap or the debt position of the states. The main

issue relating to the roles of the Planning and Finance

Commissions concerns. Plan revenue expenditure. A s a result,

the division of total revenue expenditure into Plan and non-Plan

and the division of functions and responsibilities between the

Planning and Finance Commissions have become important

issues in federal financial relations.

The Eleventh Finance Commission was however required

to look into “ the requirements of the states for meeting the Plan

and non-Plan revenue expenditure” (Para 5 (iii) and terms of

reference in the Presidential Order of 3rd July 1998. In its report

Section-II 421

the Eleventh Finance Commission referred to the terms of

reference and the submission of Minister of Finance that

devolution package should be based on an integrated view of the

transfers so that the impact on the Center budget becomes

transparent and amenable to control and observed that “ viewing

the Plan and non-Plan grants in tandem is essential for

restructuring of public finances and restoration of budget

balance” it however felt that there were practical difficulties for

the Finance Commission in assessing the requirements of

revenue expenditure under the Plans, as the Finance

Commission appointed periodically cannot be in a position to

determine the developmental requirements of each state

individually and further the de-synchronization of the reference

periods of the Finance Commission and The Five Year Plans

post difficulty in integrating the Plan and non-Plan components

of revenue expenditure. The Eleventh Finance Commission

reiterated the point that “ restructuring towards fiscal balance is

not possible unless the expenditure needs of a Center and the

States are looked at in their totality and non segregated into

compartments like Plan and non-Plan.

Quantum of Grants and Federal Transfers

Federal transfers to the States, are made in three streams,

as

Section-II 422

(4) Devolution of States share in Central Taxes (5) Grants from Central to the States covering

(i) Non-Plan grants –

(a)Statutory grants recommended by the Finance Commission to cover gap in revenue.

(b) Assistance for relief measures after natural calamities

(c)Non Statutory grants(ii) Plan grants –

(e)State plan schemes(f) Central plan schemes(g) Centrally sponsored schemes(h) North Eastern council/Rural electrification etc

(6) Loans from Centre(j) Plan loans(ii) Non Plan loans including Ways and Means

Advance

A clear view of the implications, flowing from grants in

aid to the states, for the Union budget and the state budgets can

be obtained by looking at the trend in Federal transfers and the

share of Tax devolution, statuary grants, plan grants and

discretionary grants as a share of (a) Gross Revenue Receipts of

the Center and (b) Revenue Receipts of the states. The Eleventh

Finance Commission took note of the transfers as percentage of

gross revenue receipts from the First Five Year Plan period to

the First Three Years of the 9th Five Year Plan.

Share of Federal transfers in Gross Revenue Receipts of CenterPeriod Tax

devolution

Statutory

grants

FC

transfers

Plan

grants

Discretionary

grants

Total

grants

Total

transfers

Section-II 423

1951,52 to

1991,92

20.76 4.47 25.23 13.27 1.16 18.91 39.66

VIII FYP 21.66 2.66 24.32 13.52 0.75 16.93 38.60

1997-98 24.54 1.85 26.39 10.24 0.49 12.58 37.12

1998-99

(RE)

19.90 1.47 21.37 10.60 0.60 12.67 32.57

1999-2000

(BE)

20.59 2.40 22.99 10.63 1.13 14.16 34.75

Total 21.54 1.93 23.47 10.50 0.76 13.19 34.74

Between 1951-52 and 1991-92 the total transfers from

Centre to the states has been estimated to be about 39.66% of

the gross revenue receipts of the Centre during this period.Of

this transfer by way of grants from the Centre to the States had

accounted for 18.91% of the gross revenue receipts of the

centre. This comprised of 4.47% on account of statutory grants,

recommended by the Finance Commissions, 13.27 % by way of

Plan grants recommended by the Planning Commission and 1.16

% by way of discretionary grants for various purposes from the

Government of India. Finance Commission transfers totaled

25.23 %, with 20.66 % by way of tax devolution, and 4.47 % by

way of grants, and accounted for nearly 64 % of the central

transfers.(see table 9.1) During the nineties while tax devolution

continued to account for about 21 % of the gross revenue

receipts of the centre, the share of total central grants appears to

have declined from 15.98 % in 1990-91 to 14.16 % in 1999-

2000. The share of Plan grants have been much lower in the

second half of the nineties as compared to the first half.

Section-II 424

From the point of view of the states, the role of Federal

transfers has to be seen not only in relation to the differences in

the share of Tax devolution and grants in aid but also from the

points of view of the relative status of the general category of

states and special category of states. The differences emerges

from the following from the following table :-

Share of Federal transfer in revenue receipts of states

Year General Category Special Category All States

Devolut

ion

Grants Devolut

ion

Grants Devolut

ion

Grants

1996-97 22.83 11.95 22.55 56.47 22.81 15.21

1997-98 23.14 11.26 26.09 52.19 23.37 14.46

1998-99 21.72 10.54 29.71 48.11 22.35 13.51

1999-

2000

20.89 11.58 26.95 47.70 21.40 14.59

2000-01 20.45 13.02 11.81 68.76 19.86 16.83

Averag

e

21.80 11.67 23.42 54.69 21.96 14.92

Note : Shares are indicated as for revenue receipts of respective

categories.

State Finances – A Critical Appraisal – CAG of India

It can be seen from the above table, that in the case of 14

States falling into General category. Tax devolution contributed

on an average 21.80 % of the revenue receipts, while the

contribution of grants in aid was only half of that. In the case of

Section-II 425

11 States falling into Special category, Tax devolution

accounted for 23.42 % of the revenue receipts and grants in aid

accounted for 54.69 %, with their relative importance in the

flow of resources to the backward states emerging emphatically.

This aspect needs to be kept in view. The details of transfers by

way of Tax devolution and grants in aid given by the Finance

Commission can be seen in Annex XIX in B.P.R.Vithals Fiscal

Federalism in India.

Grants from Finance Commissions

Finance Commissions have been making

recommendations covering in main Grants-in-Aid of revenues

of the states and special purpose grants like those for

upgradation of standards of administration, dealing with special

problems, calamity relief and others like grants in lieu of tax on

railway passengers.The total grants given to the states on the

recommendations of the previous finance Commissions has

increased from Rs.50 crores during the award period of the First

Finance Commission (1952-57) to Rs.711 crores for the period

of the Fifth Finance Commission award. These covered mainly

non plan revenue deficits of the states. It was with the Sixth

Finance Commission that the scope got enlarged with the terms

of reference specifying that the recommendations should take

into account, “ the requirements of states which are backward in

Section-II 426

standards of general administration etc. There after the Finance

Commissions not only made recommendations on grants to

cover deficits in revenue but also for specific purposes like

upgradation of standards of administration, calamity relief etc.

In view of this, the grants component of the finance

Commission recommendations increased from Rs.2510 crores in

the VI FC period (1974-79) to Rs.20300 crores in the X FC

period(1995-00). The XI FC recommended grants to the tune of

Rs.58587 crores (2000-05). See Table 8.1

Table : 8.1 Finance Commission Transfers

Breakup (Rs.Crores)

Devolution grants Total

I FC 362 50 412

II FC 852 197 1049

III FC 1068 244 1312

IV FC 1323 422 1745

V FC 4605 711 5316

VI FC 7099 2510 9609

VII FC 19233 1610 20843

VIII FC 35683 3769 39452

IX FC 1989-90 11785 1877 13662

1990-95 87882 18154 106036

X FC 206343 20300 226643

XI FC 376318 58587 434905

Total 752553 108431 860984

Section-II 427

It may be seen from Table 8.1 that the total transfers from

Centre to the States on account of the recommendations of the

last eleven Finance Commissions amounted to Rs. 8,60,984

crores of which devolution of taxes and duties accounted for

Rs.7,52,553 crores, (87.41%) and grants –in-aid involved a

relatively smaller quantum – Rs.1,08,431, crores (12.59%).

Grants to cover non-plan revenue deficits were recommended by

all the eleven Commissions with the quantum rising from Rs.25

crores in the First Commission to Rs.711 crores by the Fifth

Commission. The Sixth Finance Commission more than tripled

the quantum of grants to Rs.2510 crores, entirely to cover

revenue deficits of the states. The next Commission the Seventh,

preferring to increase tax devolution, reduced the total grants to

Rs.1610 crores,(Rs.1173 crores to cover revenue deficit and

Rs.437 crores for upgradation of standards of administration.

Finance Commissions from the Seventh to the Eleventh were

specifically enjoined in more or less similar words in the Terms

of Reference, to make recommendations on grants taking into

account the needs of upgradation of standards of administration

or special problems. The purpose-wise grants recommended by

the various Commissions are shown in Table 8.2.

Table :8.2 : Breakup of Grants from Finance Commissions

(Rs.Crores)

Section-II 428

Rev

defici

t

Standa

rds

upgrad

e

Specia

l

Proble

ms

Calam

ity

relief

Loca

l

bodi

es

other

s

Tota

l

First

1952-

57

25 9 16 50

Secon

d

1957-

62

185 12 197

Third

1962-

66

244 244

Fourth

1966-

69

422 422

Fifth

1969-

74

711 711

Sixth

1974-

79

2510 2510

Seven

th

1173 437 1610

Section-II 429

1979-

84

Eighth

1984-

89

2200 914 53 602 3769

Ninth

1989-

90

984 172 552 169 2475

**

1877

90-95 6016 122 3015 9001 1815

4

Tenth

1995-

00

7583 1362 1246 4728 5381 2030

0

Eleve

nth

00-05

3535

9

4972 - 7256 1000

0

5858

7

** Plan revenue deficit

Selection of States

The selection of states eligible for grants was made by the

various Commissions on the basis of their assessment of the

revenue needs of the states in the first three decades, to be

Section-II 430

followed from eighties onwards by needs for upgradation of

administrative standards, special problems, calamity relief.

Following the abolition of the tax on Railway passenger fare in

1961, it was decided that the states should be compensated for

this, as the proceeds of the tax were earlier completely assigned

to the states, from the time of their levy under Article 269 in

1957. Finance Commissions have been making

recommendations in respect of this also. The Ninth Commission

working on a normative basis, recommended grant to cover plan

revenue expenditure.

Analysis of the distribution of the grants from the first to

the seventh Commission shows that not all the states received

grants from the Centre. Among the states missing out, Gujarat

received grant from only the third Commission, Maharashtra

from only the first Commission, Punjab from first and second

Commissions, Tamilnadu received only from third, fourth and

fifth, and West Bengal from first, second, fifth, sixth and

seventh From the eighth onwards all the states received grants

from the Centre on account of Finance Commission’s

recommendations.

While determining the principles governing grants to help

the states close their budgetary gaps, Finance Commissions have

examined whether these grants should be conditional or

Section-II 431

unconditional, whether they should be for revenue or capital

items, as also the purposes for which the grants should be made.

(for a detailed discussion of the scope of the various Articles

and views of the previous Finance Commissions see Fiscal

Federalism in India, B.P.R.Vithal, pg146 to 177).

The First Finance Commission, took into account tax

effort, economy in expenditure, standards of social services,

special obligation of states and broad purposes of national

importance in determining the grants for states. Subsequent

Commissions followed this approach, and also sought to fulfill

the objective of reducing regional disparities. The First

Commission estimated the budget deficit and the post

devolution gap of the states and recommended annual grants to

cover revenue deficits to seven states totaling 25 crores, along

with special purpose grants for education, all totaling Rs. 50

crores.The Second Finance Commission took into account the

fiscal needs of the 14 states to be covered, and after omitting

Bombay, Madras and Uttar Pradesh recommended revenue

deficit grants for eleven states totaling Rs.185 crores and

providing further Rs.12 crores all totaling Rs.197 crores. The

Third Finance Commission followed more or less the same

principles as the first and felt that the grants-in-aid should cover

75 % of the revenue component of five year plans but this was

not accepted by the government. Its recommendations for

Section-II 432

covering revenue deficit and improving communications

services all accounting for Rs.244 crores. The Fourth Finance

Commission extended the coverage of Grants to expenditure on

debt servicing. As per its analysis five out of sixteen states were

considered to be revenue surplus ( Bihar, Gujarat, Maharashtra,

Punjab and West Bengal) and the remaining states were

recommended grants. The total grants recommended amounted

to Rs.420 crores, (Rs.331 crores for 8 general category states

and 3 special category states.The Fifth Commission restricted

its grant to revenue account to only considering only revenue

deficit, interest payment and maintenance expenditure on grant

schemes. In its assessment only 10 states were found to be

revenue deficit. The total grants covering revenue deficit and

others amounted to Rs. 711 crores.(seven GCS states and 7 SCS

States). The Sixth Commission covered specific items

mentioned in the TOR like the needs for maintenance and

upkeep of capital assets, committed expenditure and upgradation

of general administration and recommended in all Rs.2510

crores for 14 states, (7 GCS and 7 SCS).

Required by the TOR to examine the requirements of the

states which were backward in general administration for

upgrading services in non developmental sectors to bring them

on a par with their level in developed states, Seventh Finance

Commission recommended Rs. 1173 crores to cover revenue

Section-II 433

deficit and Rs.436.80 crores as grants for upgrading standards of

administration in (i) Judicial services (ii) revenue and tribal

administration (iii) police (iv) jails (v) stamps and registration

and(vi) treasury. The grants totaled Rs.1610 crores

The Eighth Finance Commission recommended, in

addition to Rs. 2200 crores for revenue deficit cover to the

needy states, a further sum of Rs.967.33 crores ( Rs.914 crores

for upgradation of standards and Rs.53 crores for special

problems) and specified for upgradation services in (i) police (ii)

education (iii) jails (iv) tribal administration (v) health (vi)

judicial services (vii) district and revenue administration (viii)

treasury and accounts. These grants were given to seventeen

states with a recommendation that their utilization should be

monitored.

The Ninth Finance Commission, having been asked to

adopt a normative approach, made recommendations, which

differ from the other Commissions.In making recommendations,

it estimated the fiscal needs of the states as modified by factors

of tax effort and economy in expenditure, took into account the

need for equalization of standards of social services and the

need to meet special problems. Unlike the previous

Commissions which recommended grants to meet budgetary

gaps as judged from the states representations the Ninth

Section-II 434

Commission recommended grants to cover gaps as estimated on

normative basis. For 1989-90 it recommended Rs. 984.06 crores

as non plan revenue grant for thirteen states, Rs.171.7 crores for

upgradation of standards in nineteen states.Rs.537 crores for

meeting special problems to twenty one states, Rs.169.5 crores

as margin money for relief expenditure for all twenty five states

and Rs.14.55 crores for the eight states to meet the shortfall

during the award period of the Eighth Finance Commission. The

total of these grants for 1989-90 amounted to Rs.1877 crores

apart from a grant of Rs.2475 crores to meet plan revenue gap

for all twenty five states.

For the period 1990-95 the Ninth Finance Commission

classified the states into different categories, and recommended

a total grant of Rs. 15,017 crores, covering Rs.6016 crores to

meet the non plan revenue deficit of fourteen states and Rs.

9001 crores to meet the plan revenue gaps of other states. An

analysis of the states showed that nine states received grants to

meet non plan revenue deficits, seven states to meet plan

revenue deficits and five states to cover both non plan and plan

revenue deficits. The Ninth Finance Commission did not

consider grants for upgradation, as such grants did not have a

role in the normative approach to transfer of Central funds. It

however recommended Rs.122.25 crores to meet special

Section-II 435

problems in addition to the Rs.3015 crores as margin money for

calamity relief to all the 21 states.

The Tenth Finance Commission estimated the yearwise

post devolution revenue situation of the various states, and

recommended grants to the tune of Rs.7583 crores to cover the

revenue gap of the states in each year tapering down as shown

below

Year No. of

states

Grant

(Rs.Crores)

1995-96 16 4005.71

1996-97 15 2541.06

1997-98 12 771.15

1998-99 12 258.76

1999-

2000

nil Nil

Total 7582.68

The Commission also recommended a,total grant of Rs.

2608.50 crores for all the 25 states, with Rs. 1362.50 crores ear

marked for upgradation of standards and Rs. 1246 crores

provided for dealing with special problems faced by individual

states. The upgradation grants were further split into a sub-total

of Rs.585.35 crores for district administration covering (i) police

Section-II 436

(ii) police housing (iii) police training (iv) police

communications (v) fire services (vi) jails (vii) record rooms

and (viii) treasuries and accounts. There was also an allocation

of Rs. 755.75 crores for education including female literacy. IT

recommended Rs.4728 crores as margin money for calamity

relief and Rs.5381 crores towards grants for local bodies.

The Eleventh Finance Commission, estimated the

revenue status of each state in each year of its award period

2000-05 after accounting for tax devolution. It indicated the pre

devolution and post devolution status of each of the 25 states for

each year. On the basis of its assessment it recommended non

plan revenue grants to certain states to the extent of Rs. 35,359

crores on a tapering basis as indicated below.

Year No. of

states

Grant

(Rs.Crores)

2000-01 15 10153.76

2001-02 12 7202.89

2002-03 11 6630.91

2003-04 9 5744.912004-05 9 5626.60

35359.07

Section-II 437

The Eleventh Finance Commission was required by its

terms of reference to take into account,“ the requirement of

states for upgradation of standards in non developmental and

social sectors and services particularly of states which are

backward in general administration with a view to modernizing

and rationalizing the administrative set up in the interest of

speed, efficiency and sound fiscal management.” This TOR

appears to have spurred the states to seek in their memoranda,

grants to meet a variety of purposes and special problems, all

involving a financial requirement of Rs.1,81,011 crores. The

Eleventh Finance Commission responded with a

recommendation for a total grant of Rs. 4972.63 crores for 25

states, earmarking Rs. 3843.63 crores for upgradation of

standards in 12 sectors and Rs. 1129 crores to deal with special

problems.

The upgradation grants were further earmarked for 12 sectors as

indicated below

Sector Rs.Crore

s

i) district

administration

370.00

ii) police

administration

509.00

Section-II 438

iii) prison

administration

116.00

iv) fire services 201.00

v) judicial

administration

502.90

vi) fiscal

administration

200.00

vii) health services 432.00

viii) elementary

education

506.00

ix) computer training

for school children

245.53

x) public libraries 139.20

xi) heritage

protection

122.00

xii) augmentation of

traditional water

resources

500.00

Sub Total 3843.63

Special problem 1129.00

Total 4972.63

The Eleventh Finance Commission has also required to

make recommendations for the augmentation of the

consolidated funds of the states for supplementing the resources

Section-II 439

of the panchayats and the municipalities on the basis of

recommendations made by the Finance Commission of the state,

taking into account the provisions required to be made for the

emoluments and terminal benefits of the employees of the local

bodies, the existing powers of the local bodies to raise financial

resources including additional taxation and the powers, authority

and responsibility transferred to the local bodies under Article

243 (G) and Article 243 (W) of the Constitution, the EFC made

a number of suggestions regarding the state Finance

Commission, maintenance of accounts and audit of the local

bodies, creation of the data base on the finances of the local

bodies and recommended a total grant of Rs. 1600 Crores per

year for the panchayats Rs. 400 Crores per year for the

municipalities and it also suggested that the inter-se share of the

states be drawn on the basis of rural/urban cooperation of the

state (40%), index of decentralization (20%) distance from the

highest per capita income state (20%), revenue effort of the local

bodies and geographical area (10%). The Commission suggested

that legislative arrangements should be made to clearly indicate

the role that the local bodies have to play the systems of

governance. It also suggested that the three tier Panchayat Raj

system was very rigid and that the states may be provided

flexibility to decide whether a two tier system could operate

with greater efficiency and economy or a three tier structure

would be essential. The EFC suggested that Government

Section-II 440

properties of the Center as well as the States should be subject to

levy of user charges.

A perusal of the reports of the various Commissions

indicates that the main thrust of the recommendations have been

to cover fiscal gaps after devolution, narrowing the disparities

between developed and less developed states in the availability

of various administrative and social services by providing

assistance for equalising standards of basic services in different

states and reduction of the burden cast on the finances of

individual states on account of special problems, their particular

circumstances or matters of national importance.

Examination of the principles, criteria and purpose

enunciated by each commission and of the resultant flow of

funds to their various states may not convince everyone that

impeccable logic has underpinned all the recommendations.

Survey of the grounds on which states have been picked or

sectors of administration chosen for grants would make one

agree with the view expressed by the Sixth Finance

Commission, that it was hardly possible for a finance

commission “ within the time allowed to it to either examine in

depth, the soundness and adequacy of administrative setup in

various states or to formulate specific proposals.”

Section-II 441

It is however possible, to find both commonality in their

approaches as in making provisions for district administration,

police, jails, judicial services etc as also contradictions as in the

Tenth Finance Commission discarding computerisation of land

records as a purpose eligible for grants and the Eleventh Finance

Commission providing grants for imparting computer training

for school children. It should be conceded however that given

the differences in the local conditions in different states and

wide variety of demands made by the State Governments,

Finance Commissions may have nodded a bit in their choice of

purposes or of states, throwing a bit of generosity at micro level,

not quite consistent with the rigid standards of expenditure

required to deal with revenue deficit at the macro level. Given

the large quantum involved in the federal transfers, the sums

attributable to such generosity is only a miniscule proportion

and can be ignored.

While earlier Finance Commissions debated the question

whether grants should be conditional or unconditional, the later

commissions did well to insist on monitoring the expenditure,

but this does not appear to have become a regular

exercise.Monitoring of expenditure without a review and

initiating corrective steps, cannot lead to proper utilization of

funds or improvement in efficiency of services. Visits to offices

in the state headquarters and in districts reveal substantial

transformation of facilities in state head quarters while unit

Section-II 442

offices in districts present a contrast of inadequate facilities for

officials and the public. Even in State headquarters

modernization of administration has meant making offices of

ministers and senior officials highly decorated and attractive

with plush furniture, wall paintings, and computers as item of

decoration while, just a few feet away iron racks with dust

gathering files reduce walking space in the corridors and on

rooms in which staff pour over papers in murky light. There

hardly appears to be any consideration for the health and

efficiency of the staff called upon to perform services to the

public or of essential facilities for the visiting public. There are

in each state notable exceptions to the above. Prescription of

norms or indication of unit costs for services for states spread

far and wide may pose problems for the Finance Commission

operating at the national level.

Effective targeting of Grants

Member secretary of the Twelfth Finance Commission has

requested that states specific norms/standards with regard to the

future performance and expenditure efficiency could be

suggested so as to ensure that grants in aid recommended by the

Commission are well targeted and can result in intended benefits

to the grantee states, suitable waitage for efficiency parameters

Section-II 443

could also be suggested to achieve a quicker equalization of

public services across the states.

It has been mentioned in a World Bank study of 2000 that

widening inequality among Indian states is in sharp contrast

with the evidence from other countries and that interstate

inequality has declined in USA, Canada, Europe, Australia,

Japan, China(until 1992) and at a slower phase Indonasia. In

India interregional inequality is also significantly higher has

compared to other large federal states with the exception of

china.

Intra state disparities have also been noticeable in several

states, and the need for upgradation of standards of public

services has to be considered not only at interstate level but also

intrastate levels. The grants recommended by the Finance

Commissions for upgradation of standardards has no doubt

increased from Rs. 437 Crores recommended by the Seventh

Finance Commission for the period 1979 – 84, to Rs. 4972

Crores recommended by the Eleventh Finance Commission for

the period 2000 – 2005. As mentioned earlier, the departments

of Police, Judicial services, Revenue Administration, Health and

Education have been covered by the schemes for upgradation of

standards of services. These fall within the category of general

services, which are not amenable to cost norms or prescription

Section-II 444

of measurable standards of service. What however emerges from

the attempt made to estimate cost and prescribe standards is that

the efforts at the State and National level to ensure fiscal

consolidation as resulted in, restrictions on filling up of posts,

and to ignore the given prevalent ratios of staff to material cost.

There is a vital need for a more detailed field survey, in different

parts of the country to be able to arrive at any meaningful

suggestion for fixing performance standards in the individual

sectors for which grants have been recommended by the

Eleventh Finance Commission.

It should however be noted that the Ministry of Finance,

Department of Expenditure (Finance Commission Division) has

issued guidelines on the utilization of grants of (a) Rs. 3843.63

Crores for upgradation of standards in twelve sectors and (b) Rs.

1129.00 Crores for tackling special problems, the Ministry has

indicated that these guidelines are issued, “ in order to view

greater responsibility to the states for sanction of the schemes

and to vest with state level empower committee, the power to

sanction individual schemes as well as to determine the unit

cost. The guidelines envisaged

Section-II 445

(i) Constitution of State Level Empowered Committees (SLEC)

(ii) Preparation of detailed action plans both in physical and financial terms by administrative departments for submission for SLEC and securing its approval.

(iii) Forwarding of the approved action plan to the Union Ministry of Finance through the State Finance Department.

(iv) The State Finance Department making suitable expenditure provision under the appropriate functional major head, with the approved programme being shown as a distinct and identifiable item with a minor head.

(v) The State Finance Department displaying an amount equivalent to the grant in aid for the purpose as a receipt in the non-Plan revenue budget, issue of formal expenditure sanction for the scheme to be communicated to implementing agency.

(vi) Regular monitoring of the projects by the SLEC of the Physical and Financial target set.

(vii) Conduct of evaluation of specific projects through independent agencies.

The Ministry of Finance has also indicated that the plans

of action should emphasize the provision of facilities at the

gross route level, lay stress on backward areas and weaker

sections of society, providing details of the nature of

expenditure proposed, the norms adopted, latest unit cost,

location of the work and other relevant particulars. The

guideline also suggest delegation to executive agencies adequate

administrative and financial powers.

Section-II 446

The guidelines specifies the pattern of release of grants,

50% on receipt of detailed plans of action dully approved by the

SLEC, subsequent quarterly releases upto 90% to be made on

the basis of utilization of dully certified in the prescribed

proforma and release of balance 10 % on receipt of completion

certificate. The formats for utilization and completion

certificates appear to provide sufficient details for evaluation.

The Ministry of Finance has rightly decided that the prescription

of unit cost should be left to the SLEC, has the works to be

taken up are likely to be scattered in nature, spread over

different districts with varying local conditions and material

availability, it is suggested that the implementation of the

scheme has per the guidelines issued be continued for the period

of the Twelfth Finance Commission recommendations. The

emphasis appears to be on accountability for expenditure.

Submission of Annual progress report indicating the status of

work, expenditure incurred, problems encountered in

implementation, steps proposed for solving the local problems

and the likely date of completion could be prescribed. Such an

approach adopted in the execution of rural works programme

and special employment programmes enabled better

implementation and flow of benefits to the local area as a

envisage in the scheme. Marking a copy of the sanction order to

the local panchayats may also facilitate better monitoring of the

physical progress and solution of local problems. De-

Section-II 447

centralization and empowerment of local bodies to ensure

greater participation of the grass roots institutions have also

been suggested in some circles to ensure more effective

targeting and ensuring flow of benefits to the people.

The Constitutional and legal frame work of

decentralization, with emphasis on a three tier structure has been

in place for nearly a decade. It was noted that in 1991-92 local

bodies own revenue receipts constituted very small proportion

of total Government revenues. Revenues raised by

municipalities amounted to 4.6 % of the revenue raised with the

Central Government and 8.05% of the revenues of State

Governments. Similar estimate for panchayats are not available

but what has been evident for several years is that the own

revenues of the local bodies meet only a part of their recurrent

expenditure, 5 to 10% in the case of panchayats and 65 to 75 %

in the case of municipalities, this had made them wholly

dependent on the State Governments. Though legally

empowered to raise taxes on the number of items,the local

bodies have not been diligent in their exercise of these powers

and the collection to demand ratio has been consistently very

poor. Grants from the Centre, if effectively channelized to local

bodies can improve performance of services to the people. The

general picture of indifferent public services can in most cases

be attributed to inadequacy of resources to meet the increasing

Section-II 448

demands and pressures from a growing population. Effective

targeting can become a reality, if the differences in the levels of

population, geographical spread of the states and the culture and

behaviour pattern specific to the local areas are taken into

account.

Suggestions of standards

As regards quicker equalization of services across the

states, initiatives can be taken to prescribe physical targets to be

achieved as suggested below :-

Health - the number of PHCs, Community health centers and

sub centers, rural family welfare centers,

hospital beds/number of nurses/medical officers for a

specified size of population.

Education – Prescription of distance.

Access to primary schools within a distance of one kilometer

and

for middle school three kilometers,

teacher pupil ratio at the primary and secondary level,

availability of pucca school buildings,

availability of mid-day meals.

Civil Supplies – Increasing coverage by public distribution

scheme.

Section-II 449

Prescription of number of fair price shops per thousand

population,

specifying frequency of allocation, lifting and issue of stocks

(weekly, fortnighthly or monthly)

Police – The number of police stations in a district,

the number of stations per fifteen thousand of population,

the number of constables/ Officer per station.

Facilities for mobility and communication.

Apart from the above, in respect of service departments,

physical facilities like number of counters in revenue

commercial tax and other offices related to population size can

be prescribed.Changes in the working hours like operation of

shift system to facilitate payment of government dues can also

be considered and prescribed.

One aspect that deserves consideration is the need to make

government offices more accessible to the public both for

rendering government and for making representations on

problems solved or grievances redressed. There is a strong case

for dispersal of the offices of the decision making authorities

like the District Collector and Superintendent of Police, if need

be by creation of new districts keeping size of population served

as a criteria. The number of districts in the country have

increased from 466 in 1991 to 593 in 2001, with the addition of

Section-II 450

127 new districts coming mainly from UP (16), Orrisa (17),

Tamilnadu (9), Chattisgarh (9), Bihar (8), Delhi (8), MP (7), and

Karnataka (7). Of the special category states only Mizoram (5)

seems to have been covered. There is need to consider the

balance of advantage from size of population and distance to be

covered in accessing government offices.

The Twelfth Finance Commission may for the purposes of

grants consider the needs of (i) governmental departments into

those dealing with public on a large scale like police and

revenue - requiring adequacy of space and facilities for waiting

public (ii) the needs of revenue earning departments dealing

with commercial taxes, motor vehicle taxes, property taxes and

the like where the speed in attending to the tax paying citizenry

should be a prime consideration and (iii) the needs of asset

creation in the form of permanent facilities like buildings as

against expenditure on fixtures like air-conditioning and

furniture.

There is need as much to indicate what items are excluded

from eligibility for expenditure as specifying in broad terms the

purposes for which grants are made. While services like e-seva

in AP state for collection of government dues have been found

to be useful, there is the recurring problem of power fluctuations

affecting their efficiency. Technical solutions like uninterrupted

power supply equipment normally available for such

Section-II 451

contingencies are not always made available because funds have

not been provided for. While allocating grants for various

purposes, and making provisions for them, the XII Finance

Commission may like to indicate standards of austerity to be

observed in the utilization of the funds.

Strengthening of district, judicial and police administration

have received attention from the previous Commissions and

should continue to receive similar attention. There is need to

consider the modernization of the Departments of Forest

and Minerals, with emphasis on increasing the knowledge

quotient and development aptitude in these departments as

they have remained mainly regulatory in character, and appear

to have not realized the contribution to value addition they can

make even while ensuring environmental and resource

conservation purposes. These departments need to be provided

with increased access to information from and familiarity with

techniques of remote sensing etc. The National Remote Sensing

Agency, the Geological Survey of India and the Forestry wing

of the Environment Ministry can identify the districts which

need attention.There is also need to revive and strengthen the

Public library system by providing grants to public libraries at

district headquarters, for acquisition of books and proper

stacking arrangement.

Section-II 452

Chapter IX

Financing Disaster Management

The Twelfth Finance Commission has been required to “review the present arrangements as regards financing of disaster management with reference to the National Calamity Contingency Fund and the Calamity Relief Fund and make appropriate recommendations thereon” (Para 10 of Notification 1st November 2002)

While natural disasters of various kinds have been a regular phenomenon in the country, and relief and rehabilitation arrangements were made by the governments of the day, it was the Sixth Finance Commission that was given the specific task of review of financing relief expenditure by the states affected by natural calamities.

The terms of reference of the Sixth Finance Commission mentioned, “The Commission may review the policy and arrangements in regard to financing of relief expenditure by the States affected by natural calamities and examine, inter alia, the feasibility of establishing of a National Fund to which the Central and State Governments may contribute a percentage of their revenue receipts”. (Para 7 of the Presidential Notification of June 28th 1972).

Writing on the TOR for the Sixth Finance Commission and the scope for rationalisation, Dr. VKRV Rao opined, “The feasibility of establishing a National Fund would depend on the factual assessment the Commission makes of the history of such relief during the last 25 years. What is clear is that no state is free from the incidence of natural calamities; the financial impact differs from state to state and is only related to the level of its income and its revenue resources that the Centre has to bear the main brunt of relief expenditure. I believe it is possible to identify an insurance principle in the incidence and relief on account of natural calamities, the premium to be contributed by the states and the Centre determined by the history of such expenditure between them.” (EPW, Nov 3rd 1973)

The Sixth Finance Commission reviewed the transfers made up to 1972-73 and found that relief expenditure for natural calamities during the four years 1965-66 to 1968-69 amounted to Rs 271 crore and this had nearly doubled to Rs 530 crore in the next four years between 1969-70 and 1973-74. During a single year 1973-74 the total amount of transfers was Rs 238 crore. Sixth Finance Commission felt that it was possibly on account of the resource constraint they faced, the States pressurised the Centre for larger relief assistance. Earlier Finance Commissions had recommended that the funds provided in the budget for financing relief but not utilised in normal years should be appropriated towards a Famine Relief Fund for utilisation during the distress period.

The Sixth Commission took the view that the distribution of Central assistance for drought relief outside the framework of Central assistance for Plan set at naught the Gadgil Formula for Central assistance according to the criteria approved by the NDC. Noting that no clear guidelines were available for State-wise distribution and that there was considerable room for exercise of discretion, the Commission observed: “the present system of assistance for natural calamities has thus introduced serious distortions in the scheme of allocation of Central funds among the states and if

Section-II 453

continued any longer, will accentuate inter-state jealousies and rivalries.” (p. 64 of the Report of the Finance Commission).

In its recommendations, Sixth Finance Commission observed that: “in the light of our analysis of the advantages and disadvantages of the establishment of a National fund and the views expressed by State Governments, we have concluded that the establishment of a National Fund fed by Central and state contributions is neither feasible nor desirable. At the same time, the present arrangements for providing assistance to the states for meeting expenditure on relief operations need to be completely overhauled. Detailed programmes of both medium and long-term significance for permanent improvement of the areas liable to drought and flood should be drawn up with the utmost urgency and these programmes fully integrated with the Plans. We strongly urge that instead of incurring expenditure on relief on an ad hoc basis on schemes of dubious value, provision should be made on a larger scale for development of drought and flood prone areas in the Fifth Plan both in the State and Central sectors. Any assistance that is provided to the states for relief in this manner would be subject to the overall ceiling of Central assistance for the Plan period as a whole. At the same time, we feel that the provisions of a reasonable margin in the forecasts of state expenditure should be considered as a legitimate charge on the revenue account of the states.”

The Commission recommended Annual Provisions for 21 states totalling Rs 50.71 crore, taking into account the figures for arriving at the grants under Article 275. The state-wise figures show that Rajasthan, with desert areas received Rs 10.19 crore, and the flood prone West Bengal Rs 6.61 crore. States with chronically drought prone districts like AP, Bihar, Gujarat, MP, Maharashtra and Orissa received reasonable provisions.

Placing the Commission’s Report on the Table of the Lok Sabha, the Finance Ministry, in its Note on Action Taken stated that: “the Commission has not favoured the establishment of a National Fund for financing the relief expenditure of the states affected by natural calamities. Instead, it has made detailed suggestions in this regard and these will be examined in consultation with the Planning Commission.”

Seventh Finance Commission

The TOR for the Seventh Finance Commission read as follows: “The Commission may review the policy and arrangements in regard to the financing of relief expenditure by the states affected by natural calamities and suggest such modifications, as it considers appropriate, in the existing arrangements having regard, among other considerations, to the need for avoidance of wasteful expenditure” (Presidential Notification of 22nd June 1977)

Giving detailed consideration to various issues, in Chapter IV of its Report, the Seventh Finance Commission observed, among other things that: “it is a well accepted proposition that the primary responsibility for relief measures for the people affected by natural calamities is that of the State Governments concerned. However, it often happens that the seriousness of a calamity calls for relief measures and consequent expenditure, which may be of an order beyond the means of the state in a particular year. In such a case, the State Government calls upon the Centre for

Section-II 454

financial assistance. The Central Government has from time to time laid down its policy for such assistance.” With this finding on justification of Central Assistance to the States on calamity relief, the Seventh Finance Commission indicated that its review of Central Assistance for relief expenditure considered how such expenditure was likely to affect the finances of the states visited by natural calamities and the possible undesirable effects of dislocation in the finances of a state, as also the necessity for minimising any tendency for wasteful expenditure on the part of the states and indicated that “its scheme for federal transfers is intended to enable the states maintain financial equilibrium.”

Seventh Finance Commission felt that “the states should bear a significant share of the relief burden” but that “the burden of non-Plan expenditure which does not create any new assets following serious damage caused to public assets by cyclone, floods and the like cannot be properly or adequately taken care of in the present scheme of Central assistance.” It noted that “Central Government has not found it possible to adjust advance Plan assistance given after 1976-77 against the Plan ceilings of the states concerned” and that “there are real limitations in the scope for such adjustments when the advance assistance is too large in relation to the minimum Plan outlays for the years following the calamity.” In view of this, it considered it appropriate and necessary to introduce modifications in the present arrangements and that “it would be useful to distinguish between relief expenditure necessitated by droughts on the one hand and floods, cyclone earthquake and the like on the other” and proposed modifications by suggesting that “for drought relief expenditure in excess of the margins provided, the state should make a contribution from its Plans for providing employment and the extent of contributions should be assessed by a Central team and approved by Central Government. The contribution should not exceed 5% of the Annual Plan outlay, and should be treated as an addition to the Plan outlay and covered by Advance Plan assistance, adjustable in the period of five years, following drought. The Commission also indicated that if the expenditure requirement assessed by the Central team & High Power Committee, can not be adequately met by the sate contribution, the additional expenditure should be covered by central assistance to the full extent of extra expenditure half as grant and half as loan.

The Commission suggested a different pattern of assistance in regard to expenditure on relief, repairs and restoration of public works following floods, cyclones and other calamities of this nature, indicating that Central assistance should be made available as non-Plan grant, not adjustable against the Plan of the State or against Central assistance for the State Plan, to the extent of 75% of the total expenditure in excess of the margins. The Commission also suggested that where a calamity is of rare severity Central Government may extend assistance to the states even beyond the scheme. Seventh Finance Commission recommended an annual provision totalling Rs 100.55 crore indicating the margins for each state

In its Note dated 24th November 1978, on the Action taken on the Report of the Finance Commission, submitted to the Parliament, the Finance Ministry stated: The recommendations of the Commission relating to modifications in the existing arrangements of financing relief expenditure by the states affected by natural calamities have been accepted by the Government.”

Section-II 455

The recommendations of the Sixth and Seventh Finance Commissions differed so fundamentally that their impacts were a study in contrast. As pointed out by K.K.George, the implementation of the Sixth Finance Commission recommended that transfer of relief funds over and above the provision made by the Commission against Central Plan assistance, “could be said to have reduced not only the quantum of such non-Plan expenditure during the Fifth Plan but also the possibilities of diverting relief funds for other purposes. At the same time, it could not be overlooked that they impinged rather harshly on the States’ Plans.”…Whereas all except three states applied for and received Central funds for relief during the Fourth Plan, only very few states received much assistance during the Fifth Plan. Central assistance for relief expenditure came down from Rs 769 crore in the Fourth plan to Rs 6 crore in the Fifth Plan. …However with the Seventh Finance Commission recommendations made after noting the difficulties in adjusting advance Plan assistance, and the fall in advance plan assistance for relief expenditure, the quantum provided during the Sixth Plan increased from Rs 6 crore in the Fifth Plan period to Rs 555 crore during the Sixth FYP (see K.K.George: Discretionary Budgetary Transfers in Centre-State Budgetary Transfers, I.S. Gulati (Ed), p.260 to 263”)

Eighth Finance Commission

The Eighth Finance Commission set up in June 1982, which was given a TOR identical in language with the TOR of the Seventh Finance Commission, observed that: “the existing arrangements are basically sound and should continue subject to modifications.” Its recommendations were that

(i) The margin money provisions should be modified and increased, totalling Rs 240.75 crore annually. (ii) The state and centre should each contribute 50% of the margin money and the states will be entitled to draw on the Centre’s contribution after it has exhausted its own share of margin money and provisions not released to the states will be carried forward to the next year.(iii) Relief for fire accidents should be on the same footing as floods.(iv) Centre should review the cost norms adopted for items like repair and reconstruction of houses.(v) In respect of damages caused to public works by cyclone, floods, etc., the expenditure could be, subject to Centre’s satisfaction of the extent of need, spread over the next and subsequent financial year.

In case of drought relief expenditure in excess of margins State Government should make a contribution from its Plan funds for providing relief employment and the extent of state contribution should be assessed by a Central team and approved by the Central Government and be subject to a limit of 5% of the Annual Plan outlay. This should be treated as addition to the Plan outlay and covered by advance Plan assistance, to be adjusted against the ceiling for Central assistance within five years. In the case of floods etc., the pattern will be the same as recommended by the Seventh Finance Commission. In the Action Taken Note of 24th July 1984, presented to the Parliament, Government of India indicated the acceptance of the increase in margin money provisions and other modifications proposed by the Seventh Finance Commission.

Section-II 456

Ninth Finance Commission

The Ninth Finance Commission, constituted in June 1987, had nearly the same terms of reference on Relief Expenditure as the Seventh and Eighth Finance Commission, but was also requested to examine, inter alia, the feasibility of establishing a national insurance fund to which the State Governments may contribute a percentage of their revenue receipts. In its First Report, the Ninth Finance Commission recommended that “the scheme of financing relief expenditure recommended by the Eighth Finance Commission should continue” and suggested increase in margin money provision to Rs 339 crore with the Centre and states contributing 50% each. In its Second report, the Commission recommended that “the existing arrangements for financing relief expenditure should be replaced by a new one under which states will have much greater autonomy and accountability” and that “a Calamity Relief Fund should be constituted for each state with specific provision in each year.”

The Commission proposed state-wise provisions totalling Rs 804 crore each year to be made up by contributions for Government of India to the extent of 75% as non-Plan grant and state contribution of 25% from its own resources. The Relief Fund is to be kept outside general revenues of the state but deposited in a nationalised bank administered by a State level Committee headed by the Chief Secretary with powers to decide all matters connected with relief expenditure including variations in the norms of assistance. Expenditure on calamity relief will be met from yearly accretion to the fund and interest earned. No further Central assistance will be made available. The Commission suggested that if in any year, the requirement was more the state could draw in advance 25% of Centre’s contribution due next year and that the balance left in the Fund unspent at the end of the fifth year (1994-95) will be available for being used as Plan resource. It proposed treatment of all calamities on the same footing, eliminating the distinction between drought and other calamities and the constitution of an Expert Group to monitor relief works taken up with calamity relief Fund and render advice to state agencies. In its Note on Action Taken, dated 12 th

March 1990, the Finance Minister informed the Lok Sabha that “the Government have accepted the recommendations of the Commission relating to financing of relief expenditure and setting up of a Calamity Relief Fund in each state” and that “the arrangements for custody and operations of the Fund will be separately worked out in consultation with the Comptroller and Auditor General and the Reserve Bank of India.”

Tenth Finance Commission

The Tenth Finance Commission constituted on 15th June 1992 which was set the term of reviewing the present scheme of Calamity Relief Fund(CRF) and making appropriate recommendations, made detailed review of the Calamity Relief Fund and in particular the approach of the Ninth Finance Commission to determination of the size of the CRF and the annual contribution, obtained the views of the State Governments which while favouring the continuation of the scheme, raised objections to the investment pattern of the CRF. the views of the Ministry of Finance on investment patterns and of Ministry of Agriculture on the poor response from State Governments for requests for information. The Tenth Finance Commission felt that “

Section-II 457

there is room for inter-state variations on items of relief expenditure depending upon local requirements there is a need to evolve an all-India framework” and suggested that the Ministry of Agriculture should set up a Committee of experts to evolve the guidelines in regard to the items and their rates and norms for expenditure that can be debited to CRF. The Tenth Finance Commission also agreed with the suggestion of the Ministry of Finance that a separate fund outside the public account must be created so that the balances in the fund are available when needed.

On the issue of quantum of CRF, the Tenth Finance Commission examined the plea of the State Governments that this should be based on an average of the actual relief expenditure incurred by them and not on the ceilings of expenditure fixed by Government of India and felt that it was difficult to distinguish between expenditure incurred on calamity relief and other normal expenditure and took the view that the most appropriate and objective manner of assessing relief expenditure will be take into account expenditure booked to Major Head 2245-Natural Calamities.

The Tenth Finance Commission took into account, the average of the aggregate of ceilings of expenditure for the years 1983-84 to 1989-90 and the amount of calamity relief for the year 1990-91 and 1992-93 and adjusted the amount for inflation up to 1994-95 and elasticity factor and estimated that the amount to be provided for 1995-2000 will be Rs 6304.27 crore with (Centre Rs 4728.19 crore – 75% and states Rs 1576.08 crore – 25%). The Tenth Finance Commission recommended the continuation of CRF with some modification detailed in Chapter IX of their Report.

Taking note of the fact that between June 1990 and May 1993, Central Government had received 30 Memoranda from the states for additional Central assistance with the plea that they had experienced a calamity of rare severity, Tenth Finance Commission felt that Central Government must be in a position to come to the rescue of the states and organise relief on a national scale, in cases of calamity of rare severity. It suggested that in addition to the CRF for states, a National Fund for Calamity Relief should be created with contributions from the Centre and the States. Suggesting the management of the NFCR by a National Committee, which could be a Sub-Committee of the National Development Council, the Tenth Finance Commission proposed its administration outside the Public Accounts of the Government of India and its size as Rs 700 crore to be built up over the period 1995-2000, with an initial corpus Rs 200 crore with the Centre contributing Rs 150 crore and the states Rs 50 crore and the balance raised in the same proportion each year between 1995-96 and 1999-2000. The contributions to be made by each State were also indicated.

Government of India accepted the recommendations of the Tenth Finance Commission on the continuance of CRF with enhancement in its corpus fund and indicated to the Lok Sabha that the scheme will be modified as proposed, in consultation with the states so as to provide flexibility in the choice of avenues for investment. GOI also accepted the recommendations for the creation of National Fund for Calamity Relief with a corpus of Rs 700 crore and indicated that the arrangements for custody and operations of the Fund will be separately worked out in consultation with the CAG and the RBI. (Action Taken note of 14-03-95)

Section-II 458


The Eleventh Finance Commission which was required to review the Calamity Relief Fund and make appropriate recommendations,suggested in its Interim Report of 15th

January 2000, the continuation of CRF with the Fund size of Rs 2000 crores for 2000-01, with Central contribution of 75%, and made a detailed review of the operations in its Report of 7th July 2000. It recommended the following:

(i) The continuation of the existing schemes of CRF with the size of the Fund at Rs 11007.59 crore for the period 2000-05 (Centre Rs 8225.69 crore and the states Rs 2751.90 crore) indicating the state-wise contributions.(ii) The discontinuance of National Fund for Calamity Relief as it is difficult to anticipate and provide in advance for a calamity of severe intensity.(iii) The financing of national calamities should be financed by a levy of special surcharge on Central taxes for a specific period and the surcharge collected should be collected in a separate Fund called National Calamity Contingency Fund created in the Public Accounts of the GOI.

Indicating that such a surcharge may generate a feeling of national participation, the Commission suggested that the GOI could make an initial contribution of Rs 500 crore, that drawals from the Fund should be recouped by the imposition of special surcharge and that a legislation to enable the levy of such a surcharge may be enacted. It also made recommendations on the treatment of expenditure on restoration of infrastructure and other capital assets and the need for devising medium and long-term measures to reduce and if possible eliminate the occurrence of the calamities. It also suggested that the Planning Commission should identify works of capital nature to prevent recurrence of specific calamities and that these could be funded under the Plan.

In its Action Taken Note of 27th July, 2000 GOI indicated to the Lok Sabha the acceptance of the recommendation and announced that the recommendations on NCCF will be implemented after the enactment of the necessary legislation. It may be noted that while CRF continued the NCCF came into effect from FY 2000-01 to be operative up to the end of FY 2004-05.

Other Views

A High Power Committee on Disaster Management constituted by the GOI in 1999 submitted its Report in October 2001 coming up with the suggestion on common response and preparedness mechanism and on earmarking of 10% of plan funds for schemes concerned with prevention, reduction and mitigation of disasters.

In recent years there has been emphasis on involving Non

Governmental Organisations in relief and rehabilitation works

following natural calamities.Some international funding

agencies appear to be of the view that NGOs are effective

delivery mechanisms in these areas. The relief and rehabilitation

Section-II 459

works carried out in the areas affected by earth quake, Lathur in

Maharashtra and Kutch in Gujarat, have been studied by Dr.Nita

Mukherjee a former senior executive of the ICICI. She observes

that, “in developing countries there is the problem of prioritising

expenditure – with inadequate resources for meeting all the

demands of infrastructure and social sector investments, there is

resistance to allocating resources for probabilities. The political

dilemma is further exacerbated because expanding federal

disaster relief assistance is popular and expedient. But it is

costly and does little to either control disaster losses or to

rebuild assets. However mundane the actual tasks, mitigation

and preparedness are crucial to an effective disaster policy that

can prevent and lessen the losses rather than respond only when

disaster strikes. Indeed, studies on disaster after disaster have

shown that institutions are poorly prepared to handle the crisis

and they are unwise in post-disaster reconstruction in hazard-

prone areas. Disaster specialists have increasingly emphasised

the importance of preventing or ameliorating losses. This

involves activities at the Centre, state, district and even local

community level. Since policies which are effective, as they

deal with mitigation and preparedness, are likely to receive little

attention during active stages of federal disaster policy making,

there is need to concentrate on these aspects through a Centrally

established corpus and implemented through non-political,

NGOs and CBOs (community-based organisations).”

Section-II 460

Planning Commission

The Planning Commission has taken the view that calamities can cause economic losses and development setbacks and that, “the impact of major disasters cannot be mitigated by the provision of immediate relief alone which is the primary focus of calamity relief.” Devoting a chapter to Disaster Management – the Development perspective in Volume 1 of the Tenth Plan document, the Planning Commission provides data on disasters and the losses incurred and suggests strengthening of institutional arrangements at the levels of Central Government, State Government and Districts. It indicates the schemes of financing relief works and rehabilitation or restoration schemes including those recommended by the Finance Commissions and draws attention to the fact that funds are available from multilateral agencies like the World Bank for long term preparedness and preventive measures.

Recommendations

A study of the recommendations of the various Finance Commissions indicates that except for the Seventh Finance Commission which came up with a qualitatively significant recommendation on the distinction between drought relief and calamities like floods cyclones, etc, other Commissions have focussed on the accounting of relief expenditure and allocation of responsibilities. Many of these recommendations may have no significance for the people affected by natural calamities and the field officials concerned with providing relief.

Finance is only one aspect of relief management. The suddenness of the disasters and need for promptness in official response have yet to be dealt with adequately. Whether Finance Commissions should be concerned with macro-level issues only, and not get down to the micro-level management is a crucial question. Given the time bound nature of their assignment, one can only suggest that that Finance Commissions should not suggest frequent changes even in the macro level arrangements, as these disturb the chain of command and flow of resources and ultimately affect the effectiveness of Government response to the public demand for relief.

While, as someone said, everyone loves a good drought and some politicians even treat flood relief as an opportunity for patronage, one must realise that “emergency relief” implies urgency of action and consequently inadequacy of time for following time-honoured and rule-prescribed procedures for examination of proposals and expenditure sanction and that expenditure incurred on relief works may well exceed the cost norms that could be observed when works are planned, tendered and executed. There is, a premium for Tatkal Seva in other sectors - Should this be denied in emergency relief ? Invariably the complaints from public are that relief provided is not immediate or adequate and in such cases one would have found that local administrations have been rule bound and procedure conscious. The trade-off between effective “emergency relief” and economy in expenditure cannot be reduced to a formula.

Further the present procedure requiring visit of a Central Team to assess damage and recommend relief is marked by time lag in provision of relief and arouses undue expectation in the public and in the State Governments. The attention of

Section-II 461

officials responsible for providing relief to affected people, gets diverted to preparation of Memoranda for visiting central teams. There is need to reassert the basic position that provision of relief and rehabilitation is the responsibility of the State Government and Central assistance if any can only be supplemental. Such an assertion can atleast serve to moderate the tendency of State Governments to present exaggerated demands for relief, and needlessly drag political issues into a sensitive public affair.

The areas that require deeper study and provision of special arrangements are: 1. Delegation of financial powers and sanction of works to technical

departments 2. Revision of norms for expenditure for immediate relief like provision of food

and shelter in the case of floods and cyclone3. Review of the cluttered and complex relationship between the credit

institutions and district administration in finalising levy remission and reschedulement of loans in the case of drought and floods.

4. According formal recognition to specific non-government organisations like Ramakrishna Mission and Church organisations for relief and rehabilitation work.

Section-II 462

Chapter -X Central Plan and Centrally Sponsored Schemes

In view of the continuing debate on the need for and proliferation of number of centrally sponsored schemes, their impact on transfer of resources from Centre to the States and the role of Central Ministries in devising schemes in sectors that come exclusively under the State List, XII FC has sought examination of the desirability of transfer to States, of Central Sector and Centrally Sponsored Schemes (CSS) along with funds, with or without modifications, as also grant of absolute freedom and discretion to the States in devising or revising schemes and the scope for linking central support to results rather than activities.

While the issues involved have been examined by several committees and discussed at various meetings of the National Development Council, the matters have not been taken to their logical end, requiring a revisit of this territory.

Constitutional Position

It may be worth while to set out in brief, the constitutional position. The Indian Constitution has, under Article 246, and Seventh Schedule, distributed powers and allotted subjects to the Union and the States with a threefold classification of subjects.

List I, the Union List containing 97 subjects in which the Union Government has exclusive authority and Parliament can legislate. This includes subjects of national importance such as Defense, External Affairs, and Communications Higher Judiciary Elections

List II the State List containing 66 subjects in which the State Governments have exclusive authority and the State Legislatures can enact laws. These include subjects which impact on the life and welfare of the people such as Public Order, Police, Local Government, Agriculture, Land Water, and Public Health.

List III Concurrent List containing 47 subjects in which the Union and the States exercise concurrent powers. This covers administration of Justice, Economic and Social Planning Trade and Commerce, which have National and Inter-state implications.

As per article.248, the Union has exclusive power on any matter not enumerated in the State or Concurrent List and as per Article 254, in case of conflict between union laws and the state laws, the Union law shall prevail

The enumeration of taxation powers places in the Union List, taxes on Income other than Agricultural Income, Excise Duties, Customs and Corporation Tax. The State List contains Land Revenue, Excise on alcoholic liquors, Tax on Agricultural Income, Estate Duty, Taxes on sale or purchase of goods, taxes on vehicles, taxes on profession, luxuries, entertainment, stamp duties etc.The Concurrent List does not include any tax power.

Origin and Growth of CSS

Section-II 463

Centrally Sponsored Schemes are those that are sponsored by the various Ministries of Central Government and not initiated by the State Governments as such Plan assistance is made available to states for these schemes is different from and over and above the Central assistance for state plan schemes. The origin of the schemes can be traced to the Second five Year Plan which had to deal with programmes that were sponsored and assisted by the Central Governments through various ministries and whose expenditure was met on a matching basis by centre and the states. The Planning Commission found that there were a few schemes which belonged to state plans but some parts of the expenditure were also shown in the central budget, and that the principles for selection of these schemes were not spelt out and the state-wise allocations not settled at the time of the finalisation of the First Five Year Plan. The Planning Commission believed and indicated in the Second and Third Five Year Plan that Plan provisions should be settled on the principle that development schemes to be implemented by State Governments should form part of the state plan. And only certain limited categories of schemes should be shown in the Plans of the Central Ministry as being sponsored by the Central Government.

On the eve of the finalisation of the Fourth Five Year Plan(1966), the Planning Commission proposed for the consideration of the NDC that the criteria for CSS schemes could be a) the scheme should cover a matter of national policy such as family planning, resettlement of agricultural workers b) involve specialized research and training to be of benefit to more than one state c) pilot projects for research and development. The NDC appointed a sub committee which decided that some schemes should be centrally aided schemes and that the number of centrally sponsored schemes should be reduced to the minimum. As a result of this, of the 92 CS schemes remaining at the end of Third Five Year Plan 36 schemes were transferred to the state plan sector. Nonetheless, the draft Fourth Five Year Plan circulated to the states in 1967, showed number of CSS to be 90 with different pattern of assistance, 100% central assistance for 60 schemes, 75% for 12 schemes, 60 % for 3 schemes and 50% for 15 schemes.

While the Planning Commission and some of the State Governments appeared to be inclined to get the number of schemes reduced, most Central Ministries suggested the continuation of CSS and the ministries of food and agriculture, health suggested addition of new schemes. The Administrative Reforms Commission considered the issue and came up with the recommendation that the criteria for CSS should be, i) relation to pilot projects, surveys and research ii) regional or inter-state character iii) overall significance from all India angle and recommended that provision should be made in lump sum and then broken down territorially. The NDC reviewed the position in May 1968 and a Committee appointed by NDC decided that 52 out of 92 schemes should be retained in centre and of this 7 were later transferred to ICAR. As a result number of CS schemes was 45 during the Fourth Five Year Plan (1969-74). There was a further recommendation that the assistance through CSS should be limited to one-sixth of the quantum of central plan assistance to states. This limit was however not observed and new schemes got introduced during the Fifth Five Year Plan.

Academic View

In 1968, Dr.K.Venkataraman observed in his book ‘ State Finances in India’ that “Empirically, the only definition of CSS is that CSS are those for which

Section-II 464

assistance is given over and above the assistance assured for the State Plan as a whole” and the Study Team on Centre-State Financial Relations, constituted by the Administrative Reforms Commission(ARC) had also offered a similar perception pointing out that “schemes are sometimes converted from State Plan schemes into Centrally sponsored schemes with no interest other than the obvious one of getting the State better financial assistance”(Report of the ARC Study Team on Centre-State Relations.P.128)

As pointed out by D.R.Khatkhate and V.V. Bhatt ‘ The genesis of Centrally Sponsored Schemes,CSS is to be traced to the reluctance of the states to undertake certain schemes of national importance. These related to schemes like Family Planning or schemes that would be of benefit to more than one state. Hence the centre offered to foot the bill by way of grants and loans depending on each scheme” (Accommodating Planning Dimension, EPW.February 21,1970)

But the number of C.S.S schemes continued to increase in the seventies leading M.J.K.Thavaraj,to point that,” Despite the recommendations of theA.R.C and the N.D.C, the scale and relative shares of centrally sponsored schemes have increased over the Fourth and Fifth Five Year Plan. Often CSS proved to be a lever through which the Centre was intervening in the State sphere. Secondly many of the schemes have low priority for the states. Thirdly the pattern of financing CSS has undermined the Gadgil formula.Lastly it is the most regressive form of transfer in so far as it involves higher grant content, in the case of the richer states” (Financial Administration of India 1978 page 138)

In the meanwhile the Janata Government that came to power after 1977 general elections terminated the Fifth Plan in 1978, and announced the formulation of a Rolling Plan and the NDC in its meeting of March 1978 decided on a review of the Gadgil formula of Central assistance and the CSS. By this time the number of CSS financed by the centre and the states had grown to 116, with 74 schemes classified as central sector schemes fully financed by centre. A Committee under the chairman-ship of D.T.Lakhdawala Deputy Chairman Planning Commission, reviewed the provisions made for the Centrally sponsored schemes and suggested a reduction in the provision from Rs.6000 crores to Rs.3500 crores and recommended important changes in the procedure for operation of CSS, particularly that central ministries should lay down only broad guide lines leaving the detailed sanction to the State Governments. The proposals got reflected in the draft Sixth Plan (1978-83) which classified Central schemes into three categories a) CSS entitled for 100% assistance b) CSS to be jointly funded by centre and the states and c) 70 schemes which would cease to be centrally sponsored. With the change of government in 1979, this formulation got lost in the conversion of first two years of the Sixth Plan as Annual Plans. The Sixth Five Year Plan (1985) once again saw the growth of Centrally Sponsored schemes.

In July 1984 when the NDC considered the Approach to the Seventh Five Year Plan, it once again appointed an Expert Committee of officials under the Chairmanship of Sri.K.Ramamuthy to examine “the scope and role of CSS in sectoral development plans”.In its report submitted in January 1985, the Committee noted the increase in number of CSS from 45 in 1969 to 190 in the Sixth Plan, and the increase in provisions for CSS from Rs.1238 crores in 1980-81 to Rs.3004 crores in 1984-85,

Section-II 465

with a total assistance during the Sixth Plan placed at Rs.9318 crores, 35% of the total assistance to the states. The Committee also noted that by the end of Sixth Five Year Plan, the number of schemes had increased to 201 with spread among the ministries, Agriculture-53, Health-21, Home Affairs-12, Industry –11, Rural Development-12, works and housing-7, Irrigation-7, and others –78.

The Expert Committee’s report was considered by the NDC in November 1985, and as there was differences of opinion, another Committee under the Chairmanship of Sri P.V.Narasimha Rao, HRD Minister, including eleven Chief Ministers and three Union Ministers and one Member Planning Commission was constituted. The Committee appeared to differ from the views of the official committee and suggested that the criteria for CSS should be a) fulfillment of National objectives like poverty alleviation or achievement of minimum standards in education b) regional or inter-state characters c) pace setting nature or concerned with research and demonstration. This Committee set up a Group of Officials headed by Secretary Planning Commission to review the CSS schemes as per its guidelines.

Group of officials updated the details and noted that as on 1-4-1985,there were 262 schemes (140 of the Sixth Plan+122 added during the Seventh Plan) with a total outlay of Rs.15757 crores and in its report of April 1987 recommended that 149 schemes with a total outlay of Rs. 14496 crores be retained and the balance 113 schemes with an outlay of Rs. 1261 crores be transferred to the states along with balance outlay of Rs.800 crores during 1988-89. When the NDC considered the report in August 1987, Chief Ministers of various states were very critical of the report. No final decision on this proposal could not be taken in the NDC meeting in 1987 nor later.

Reviewing in1986, the Discretionary Transfer of Resources of which funds for CSS is one, K.K.George had pointed (in EPW,Nov 15,1986) that (i) during the period 1951 to 1984 covering the First to Sixth Five Year Plans, the gross transfer from centre to states was Rs 110443 crores of which Discretionary Transfers amounted to Rs.33914 crores (30.7%) Statutory transfers Rs.43527 crores (39.4%) and Plan transfers Rs 33002 crores (29.9%) (ii) scheme wise transfer outside the State Plan Framework(Central Sector,CSS and others financed 8.2% of the States ‘expenditure’ and constitution was higher in some sectors, Agriculture 18% and industry and minerals 23%.(iii) “the origin of these schemes had been modest. The rationale of their genesis too had been quite acceptable. But as these schemes proliferated, the differences between the State Plan Schemes and these Schemes came to be marginal” K.K.George summed up the criticism of CSS, by observing – “generally speaking, the States are not happy with the increase in scheme wise transfers, whether rich or poor. Those schemes are mostly thrust upon the State Governments and do not correspond to the States own order of preferences, These transfers regardless whether they are effected by the Planning Commission or Union Ministries undermine the importance of the criteria adopted by the NDC for plan assistance to the states. Such transfers reduce the pool of funds available for distribution on the basis of Gadgil Formula. Often the criteria used for those transfers are the ones rejected by the Finance Commission”

Analyzing the scheme wise transfer to see how the objective of equity is served, K.K.George had pointed out that during the Fifth Five Year Plan, Central

Section-II 466

Schemes and Centrally Sponsored Schemes showed a positive but weak correlation with per capita income and that during the Sixth Plan period, the trend was reversed in the case of Central Plan schemes and the trends was continued in the case of centrally sponsored scheme.. Pointing out that the grant content of discretionary transfer.87% for Central Plan scheme and 93% for CSS were higher than the 41% share in State Plan assistance, George argued that such transfers introduced distortions in federal financial relations

Continuing unease over the number and nature of CSS and their implications for a principle based system of federal fiscal transfers has not only been voiced by academics but also has been reflected in the constitution of Ministerial committees to review the CSS, first headed by Shri K.Ramamurthy and the second headed by Shri P.V.Narasimha Rao in the eighties but the end result of their labours were not significant.

The issue once again cropped up when the Eighth Five Year Plan was under formulation, and the Planning Commission circulated its views on “the distribution of central budget support for state’s plan expenditure and obtained the views of the states government and central ministries and placed it for the consideration of the NDC in its meeting of October 1990. The Prime Minister had announced that Centre was considering decentralization of the CSS and sought commitment from the states regarding further decentralization to the Panchayat on any appropriate level. No clear view emerged, and the matter once again reared its head when the NDC met in January 1997 to consider the draft approach to the Ninth Five Year Plan, Chief Ministers of several states raised a demand that those CSS falling within the purview of the state list as per the Constitution should be transferred to the states along with the funds earmarked for the same. The Planning Commission’s Approach paper had argued that “ in principle CSS should be confined to schemes often inter-state character : matters impinging on national security : selected national priorities where central supervision is essential for an effective implementation and externally financed multi-state projects where central coordination is necessary for operational reasons.”

Views of TFCIn the meanwhile the Tenth Finance Commission, in its Report of 1994, had

observed, “In the area of Centre-State relations there is one specific matter which we would like to draw attention. It is the persistence of a large number of centrally sponsored schemes although a number of them have been closed down following a review by Committee set up by the National Development Council. These were relatively small representing an annual provision of only about 200 crores as against the total for all CSS of about Rs 14000 crores. Central intervention through such schemes is presumably acceptable to the states because they carry with them additional resources. Their continuance makes for large and sprawling beauraucracies at the centre dealing with what are primarily state subjects – e.g. Agriculture, Rural development, Education and Public Health. Given adequate decentralization it should be possible to effect considerable economies in such schemes” (Para 15.7, page 63 of the Report of the X FC)

Section-II 467

Views of the Pay CommissionIt view of the reference to sprawling beauraucracies it may be useful to

recapitulate the views of the Fifth Pay Commission on the role of CSS and size of beauraucracies. In its Report of January 1997 the Fifth Pay Commission constituted by the Government.of India commented on one of the striking features of the Indian economy, the growing size of the central and State Governments and the increasing complexity of their mutual involvement. It observed that, “Proliferation of departments is a sure index of the widening net of the Government. Against only 35 Ministries and Departments in 1962, we had 50 in 1972 and now there are 81 Ministries and Depts.” and five new depts. were set up in 1995.(Para.7.4 of the Pay Commission report).Elsewhere in Para 9.2,of the report states,” we had eight posts of secretaries, 18 departments and a total workforce of 14.40 lakhs in 1948.Today we have 79 depts,92secretaries and a workforce of more than 41 lakhs.”

The Pay Commission had earlier raised the question of jurisdiction of Governments, and indicated that, “We have to examine whether within the overall parameters of what the state should directly do, a particular item should be within the jurisdiction of the central or State Governments or the third tier of government that is now being established at the level of urban local body or the village panchayats” (Para 4.8) The Commission felt that “when the constitution was initially framed it was intended to be a federal polity with a unitary bias” and that “the unitary bias got a tremendous boost during 1980-90” and pointed out that “after 1967 there was a change with formation of coalition governments in the states” and that “during 1977-89, when the Janata Dal was in office, the opposite trend of states asking for greater powers was also set in motion.”

The Pay Commission argued for a two fold change, “a transfer of functions, powers and resources to the states” and “ delegation of authority to self governing institutions, where the people themselves take over the function of the state.”The parameters of action suggested by this Commission were

(i) Central Government should confine its activities only to the core functions mentioned in the Union List

(ii) Some items could be shifted from the concurrent List to the state List (eg Education)

(iii) Matters which are itemized in the State List could generally be left to the States

(iv) List of centrally sponsored schemes could be brought down sharply to almost ten National Programmes with the rest being transferred to the States

(v) The entire scheme of sharing of revenues as between the Union and the State could be worked out afresh so as to allow the State Government to have elastic sources of revenue or a larger statutory share in central revenue receipts (Para 4.11 of the report)

The Commission also referred to the suggestions of the Report of its Consultant, Tata Consulting Services that there could be a threefold classification on the basis of the role performed by them as shown below

Section-II 468

Classification of Government DepartmentsCharacter of Organisation Role DepartmentsCore Assigned by constitution

with exclusive responsibility

Atomic energy, Defence, External affairs, Home, Finance,Law,planning, S&T, Rural Development

Participatory Government has policy making and Enforcement role and ensures Delivery of services by private & public sector units

Education, Health Family Welfare, Information and Broadcasting, Railways Surface, Transport Telecom,Posts, Civil, Aviation, Energy, Coal, Pertroleum Steel, chemicalsand Fertilizers

Auxiliary Government only policy making and some regulations and not delivery of services

Water resources, food

processing,textiles,labou

r consumer affairs, food

Processing, tourism,

sports

The Pay Commission recommended increase in scales of pay

and rationalization of services by downsizing of the employee

strength. The Government Of India however accepted the

recommendations on increase of pay scales, the

recommendation on reduction of staff strength was put on the

back burner. The pay increase of Central Government staff and

its echo from the States made significant difference to the cost

of administration and supervision of C.S.S

Views of CAG

The Reports of the Comptroller and Auditor General, have repeatedly pointed out several deficiencies in the implementation of schemes and utilization of funds of

Section-II 469

CSS by the State Governments. The Reports on civil accounts of the State Governments had raised a number of questions on propriety of expenditure. The Report of the Comptroller and Auditor General on the civil accounts of Government Of India for 1999 critically examined the utilization of funds released for poverty alleviation schemes and made sharp comments on the quality of implementation, supervision and monitoring.

CSS Transfers

The proliferation of centrally sponsored schemes and central sector schemes, and the increasing level of resource transfers to the States for their implementation has been a matter of concern for the Planning Commission, and the deliberations of the National Development Council have been marked by demands from the State Governments for transfer of schemes along with funds from centre to the states. The increasing quantum of transfers, and the conditions accompanying the CSS transfers appear to be a major factor in generating this demand, while the quantum of funds involved and the size of the supervising machinery in the central ministries appear to be the major factor, at the central level, prompting the suggestions for transfer of CSS schemes to the states.

The magnitude of the transfers from centre to the states, has been increasing despite the pressures on centre’s resources, from Rs. 21951 crores in gross terms and Rs.17633 crores in net terms to Rs.148010 crores in gross terms and Rs.104261 crores in net terms as per the budget for 2002-03. Of this grants play a significant element, and the purposes for which grants are made and the terms of which these are made acquire significance both for the central ministries and the State Governments. With coalition governments emerging at the Centre and regional parties coming to power in various states, there is an under current of suspicion that the discretionary element involved in the transfers often lead to exercise of patronage at the expense of the national objectives and fulfillment of the specific purposes for which Centrally Sponsored schemes were conceived. The schematic breakup of the grants made by centre to the states is shown in Table : 10.1

Table : 10.1:- Central Grants to the states(Rs.Crores)

1985-86 1990-91 1995-96 2000-01 2002-03(BE)

Total Grants 6323 12644 20996 37783 54102State Plan Schemes

2771 4796 8134 16200 23061

Central Plan Schemes

785 813 1586 1132 3898

CSS 1293 3763 4867 7182 14150North East Schemes

- - 432 127 630

Non Plan 1474 3272 5977 13141 12362

The state-wise breakup of transfers only on account of Centrally

sponsored schemes is shown in Table 10.2

Section-II 470

Section-II 471

Views of Planning Commission.

The views of the Planning Commission, have found

expression in the Approach paper to the Ninth Plan 1997 (para

5.11), Mid Term Appraisal of the Ninth Five Year plan,(October

2000 chapter 31) The Paper on Approach to the Tenth Five year

Plan (chapter 4,November 2000) and the Tenth Five Year Plan

(volume 1,chapter 6,p.186,December 2002)

The Mid Term Appraisal of the Ninth plan pointed out that the successful implementation of development programme requires adequate funds, appropriate policy framework and effective delivery system and observed that, “past experience has shown that availability of funds is no panacea for tackling problems of poverty and backwardness. What is the determining factor, it would seem is the capability of the funding ministries to formulate viable schemes and the delivery system to utilize the funds and achieve sustainable growth optimally.”

The Appraisal drew attention to the annual expenditure of Rs.35000 crores by Central Ministries on subsidy and Poverty Alleviation Schemes and raised a question on the validity of basic assumption that benefits will accrue to the poor through planned expenditure via beauraucracy.Citing the 1999 report of the C &AG indicting the State and Central Governments for “Shabby implementation of CSS, Planning Commission adduced the reasons for poor implementations and defects which can be summarized as1) too many schemes to be monitored2) unwillingness to accept or admit poor performance for fear of criticism of the Parliament, vested interest in concealing defects3) limited capacity and lack of will to monitor the schemes4) sensitive aspects of centre- State relations precluding ministries from asking embarrassing questions for response from State Government.5) Uniformity of schemes of all over the country without sufficient delegation of powers to the states to change the scheme contents to suit local condition6) The schemes assume a highly committed delivery machinery which will act as ‘ friend,philosopher and guide of the people’ and this is a rarity7) Sates do not release the counter part funds in time leading to uncertainty at the field level about of funds

The Appraisal drew attention to the weakness and problems of the plan implementation machinery and commented that, “the widening outlay – resources gap weakens the link between physical targets and plan expenditure.Prioritisation of schemes becomes ad hoc.This distorts the development process and undermines the sanctity of the plan. Apart from this, it also makes the whole process non transparent and prone to corruption” and opined that there were “too many schemes and lack of convergence” and observed that “though a rigorous procedure has been in place for

Section-II 472

introducing new centrally sponsored schemes (CSS), there is a proliferation of CSS which could not be kept in check. Following a direction from the National Development Council several CSS were sought to be transferred to the states. In February 1999, Planning Commission prepared a list of such schemes with an annual outlay of rs.3709 crores for being handed over to the states. But Central ministries have been reluctant to fall in line and as of July 2000, they have agreed to give up schemes worth Rs.163 crores and transfer them to the state. In the meanwhile several new CSS have been introduced in the last two years. New CSS get imitated mid stream through announcements in the Annual Budgets, at the time of Independent Day and other such events”. The Appraisal cited six such newly introduced schemes.

The Approach Paper to the Tenth Five Year Plan is also in a Critical vein in its commented on the CSS and observed that “the proliferation of CSS is an example of the State overstretching itself” and that, “it would be better to do a fewer things well rather than messing up with a large number of activities” and suggests that policy makers should attempt to match the role of Government of India to its existing capacity while at the same time strive to improve the effectiveness and efficiency of public resource use so that gradually the State functions could be enhanced”. Pointing out so that the share of CSS in the Plan budget of the Central Ministries has now increased to 70% against 30% in the early 1980s Approach Paper comments that “this expansion has taken place at the expense of investments in infrastructure, Industry and Energy sectors,” and that , “the massive increase in allocation has however not been matched by improved monitoring and effective control. There is ample evidence of diversion of plan funds for salaries and other non plan expenditure. This suggests that the number of CSS needs to be curtailed drastically from more than 200 today to just about 20 to 40 so that effective systems for their monitoring can be developed”

A group of eminent economists, chaired by Dr.I.G.Patel while outlining the steps required for fiscal correction at the Centre, emphasized expenditure control, and indicated that, “detailed studies by the Planning Commission had shown that many plan schemes donot achieve desired results and are continued simply because of the vested interest of Central Ministries who operate these schemes. We would recommend that for the Tenth Plan period beginning 2002 all existing plan schemes should be deemed to have ended and new plan schemes should be approved in each sector only on the basis of a careful assessment of the efficacy of these schemes in achieving targets.”

Pursuing this line, a Special Sub Committee of NDC met in August 2002, under the Chairmanship of Shri.KC.Pant and decided that out of 210 CSS in operation 49 would be discontinued, 161 other schemes will be merged and the total number reduced to 53.Nine schemes would be transferred to the States (as per news report in Hindu Business live 23.8.2002)

The Tenth Five Year Plan Document approved by the National Development Council In December 2002, elaborates on this approach and indicates the result of the Zero Based Budgeting exercise carried out for the rationalization of centrally sponsored schemes(CSS) and central sector schemes(CS).In a succinct review of the schemes, the Document observes “Centrally sponsored schemes were originally to be formulated only where an important national objective such as poverty alleviation was to be addressed or the programme has a regional or interstate character or is in the

Section-II 473

nature of pace- setter or is for the purpose of survey or research. However CSS have proliferated enormously and in the terminal year of the Ninth Plan, there were as many as 360 centrally sponsored and 2247 central sector schemes. Many of these have similar objectives and target the same population. Certain generic components like Information, Education, and Communication are repeated in a number of schemes. This also leads to multiplicity of implementation agencies and lack of synergy and coordination.CSS rarely follows a project approach and normally do not have benchmarks or performance indicators. The Tenth Plan clearly aims at improving efficiency of public assets and quality of expenditure of the public sector through the rationalization of the central sector and centrally sponsored schemes by way of convergence, weeding out and transfer to the states”

The Zero based budgeting exercise for all the central ministries to rationalize the CSS and CSs carried out by the Planning Commission, involved. weeding, merger and retention of schemes and the results is summarized as below

Total number of schemes during IX FYP

Proposed for TotalMerged/Retained

weeding Merger RetentionA.Centrally sponsor

ed Schemes

360 48 61 into 53 135 188

B.Central SectorScheme

2247 539 1001 into 233

689 922

Source Tenth Five Year Plan, Planning Commission

The Tenth Five Year Plan Document also outlines the strategies that will be followed in the Tenth Plan Period, indicating restrictions on the start of new CSSs, monitoring of state wise flow of funds and physical targets achieved, greater flexibility between components of a scheme and adoption of macro management or cafeteria approach in which the Centre provides the states a basket of schemes to choose for the ones most suited to their local requirements

It remains to be seen as to how the decisions will be translated into action and what their implication will be for the different sectors, as the decade of economic reform and fiscal consolidation is already marked by differential impact on the various sectors with social services bearing most of the adverse impact. Since the proposals of the Planning Commission have the approval of the NDC it may not be necessary for the XII FC to carry out a fresh exercise on the centrally sponsored and central sector schemes. It may however be necessary for the Commission to assess the financial fall out of the NDC decisions for the both the Union Ministries and the cash strapped State Governments

While devising its approach to the central sector and centrally sponsored schemes Twelfth XII FC could perhaps take note that the Planning commission’s

Section-II 474

ZBB exercise has carried forward the Tenth FC’s observations in Para 15.7 of its report but has stopped short of carrying out the suggestions of the Eleventh Finance Commission which observed “in our view CSS need to be transferred along with the funds to the states. All other schemes should be implemented by PRIs and urban local bodies on the basis of plans prepared by District/Metropolitans Planning committees. The transfer of these schemes would mean that the staff working in the ministries would become surplus and need to be redeployed. This would lead to a reduction in the Revenue Expenditure of the Centre”(p.32 of the report)

Recommendation

Eleventh Finance Commission’s suggestions are a over simplification of the plan implementation process. Despite the Constitutional Amendment and various declaration on the empowerment of rural and urban local bodies, it cannot be said that the PRIs and ULBs have acquired planning or implementation capabilities in all the States. If these local bodies are entrusted with responsibilities for implementation of central schemes conceived with national objectives in view, one cannot rule out a deceleration in the social and community services and developmental schemes in the rural areas of the country. The State Governments are strapped for funds and the transfer of responsibility for CSS all at once to them may only create a weak structure. The wiser course would be to opt for a phased restructuring of the CS and CSS schemes, though some experts tend to feel that in matters of this nature a snap decision or a ‘big bang’ approach is the only effective way. The restructuring of CS and CSS should be continued with a critical sectoral review of the cost and benefits of the various schemes and the difficulties of sudden structural changes forced upon the Union and State Government on account of purely financial considerations. There are areas where the CS and CSS have added to planning capabilities of the States by providing research and other inputs of a level that the States cannot individually access on their own.

The complaints against CSS, emerge from a financial point of view and increasing size of central ministries. While successive plan documents have argued for curtailment of CSS, it is a patent fact that this did not carry conviction with central ministries and the demand of the states that the outlays meant of CSS should be transferred to them also appears to have put a spoke in the entire process.

What surprises one is that the persons and the agencies that are now vociferous on the proliferation of the CSS have all been participants in the decision making process -the Annual Plan exercises and Scrutiny and appraisals of schemes for the consideration of Expenditure Finance Committee. Should one take it that they did not exercise their critical faculties well in time, to prevent the proliferation they are now carping about? To be charitable to them,one could presume that schemes which appeared to be meritorious and deserving support when viewed in isolation in the meetings of the Expenditure Finance Committee, turn out to be a financial burden on the Centre when considered in their collectivity and cumulative financial demands.

As regards the argument that subjects in the state list, should be handled by the states, one should point out that the listing of subjects was for the specific purpose of enactment of laws, and defining taxation powers. This does not preclude the whole country from being treated as a common economic space for the centre and the states

Section-II 475

to operate in the combined manner for the benefit of the nation. The Mid Term Appraisal of the Ninth Plan states “The Department of Agriculture and Cooperation (DAC) has 182 attached/subordinate/autonomous offices under it. As many as 7500 people work in these offices, not counting about 30000 working for the Indian Council of Agricultural Research. All this is not withstanding the fact that Agriculture is a state subject. The Department runs 147 schemes with a total Ninth Plan outlay of Rs. 9228 crores”

The critical remarks overlook the fact that agriculture still accounts for 24% contribution to GDP 56.7% of employment of country’s workforce,14.7% of total export earnings apart from the well recognized increase in food grain production from 50.82 million tones in 1950-57 to 211.32 million tones in 2001-02 and in per hectare yield from 522 kgs in 1980-51 to 160 kg in 1998-99. It should also be recognized while Plan outlay on Agriculture and Allied activities has increased from Rs 354 crores in IFYP to Rs.42462 crores in the Ninth Five Year Plan, its share in Total Plan outlay has registered a steep fall from 14.9% to 4.9% in the corresponding periods.Agriculture’s share in gross capital formation is estimated to be a mere 6.62% (Rs16,545 crores in total economy’s gross capital formation of 274917 crores in 2000-01.Critics have been pointing out the low capital formation and investment in agriculture. Agricultural sector with the continuing importance of dry land, agriculture, oil seeds, and millet production apart from cereals and commercial crops continues to need supervising staff and research support.The current expenditure on this, is of a level that the nation can very well afford. What may be needed is reorientation and recasting of programmes to meet the current challenges of crop production and distribution in the WTO era. Farmers should not be without support of research at national level when global competition threatens them.

While research and technology have definitely contributed to the food security, and export potential, it must be recognized that the nation is yet to free Agriculture from the vagaries of monsoon, and food grain and commercial crop production are still vulnerable to seasonal fluctuation and investment in staff and research support for the farming community should be considered an essential charge on the nation’s resources. Dismantling of the structure established will involve avoidable waste of money and time and loss of experience gained from previous investments. While some CSS are in areas falling in the State List, it should not be forgotten that there could be economies of scale and of co ordination when the schemes are of common interest to several States.

The imperative need is to address the needs of Agriculture and allied activities, education and related subjects as sectors across the nation and set the relative sectoral financing priorities for the economy. While there could be no objection to take into account the totality of transfers from Centre to the States, by way of State Plan Assistance, Central Sector Schemes, and Centrally Sponsored Schemes and set a limit, segmented chopping of the transfer mechanism like transfer of only CSS to the states, maybe counter productive. From the financial point of view, the differential patterns of assistance of grant and loans should be done away with, and an alternative approach of linking budget support to mobilization of institutional finance can be considered. Review of the size of the central staff concerned with CSS can also be taken up to reduce the budgetary outgo.

Section-II 476

Table : 10.2 :- Centrally Sponsored Schemes Allocation (Rs.Crores)

1990-91(AC)

1991-92(AC)

1992-93(AC)

1993-94(AC)

1994-95(AC)

1995-96(AC)

1996-97(AC)

State-24 Andhra 264.47 365.43 418.65 577.68 431.74 476.01 565.29

Section-II 477

Arp 21.93 21.73 15.97 26.26 31.83 33.21 29.74Assam 113.64 116.88 84.32 132.37 279.82 135.97 134.02Bihar 250.41 485.85 676.70 769.39 416.13 575.80 90.46Goa 6.28 5.45 5.60 8.55 9.63 9.80 13.35Gujarat 164.15 93.74 194.20 434.22 330.89 - 197.24Haryana 84.10 105.56 120.82 169.99 117.12 136.78 182.68H.P 47.16 99.47 64.18 85.24 71.54 73.25 85.91J & K - - 7.03 7.34 8.37 9.53 146.53Karnataka 204.51 224.23 283.02 390.68 335.66 293.26 325.24Kerala 132.14 124.63 154.62 191.23 243.54 208.02 220.37M.P. 330.89 342.81 457.62 541.11 532.13 627.29 622.78Maharastra 396.18 417.04 452.31 588.67 372.45 462.04 480.94Manipur 15.35 30.89 17.92 25.15 28.75 36.83 62.10Meghalaya 12.93 24.16 16.11 24.79 19.85 22.15 21.39Mizoram 20.96 21.81 8.16 44.56 - 47.49 42.26Nagaland 37.40 59.51 29.08 40.15 63.06 - -

Orissa 208.25 258.49 272.00 309.99 217.96 196.02 243.25Punjab 55.14 88.25 101.60 113.26 123.76 115.69 126.65Rajasthan 267.12 291.36 348.38 431.82 440.06 395.56 594.85Sikkim 14.67 16.14 - - - -

Tamilnadu 253.78 278.91 264.25 440.81 279.34 268.12 223.73Tripura 22.95 22.92 17.32 42.52 31.44 30.11 67.79U.P. 725.01 874.08 1189.93 1024.18 485.10 505.71W.B. 129.01 255.59 169.80 161.97 155.80 228.98 252.99NCT Delhi - - - - - - -

All States 3763.76 4623.46 5485.73 6581.93 4540.87 4867.01 5235.24

Table : 10.2 :- Centrally Sponsored Schemes Allocation (Rs.Crores)

1997-98(AC)

1998-99(AC)

1999-00(AC)

2000-01(AC)

2001-02(RE)

2002-03(BE)

State-24 Andhra 536.61 552.07 671.19 752.67 1142.93 1433.65Arp 53.26 49.11 57.02 63.69 350.16 240.40Assam 118.42 181.35 209.58 222.63 515.22 531.74Bihar 261.77 91.21 684.66 512.11 424.08 682.84Goa 10.77 9.80 11.37 22.02 19.05 24.06Gujarat 257.14 222.61 303.40 229.89 579.23 578.78

Section-II 478

Haryana 183.00 186.27 213.64 163.64 355.69 536.90H.P 81.60 95.25 120.04 169.66 139.92 98.72J & K 161.70 124.85 97.16 145.62 180.00 180.00Karnataka 351.98 322.43 598.65 524.10 757.91 807.99Kerala 185.84 222.90 199.03 209.90 395.64 474.28M.P. 640.89 763.38 577.40 627.98 639.01 1000.24Maharastra 372.32 417.56 448.61 611.26 1237.43 1282.51Manipur 44.53 4.68 40.64 58.80 52.31 68.71Meghalaya 24.78 45.92 41.31 60.84 128.56 118.25Mizoram - - - 55.80 105.81 0.17Nagaland - - - - - -

Orissa 228.99 251.44 214.21 323.59 65.42 96.30Punjab 103.24 151.59 204.43 167.48 359.28 667.73Rajasthan 529.40 541.82 591.79 679.56 1064.72 1128.40

Sikkim - - - - 92.93 79.29Tamilnadu 392.50 465.76 513.87 539.23 406.43 557.31Tripura 61.74 106.23 84.07 90.18 81.27 112.03U.P. 599.83 695.64 808.75 391.16 1916.86 1601.04W.B. 294.98 427.20 280.78 448.73 541.27 521.66NCT Delhi - - 45.18 54.00 64.83 54.37All States 5495.29 5929.07 7016.78 7182.44 12173.21 14150.58

Section-II 479

Chapter XINorms For Maintenance Expenditure

The XII FC has been required in Para 6(VI) to have regard to “The expenditure on the non salary component of maintenance and upkeep of capital assets and the non wage related maintenance expenditure on plan schemes to be completed by 31st March 2005, and the norms on the basis of which specific amounts are recommended for the maintenance of capital assets and the manner of monitoring such expenditure.”

XII FC has in the TOR for this study, sought coverage of “Norms for admissible expenditure on maintenance of capital assets, category wise (such as roads and bridges, buildings, irrigation dams etc) and the methodology for computing non salary expenditure on maintenance of various categories of capital assets. Norms of computing maintenance expenditure on Plan Schemes to be completed by 31st March 2005 and methodology for segregating salary or wage related maintenance expenditure.”

Commencing from the Fourth Finance Commission constituted in May 1964, which was required to have regard among other things to requirement of the States ( in need of grants in aid under Article 275, “to meet the committed expenditure on maintenance and upkeep of plan schemes completed during the Third Plan,” successive FCs have been making recommendations on the sums required to maintain assets created under the Plan Scheme. The TOR for the Sixth Finance Commission was clearer in indicating the requirements of “adequate maintenance and upkeep of capital assets and the maintenance of Plan Schemes completed by the end of 1973- 74. The norms, if any, on the basis of which specified amounts are allowed for the maintenance of different categories of capital assets being indicated by the Commission” ‘Adequacy’ involved an element of judgment relative to the varying needs and local condition and reference to ‘capital assets’.

The Seventh Finance Commission was requested in the Presidential order of June 1977,to not only cover maintenance needs like the earlier commissions, but also indicate “the manner in which such maintenance expenditure could be monitored.”

The Terms of Reference for Eighth, Tenth and Eleventh Finance Commissions were almost identical except the date of plan schemes to be completed.-“The maintenance and upkeep of capital assets and maintenance of expenditure on plan schemes to be completed by…, the norms on the basis of which the specified amounts are recommended and the manner of monitoring such expenditure.”

Following perhaps the observation of the Tenth Finance Commission that salary expenditure of staff absorb maintenance provisions and the Eleventh Finance Commission’s reiteration of the suggestion of its predecessor on redesigning of the Accounts, the terms of reference for the Twelfth Finance Commission, seeks to focus attention on “the expenditure non-salary component of maintenance” and “the non wage related maintenance expenditure” on plan scheme.

Section-II 480

It will be seen that the TOR of the various Finance Commissions on Maintenance have been marked by initially by elaboration and later by refinement. As Dr.VKRV Rao explained(EPW,Nov 3,1973),”the elaboration of the reference to committed expenditure under the completed preceding plan projects makes it possible for the Commission to make realistic assessment of such expenditure, especially in terms of adequate maintenance and by indicating the norms used for the purpose not only to satisfy the states about the reasonableness of the calculations but also to ensure the observance of these norms by the State Government during the next five years” (Centre State Budgetary Transfers.P.88)There has been an increasing degree of specificity in the approach of various FCs to provisions for adequate maintenance expenditure.

The IX FC observed that “It would not be correct to state that previous FCs did not adopt any norms in re-assessing revenue receipts and non- plan expenditure of the states and the Centre. On the expenditure side, certain items of expenditure were wholly or partially disallowed. Again maintenance expenditure on irrigation, buildings and public works were projected on the basis of certain engineering norms. But norms were only selectively applied. In general, except for occasional disallowances, all other commitments made by the different States and the Centre as on a particular date were accepted and the norms were brought in only to determine the rate of the growth of expenditure items that were to be allowed.”(Para 2.33)Ninth Finance Commission explained that “in regard to the expenditure on the maintenance of assets, engineering norms have been applied in a graded scale, assuming that the full norms will come into operation in the last year of the Report (Para 2.15 of the Final Report)It also clarified that “the norms are relevant only in arriving at the relative entitlement to Central transfers and are so designed to ensure inter-state equity in working out such entitlements,” and that “the State Governments were free to raise resources and incur expenditure at such levels and in such manner as may be desired by its people and its Legislature.”

However the developments were not on those lines. The Tenth Finance Commission highlighted that in the process of fiscal consolidation at the Centre “fiscal deficit has been reduced primarily by reducing capital expenditure.” The X FC added, “in the case of the states, rising revenue deficits has also cut into maintenance expenditure in the Revenue Budget. In order to accommodate the rising interest payments and the growth of the wages and salaries which have come to be regarded as committed expenditure, maintenance expenditure has been treated as a residual item. This has had visible impact on infrastructure. The deteriorating conditions of roads, poorly maintained hospitals, neglected school and administrative buildings have together become a formidable supply side constraint on growth.Most assets like power stations, irrigation systems and highways are operating at levels below their capacity on account of poor maintenance and continued neglect” It further added that “Clearly an attempt to curtail the growth of expenditure must be accomplished by measures to protect essential expenditure on maintenance of existing infrastructure and creating of new capacities. This requires a change in the emphasis and priorities of government expenditure”(Para 2.16 to 2.20).

Like some of earlier Commissions X FC also drew attention to a weakness in the expenditure projections on account of classification of expenditure into plan and non plan. It observed, In an effort to project large plan outlays, inadequate provisions

Section-II 481

is made for crucial expenditure like the maintenance of existing assets which are in current practice, regarded as Non Plan expenditure and hence of low priority. New schemes take priority over maintenance leading to sub-optimal use of resources. We think that such a bias arises at least in part, from the artificial classification of expenditures between the plan and the non pan and the attitude of regarding all non plan expenditures as of low priority. It needs to be appreciated that a large part of non plan expenditure is of a developmental nature and should enjoy the same priority, if not higher as new plan schemes (Para 2.26).

Dealing specifically with the Maintenance of Capital Assets X FC drew attention to the post maintenance and observed that,” we are also extremely concerned that though successive Finance Commissions have provided for this purpose’ (maintenance) and actual expenditure have exceeded the provisions, most of it has got diverted to payment of wages and salaries rather than to materials and equipment necessary for maintenance work.”

Explaining the provision, it had recommended, X FC indicated that it has been “quite liberal” and was hopeful that’ this would motivate the State Governments to earmark sufficient funds for this purpose,’ and ensure that the funds are utilized efficiently and economically. the X FC also explained that(i) not more than 20% of provision would be spent on establishment and tools and plants in any year “ and that (ii) maintenance work may be done by groups of beneficiaries or non governmental organizations or even through private bodies, if they happen to be cost effective options.”

Pointing out that the maintenance of asstes continued to be neglected and that the monitoring mechanism suggested by the X FC had not become fully operative in all the States the XI FC attributed this to the three reasons – low priority to non plans in Budget allocations, diversion of funds to other areas and budget allocations are short of requirements and get used to meet Salary Exp (P.50)It recommended a total provision of Rs 28576.75 crores for roads and buildings Rs.9891.61 crores for minor irrigation projects and Rs.11709.10 crores for major and medium irrigation projects towards maintenance.

What emerges from the above review, is that successive FCs have considered maintenance expenditure as of vital importance and have in their assessments and awards, ensured proper provisions and yet the ground reality is that the state and the union government engineering organizations have not been able to ensure that assets created at considerable expenditure of funds are maintained properly.

The Planning Commission has drawn attention to an important aspect, stating that ‘a close observation of the States Budgets during the past decades reveal blurring of plan and non plan distinction of Government expenditure,’ and “misinterpretation of non plan as plan expenditure” and this meant ‘an underestimation of the genuine requirements for non plan Finance Commission which assess the non plan requirements of the States and accordingly award necessary share of Central taxes and grants ended up devolviong a lower amount. As a result the savings under non plan, which the States were banking upon, due to misrepresentation, did not materialize for augmenting plan resources. As a result, the misrepresented non plan schemes not only faced a tight plan budget but also found themselves in direct conflict with new

Section-II 482

schemes in matters of resource allocation. Consequently provision for maintenance of existing capacities suffered both on account of lower devolution by Central Finance Commission and a limited availability of plan resources. The benefits gained from the creation of productive capacities by new investment were therefore neutralized by the loss of existing capacities caused by curtailment of maintenance outlays.” (Tenth Five Year Plan, Vol III P4 ).

While the Finance Commissions have been rightly emphasizing the maintenance of immovable assets it may perhaps be necessary to draw the attention of the State Governments to the need for proper maintenance of (i) Vehicles of various descriptions owned by them (ii) Plant and equipment and (iii) Computer and other electronic systems in offices and hospitals. Some of these are covered by warranty and Annual Maintenance Contracts. There is a scope for considerable improvement and adoption of uniform systems in this area. While computerization has picked up pace and equipment purchase sprees is common to all states, there does not appear to be sufficient attention to maintenance by qualified and well trained staff or proper contractual agreements. Costly electronic diagnostic equipments in hospitals also suffer on account of poor maintenance There is need for as much attention to the maintenance of assets in Health and other sector as given to irrigation and buildings. Further while reasonably efficient systems and workforce were available in PWD workshops for maintenance of tools and equipments, there has been a decline in efficiency on account of attempts at privatization. There is need for clarity both in policy and budget provisioning in this area and prescription of practices consistent with efficiency and economy in expenditure.

Adoption Of Norms

As regards norms on the basis of which the specific sums required for maintenance are recommended, no radical departure may be necessary from the procedures prescribed by the previous Finance Commissions.It is quite instructive to refer to the detailed information obtained by the Seventh Finance Commission on the maintenance practices and procedures for buildings, roads of different categories, irrigation schemes and in flood control works etc and the manner in which it had worked out the norms. For computing maintenance provisions.

In respect of buildings, VII FC took note of change in the CPWD’ method of making provision for maintenance from norms based on percentage of capital costs, varying with age of the buildings to one based on the Plinth area of buildings. The commission obtained details of capital value of buildings as of a date and updated it for 1978-79.

In respect of roads, the VII Finance Commission consulted the Director General, Road Development, in the Ministry of Shipping and Transport and recalculated the cost of maintenance by providing an escalation of 45% to the norms adopted by the Sixth Finance Commission. In doing so the Commission took into account, the Natural zones in which the roads fall, as also traffic intensity.It adopted a traffic intensity of 150 to 450 commercial vehicles per day for state highways and 45 to 150 commercial vehicles for major district roads, and added to annual maintenance, provisions for ordinary repairs and periodical renewals and 20% for special repairs. It also made percentage additions for roads in hilly areas, heavy rainfall areas and desert

Section-II 483

areas. The VII FC also provided for maintenance of village roads remaining with the local bodies.To cover the cost of establishment, VII FC added 16% of the provisions and to cover tools and plants another 4%.

In respect of irrigation works VII FC corresponded with the State Governments and the Accountant General and gathered details of working expenses.It also obtained the views of the Dept. Of Irrigation, Government Of India since it found that the material components and work charged staff in expenditure varied very widely from state to state.

The VII Finance Commission examined

(a) The recommendations of the Dept of Irrigation covering (i) Gravity Canal Systems (ii) Lift Irrigation schemes (iii) tube well irrigations (iv)special repairs

(b) The recommendations on maintenance made by the Third Conference of State Ministers held – Nov 1977

(c) Assumptions in the Appraisal Reports of the International development Agency on projects in – MP, AP,Rajasthan, Kerala, Orissa.

It reached the conclusion that’” as a rule the provisions required on the account would be adequate of calculated at Rs.50 per hectare of gross irrigated area with an addition of 20% there of for special repairs. These provisions will include the cost of work charged and regular establishment and tools and plants.” The Commission adopted a norm of Rs.45 per hectare for states like AP, Kerala and Orrissa. In deciding the final provisions, the Commission assumed that the receipts from the projects should cover not only working expenses but also provide a return by way of interest at 1% on the total capital invested by the state at the end of 1978-79.

The norms were subjected to revision by the FCs that followed and the position emerging is summarized below

Table 11.1 –Norms for maintenance expenditure

Item IX FC X FC XI FCMajor and Medium irrigation

Rs.180 per hectare of utilized potential Rs.60 per hectare for unutilized potential & 30% more for hill areas

Rs. 300

Rs. 100

30%

Rs. 450

Rs.150

30%

Minor irrigation No Indication Rs.150/ Hectare Rs.225 per hectareFlood Control Work

10% over Exp of March 1990

30% more for hilly area

Buildings 180 to 220 % 250% over IX FC Compared to

Section-II 484

Age Yrs 10-20 20-40 over 40

over rates of 1998-89 rates for 1994-95 CPWD max of 25% over 1998-99

Roads Twice the rates adopted by IX FC

Adopted MoS & T norms with 5% increase in each Year

Accounting and Monitoring System

Tenth Finance Commission had pointed out that “it is not enough if liberal provisions are made for the maintenance of capital assets as in the past there have been misdirection of available resources as a large part of the provision has been absorbed by establishment expenditure” and that to ensure easy monitoring, “it was important to redesign the presentation of accounts in such a manner as to indicate separately the works component and establishment expenses.” This observation was prompted by the tendency to pre-empt bulk of the maintenance provisions for payment of salaries and wages, leaving very little money for the works component. The Tenth Finance Commission had in Appendix 3 of its Report (P.169 and 170) devised a scheme of accounts to show the works component and the work charged establishment separately under total maintenance expenditure’.

X FC had reviewed the major heads and the minor heads and indicated sub heads to reflect separately the provisions for works, provincial establishment and work charged establishment and presented a detailed scheme of accounts for monitoring of maintenance expenditure and suggested its adoption in consultation with the CAG. It also suggested the constitution of a High Power Committee under the Chairmanship of Chief Secretary of the State with representations with Finance, Planning, Irrigation, Public Works to review every quarter the allocation and utilization of funds. It also recommended constitution of the District level Committees

In its report Eleventh Finance Commission recommended that (i) the states should make budgetary provisions for maintenance of capital assets at the levels recommended by the FC (ii) Monitoring by a High Power Committee, as recommended by the Tenth Finance Commission should be actively operationalised.(iii)Budgetary provisions for maintenance of capital assets and committed liabilities on plan schemes should be assessed by the Planning Commission at the time of the assessment of state’s resources and estimation of balance from current avenues after devising a suitable mechanism for this purpose. XI FC noted that the suggestions of the Tenth Finance Commission regarding accounting system has not been adopted by all the states.

Recommendations

The Twelfth Finance Commission has been requested to have regard to and to indicate the basis on which provisions are recommended for ‘expenditure on’ ‘non salary component’ of and ‘non wage related’ maintenance expenditure. The terms of reference are far more specific than those indicated to the earlier Commissions which covered ‘Maintenance expenditure.’

Section-II 485

There are two issues to be considered. First, making adequate budget provisions for maintenance expenditure and two ensuring that the provisions are released and works carried out. The emerging weakness in the system is that, faced with financial stringency, State Governments do not release the funds required in time and whatever provisions are made, they are utilized for payment of salaries and wages. It is apparently hoped that making separate and clear provisions for salaries and wages and for works component, the maintenance works could be ensured. The realization of this hope hinges on the slender line that the engineering establishments will not resort to re-appropriation of the budget provisions to meet the salary demand. If for purposes of deciding budgetary provisions, earmarking of staff and works component, is considered desirable, one could broadly suggest that the salary component should be about 20 to 25 % of the total provision for maintenance, though individual state needs may depend on the extent of regularization of work charged establishment that has taken place. The total provision for maintenance, will depend on the nature and number of assets to be maintained. While in the past most State Governments had a list of assets of buildings and irrigation projects, almost all states had a reasonably good system of preparation of schedules of rates, indicating item-wise expenditure norms and scope for periodic revision by a Board of Chief Engineer.

One of the problems in the adoption of national level prescription of norms for works is that these are not adequate to deal with the vastly differing ground conditions in different states and this is the reason why the previous Finance Commissions made recommendations for maintenance expenditure in terms of percentage increase over previous stipulations. It may be appropriate if the Twelfth Finance Commission considers prescribing an inventory of assets, a periodic cycle of repairs and maintenance to be observed by the states and allowing the financial component to be worked out on the basis of the schedules of rates for different works. The staff component may, as indicated above be fixed at 20 to 25 %.

Twelfth Finance Commission may insist on 1) revision of schedules of rates on a regular basis, 2)Maintenance of registers of inventory of assets at the District and State levels and should be open to inspection by Superior Officers,of the State Governments and the Government.Of India, 3) The cycle of periodicity may be settled by the Finance Commission, in consultation with the CPWD,D.G. Roads,CWC and similar technical bodies of Government Of India. 4) carry out a review of the implementation of the Tenth Finance Commission recommendations by the states and the current status of accounts and make it compulsory for all the States to keep accounts in the manner suggested. This will enable the segregation of salaries and wages related, maintenance expenditure from the works component.

It is likely that even after this segregation takes place, the States may face some problems in ensuring proper maintenance, on account of funds constraint and problems of staffing.One of the major problems faced by some State Government relate to the Court Judgments ordering regularization of work charged establishment on grounds of legality without taking into account, in an adequate measure, the financial implications. This is one of the major reasons for the run of staff component on the maintenance provisions and the elbowing out of the works component. There is also a good deal of confusion on the front of new recruitment with a sizeable number of posts at operational level remaining unfilled or unoccupied. Freeze on new recruitment imposed for budgetary reasons have whittled the staff component. There

Section-II 486

does not appear to be regular review of staff strength and work load norms, in recent years in most of the State Governments.

What is required to improve the state of affairs on ground, may not be the refinement of norms for preparing budget estimates for maintenance but concentration on the methods of ensuring that there is proper match between the salary and wage components on the hand and the provisions for works component on the other and that the funds are released at the appropriate time for execution of works. Selection of agency for execution should take into account that maintenance works tend to be scattered in space and low in value of contracts. Some experienced engineers in the field feel that such works could be entrusted to local bodies or NGOs or cooperatives of unemployed engineers. The previous experience of states vary widely, and adoption of such a policy may not necessarily ensure execution of works on a cost effective and efficient manner, though in individual cases, such experiments could be commendable.

As regards the rates it may be noted that the Public Works Codes of State Governments provide for regular review by a Board of Chief Engineers and publications of Schedules of rates for various categories of works. These indicate general conditions for contracts, specifications of various items of works and norms for consumption of materials like earth work, brick work, concrete, plastering carpentry etc and materials like bricks, aggregates, Surki, Lime, Cement, Steel, Timber, and Glass. They also indicate labour rates per items, keeping in view the obligation to comply with provisions of Minimum Wages Act.It may not be necessary for the FC to get into the details for the purposes of computation of admissible items of non salary expenditure. There should be no objection to the FC providing a uniform rate of contribution from the Centre for different items of work and leaving it to the states to make up the difference if any on account of local conditions.

Given the diversity of ground conditions in different parts of the country and fairly well established practices of publishing schedule of rates, what may be required most and needs to be insisted upon is(a)preparation of an inventory of assets, prescription of a cycle or calendar of maintenance and periodical inspection by superior officers (b) a system of monitoring the works and budget allocation and utilization (c) and the adoption of separate account heads for salaries and wages and work components. The recommendations of the Tenth Finance Commission need to be carried further.

Section-II 487

Chapter XII Off Budget Borrowing and Contingent Liabilities

The Terms of Reference for this study includes- “Projection of expenditure liabilities on account off budget borrowings and contingent liabilities of the Centre and the states – View to betaken by the Finance Commission on such liabilities”

According to Article 293, clause 3,of the Indian Constitution ‘A State may not without the consent of the Government of India raise any loan if there is still outstanding, any part of a loan which has been made by the Government of India or by its predecessor government, or in respect of which a guarantee has been given by the Government of India or by its predecessor government”

In view of their large outstanding loans from Central Government,some State Governments began to constitute Special Purpose Vehicles for raising loan from the market with State Government guarantees, as they do not technically fall within the purview of the above restrictions. This was done mainly to meet what they perceived to be urgent requirements for completing certain projects in irrigation sectors to buttress their claims for river waters in inter-state disputes, and this got extended to other areas.

What is significant is that the resort to such innovative and at the same time burdensome practices were made by State Governments that were once considered financially well managed. Some examples are:-(i) Government of Maharashtra set up several PSU and authorized them to borrow and finance programmes in Irrigation, Water Supply and Power Sectors. While the Maharashtra Krishna Valley Development Corporation, Godavari Marathwada Irrigation Development Corporation, Konkan Irrigation Development Corporation, Vidharbha Irrigation Development Corporation, Tapi Irrigation Development Corporation have recently carried out such programmes in irrigation sector, the Maharashtra Pradhikaran in Water Supply, Maharashtra State Road Development Corporation in roads, the Maharashtra Electricity Board in the Power Sector have also been authorized to raise resources through bonds guaranteed and services by the State Government. It has been estimated that the Gross of budget borrowings, bonds guaranteed and serviced by the Maharashtra Government, has averaged Rs.2100 crores per annum or 0.9% of GSDP, per annum, between 1996-97 to 2001-02 and that gross guarantees given for bonds (excluding bonds serviced by the Government averaged Rs.800 crores or 0.4% of GSDP per annum in the same period.

(ii) Karnataka Government has also resorted to off- budget borrowing to finance investments in Irrigation, Roads and Housing. Krishna Bhagya Jala Nigam Ltd and Karnataka Road Development Corporation in roads, Karnataka Residential Education Institutions Society and Karnataka Police Housing Corporation in Housing are the agencies through which this has been carried out between 1996-97 and 2001-02. Gross off budget borrowing averaged Rs.1050 crores or 1.1% of GSDP per year and guarantees Rs.850 crores or 1% of the GSDP (See V.J.Ravishankar and Priya Mathur, “Facts from Figures in Public Investment in Infrastructure”, India Infrastructure Report 2003,Oxford University Press, P 165)

Section-II 488

(iii) Andhra Pradesh Government has also resorted to off budget borrowing to finance projects in power, irrigation, roads and other sectors.

The Study on Management of Public Expenditure in India (by the Indian Institute of Economics 2000, commissioned by the Planning Commission) had pointed out that “an important dimension to the discussion on sustainability of state finances has been added by the Reserve Bank of India in drawing attention to the growing trend in guarantees at the State level in the recent past on account of demand for extending guarantees for setting up basic infrastructure. State Government guarantees outstanding at the end of financial year had increased from Rs.40159 crores in 1992 to Rs.83075 crores by March 1999 and this had risk implications for the loans obtained from financial institutions.”

It is also to be noted that amounts covered by guarantees given by the Central Government had steadily increased in absolute terms, from Rs.58088 crores by March 93 to Rs 95859 the end of March 2002; even while registering a fall as a % of GDP from 7.8% to 4.2% during the same period. What is striking is that while the Central Government had continued with a measure of circumspection in extending guarantees, the State Governments have resorted to this with far greater frequency.

The rapid growth of liabilities on this account has been such that the State Government burden and risk has outstripped those of the Central Government as can be seen from Table 12.1

Table : 12.1 : Outstanding Government Guarantees Centre States Total

Amountas a % of GDP Amount

as a % of GDP Amount

as a % of GDP

1991-92 40159 6.1 1992-93 58088 7.8 42515 5.7 100603 13.41993-94 62834 7.3 48866 5.7 111700 13.01994-95 62468 6.2 48479 4.8 110947 11.01995-96 65573 5.5 53631 4.4 118204 9.61996-97 69748 5.1 63409 4.6 133157 9.71997-98 73877 4.9 73751 4.8 147268 9.71998-99 74606 4.3 97454 5.6 172060 9.91999-00 83954 4.3 132029 6.8 215983 11.22000-01 86862 4.1 168712 8.0 255574 12.12001-02 (P) 95859 4.2 166116 7.2 262965 11.5Source : Annual Reports of RBI

In Country Report no.03/261 titled India: Selected Issues and Statistical Appendix, (August 2003),IMF staff papers have pointed out that, “the level of outstanding guarantees grew even faster as States made increasing use of guarantees and other assured payment arrangements to finance investments, although in 2002, progress was made in reducing the outstanding staff. …These guarantees could well result in direct claims on State’s Budgets as the funds are mainly used for infrastructure projects.. Of the total guarantees 44.6% are for power projects 13.4% for irrigation, 0.7% for road projects” The IMF staff papers indicate that banking

Section-II 489

industry estimates show that defaults on states government guaranteed loans have exceeded Rs. 2500 crores (0.1 % of GDP) in September 2002. A steep increase from Rs. 1800 crores as at end of March 2002.

In the section on State Government Finances, it was pointed out that, “Fiscal activities are also conducted off budget through various State owned Financial Corporations and utilities and in turn the financials of these entities has deteriorated.”

Waking up to the situation in 1998-99,RBI set up a Technical Committee on State Government Guarantees and the Committee’s Report (February 1999,recensuring greater selectivity in providing loans and transparency in reporting Government Guarantees. Concern was expressed by the R.B.I as also the Eleventh Finance Commission over the tendency of the State Governments faced with the budgetary constraints, to consciously shift some of capital investment and liabilities to the public sector undertakings as a way of by passing the Constitutional restrictions in the Article 293.

While RBI has since indicated (Page 70 of Annual Report of 2001-02) that some State Governments have taken initiatives to place ceilings on guarantees and that the States of Goa, Gujarat, Karnataka, Sikkim and West Bengal have placed statutory ceilings and the States of Rajasthan and Assam have imposed ceilings on administrative ceilings. the same report however indicates that apart from the explicit contingent liabilities,State Governments also issue letters of comfort to banks/financial institutions to State Public Enterprises to raise funds and these implicit guarantees are not included in the RBI’s estimates of guarantees, which showed further increase of the amount covered to Rs 132029 crores by march 2000,Rs.169712 crores by March 2001 and Rs.166116 crores by March 2002.

In its Annual report 2002-03, Reserve Bank of India has once again pointed out that the growing size of contingent liabilities has implications for the sustainability of Government.finances and that the increase in contingent liabilities reflects the practice of setting up Special Purpose Vehicles and observed that, “Given the low user charges and inefficient operations of PSUs, these contingent liabilities are potential threat to the stability and the sustainability of the fiscal system.”

The RBI has also indicated that the report of the group to assess the Fiscal Risk of State Government Guarantees (2002) has made a number of recommendations to limit guarantees by the State Governments to as to contain the fiscal risk. These include “(i) Guarantees to be met out of budgetary resources should be identified and treated as equivalent to debt.(ii) For other guarantees, projects/activities need to be classified and assigned appropriate risk weights(iii) Mapping of guarantees and future developments(iv) Certain financial institutions should amend their acts/policies and do away with the practice of insisting on guarantee.(v) Regular publication of data regarding guarantees in budget documents(vi) State level tracking unit for guarantees(vii) At least one percent of outstanding guarantees to be transferred to the Guarantee Redemption Fund each year to meet the additional financial risk”

Section-II 490

(RBI Annual report 2002-03 P.68)

It is to be noted that in the case of loans obtained by 10 co-operative sugar factories and 12 co-operative textile mills in Maharashtra, a consortium of financial institutions like the IDBI, IFCI and IIBI initiated proceedings before the Debt Recovery Tribunal for recovery of Rs 163.79 crores plus interest and the DRT ordered the attachment of Government properties in Pune and the freezing by RBI of the State Treasury account. As per the report in the Times of India dated 29/11/03 the Government of Maharashtra was obliged to enter into an one time settlement of Rs 210 crores.

In its memorandum to the Twelfth Finance Commission the Government of Maharashtra has explained the background and implications of its resort to off budget borrowings which played havoc with its Finances of the State between 1997–98 and 2001-02, and as indicated that the number of unfinished irrigation works with the five Special Purpose Vehicles where 1117 and required Rs 35335 crores for completion. These are to be completed as non-performing assets. The memorandum explains that the interest and the repayments are so large that they cannot be honoured from the resources at its disposal. The sad story of a State Government that was a pioneer in the innovative practice of off budget borrowings has its lessons for other State Governments.

As regards the view to be taken by the Twelfth Finance Commission on such contingent liabilities, on account of guarantees it may be noted that the Eleventh Finance Commission had already expressed its views stating that, “Guarantees are not immediate liabilities but liabilities contingent on default by the borrower to whom the guarantees has been extended. In many cases the State Governments have given guarantees for their public sector enterprises. Sometimes the PSE’s are running in loses, the risk of default is also high. States are not alone in giving guarantees. Centre has also given guarantees and counter guarantees for the debts contracted by the various agencies and thus has increased its burden on their account. Based on the Finance Accounts data the RBI, in its report on Currency and Finance for 1998-99 has estimated that the outstanding guarantees obligations of the Central and the State Governments together account for 9.4% of GDP Cal 1993-94 prices, with Centre and States sharing responsibility in equal measure (4.7% of GDP).In our view, contingent liabilities form an indirect burden as the States and Centre’s finances as these have to be discharged in the event of the borrower failing to honor its obligation to the funding agency. We feel that there is a need to fix a limit on the giving of such guarantees by enacting suitable legislation and such limit should form part of the overall limits of borrowing under Article 292 and 293.” (Para 11.45 of the Report Page 107)

A different perspective on this issue is offered by Tapas K Sen, in his paper “Improving Sub – National Fiscal Responsibility in the Federal Context of India after covering second generation theories if federation and studies of experience in Latin America and Australia (See Tapas Sen.India Infrastructure Report,2003,pages 85 to 90,OUP 2003)

Tapas K Sen observes, “A rule based system controlling sub national debt is rarely sufficient by itself. After all the growth of contingent liabilities and some other

Section-II 491

forms of debt not under Central control probably represents a successful strategy adopted by states to borrow and spend while avoiding the constitutional constraints in their debt”.refering to a study of Germany by Helmut Seitz he notes that, “Even in an industrialized country like Germany where borrowings are supposed to be restricted to the amount of capital only, all levels of Government are quite innovative in developing procedures to circumvent debt restrictions. These practices include reclassifying current expenditures whose expenditures as capital (investment) expenditures, setting up entities whose operations are kept off budget and using innovative debt instruments such as private public partnership in running and financing infrastructure projects.” (Helmut Seitz, ‘Sub National Government. Bailouts in Germany ‘Research Network Working Paper No.R 396 inter American Development Bank 2000. He also refers to the papers of Marcelo Guigale, Adam Korobow and Steven Wett)

A new model for Market Based Regulation of Sub National borrowing - the Mexican Approach Policy research Workshop paper no 2370, world Bank) and states that Mexican system is too complicated and involves too many parts but manner of ensuring full disclosure can be emulated. Citing another study,Bhajan s Garewal,Australian Loan Council: Arrangements and Experience with bailouts, research Network working Paper no.R 397,Inter American development Bank Washington,2000

Tapas Sen observes that any complicated and non – interactive system is not likely to work for a long time. ‘An ideal should not be based on externally given inflexible limits, particularly when macro-economic parameters are given paramount importance at the cost of sub – national budgetary needs. “There is merit in this view point too and one needs to strike balance statutory restrictions on State Governments on borrowing entities and ensuring risk assessment capability of financial institutions. In the light of this survey Tapas K Sen suggests that a system with following features could be considered.

Substitution of plan loans by market borrowings Scaling down of Gadgil formula assistance by 50% consisting of entirely of

grants for special category states may continue Market determination of interest rates through a suitable mechanism operated

by the RBI possibility through auction of the State Government bonds. The State Government will be free to get their bonds credit rated by recognized agencies that RBI approves.

A disqualifying limit (say 25%) set by the ratio of interest payments to revenue expenditure of the concerned states, beyond which the RBI will not undertake to market the bonds

Negotiated loans of public enterprises, statutory boards, from financial institutions will not be provided with any form of government guarantees.Any state not observing the this rule will not have the benefit of marketing its bonds by RBI

A discretionary limit of another 5% of the same ratio provided RBI is given full information as the States liabilities and a credible plan for better fiscal management

Additional special ad hoc loans from the Central Government, the Quantum and the term specified only on the recommendation of at least 75% of the

Section-II 492

member of NDC which would decide special cases on the basis of an assessment by the Planning Commission and on a presentation of their case by the representative of the concerned state. Central Government will have a veto power but no loans can be given to States on its own by the Central Government.

“Such a system will address the basic concerns of macro economic imbalances, State autonomy and special considerations without unduly loosening the market regulations of sub national borrowings. Obviously this kind of supply side measures needs to be complied with measures on the demand side but one feels that excepting possible improvements in the estimation of normative revenues and expenditures for the purpose of statutory transfers and some marginal improvements in the system of plan assistance, the incentives in the present system of currents transfers as better than those that obtained in the poor, further improvements must weigh the trade off with simplicity as also with political and administratively feasibility. Further incentives for optimal fiscal behaviour must also come from the electorate but the system must be amended to allow complete transparency for the electorate to discipline errant Governments (11R.2003, P 89 and 90)

In our view, much of “ the fiscal risk “ has emerged mainly because the financial institutions and banks have too willingly allowed the substitution by State guarantees, of their basic responsibility for examination of financial and economic viability of the projects and enterprises seeking credit assistance. Failure of some high functionaries to discharge their basic responsibility in research of personal popularity and accommodation and support from political functionaries for career advancement has spread a virus in the fiscal and the financial systems and there is an attempt to pass this as ‘a systematic weakness’ and ‘failure’ to be treated by remedies like legislative changes. It is significant that in a case like Enron where guarantees and sovereign guarantees were utilized to finance a project in vital sector and chisel away public funds for private benefits, no one has yet been held accountable and asked to pay a price in India while in the U.S.A, the company has collapsed and its top executives have lost their jobs and perks and as per the news report of 28/11/2003 Enron Head quarters Building is to be auctioned. Judged on a relative scale some Indians who have participated in the decision making in the Government have not only been not held accountable but are too well taken care of by their international connections

To be effective, in the financial world risk assessment and

accountability for failure should be anchored in individual

responsibility and personal liability and not to be enveloped and

screened by institutional shields like government guarantee.

Such instruments like guarantees should continue to be available

but their use conditioned by specificity of exceptional

circumstances to be made explicit by the borrowing entity and

Section-II 493

admitted only after rigorous scrutiny by the lending agency.

What has been witnessed is not the venality of the instrument

but the wanton abuse of it. RBI’s study of State Finances (2003-

2004) has reported that “ in view of the financial implications of

rising level of guarantees, five states (Goa, Gujarat, Karnataka,

Sikkim and West Bengal) have imposed statuary ceilings, and

three states (Assam, Orrisa and Rajasthan) have imposed

administrative ceilings on guarantees.

Given this perspective, Twelfth Finance Commission which is primarily a body to make recommendations on the sharing of the resources between the centre and the states in the fiscal system, could well leave the issue of restrictions and the modalities to the financial system and its regulators to determine the conditions and circumstances that could permit the acceptance by financial institutions and banks of guarantees from the government at the Center and the States. Where such guarantees have been extended in the past there should be no hesitation to set in motion, the invocation of guarantees and initiation of the recovery proceedings.

It does appear that the RBI study – “State Finances - A

study of Budget 2002-03,” has correctly analyzed the fiscal

implications of State Government guarantees and properly

delineated the manner in which the issues need to be addressed,

by both the Governments and the financial institutions (P.32 of

the study).This is commended for the consideration of the

Twelfth Finance Commission. For its part, the Finance

Commission may stipulate that in respect of guarantees to be

extended by State Governments for loans to be obtained by the

public sector enterprises there should be a full-fledged appraisal

by the Finance Department of the projects viability and financial

status of the public sector enterprises and submission to the

Section-II 494

Cabinet for its approval. While the present Rules of Transaction

of Business in most State Government require Cabinet approval

for guarantees, they are being treated as a mere formality, and

there is no monitoring of the utilization of loan and propriety of

expenditure by any agency of the Government.The Twelfth

Finance Commission may prescribe a mechanism by which the

State Governments and the Union Government ensure that the

loans for which guarantees have been provided are utilized for

the specific purposes for which they have been obtained and are

not diverted to other purposes or used for covering budgetary

inadequacies.

Section-II 495

Chapter XIII

Fiscal Reform Facility

The emergence and spread of fiscal problems in the States, following the persistent fiscal challenge faced by the Centre in the 1990s has come to be widely acknowledged by the authorities at the Centre and the States.

The indicators of deficit for the Centre and the States at the commencement of three decades shown in the Table 13.1 spells out the secular decline and the more decent data in Table 13.2 confirms the persistence of the problem.

Table 13.1. Deficit IndicatorsCentre All States

(in Rs.Crores) 1980-81 1990-91 2000-01 1980-81 1990-91 2000-01 RevenueDeficit

2037 18562 77425 -1486 5309 53569(1.41) (3.47) (3.6) (0.11) (1) (2.5)


8299 44632 111275 3713 18787 89532(5.75) (8.33) (5.1) (2.73) (3.5) (4.3)

Net FiscalDeficit

5110 30692 111972 NA 14532 84698(3.54) (5.73) (5.1) (2.7) (4.1)

Primary Deficit

5695 23134 17473 2488 10132 37830(3.94) (4.32) (0.46) (1.83) (1.9) (1.8)

Figures in Brackets are % of the GDPSource : RBI

Table 13.2 Centre

(in Crores)

2001-022002-

03(BE)2002-

03(RE)2002-

03(AC)2003-

04(BE)2003-

04(RE) RevenueDeficit

100162 95377 104712 107879 112292 99850(4.3) (3.8) (4.2) (4.4) (4.1) (3.6)


140955 135524 145466 131306 153637 132103(6.1) (5.3) (5.9) (5.4) (5.6) (4.8)


33495 18134 29803 13502 30414 7548

1.5 0.7 1.2 0.6 1.1 0.3

Section-II 496

Table 13.3 All States

(in Crores)

2001-022002-

03(BE)2002-

03(RE)2002-

03(AC)2003-

04(BE)2003-

04(RE) RevenueDeficit

59233 48314 61302 49008(2.6) (1.9) (2.5) (1.8)


95986 102882 116730 108861 (4.2) (4.0) (4.7) (4.0)


33497 30629 42584 26573

1.5 1.2 1.7 1.0

Deterioration in fiscal position of the Centre and the states have been analyzed and causes identified. The RBI in its Annual Report for 1991-92 pointed out that the overall resource gap of the states began to increase mainly on account of worsening deficits on the Revenue account since 1986-87 and increasing resort to the financing of gap through loans from the Central Government, market borrowings and State Provident funds.(RBI Annual Report 1991-92,Oct 1992 page 45)

Dr. S.P.Gupta and A.K.Sarker traced the genesis of escalating fiscal deficit of the Centre to the burgeoning revenue deficits with the rate of growth of expenditure accelerating from an annual average of 2.6% in the Seventies to 10.8% in the eighties, with the acceleration of spending visible in all the three functional categories – Economic, Social and General.” In respect of States, Gupta and Sarker pointed out that in the eighties the revenue expenditure grew at an average of 17.6% per annum, much faster than growth of revenue receipts and attributed the deficit to the introduction of Overdraft Regulation Scheme and regulation of market borrowing.(The Fiscal Correction and Human Resource Development.EPW. March 26, 1994)

M.Govinda Rao and T.K.Sen have attributed the worsening of the fiscal position of the States to the increase in expenditure on quasi-public goods, subsidies and transfers following high expenditure growth at the central level, increasing requirements of matching contributions from the states resulting from proliferation of centrally sponsored schemes (Government. Expenditure in India, Level, Growth and Composition, National Institute of Public Finance Policy,1993)

RBIs study of the finances of State Government 1995-96 has pointed out that, “the aggregate consolidated budgetary position of the States Government in 1995-96 reflected an acceleration of the structural weakness in their finances. A matter of particular concern is the deficit of the revenue account which persists for the ninth year in succession and is estimated to increase by nearly 36% to Rs 10416.7 in 1995-96 (RBI Bulletin, Dec 1995,Page 1000)

Tenth Finance Commission’s Analysis

Section-II 497

Presenting an analytical overview of public finances, the Tenth Finance Commission observed that “ the macro economic vulnerability of the economy is linked in no small measure to the secular deterioration in its fiscal balance. The magnitude of aggregate deficits – Revenue and fiscal, had reached levels in the eighties that set the economy on a medium term path of stagflation and a recurring balance of payments problem. From a revenue surplus, the economy moved into a state of continuous deficit on revenue account in 1982-83.While in 1975 – 76, there was a revenue surplus of 2.5% of GDP revenue deficit reached 3.6% of GDP in 1990-91.This rise has been even faster than that in fiscal deficit which increased from 6% in 1974-75 to about 12% in 1990-91” (Report of Tenth Finance Commission 1994, Page 4)

The Tenth Finance Commission dissected the transition from healthy revenue surpluses that the system used to generate to chronic deficits and identified a three phase deterioration in the revenue account balance of all states by disaggregating the Revenue Account into Plan and Non Plan as follows1. First phase Non Plan Account Surplus was larger than Plan Deficit upto 1986-87 yielding an overall revenue surplus.

2. Second Phase Magnitude of Plan deficit increased sharply and became 1986-87 to1991-92 larger than the Non Plan Surplus which was declining

3. Third Phase Non Plan Revenue Account itself went into deficit After 1991-92

The Tenth Finance Commission went on to observe that, “the fact that all the States have almost identical turning points seem to suggest that there are systematic factors underlying this deterioration rather than State specific reasons…for the first time, not a single State has submitted a pre-devolution surplus on the non plan revenue account. Thus the problem posed to us was far worse than that faced by earlier Finance Commissions” (The Report of X FC 1994)

In 1995, a World Bank team in its Country Economic Memorandum on India, observed that, “ the financial and institutional weaknesses at the State level are becoming a major constraint to the provision of infrastructure and social services and pointed out that the State Government were accounting for 53% of the total combined expenditure of the Centre and the states, 56% of the expenditure on social services and 85% of total combined expenditure on economic services. The Bank offered the view that discrete changes in the policy regimes by a few Central Ministries and Departments (Finance, Commerce, Industry and Telecommunications) can no longer profoundly improve the enabling environment.” (India-Recent Economic Development Achievement and Challenges – World Bank – May 1995)

While the fiscal deterioration in the first half of the nineties called for attention, the later half of the Nineties was marked by the gathering clouds of political and economic uncertainty, delay in the finalization of the Ninth Five Year, economic sanction against India issued by U.S.A, Japan and others following nuclear testing as Pokhran, the East Asia crisis and conflicting estimates of growth rates of the economy in 1997-98 and frequent Elections. Political issues appeared to dominate the scene

Section-II 498

though there was clear recognition that the economy was slipping and needed corrective action. At the Inter State Council Meeting held on 22nd January 1998,the Chief Ministries of several States spoke of the poor financial health of the States and drew attention to their high level of borrowings. Presenting the Union Budget for 1998-99, the Finance Minister Yashwant Sinha drew attention to, “disquieting trends in the economy” and outlined the strategy to deal with them (Para.6 of the Speech)

Addressing the Economic Advisory Council, on October 14,1998, the Prime Minister, Shri A.B.Vajpayee drew attention to the strengths of the economy. (Low short term debts, higher foreign exchange reserves, orderly external market relations despite problems in the surrounding region) and the challenges (inadequate infrastructure, fiscal imbalance and price control).Emphasizing the need to get the nation back to the growth paths, Prime Minister outlined the main areas of concern(a)The need to reactivate growth impulse in the economy, improve confidence level and impart buoyancy to the investor decision making.(b)Need to take immediate measures to strengthen the financial services (improvement of quality of portfolios, reduction of non performing assets and provision of adequate finance for infrastructure development.(c) The need for reining in fiscal deficit (by reducing government expenditure, improving the efficiency of public expenditure with a sensible expenditure management policy, greater revenue buoyancy, improving the tax/GDP ratio, restructuring of public sector with a credible disinvestment programme)(d) The need to pay attention to monetary policy and price stability and to take measures to bridge the financial gap in the medium term, to increase the flow of direct foreign investment and positive FII flows and to ensure pick up in the export momentum(e) Need to build a broad national consensus on the sequencing and pace of reforms, keeping them India specific without being misled by global bench marks and the need for resetting goals according the requisite priority to social sector development in the country’s planning process.(f)The need to consider long term issues concerned with human resource development, demographic planning, a sensible labour policy and restructuring of the planning process.The clarity in Prime Minister’s prescription made a considerable difference in dispellingthe clouds over Economic Policy Issues and move the government to action.

In January 1999,the Finance Minister Shri Yashwant Sinha in his meeting with Economists for Pre Budget Consultations, indicated that the Agenda for action could be

(i) Pending Issues of Phase I of Economic reform such as Investment, Licensing, Prices, Distribution Control and Foreign Exchange Management.

(ii) Launching the Second Phase of Reform covering Capital market, Labour Laws, Law Reforms Competition policy, Public Sector Enterprise Reform.

(iii) Bringing Public Finances back on rails keeping in view the constitutional provisions, federal character of the polity, institutional changes needed and steps for changing the mindset of those in politics, bureaucracy industry and trade.

Section-II 499

It was more than evident that the task of putting the public finances back on the rails needed close and immediate attention to domestic economy though the Government was preoccupied with what the Finance Minister in his Budget Speech of February 1999,referred to as, “unprecedented global turmoil marked by East Asian financial crisis, recession in Japan, economic crisis in Russia, currency collapse in Brazil, disturbances in international capital flow and deceleration in World Trade – all impacting on the Indian economy without affecting its fundamental strength.” (Budget Speech of February 1999)

The problems faced by the State Governments on the financial front continued to demand attention, particularly the budgetary impact of pay hikes following the award of the Fifth Pay Commission. The fiscal indicators hoisted the Red Flag [See Table 13.4 for fiscal Indicators (1993-94 to 1999-2000)]

Table 13.4 Finances of State GovernmentsFiscal Indicators (1993-94 to 1999-00)

Revenue Deficit GFDOutstanding

Debt

Yearas % of GSDP

as % of GFD

GFD % of GSDP

as % of GSDP

1993-94 0.53 19.05 2.8 22.21994-95 0.83 25.55 3.24 21.681995-96 0.88 28.06 3.15 21.691996-97 1.6 57.61 3.36 21.621997-98 1.5 41.96 3.58 22.481998-99 3.19 60.86 5.24 23.991999-00 3.57 61.83 5.78 25.87GSDP is as per New Series 1993 -94 = 100

NDC Discussion

It was in these circumstances, that the 48th Meeting of the National Development Council held on 19th February 1999 deliberated on the fiscal problems faced by the States and decided that the Union Finance Minister could discuss the problems with a group of representative States and enable the formulation of a medium term fiscal strategy. This was followed by a meeting of the Union Finance Minister with the Chief Ministers and Finance Ministers of Seven representative states on 20th March 1999.It was agreed in the meeting that there was need for a joint effort of the Centre and the States to evolve a strategy to tackle the fiscal problem confronting the states and that there should be a package of measures including advance financial assistance from the centre along with an appropriate time bound programme of medium term fiscal reforms to be undertaken by the concerned States. It was also decided that a Committee of officials under the Chairmanship of Secretary Planning Commission could finalize the state specific fiscal reform programme and package of immediate financial assistance and further, monitor the implementation of the reforms programme.

The Fiscal Reforms Facility of 1999 envisaged that the Centre would make(a) tax devolution in advance during 1999-2000

Section-II 500

(b) provide ways and Means Advance(c) release plans assistance in advance

As the Economic Survey 1999-2000 explained, “the immediate objective of the financial package has been to assist States which have gone in overdrafts with the RBI subject to the states taking some concrete steps to address the underlying causes of their endemic financial problems and unsatisfactory growth. As the Ways and Means system is basically meant to tide over temporary mismatches between receipts and expenditure rather than structural deficits in the finances of the states, an extended WAM facility of Rs.3000 crores has been crated to address structural deficits in the State finances”

As Economic Survey had further indicated, the main objective of fiscal reform programmes was aimed at wiping out the revenue deficit in the medium term, with specific time bound measures aimed at

(i) reduction in non plan revenue expenditure through appropriate taxation and expenditure measures and downsizing of the Government where possible

(ii) Pricing/subsidy reforms to reduce the fiscal burden of the State and improve allocative efficiency

(iii) Institutional Reform to improve regulation and efficiency in delivery of public services

(iv) Reduction in the role of the Government from non essential areas through decentralization disinvestment and privatization.

The modalities finalized called for a Memorandum of Understanding between the

Centre and the State Governments covering the contents and action plan for the

medium term fiscal strategy.

Initially Nine States had come forward and signed the MOUs and by the end of 1999-2000 some more had joined.In all Thirteen States, Punjab, Rajasthan, Himachal Pradesh, Manipur, Nagaland, Mizoram, Orissa,, Sikkim, Uttar Pradesh,Madhya Pradesh, Assam, Andhra Pradesh and Jammu and Kashmir had signed Memoranda of Understanding(MOU) with the Union Government spelling out their medium term fiscal reform programme.While the first nine states signed the MOUs were indicated that assistance would be available to the extent of Rs.3387 crores, a sum of Rs 1183 crores was reported to have adjusted by Feb 2000.It has been indicated later that a sum of Rs.2570 crores was made available to the States.

In an assessment of the schemes of 1999, Dr.D.K.Shrivastava comments, “This facility was a one time measure. It was almost a non-starter. First, a majority of States did not sign the MOU with the Ministry of Finance. Secondly, once the advance money to which the States were even otherwise entitled was released, any pressure to pursue reforms was removed. Thirdly how can effective incentives for a medium term be provided if the incentive money relates only to the first year.” (See D.K.Shrivastava, Inter Governmental Fiscal Transfers. NIPFP Nov 2001, page 54 and 55)

Section-II 501


Even as the grim realities of the fiscal deterioration were confronting the Union and State Governments, and efforts were being made to emphasis the need for medium term fiscal reform strategies the time for constituting Finance Commission to make recommendations for the period 2000-05, had arrived. The Presidential Notification of 3rd July 1998 constituting the Eleventh Finance Commission enlarged the tasks of the Finance Commission, and stipulated that, “the Commission shall review the state of the finances of the Union and the states and suggest ways and means by which the governments, collectively and severally may bring about a restructuring of the public finances so as to restore budgetary balance and maintain macro-economic stability.”( Para 4 of the TOR)

The Commission was required to give its report by 31st Dec 1999 covering the period 2000-05. As the commission could not complete its deliberation owing to the pre occupation of states with General Elections the Commission was given on 28 th

Dec 1999 was an extension of time upto 30th June 2000 with the direction to give an Interim Report to enable provisional arrangement for 2000-01.The Commission submitted its Interim Report dated 15th January 2000 covering the one year period from 1st April 2000.

Placing the Interim Report on the table of Lokh Sabha on 16th March 2000, the Union Finance Minister dwelt on “ the critical challenges posed by a weakening fiscal situation’ that must be squarely confronted and overcome” and indicated that “ keeping in view the difficult fiscal situation and collective efforts of the central and the State Governments required in dealing with it, the Government has decided that the Finance Commission should draw up a monitorable fiscal reforms programme for the states and that the non plan grants to cover the assessed revenue deficit should be suitably tied up with the progress made in the implementation of the programme.” (Para 10 of Action Taken Report of 16th March 2000). In pursuance of this decision, an Additional term of Reference was issued by Presidential notification dated April28 2000, indicating that, “The Commission shall draw a monitorable fiscal reforms programme aimed at the reduction of Revenue Deficit of the states and recommend the manner in which the grants to the States to cover the assessed deficit in their non plan revenue account may be linked to progress in implementing the programme.” The Eleventh Finance Commission submitted its supplementary Report on August 30, 2000 with a Minute of Dissent by a member, Dr.Amaresh Bagchi.

The EFC’s scheme suggested the with holding of 15% of Rs.35359 crores, the grants under Art 275 recommended for 15 revenue deficit States (Rs.5303.86 crores for the period of 2000-01 to 2004-05) and its supplementation by a Central contribution of an equal amount of Rs.5303.86 crores to constitute the corpus of Rs 10607.72 crores, of State Fiscal Reforms Facility. The Commission recommended that the first part of Rs.5303.86 crores be released to only the 15 States assessed to be in revenue deficit and that for the second part all the States be made eligible and that the releases be made in both cases, linked to the progress in the implementation of reforms programme targeting five items (i) Growth of tax revenue treating 1999-2000 as base year and improvement assessed in relation to the growth rate assumed by the Commission in the main report

Section-II 502

(ii) Growth in non tax revenue with progress judged in relation to the growth norms used by the Commission in its assessment in the Main Report.(iii) Ceiling on growth of salaries and allowances with growth restricted to 5% or the inflation rate (iv) Growth of interest payment to be restricted to 10%(v) Reduction in subsidies which were to be reduced to zero in ten years on a Pro data basis

The EFC also recommended that the grants for specific purposes like upgradation of standards special problems, local bodies, which remain unutilized owing to non fulfillment of grant conditions by the states could be credited to the incentive fund during 2004-05. The Commission also suggested that the implementation of reforms by the states be monitored by a committee of officials and releases be made on the Committee’s recommendations. Presenting the EFC’s supplementary report of 30th of August 2000 to the Lok Sabha on 19th Dec 2000, Union Finance Minister indicated that the recommendations in the supplementary report “substantially alter the recommendations already made in the Main Report and accepted by government.Nevertheless the recommendation have been accepted by government in the interest of furthering the cause of fiscal reforms in the states.”

Notified Scheme of SFRF

After the acceptance of the supplementary report of the Eleventh Finance Commission, the Union Finance Ministry notified the scheme of States Fiscal Reform Facility (2000-01 to 2004-05), which traced the background of deterioration in the finances of the State Government in the nineties, the final recommendation of the Interim,Main and Supplementary Reports of the EFC, the composition of the total incentive fund of Rs 10607.72 crores, important features and objectives of fiscal reform proposed by EFC. The scheme circulated by the Ministry of Finance to the States called for time bound action points in the Medium Term Fiscal Restructuring scheme to be formulated by the State Governments covering (i) Fiscal reforms objectives (ii) Power Sector Reforms(iii) Public sector restructuring and (iv) Budgetary reforms.Initially only 15 states were assessed to be in revenue deficit, and the fiscal reforms programme recommended by the commission should have normally covered only these fifteen states. However in the supplementary report of 30 th August 2000 EFC recommended a monitorable fiscal reforms programme for all the states, and that 15% of the revenue deficit meant for 15 states during 2000 – 2005 and a matching contribution by the Central Government should be credited into an incentive fund from which fiscal performance based grants should be made available to all 25 states. Since the recommendation was made the number of states have increased to 28. Apart from the incentive additional amounts by the way of additional open market borrowings are to be allowed to the state concerned has a structural adjustment burden necessitating voluntary retirement payments for down sizing the public enterprises.

Finance Ministry indicated that each State must draw up a Medium Term Fiscal Reforms Programme and left to the states flexibility in designing the MTFRP, and that the releases from the Incentive Fund will be based on a single monitorable fiscal objective. Revenue deficit states were expected to achieve a minimum improvement of 5% in the Revenue Deficit as a proportion of their Revenue receipts each year till 2004-05.The base year was indicated as financial year 1999-2000. For revenue surplus states a 3% annual improvement in the balance from current revenue

Section-II 503

(BCR) as a percentage of their Non planned revenue receipts was prescribed to qualify for release from the Incentive Fund. The scheme notification also offered explanations of concepts and mechanisms of release and carry over of ear marked funds and indication of the composition of the Monitoring Council.

Commenting on the SFRF, in his study of “Intergovernmental Fiscal Transfers” Dr.D.K.Shrivastava of NIPFP raised two questions – ‘the broader issue concerning the design of suitable incentives mechanism by which fiscal reforms may be induced and strengthened in the states”, and the second, “the narrower question of the efficacy and implementability of the SFRF,’ and observed that “there is hardly any dispute that fiscal reforms are urgently needed at the state level. The issue is whether the central intervention of the proposed kind is the best alternative and whether even this will be adequate” He also pointed out that the guidelines issued by the Ministry of Finance were quite different from the EFCs majority recommendation. (i) the guidelines of SFRF to stipulates one condition for eligibility for release of funds - a minimum improvement of 5% in the revenue deficit (surplus) as a proportion of their revenue receipts for each year till 2004-05 with the base year being 1999-2000 though the EFC had suggested consideration of five factors,tax revenue, non tax revenue, expenditure on salaries and allowances, interest outgo and reduction of subsidies (ii) MTFRP suggests increase in tax rates on a year to year basis whereas stabilization of tax rates is desirable. (iii) Narrowness of the focus on revenue deficit as an index of progress in fiscal reforms since “the real casualty in many states is extremely low level of services of administration, education and health, i.e. services in the nature of public goods and high merit goods(iv) Absence of indicators of efficiency of expenditure and need for norms for transparency and efficiency. (v) States could shift expenditures on the capital side or off the budget, thereby meeting the revenue deficit target without any actual improvement in fiscal balance.(vi) States may only concentrate on getting the release of ear marked funds and may not be competing with each other for better fiscal performance.

Implementation of SFRF

The implementation of the scheme has been gradual. By November 2002 Medium Term Fiscal Plans were finalized for 16 States – Andhra Pradesh, Arunachal Pradesh, Orissa, Maharashtra, Kerela, Karnataka, Manipur, Sikkim, Tamil Nadu, Himachal Pradesh, West Bengal, Rajasthan, Mizoram, Meghalaya, Tripura and Jammu and Kashmir. By September 2003 plans were finalized for 6 more states namely Assam, Chattisgarh, Madhya Pradesh, Nagaland, Manipur and Punjab taking the total number of states covered by the programme to 22. The states not covered were Bihar, Goa, Gujarat, Haryana, Jharkhand and Uttaranchal.

During discussions in October 2003 officials of the Ministry of Finance indicated that the Ministry has taken up a Mid Term Review of the Programme, and its views will be communicated to the State Governments and the Twelfth Finance Commission.

Contacts established with the State Government officials revealed that not all of them were happy with the scheme as notified and it appears that SFRF is yet to be reckoned as a useful facility or a source of inspiration from the State Governments

Section-II 504

and much less the incentive considered attractive enough to bring the political executive to some degree of conformity with the dictates of budgetary prudence. State Governments appear to have serious reservations regarding the manner of creation of corpus for SFRF by withholding 15 % of the Grant under Article 275 and feel that it is a violation of the spirit of federalism and the constitution. It is their argument that Art 275 does not permit withholding of the grants.Some State Governments have even argued that the tax sharing and grants in aid schemes should be, as they were before and not converted into vehicles for carrying fiscal reform of some variety conceived by the Centre.It is their argument that incentives, if any, should be made available over and above the devolution suggested by Finance Commission. Some State Governments appear to have indicated to the Twelfth Finance Commission that achieving 5% improvement in revenue balance as proposed in the notified scheme is impractical.

There appears to be some degree of unease in some State Governments that the Union Finance Ministry is seeking to change the rules of the game with a view to holding back the funds earmarked as incentive for the State Governments. In brief, SFRF appeared to be facing more than teething problems. While the states may and do grumble, it must be acknowledged that incentives for performance are not meant to be disbursed as per the dictates of the State Governments and that the Finance Ministry is on the right track in demanding evidence of improvement in fiscal performance.

Finance Ministry (Department of Expenditure – Finance Commission Division) has carried out a mid term review of the States Fiscal Reform Facility as an internal assessment. According to this, while 22 states were covered by the programme, only 15 states had signed Memoranda of understanding with the Finance Ministry regarding the implementation of the programme and had received letters of exchange with the Ministry of Finance. As of 30th September 2003, this 15 states had received, as incentive a total sum of Rs. 3278.20 Crores for the period 2001 – 2002, 2002 – 2003 and 2003 – 2004. The year wise break up is given in (Table 13.5):-

Section-II 505

Table 13.5 – Releases from States Fiscal Reform Facility

Year Part A Part B TotalNo of states Amount No of states Amount No of states Amount

2001 - 02 9 1185.22 11 271.35 13 1456.572002 – 03 9 893.25 12 287.04 13 1180.292003 – 04 3 278.19 5 363.15 5 641.34

3278.20

As part of the scheme additional open market burrowings to the tune of Rs. 2363 Crores were allowed for 7 states namely Nagaland – Rs. 33 Crores, Mizoram – Rs. 70 Crores, Kerala – Rs. 250 Crores, Andhra Pradesh – Rs. 1200 Crores, Tamil Nadu – Rs. 500 Crores, Orissa – Rs. 300 Crores and Sikim – Rs. 10 Crores.

Under SFRF, Rs. 3154 Crores was extended as medium term loan facility for 6 fiscally stressed states, and of which Rs. 2794 Crores has been released. This covered Manipur – Rs. 371 Crores, Orissa – Rs. 692 Crores, Assam – Rs. 465 Crores, Rajasthan – Rs. 463 Crores, West Bengal – Rs. 438 Crores and Nagaland – Rs. 365 Crores.

The Finance Ministries interim assessment of the fiscal trends in the states showed that from 1999 – 2000 to 2002 – 2003, the states in general have been able to arrest the increasing trend in revenue deficit, while gross fiscal deficit were also marginally controlled. The assessment also showed that while the scheme envisaged reduction in revenue deficit of 5% each year, the performance of the states showed that as against 15% points improvement to be achieved over the base year. 1999 – 2000 the achievement was only 7.24%. The Ministry however feels that “considering the rapid deterioration in the trend from 1997 – 1998 to the base year 1999 – 2000 this by no means is an insignificant achievement”. The Ministry also noted that over a period of three years, the revenue deficit of the states as a percentage of total revenue receipts improved by almost 7% points, 4% point improvement on account of states own fiscal effort and 3% point improvement on account of central transfers and observed that “ The improvement discerned in states finances appears to be a combination of states own fiscal effort as well as a study step up in the level of central transfers”.

Comparing the performance of the states with the Finance commission reforms projections, the Finance Ministry review observes that “ on both tax and non tax revenues, the performance of the states have been approximately in line with what was projected by the Eleventh Finance Commission” and that “ the problem lies with trends for revenue expenditure. “ Even if the trends of non interest revenue expenditure have not decreased it would be safe the assume that the effects of the Fifth Pay Commission have reached a plateau. The crux of the issue is rising interest payments, as the EFC had underestimated the dimensions of the debt build up in the states.

Assessing the performance of 29 states in correcting fiscal imbalances between 1999 – 2000 and 2002 – 2003 the Finance Ministry review placed the states in four categories as shown in Table 13.6 :-

Section-II 506

Table : 13.6 - Fiscal Improvement - Classification of states.

Category Nature of Improvement No of states

Names of the states

1 Consistent improvement 6 Kerala, UP, Goa, Sikkim, Delhi and Chattisgarh.

2 Consistent deterioration 4 Gujarat, Himachal Pradesh, Uttaranchal and Jharkhand.

3 Initial improvement and then deterioration

12 West Bengal, Rajasthan, Punjab, Bihar, Tamil Nadu, Manipur, Madhya Pradesh, Assam, Haryana, Karnataka, Tripura and Meghalaya.

4 Initial deterioration and then improvement

7 Maharastra, Jammu and Kashmir,Andhra Pradesh, Mizoram, Nagaland, Arunachal pradesh and Orissa.

Seeking independently evidence of improvement in states fiscal health one finds that, there is no comfort available from the data on major deficit indicators put out by the RBI, which shows that Gross Fiscal Deficit, Net Fiscal Deficit, Revenue Deficit and primary deficit have maintained their rising trend at the aggregate level even after 1999-2000 (see table 13.7).The continuous deterioration from 1996-97 to 1999-2000 appeared to halt in 2000-01 but the previous trend resumed from 2001-02 with State Governments losing control over the actuals, even while budget estimates seem to indicate an intent to keep the deficits under control.

The State Governments seem to provide low budget estimates of deficits but this get modified at the Revised Estimate stage, and the Accounts figures that emerge show a deterioration from the previous year. The major deficit indicators as emerging in the BE,RE and accounts shown above confirm this. The slippages appear to be marginal when viewed in terms of their proportion of the GDP. But the absolutes are

Section-II

Table 13.7 Deficit Indicators of the States (Rs.Crores)GFD RD PD

1996-97 37251 (2.7) 16114 (1.2) 11675 (0.9)1997-98 44200 (2.9) 16333 (1.1) 14087 (0.9)1998-99 74254 (4.2) 43642 (2.5) 38381 (2.2)1999-00 91480 (4.7) 53797 (2.7) 46309 (2.4)2000-01 89532 (4.3) 53569(2.5) 37830 (1.8)2001-02 (BE) 95087 (3.8) 47060 (1.9) 30241 (1.2) RE 106595 (4.6) 60540 (2.6) 42092 (1.8) Actuals 95986 (4.2) 59233 (2.6) 33497 (1.5)2002-03 (BE) 102848 (4.0) 48223 (1.9) 30562 (1.2) RE 116730 (4.7) 61302 (2.5) 42584 (1.7) 2003-04(BE) 116175 (4.2) 48126 (1.8) 33251 (1.2) Figures in Brackets are % of GDP

507

significant and the extent of variation, a comment on the quality of estimates, if not on the intentions of the budget formulators.

In comparison with 2000-01, the absolutes as per revised estimates for 2001-02 showed that the GFD was higher by 20.3 % the revenue deficit by 15.7% and primary deficit by 14.4%. As for 2002-03, the variations as between Budget and Revised estimates were quite large Gross Fiscal Deficit Rs 13848 crores (13.5%) Revenue Deficit Rs12988 crores 26.0% and Primary deficit Rs 11955 crores 39.0% A closer look at the 2002-03 estimates shows that there were shortfalls in the States own revenue receipts, in terms of tax and non tax revenue and underestimation of expenditure a pardonable one in that the increase in expenditure was mainly on capital account caused by repayment of loans to Centre and financial institutions to retire high cost debt.

What may be of significance is the fact that as reported by the RBI in its Study of State Finances (2002-03), “the States have been undertaking a number of policy measures relating to the revenue augmentation, containment of expenditure and public sector reforms. The states initiatives towards fiscal reforms have also been supplemented by the Central Government recognizing the fact that significant improvement in the State’s fiscal health is feasible only in the medium term, a number of states have in consultation with Centre embarked upon medium term strategies towards fiscal consolidation.” (Page 1 of State Finances – A Study of Budget 2002-03).

Assessment of Ministry of Finance indicates that “ from the reform measures underlined by the states in the medium term fiscal reform programme for revenue argumentation expenditure compression, reducing debt burden, restructuring of public enterprises, power sector reforms and budgetary reforms, one can reasonably come to the conclusion that the states have been sensitized to the need for fiscal consolidation”. The revue however concludes that “ though the GFD and revenue deficit have come down and or projected to improve further, the EFC’s strong reform objectives of a GFD at 2.5% of GDB and Zero revenue deficit by 2004 – 2005 are not likely to be achieved. A programme that does not fully address the problem of a Plan Revenue Deficit will not be sufficient to eradicate the revenue deficit altogether” and that “ The facility has largely failed to address the problem of study convergence to a stable and sustainable debt path, however to the limited improvements made are not to be derailed, the facility must be strengthened, the weaknesses addressed by taking properly targeted correction.

State wise analysis does indeed reveal interstate variations that need to be addressed. In the Tenth Five Year Plan Document, Planning Commission has analyzed the trend in Revenue deficit and Gross Fiscal Deficit in the context of plan investments during the Eighth and Ninth Plan period, grouping individual States into four categoriesA. High Income B. Middle Income C. Low Income and D. Special Category States. It also makes Statewise analysis of sustainable fiscal deficit and argues that fiscal positions of all the States assessed together conceal more than what it reveals. Presenting the trends in sectoral distributions (Chapter 2,Vol.3) it argues that, “there is a case for explicitly introducing reform Linked Central Assistance” (Ch.5). But the main lesson to be drawn from even the limited experience with SFRF is that, in the

Section-II 508

view of some, the quantum of incentives earmarked for all the states is too small to make the States go for a major change in their policies and the release of incentive funds on the basis of a single parameter - improvement in revenue deficit may not be adequate and effective.

Even with Planning Commission’s support to MTFRP by

ensuring that Annual Plan frameworks are consistent with

MTFRPs, fiscal improvement is as yet not highly significant.

The SFRF incentives and additional Budgetary provisions by

Centre for Accelerated Power Development and Reforms

Programme, Accelerated Irrigation Benefit programme. Urban

Reforms Incentive Fund and Rural Infrastructure Development

Fund totaling about Rs. 12,300 crores were expected to prod

States towards speedier reforms and better control over fiscal

health. There is indeed an urgent need to link the releases to

improvements in Tax revenue, Non Tax Revenue, Revenue

Expenditure Containment, Debt Reduction and Regulation of

outgoes on interest payment and subsidies. The broadening of

the thrust may possibly lead to better distribution of the

earmarked incentives for fiscal improvement and consequent to

the greater enthusiasm on the part of the States in implementing

specific measures.

The RBI in its survey of the Finances of the State

Governments 2003-04 – A summary of Major Features, reports

that “ the finances of the State Governments have been under

continuous stress due to slow down in revenue receipts and

increase in non developmental revenue expenditure especially of

Section-II 509

a committed nature.This has been a constraining factor in the

efforts of the states to augment their development expenditure.

Fiscal developments 2002-03 indicate continued pressure on

state finances, the escalation in the borrowing requirements of

the State Governments over the years has led to continuous rise

in the level of state’s debt. On the revenue front near stagnation

in tax-GDP ratio has been a area of concern …fiscal

empowerment through revenue augmentation therefore becomes

crucial. (RBI Bulletin Nov 2003,Pg 766). The Finance

Ministry’s Mid Term Review suggests that SFRF could be

reviewed by examining the question of debt and guaranties and

focusing on a steeper convergence to a stable debt path as also

curbing state borrowings through special purpose vehicles by

disciplining both State Governments and All India Financial

Institutions in respect of lending against Government

Guarantees. Doubting the feasibility of a general debt relief

package offer by the Government of India the review suggests

classification of states into three categories of debts stress –

severe, moderate and no stress and evolving a package Central

Government and Bank Loans. It advocates the continuation of

the Debts Swap Scheme and rethinking on small saving

schemes. The Twelfth Finance Commission may consider this

suggestions in the light of the budgetary trends and fiscal

improvement, if any, shown by the states and strengthen the

Fiscal Reform Facility. Increase in the quantum of incentives,

Section-II 510

and broadening the indicators of improvement appear to be

necessary.

Section-II 511

Chapter – XIV

Ranking of States – Database and Criteria

The terms of reference for the study has sought ranking of

states based on efficiency using criteria such as debt burden,

quantum of interest payments, subsidies, salary expenditure,

pensions , availability of resources for provision of basic

services at minimum national average levels, availability of

resources for capital investment, revenue deficit , fiscal deficit ,

non development expenditure. It is necessary to set out, even at

the outset, the conceptual and operational issues involved in

attempting such an exercise, as the Twelfth Finance

Commission is a statutory body adjudicating the claims for

resources, of the Union and State Governments and its

recommendations are nearly in their nature of an award and

should therefore be based on sound principles and on reliable

data base.

For the analysis made in the previous chapters we have

drawn on data from the budget documents of the Government of

India and the State Government which have their limitations for

comparability for a Study on Public Expenditure Management,

commissioned by the Planning Commission we had assembled

the budget documents of all the Southern states, and of the

Government of India, and had compiled data published by

official agencies like the Ministry of Finance, the Planning

Section-II 512

Commission, and the Reserve Bank of India. We had also drawn

for that and the present study on analysis by the international

organizations, like the World Bank, the International Monetary

Fund and the Asian Development Bank as also on research

organizations like the Economic and Political Weekly Research

Foundation. It was found that the financial data published by

even official agencies were not strictly comparable, with one

another and need to be adjusted for various conceptual and

compilation differences. The problems relating to the use of data

on state domestic products are also well known. The budgetary

and accounting classifications pursued by Government of India

and the State Governments have their differences and need to be

understood, both in relation to the Constitutional requirements

and the host of practices that have evolved over the years.

Constitutional Requirement

The presentation of “The Annual Financial Statement’’ of the Union government to the Lok Sabha, under Act, 112 of the Indian Constitution, and of similar Financial Statement for each state under Article 202 of the Constitution to the State Legislature have by now, become time honored practices. The presentation of the government income and expenditure are in three parts (i) Consolidated Fund (ii) Contingency Fund and (iii) Public Account classified into Revenue and Capital accounts.

All the revenues which the government realizes the loans raised by it are the receipts by way of repayment of loans are credited to the Consolidated Fund of the government concerned. All the expenditures incurred out of this fund have to receive the specific sanction of the Parliament or the State Legislatures except certain expenses specified in the Constitution which are “Charged to the Consolidated Fund” such expenses like the salaries of the Judges of the Supreme Court, the Comptroller and Auditor General of India are included in the budget but not put to vote in the Parliament. The Contingency Fund consists of those moneys which are placed at the disposal of the Government for incurring urgent and unforeseen expenses which cannot be delayed. The expenditure out of these do not require prior Parliamentary or

Section-II 513

Legislative approval but need to be approved by them later for securing replenishment. The sums in Public Account Fund are those for which government acts as a banker and custodian without being a owner and includes collection of provident fund, small savings, deposits and advances. Payments of out of the public accounts do not require the sanction of Parliament or the State Legislature. Revenue Account covers those items of income and expenditure which are of recurring nature while Capital Account covers those items of income and expenditure relating to acquiring and disposal of assets. The justification for this classification is on the basis that current expenses are equivalent to consumption, which are different from acquisition of assets. The Indian Constitution demands that the budget must distinguish expenditure on Revenue Account from other expenditure but there is no specification regarding plan or non-plan or developmental or non-developmental expenditure. Since the commencement of the planning era it was the practices to present the Plan Budget, which showed the budgetary provision for important project, programmes and schemes included in the central plan with deails of budget support and extra budgetary resources, indicating a breakup of the total outlays between General Services, Social Services and Economic Services. Changes were made in mid 1980’s in pursuance of the recommendations of the CAG. According to the current practices the budget is split into plan and non-plan and within reach category there is a further division between revenue and capital accounts details are also furnished as per the classification of Plan and Non Plan expenditure. This has resulted in publication of more documents, adding to the weight and volume of the budget papers.

The Government of India budgets have 6 Accounts, covering Current (revenue), and Capital transactions, as indicated below: Account 1: Current Account of Government Administration; (Transactions in commodities and services, and transfers).Account 2: Current Account of Departmental Commercial Undertakings; (Transactions in commodities and services, and transfers).

Account 3: Capital Account of Government Administration and Departmental Commercial Undertakings (combined);

(Transactions in commodities and services and transfers).Account 4: Capital Account of Government Administration and Departmental Commercial

undertakings ( Changes in Financial Assets)Account 5: Capital Account of Government Administration and Departmental Commercial

undertakings (Changes in Financial liabilities)Account 6: Government Administration and Departmental Commercial undertakings

(Cash and reconciliation)

Economic and Functional Classification

Traversing into the past, once can trace, in the Govt. of India accounts, the start of the practice of publishing Economic Classification of the Budget to the late fifties and of the Functional Classification of Budget to the late sixties. These classifications are presented separately and we are yet to get a combined Economic and Functional Classification of the Budget items. The Government of India classification broadly follows the principles suggested by the Dept. of Economic

Section-II 514

Affairs of the United Nations, in its Manual for Economic and Functional Classification of Government Transactions, “published in 1959 with an important modification. While the UN Manual suggested classification of Expenditure into five heads (i) General Services, (ii) Social Services, (iii) Economic Services and (v) unallocable, the category of Community Services is not found in the G.O.I. classification. In spite of these elaborate exercises, some analysts argue that this classification does not help in assessing the full impact of the budget on the economy or its specific contribution to the fulfillment of important objectives of public expenditure like reduction of regional disparities and of income and wealth inequalities.

State Budget Accounts

The State Governments however present only three Accounts as against six of Govt. of India. covering

(i)Income and outlay Account of Administrative departments(ii)Production Account of departmental commercial undertakings and (iii)Capital Finance Account of the Government.

The Economic cum Purpose Classification of the State Governments also differs from the Economic and Functional Classification of Govt. of India. There is a division between Capital and Current expenditure with further sub classifications. Capital account is presented with details of i) Buildings and other construction ii) Machinery and equipment iii) change in stocks iv) Gross capital formation v) purchase of land assets vi) sale of land assets vii) capital transfer to local bodies viii) capital transfers ix)financial assets x) loans and advances. Current account is presented in three parts covering i) consumption expenditure including wages salaries and pensions etc ii) subsidies iii) transfer payments to local body and others . In some respects the detailed sub classification of Accounts of the State Governments enables a clearer analysis of the purpose of expenditure. However, there are differences in the practices adopted by various state governments and qualitative differences in classification and data presented which render inter-state comparison difficult.

While above classifications are useful, for some preliminary comparison, the data are not totally reliable. Unhealthy practices like parking of funds in Deposit Accounts have grown to avoid lapse of budget and these distort the figures presented to the Legislature and conceal the real picture from the public and analysts.

Section-II 515

Voluminous Documents

The presentation of the Union Budget in the Parliament or of the State Budgets in the Legislatures have come to be attended with public expectation, great hype and media attention. The documents presented are numerous. While the Annual Financial Statement is a brief one, the other documents like the Ministry wise Demands for Grants, Expenditure Budget in two volumes, Receipts Budget, the Finance Bill and Appropriation Bill can make dreary reading. Even experts confine themselves to the Budget Speech of the Finance Minister and Budget at a Glance. The Economic Survey that precedes the budget presentation, provides some useful material. Since the fiscal responsibility and Budget Management Act has come into force from July, the Finance Minister is expected to play before the Parliament three statements covering Macro Economic Framework, Medium Term Fiscal Policy and Fiscal Policy Strategy.

Dr. M.D.Godbole, Former Finance Secretary, Govt. of Maharashtra has pointed out that the Budget of the Government of Maharastra for 2000-01 consisted of 46 publications comprising 352 Demands running into 6336 pages. Further 57 performance budgets were also presented to the legislature and observed that “most of these budget publications comprise pages and pages of tabular material which an average person finds most unreadable. It takes a Herculean effort to pin point the information one may be looking for. In the maze of details, the larger and more important issues are lost sight of. There are hardly any analytical write ups which can enlighten any person on the critical issues in the sector..” (Making State Budgets Transparent and user Friendly, EPW April 21,2001 pgs1349-1358). There is perhaps a need for an intelligent man’s guide to budget documents to unravel the mystery of the budget figures.

Need for Transparency

Measures for revenue mobilization involved imposition of new taxes and levy and changes in the rates for the taxes and the levy’s already imposed. Since these involve commercial and revenue implications, there is a certain degree of secrecy maintained before the presentation in the Parliament. It has been argued in some quarters that the budget making is needlessly shrouded in secrecy and needs to be made more transparent. There is no unanimity of opinion on making their entire budget making an open affair. Expenditure proposals are not protected to the same extent as revenue raising measures, and these could be subjected to greater exposure to the public. There is already a new practice of publication of Annual Fiscal Framework by some state governments to indicate the broad details of expenditure proposals and obtaining public opinions and suggestions.

One should cause concern is however poor fiscal marksmanship of many state governments affecting the integrity of budgetary process. As the RBI has been pointing out there are serious variations between Budget and Revised Estimates of Revenue and Expenditure and the Accounts figures that is emerged later. In June 1999, the Reserve Bank of India constituted a Committee of State Finance Secretaries to suggest measures for enhancing the transparency of budget documents, and following its recommendation, a core group on Voluntary Disclosure Norms for state governments was also constituted to recommend improvement in the presentation

Section-II 516

aspects of the state budgets and bench marking of disclosure standards. The group suggested a common format for all the states, along the lines of the Budget at a Glance of the Central Government and suggested that the state governments should be persuaded to disseminate time series data on fiscal indicators like revenue deficit, primary deficit, tax revenue , interest payments, subsidies , contingent liabilities including guarantees etc. As of date only a few governments have implemented these suggestions and Twelfth Finance Commission, may like to not only review the status of implementation of the suggestions but also insist on the states carrying out the necessary changes in the presentation of their accounts .

The limitations of the systems of classification and the growth of unhealthy accounting practices, needs to be kept in mind, if ranking of states is to be considered. Expression of opinion on the performance of Union and State Governments or ranking of states purely on the basis of budgetary data, whether estimates or even actuals may not be wholesome. The classification of states on budgetary data may however help in gleaning and delineating broad fiscal trends, and in modifying sectoral allocations, setting up performance goals for various governmental departments and implementation agencies and broadly assessing their utilization of funds.

Comparative Analysis – A Universal Problem

Classification and ranking of states, for the purposes of

deciding criteria for statutory fiscal devolution, appears to call

for a measure of circumspection and care in selection of the data

base, with attention to the reliability and scope for interstate

comparability. Such circumspection is all the more necessary as

the recommendations of the previous Finance Commissions

have been the subject of avoidable controversies While the

Members of the Commissions made claims to have been

“objective” and “scientific”, these were not without serious

challenge in academic and official circles. Allegations of bias

have also been part of the Finance Commission lore .

Section-II 517

Even without questioning the expertise or the earnestness

of the members, or for that matter, their claims of objectivity,

one can see, in such situations, a problem that social scientists

and economists in particular have had to encounter in their

professional pursuits. As pointed out by Joan Robinson, “the

great difficulty in social sciences is that we have not yet

established an agreed standard for the disproof of an hypothesis.

Without the possibility of controlled experiment we have to rely

on interpretation of evidence and interpretation involves

judgement. We can never get a knockdown answer…. The lack

of an agreed and accepted method for eliminating errors

introduces a personal element into economic

controversies….The personal problem is a byproduct of the

main difficulty. Lacking the experimental method economists

are not strictly enough compelled to reduce concepts to

falsifiable terms and cannot compel each other to agree as to

what has been falsified. So economics limps along with one foot

in untested hypothesis and the other in untestable slogans” (Joan

Robinson, Economic Philosophy, Pelican Books, reprint 1978,

pgs26-28)

One can, in this connection also draw attention to the

observations of Gunnar Myrdal in his study, “The Challenge of

World Poverty”. Dwelling at length on “The Responsibility of

Economic Science” in dealing with the problem of policy

Section-II 518

choices Myrdal wrote of “Cleansing the Approach from Biases”

and observed that “Our policy conclusions are founded upon

ideas about reality that are systematically though unintentionally

falsified” This should not be surprising as “there is a tendency

for all knowledge, like all ignorance, to deviate from truth into

an opportunistic pitch” . Myrdal proceeded to comment on “the

lack of clarity of concepts and gross deficiencies in the basic

material indicated by the inadequacy of GNP data” and to

charge conventional economic research with “its extreme lack of

critical scrutiny of the statistical material.” In his view, the

uncritical attitude, in the field of production and income, has

made it possible to “measure” and “compare” the rate of growth

of individual under developed countries from year to year down

to fractions of a percent. Myrdal observed that “this is plain

humbug or to express it more politely, unwarranted precision. It

is not less so when these figures are dressed in impressive

looking economic models. The models represent loose thinking

presented as particularly rigourous analysis.” (see Gunnar

Myrdal in ‘Challenge of World Poverty’ Penguin Books 1970 ,

reprint 1971) One may also recall in this context the observation

of Oskar Morgenstern, made in his paper “On the Accuracy of

Economic Observations” that “the precise use of growth rates

are entirely inadmissible whether for comparing different

countries or prices in the same country”. Should such a caution

be administered in respect of interstate comparisons of fiscal

Section-II 519

performance in the Indian context ? Or should one proceed with

such comparisons after evaluating the quality of the information

base?

Information Base

It has also been argued out, for instance by

Dr.D.K.Srivastava, that “ in constructing a scheme of criteria

based devolution certain basic features concerning the

information base used for determining the respective shares may

be considered desirable. Some of these are i) information base

for reflecting capacities/ needs should be broad rather than

narrow so that fiscal performance can be properly estimated. ii)

The data used should be comparable across states and should

have been compiled using common principles. That is why

census data or income data on a comparable basis compiled by

the CSO have been used with much greater weight. iii) in the

case of tax effort data provided by the Finance Accounts are

preferable to budget data.However reservations have been

expressed by some state governments ( Tamilnadu for example )

on the reliability of the SDP data iv) data should be as upto date

as far as possible. (Intergovernmental Fiscal Transfers – for

Equitable In-Country Growth, Country Study, India,

D.K.Srivastava, NIPFP, New Delhi, November 2001, pg 41)

Section-II 520

Quality of Budgetary Data

While our search for data was exhaustive, and extended to

several sources, we found that even if one were willing to

overlook their deficiencies in order to formulate some

recommendations, there were serious reasons of academic

consistency, militating against such a willing oversight . These

doubts have been shared by others interested in the area of

public finance. The Economic and Political Weekly had

editorially drawn pointed attention to the quality of data

available, and observed that, “ there are problems of adequacy

reliability and transparency of budgetary data. The way the state

budgets are framed and presented in the budget documents

makes it very difficult to assess their fiscal health. For one thing,

seen against the actuals and the revised estimates, budget

estimates often turn out to have been way off the mark, raising

questions about the integrity of the budget….. While many of

the deficiencies inhere in the Centre’s budget as well, the non

transparency in the case of state budget seemed to be more

acute.” The EPW had also observed that “ Any attempt at

analyses of state budgets on a comparable basis encounters

problems because no all states follow a uniform system of

budget classification and accounting, not withstanding the

guidelines of the Comptroller and Auditor General.” (Editorial,

EPW, May17-23, 2003).

Section-II 521

The Reserve Bank of India has been rendering signal

service in the compilation and publication of data and analyses

of the state budgets in its Study of State Finances published

annually . While the RBI takes care to sift the data, and publish

the relevant clarification by way of foot notes, whenever it

departs from the original source , as for instance , with the data

utilized by the Ministry of Finance in Economic Survey, even

such data do not appear to be adequate for rigourous

classification of performance of states . Drawing attention to

this, the EPW editorial observed , “there are a few lacunae and

oddities that call for attention” and mentions that “ while

information on all key budget variables is available, the RBI

publication makes no attempt to normalize the data pertaining to

individual states either against the respective population (per

capita) or their Gross State Domestic Product. As a results, it is

not possible to readily make meaningful inter state

comparisons.” We share this view.

Collinearity and Other Issues

The TOR has suggested ranking of states on the basis of

interest payment, debt burden, salary expenditure, pensions and

revenue expenditure and non development expenditure. These

are interdependent. While seeking to classify the states

Section-II 522

according to the criteria indicated in the TOR, we were

confronted not only by problems of normalization of data but

also problems of statistical methodology like collinearity which

sometime underplay the effect and at others magnify the effect.

Ignoring such problems may lead to bias and distortions in

allocation formulae. Ranking of the states with such a

multiplicity of factors may lead to multiple classification and

may not bring out in specific terms the differences in the levels

of fiscal performances of the states.

Grouping/Classification of States

If differential treatment has to be accorded to the states,

some degree of even treatment can be ensured by grouping or

classifying states, choosing data relevant for the purposes for

which classification is attempted. We may need to keep in view

a) the classification of states into special category and non

special category based on locational and natural disadvantages

which has found acceptance among all states and b) income

based classification into High Income, Middle Income and Low

Income States.

Classification of states for a limited purpose has been

made, for instance by Eighth Finance Commission while

considering debt relief. It classified the states by taking the

Section-II 523

percentage of central loans (after excluding small savings and

overdraft loans), outstanding on 31st March 1984 to the State

Domestic Product (average for 1976-79) and divided the states

into four groups. Even this grouping was modified with

reference to the overall non plan capital gap. Such a

classification can be contested on the issue of exclusion of small

savings, or on the choice of the average of SDP for 1976-79 .

Experience has been that in many cases, where choice of

criteria has been reasonable and acceptable to all data

availability for determining shares of individual states appears to

have posed problems and in some, the choice of criteria itself

appears to have been influenced by data availability for

determination of the share of the individual states rather than the

relevance of the criteria itself. The dissatisfaction expressed by

some states over the allocation of the states shares can be traced

to the data inadequacies introducing weaknesses in the

application of the devolution formula. There is need to resolve

this dilemma.

Resolution of this dilemma can be attempted, if the

problems inherent in choosing parameters of an objective

formula are recognized and made explicit, without the

Commission making a claim for the formula being “wholly

scientific” or entirely “objective”. There can be some comfort

Section-II 524

however from the fact that the problem of choosing objective

formula, has been recognized to be a difficult one. As a Member

of the Tenth Finance Commission , Sri.B.P.R.Vithal put it, “

Whatever procedure we may adopt there are limits to what can

be achieved by entirely objective formulae , at some stage a

value judgement has to be exercised regarding the disparities in

the levels of development of various states, the manner in which

such disparities could be reduced and the time horizon against

which this will be attempted. Even so given the extent of the

initial disparities between different states, the objectives may

not be achieved merely by some ingenious formula for the

distribution of central assistance or statutory grants. For this

purpose several instruments will be required of which the task of

a Finance Commission will be only one.”

While it is essential to keep in view this limitation,

ranking of states may to some extent help in devising a

meaningful devolution scheme and a more purposive

distribution of grants-in-aid. Given the deficiencies in the data

base, it may be advisable to limit the choice of fiscal indicators

for evaluation and keep them strictly relevant to the core

purpose of the exercise. In respect of fiscal devolution

formulae, the key fiscal factors are a) revenue mobilization

b) quality of expenditure management c) Utilisation of debt

funds and containment of debt service obligations. Other

Section-II 525

factors may depend on these key factors, and emerge out of their

interaction. When all the key factors are considered together,

along with cost disability and resource deficiency of states as

also relevant factors, the devolution formula and other transfers

recommended by the Finance Commission may gain some

degree of balance, and be relatively less vulnerable to criticism.

Ranking of States

For taking various relevant factors into account for

finalisation of the devolution formula and determination of

grants, the Twelfth Finance Commission may consider among

other things utilizing,

i) the various ratios of fiscal indicators published by the Reserve Bank of India in its Annual Studies of State Finances

ii) Ratios published in the CAG’s Annual Reports on the Audit of the Accounts and Finances of State Governments.

The first has the merit of some degree of comparability

built into it by the competent compilation by experienced staff

of the Reserve Bank of India to even out data deficiencies, and

provision of some analysis with reference to the previous

performances of the states. But its weakness emerges from its

total dependence on the estimates in budget documents of the

Section-II 526

states, RBI cannot perform a verification of the figures

presented but can only comment on the poor fiscal

marksmanship of the states emerging from analysis of the

budget and revised estimates and the accounts figures presented

in the subsequent years. RBI’s effort’s to promote greater

transparency in budgetary disclosures has been commendable,

but only some states have complied with the suggestions made

by the Core Group on Transparency, since the recommendations

are not mandatory.

The CAG Reports have the advantage of information

gathered after close scrutiny of the accounts of the state

governments and can be considered more reliable, though the

Reports lose their thrust, by concentrating on procedural

propriety rather than the purposefulness of expenditure. Their

weakness is the lack of strict comparability as the reports are

prepared by different agencies, the Accountant Generals of the

states concerned. Still the financial data are more reliable.

Since the terms of reference for the study requires a

ranking of the states, we feel that this could be based on a

Composite Index constructed by a competent authority-

Comptroller and Auditor General of India based on verified

data from audited accounts of the state governments. An

analysis presented for the period 1996-2001, is likely to be more

Section-II 527

reliable than any ranking done by us based on budgetary data or

ratios published by RBI based on such data. It also happens that

the composite index is based on indices separately constructed

in respect of the key factors we consider important. The CAG

has also taken into account fiscal imbalances, which are in our

view influenced by revenue mobilization and expenditure

management.

Reports of the CAG on the audit of state government

accounts incorporate ratios like assets/liability etc following the

instructions of the CAG that the reports must capture and

present indicators of sustainability, flexibility, and vulnerability

of the finances of the states. The reports also publish

information on the number of days on which the states have

been on overdraft. These reports are presented to the state

legislatures, and the procedural requirements often impose a

time lag in publication of these reports.

Indicating that the approach to measuring and reporting

financial or fiscal health of the state government in terms of

either a single or a couple of ratios relating to deficits and debt,

“is too simplistic and lacks depth,” the International Centre

for Information System and Audit attached to CAGs office,

has published in January 2003 a research paper , “ State

Finances – A Critical Appraisal” covering the period 1996-97

to 2000-01 with data in respect of revenue receipts , revenue and

Section-II 528

capital expenditure and outstanding liabilities as emerging from

the audited accounts of the state governments. The analysis

presents details relating to all states, classified into general

category and special category states and provides an useful

starting point for ranking. The data presented are from audited

accounts except for 2000-01 in respect of three states MP, Bihar

and UP which were reorganized to form Chatthisgarh,Jharkand

and Uttranchal and these have been normalised with figures of

NSDP from Central Statistical Organisation. The data is

organized and presented, in aggregate terms for general category

and special category states and also for individual states.

Even more valuable is the attempt to construct a

Composite Index of Fiscal Health, encompassing all the

dimensions of the state finances. (see Tables 14.1 & 14.2) The

paper claims that this synthetic measure of state finances,

“captures multidimensional measures of the state finances and is

amenable to be viewed in different perspectives” While

admitting that, “the composite indices necessarily involved

aggregation and assignment of weights to different parameters

included in it and that it is difficult to escape some sort of

subjectivity inherent in these aggregations” the paper indicates

that they “serve useful purpose in bench marking and

comparison over time and across states which in many ways are

rather similarly placed. These indicators not only capture the

Section-II 529

static situation but the process as well and their movements over

time, providing policy options.” (State Finances- A Critical

Appraisal, International Centre for Information Systems and

Audit, January 2003)

The construction of the Composite Index of Fiscal Health

involves

a) classification of the states into general and special

categories,

b) identification of four components and assignment of

weights (Resource Mobilisation (0.25), Expenditure

Management (0.25), Management of Fiscal Imbalances

(0.10) and Management of Fiscal Liabilities( 0.20))

c) computation of NSDP growth, giving it a weight of 0.20

, as it is the final outcome of the state finances.

d) identification of four to seven indicators in each

component for purposes of constructing an index for

each of the components.

(i) Composite Resource Mobilization Index (CRMI) (ii) Composite expenditure Management Index (CEMI) (iii) Composite Fiscal Imbalances Management Index

(CIMI) (iv) Composite Index of Management of Fiscal

Liabilities (CDMI). Utilising these four indices a Composite Index of Fiscal Health (CIFH) has been compiled, to provide the comparative indicators of fiscal health of the states.

Section-II 530

Table 14.1 : Indices of Fiscal Management and Composite

Index of Fiscal Health –1996-2001

States CRMI CEMI CIMI CDMI CIFH

1.Andhra Pradesh 0.618 0.515 0.602 0.559 0.530

2.Arunachal SC0.306 0.659 0.890 0.311 0.501

3.Assam SC0.363 0.421 01.00 0.455 0.455

4.Bihar0.379 0.212 0.409 0.179 0.281

5.Chhattisgarh

6.Goa SC0.835 0.600 0.582 0.664 0.627

7.Gujarat0.707 0.730 0.403 0.452 0.490

8.Haryana0.497 0.580 0.589 0.727 0.540

9.Himachal SC0.597 0.356 0.218 0.273 0.488

10.J & Kashmir SC

0.590 0.300 0.480 0.213 0.504

11.Jharkhand

12.Karnataka 0.540 0.707 0.740 0.809 0.655

13.Kerala0.485 0.359 0.344 0.494 0.478

14.Madhya Pradesh

0.337 0.502 0.570 0.576 0.438

15.Maharashtra 0.471 0.652 0.613 0.723 0.557

16.Manipur SC0.221 0.453 0.440 0.351 0.463

17.Meghalaya SC0.406 0.438 0.769 0.556 0.599

18.Mizoram SC0.397 0.445 0.190 0.099 0.266

19.Nagaland SC0.362 0.249 0.574 0.099 0.230

20.Orissa0.337 0.452 0.090 0.120 0.323

Section-II 531

21.Punjab0.418 0.109 0.367 0.240 0.303

22.Rajasthan0.480 0.568 0.425 0.220 0.377

23.Sikkim SC0.692 0.429 0.591 0.615 0.601

24.Tamil Nadu0.513 0.461 0.572 0.868 0.594

25.Tripura SC0.438 0.383 0.730 0.362 0.515

26.Uttar Pradesh0.371 0.245 0.350 0.161 0.288

27.Uttaranchal

28.West Bengal0.071 0.222 0.140 0.401 0.367

General Cat States0.420 0.464 0.496 0.458 0.448

Special Cat States0.490 0.351 0.478 0.271 0.471

Source : CAG- State Finances- A Critical Appraisal, January 2003

Section-II 532

Table. 14.2 : Ranking of States According to

CAG’s Composite Index of Fiscal HealthCIFH Rank

12.Karnataka 0.655 16.Goa SC 0.627 223.Sikkim SC 0.601 317.Meghalaya SC 0.599 424.Tamil Nadu 0.594 515.Maharashtra 0.557 68.Haryana 0.54 71.Andhra Pradesh 0.53 825.Tripura SC 0.515 910.Jammu& Kashmir SC 0.504 102.Arunachal SC 0.501 117.Gujarat 0.49 129.Himachal Pradesh SC 0.488 1313.Kerala 0.478 1416.Manipur SC 0.463 153.Assam SC 0.455 1614.Madhya Pradesh 0.438 1722.Rajasthan 0.377 1828.West Bengal 0.367 1920.Orissa 0.323 2021.Punjab 0.303 2126.Uttar Pradesh 0.288 224.Bihar 0.281 2318.Mizoram SC 0.266 2419.Nagaland SC 0.23 255.Chhattisgarh 11.Jharkhand 27.UttaranchalSource : Compiled from CAG

Section-II 533

Chapter – XV

Leveraging Grants for Ensuring Efficiency

The TOR for the study seeks assigning weightage to efficiency parameters in determining the formula for horizontal devolution and prescribing minimum standards of efficiency based on these norms and using federal grants as a lever in promoting greater efficiency in expenditure management by the states and achieving a quicker equalization of public services across the states. The TOR also seeks the role to be assigned to past performance and the manner in which the criteria will operate in future.

A. Prescription of Norms and Parameters- Some Issues

While the identification of the immediate and long term

causes for deterioration in fiscal position of the Union and the

states, pose no problems from the diagnostic, or data analyst

points of view and the corrective steps could also be clearly

identified, both for the Centre and the states, the enunciation of

norms and parameters for, and assignments of weight to these

parameters in determining the formula for horizontal devolution

and prescription of standards and unit costs for performances of

public services appeared to call for some consideration and

resolution of issues with legal, political administrative and

operational significance.

The Twelfth Finance Commission has received a

Presidential mandate for suggesting a plan for restructuring

public finances at the Centre and the States and the Terms of

reference are broad enough for a serious and careful

consideration of problems of fiscal management, at not only the

macro level with which the earlier Commissions have grappled

Section-II 534

but also those at the micro level which in the normal course of

transaction of business by Finance Commissions, are best left to

the Union and State Governments.There is a methodological

risk in a body like the finance Commission or for that matter for

the Planning Commission, training its sights on the macro and

micro level issues at the same time, Sri L.K.Jha, who had

headed the Economic Administration Reforms Commission in

the eighties had while reviewing administrative planning and

implementation of projects, observed that, “let us recognize that

the very strength of those at the top with a wide horizon to scan

in taking planning decisions becomes a weakness when they

interfere in the functioning of an enterprise where a much more

detailed knowledge over a much narrower fields is necessary for

best results.” ( Indian Economy, Fiscal Research Foundation,

Har-Anand Publications, 1994, pg 117)

The recent experience of the Eleventh Finance

Commission’s prescription of targets for fiscal variables in

macro level terms of GDP ratio shows that, they have hardly

made any difference to the budgetary management by the Union

and State Governments and have had no perceivable impact on

the economy. In its main report, the Eleventh Finance

Commission laid down the broad parameters of fiscal

correction, over a five year period commencing from 1999-

2000, indicating that, revenue mobilization and expenditure

Section-II 535

containment by states should be done in such a manner as to

ensure that the GFD of the states as an aggregate fall to 2.5 % of

GDP, Revenue deficit of all states fall to zero, interest payments

as a percentage of revenue receipts to be between 18 to 20%.

EFCs supplementary report came up with further prescriptions

that, increase in wages and salaries should not exceed 5% or

increase in the Consumer Price Index which ever is higher,

increase in interest payments should be limited to 10% per year

and that explicit subsidies should be brought down in such a

manner as to be eliminated altogether by 2009-2010. But the

analysis of the budgets of the states show that the GFD /GDP

ratio had come down marginally from 4.3 % in 2000-01 to 4.2

% in 2001-02 and had risen to 4.7 % in 2002-03.Revenue deficit

increased from 2.5 % of GDP in 2000-01 to 2.6 % in 2001-02

and is likely to remain at the same level. The position relating to

interest payment is shown as below

01-02 02-03 BE 02-03 RE 03-04BEInterest payment 62489 72253 74146 82287Revenue Receipts 255599 306845 293873 332919

Ratio (IP/RR) 24.45 23.55 25.23 24.72

Administrative expenses was shown to rise from

Rs.27069.2 crores in 2001-02, Rs.30100.3 crores in 2002-03BE,

an increase of 11 %. It does appear that the fiscal restructuring

plan of the Eleventh Finance Commission has made no impact,

even though the Central Government had also set up the state

Section-II 536

fiscal reforms facility providing an incentive fund for

encouraging fiscal reforms in the states.

However, the very experience of Eleventh Finance

Commission prescriptions provides the Twelfth Finance

Commission with justification ample enough, to proceed with a

more detailed exercise of suggesting a plan for restructuring

spelling out the corrective targets in not only numeric terms but

also in programmatic and procedural terms.

Before proceeding to do so the Twelfth Finance Commission may like to consider and take a clear view on issues like the autonomous status of the states and diversity of political attitudes of the State Governments. The first involves an examination of the constitutional aspects and a decision whether the Twelfth Commission, like the fifth and the seventh Commissions would opt for a strict and legalistic approach or a broader approach in which the legal angle is just one aspect. The second calls for an assessment of the political circumstances in which the Union and State Governments are placed, particularly in the context of the general elections due in October 2004.

The Legal Angle

The Fifth Finance Commission while discussing the need for and a scope of re-distributive policy felt that the nature of states’ deficits on revenue account were not entirely ascribable to their low taxable capacity or their special problems and proceeded to observe that, “ under a federal constitution the states have plenary powers within their own sphere in deciding on their policies of taxation, expenditure and investment. It is difficult for a Commission or any outside authority to judge the propriety of these policies. It is not therefore possible to regulate the grants to the states on the basis of any judgment regarding the particular policies adopted by individual states.” This has led to some criticism that feel that the Fifth Finance Commission could have dealt with the issue, in the context of criticism against the gap filling approach, without avoiding it on ostensibly legal grounds. The Twelfth Commission may need, in the light of a specific mandate in its terms of reference to make prescriptions in the interests of restoration of fiscal health of the Union and the State Governments. Whether these prescriptions should be mandatory and take the form of conditionalities accompanying devolution of taxes and distribution of grants is a matter for serious consideration. Given the contentious character of some of the State Governments, it is desirable to have the legal aspects examined even at the outset. These arguments may appear to be avoidable hair splitting at this stage but one cannot rule out that in the contemporary political dispensation, with different parties

Section-II 537

leading governments at the Centre and the States, some states challenging Central prescriptions and approaching the Supreme Court on the constitutionality of any restrictive prescriptions, attached to tax devolution as distinct from grants. Further one must take into account that the composition of the Twelfth Finance Commission unlike some of the earlier Commissions has no person with legal back ground, “qualified to be appointed as a judge of High Court”, as specified in Provision-3(a) of the Finance Commission Miscellaneous Provisions Act 1951 and the judiciary will be only too happy to deal with the issue. The recent turf war over the appointments to the Competition Commission indicate a certain degree of sensitivity on the part of the judiciary. The Twelfth Finance Commission may like to avail legal advice from the Ministry of Law or Attorney General on the question whether its writ as a statutory body can extend to prescriptions of norms and parameters, enforceable as conditions to be fulfilled for entitlement of a share in Central taxes or grants.

Attitude of the states

As regards the attitude of State Governments, it cannot be ruled out that the response of the State Governments may be influenced not so much by merit per se of the prescriptions but by configurations of political parties in the pre and post election periods. Fractured electoral verdicts in the elections to the Parliament and the state assemblies have resulted in different political parties assuming reigns of the Government at the Centre and the States and in a contentious political atmosphere. This has led to political compulsions and adjustments becoming key elements in fiscal and financial decisions. This is not a mere apprehension, if one recalled that when the Sixth Five Year Plan was launched the then Union Minister for Planning and Deputy Chairman of Planning Commission Sri.N.D.Tiwari had in June 1981 written to the state Chief Ministers on resource mobilization for the Plan effort and monitoring of the implementation of the schemes. This was objected to by the West Bengal Government, whose Finance Minister Dr.Ashok Mitra quoted constitutional provisions in support of his opinion that Centre’s authority in regard to the states was confined to the enforcement of Central Acts and follow up of executive orders under those acts. He mentioned that the proposed review by the Prime Minister and discussion on different aspects of Plan implementation was, “constitutionally impermissible”. (see State Plans Propriety of PM’s Review, Plan Effort :Emergence of Strains and Sixth Plan - Emphasis on Implementation- V.K.Srinivasan, published in The Hindu, 3rd, 5th and 6th November 1981.) Dealing with different aspects of the controversy over Prime Ministers review of plan implementation by the states, the article argued that there were two sides to the thesis of fiscal domination by the federal government and the Prime Minister’s review, if viewed in proper light, may assist in speeding up implementation of projects in power and other sectors by helping to resolve issues relating to coal linkage, supply of generation equipment and inter-state movement of construction materials like steel, cement etc which were then posing problems. Prime Ministers intervention and instructions could speed up action by the central public sector enterprises. The emphasis was on seeing the review as a element of necessary coordination of different authorities rather than as an exercise in central hegemony. A similar positive view can no doubt be taken of any prescription emanating from Twelfth Finance Commission a statutory body consisting of experts reputed for their erudition and experience in fiscal matters.

Section-II 538

Operational Imperatives

There is a question of operational significance in a national level body prescribing norms and parameters for adoption by State Governments. It may be useful to recall some observations made in respect of financial services industry, in which state owned banks play a dominant role. Sri.M.Narasimham a veteran financial administrator with experience at national and international levels, and who was chairman of the Committee on Financial systems and the Committee on Banking Sector Reforms had observed that, “ the financial services industry ‘operates’ on the basis of operational flexibility and functional autonomy with a view to enhancing efficiency productivity and profitability.” Flexibility and autonomy are considered essential in areas calling for exercise of discretion in allocation of resources. As an area of management of scarce resources in the face of multi pronged demands and pressures State Governments are no less constrained than the banks though they operate on different planes of economic activity. What was said of the financial service industry has some relevance for the financial operations of the State Governments, and should not be ignored.

Leverage Effect

It is quite possible that the State Governments, in their current state of distress and deficits, may not openly challenge the prescriptions of the Finance Commission, but their willingness to abide by policy prescriptions and cost norms made by the Finance Commission may not be total. This issue becomes relevant, from yet another angle. The transfers made on account of the recommendations of the Finance Commission is only one of the three streams of transfers. The total transfers from centre to the states provide as earlier noted a declining level of cover for state expenditure. Between 1990-91 and 2000-01, the cover provided by the net central transfer for the state expenditure had declined from 34.8% to 28.5 % and that the cover by gross transfer had declined from 44.8 % to 39.8 %. The total current transfers from Centre accounted for 37.2 % of total revenue receipts in 2000-01 and 36 % in 2001-02. From the point of view of the Centre and its gross revenue receipts, the total transfers to the states had increased from 23.63 % during the First Five year plan period to 38.60 % during the Eighth Plan Period and amounted to about 35 % in the first three years of the Ninth Plan. Between 1951-52 to 1991-92, while the total transfers as a percentage of gross revenue receipts of Centre was 39.66 %, Finance Commission route accounted for 25.23 % (tax devolution 20.76%, Statutory Grants 4.47% ), Plan Grants 13.27 % and Discretionary Grant 1.6%, indicating the predominance of the Finance Commission route.

Of the total transfers of 39.66% tax devolution accounted for 20.76% and all the grants, ( statutory, plan and discretionary) 18.90%. The states can also claim that tax devolution is not a favour but their constitutional rights. Thus both the legal character and the quantum of Central Transfers may ultimately determine the effectiveness of policy prescriptions and cost norms as levers in securing fiscal discipline.

For any proposal to leverage federal transfers in prodding State Governments in fiscal reforms to be really effective, it is necessary to take the three streams of transfer

Section-II 539

together, keeping in view the finer distinctions between the purpose and nature of these flows of assistance. This inevitably gets into the familiar area of co-ordination between the Finance Commission , Planning Commission and the Union Ministries and the unending debate of relevance of plan and non plan distinctions, an area traversed earlier by many experts. The Sarkaria Commission had also gone into this aspect and favoured their continuance of the existing patterns.

Formula Vs Flexibility

The crucial questions that are required to be considered are whether federal transfers should be formula based of flexible, whether conditions should attach to the transfers, and whether the three streams-Finance Commission, Plan Assistance and Non Plan transfers should carry similar or different conditions appropriate to the purpose of the transfers.

While some Public Finance analysts appear to feel that there should be consistency and clarity in the formulae adopted for transfer to different states, eliminating discretion of whatever kind, those who have had operational experience at the state or the centre or exposure to the Planning Commission and Finance Ministry appear to feel that flexibility in approach has its own advantages, and that the existing patterns need not be disturbed purely for the sake of making a change.

If leveraging capability of transfers is the key objective, then the criteria for horizontal devolution should be more flexible, and the relative shares of tax devolution and grants, determined in a manner that could influence fiscal policies and programmes at the state level.The share of the grants may need to be higher as conditionalities are more easily attached to these and more readily accepted by the states than tax devolution formulae. However several State Governments have gone on record seeking higher share for tax devolution, which from their point of view provide a constitutionally guaranteed transfer of resources less amenable than grants to adjustments, if not manipulation on political grounds.

The experience of the State Fiscal Reform Fund (SFRF) may have to be carefully assessed in this regard. As of early 2003 the utilization of funds provided, did not appear encouraging though as many as 18 states had prepared Medium Term Fiscal Restructuring programmes. It is relevant to note that corpus of this fund was made by withholding 15% of the revenue deficit grants, assessed to be the need of 15 states, to be released to only those states, while the other states were made eligible for the balance of the Fund to be contributed by the Centre. If SFRF experience is any indication, such incentive funds should be made more attractive, and should be an additionality to the entitlements of the states settled by the Finance Commission. The Twelfth Finance Commission may like to consider and recommend changes in the size of the corpus of such funds and the manner in which states can claim their entitlement on the basis of performance.

Lessons From Reform Experience

The fiscal restructuring may call for reform of existing structures and reorientation of attitudes in the relations between centre and the states, and some of these may impinge on administrative and financial institutions. Twelfth Finance

Section-II 540

Commission is not the first body to have been required to consider or propose changes in the structure of financial and fiscal administration. The past Indian experience in considering need for reform and in implementing suggestions for reforms has many useful lessons. In the area of fiscal federalism, the interim arrangement proposed by Sri. C.D.Deshmukh in the late forties, Report of the Expert Committee on financial provisions headed by Sri.N.R.Sarkar (1947), the Report of Indian States Finance Enquiry Committee chaired by Sri.V.T.Krishnamachari, Oct 1948, helped in setting the structure which the Indian Constitution finalized giving it a legal shape to the federal fiscal frame work. Operational issues with implications for efficiency in performance were also considered by a number of Committees starting with the Report on Re-organisation of the Machinery of Government, N.Gopalaswami Iyengar,1949, Report on Machinery of Government, Improvement of Efficiency by R.A.Gopalaswami,1952, Note on changes in the system of budgetary and Financial control A.K.Chanda (1954). Several Parliamentary Committees particularly the Estimates Committee have come up with recommendations in their reports of 1956, 1958-59, 1959-60,1960-61 etc. The Pay Commission Reports of 1946 and 1958 and 1973 also made useful suggestions. In the late sixties an high powered Administrative Reforms Commission published 19 reports making 600 recommendations, after several Study Teams, deliberated for long and came up with valuable suggestions. Some of the recommendations like those on the Centrally Sponsored Scheme continue to figure in public discussions and one can say that some changes though not very drastic came about on account of ARC recommendations.

On the basis of recommendations of ARC and Public Accounts Committee many changes were effected in the Demands for Grants and in the presentation of budgets.In 1974 Government introduced a revised accounting structure intending to serve the purposes of management as well as the requirement of financial control and accountability. As a result of these changes there has been increase in the number of budget documents submitted to the Parliament but one cannot say that the opacity of the budgetary process has been reduced.

Again in the early eighties the then Prime Minister Mrs.Indira Gandhi sensed certain weaknesses in economic administration, like delays in clearances for projects and in their execution. The result was the Economic Administration Reforms Commission (EARC ) set up in 1981. The EARC submitted as many as 37 reports by July 1984 and the implementation of these reports was monitored from the Prime Minister’s office. As compared to the ARC, EARC faired better in the implementation of its suggestions. The then Prime Minister Rajiv Gandhi had gone to the polls with a promise of a ‘Government that works’ and on return to power set the first wave of liberalisation and change of procedures.

It may be mentioned that Herbert Kaufman (The Limits of Organisational Change, Alabama University Press, 1971) had classified barriers to change under three major headings, a) Acknowledged collective benefits of stability b) calculated opposition to change and c) inability to change. In the Indian context, some of these elements have been present. This study confined to specific terms of efficiency of expenditure is perhaps not the Forum for a full fledged discussion of the two approaches to social and administrative change a) incrementalism, calling for a marginal approach to the problem of change with higher degree of pragmatism as its distinguishing feature and b) ideological reform seeking a change in the belief system

Section-II 541

with a comprehensive view of the polity and the direction of change from which prescriptions of policies and programmes emanate.

It can however be noted that as pointed out by Dr. C.Rangarajan, “Economic reforms come in waves. In our own country the first wave of reform started with launching of planning with an emphasis on industrialization more particularly of heavy industries. The second wave, the precise dating of which may be difficult, began when it was found that the growth rate was weak and the trickle down effect was not adequate and when the need to focus directly on poverty alleviation become evident. The third wave which began in the late eighties gathered momentum after 1991. The period since 1991-92 have seen some important changes in the approach to and content of economic policy (Economic Reforms in India, Some Issues and Concerns, Convocation Address at the University of Hyderabad, Asian Economic Review, April 2000). Offering what could be considered as the philosophical base of the reforms programme of the nineties, the then Prime Minister Sri.P.V.Narasimha Rao in his preface to the Eighth Five Year Plan stated that, “ the Plan is being launched at a time of momentous changes in the world and in India. The international political and economic order is being restructured everyday and as the Twentieth Century draws to a close many of its distinguishing philosophies and features have been swept away. In this turbulent world, our policies must also deal with changing realities. Our basic policies has stood us in very good stead and now provide the opportunity to respond with flexibility to the new situation so that we can work uninterruptedly towards our basic aim of providing a rich and just life for our people.”(Preface to the Eighth Five Year Plan 1992-97, Planning Commission, 1992)

The policies that the Prime Minister referred were those directed towards objectives of Growth with Social Justice, Self Reliance and Balanced Regional Development assigned important place in planning with emphasis on Equity and Distributive Justice. The changes were prompted by a feeling that the rate of growth of the Indian Economy was relatively lower than what it could have been, mainly on account of multiple objectives pursued. For instance Dr.I.G.Patel observed that, “ in our anxiety to increase the supply of factors of production and reduce the constraints on growth and out of excessive zeal for distributional justice we have overlooked the importance of an efficient use of existing resources…….. the kind of use that generates the maximum growth potential for the future.” (Economic Reform and Global Change, Macmillan India, 1998)

Reforms in the Nineties

During the nineties, Economic Reform covered a) fiscal reforms b) industrial policy reform c) trade reforms d) banking and monetary reforms e) public sector management and f) expenditure reform, calling for restructuring government departments and creation of new institutional mechanisms. Both acceptance of recommendations and their translation into action were swift as compared to the earlier decades. Despite this there has been some criticism of the pace of implementation of reforms. Some of the proposals made as part of economic reform it has been pointed out, carried with them a certain universality of prescriptions without taking into account, local conditions specific to India. It was also argued that the problems faced were similar to those faced by development administrators in the implementation of administrative reforms in an earlier period which were attributed

Section-II 542

by James Bjorkman “ineffective administrative procedures and managerial techniques, inadequate development institutions and inappropriate governmental structures.” It was argued that the complexities of administration required “ a deep understanding of the varieties that affect programme implementation especially political, behavioral, cultural, economic and physical factors.”(Implementation and Development Policy, Strategic Concerns of the Public Sector In India, International Secretariat for Public Enterprises, Sept 1994). This realization in its turn led to the appreciation of the need for institution building to accompany reforms to ensure effective implementation. In respect of Economic Reforms Programme there is a distinctive difference in the approach to implementation as exemplified by gradualism and attention to institutional factors.

While the reforms initiated in the mid-eighties sought to modify regulatory procedures and protocols in industrial and other regimes, the reform movement of the nineties covered a wider range of administrative changes and establishment of new institutional mechanisms in the areas of industrial licensing, Capital Market, Foreign investment, prices and distribution controls. Experience in the implementation in some of the programmes led to a realization that they were rooted in a response to a crisis situation and called for more attention to legal and institutional changes. This led to the launching of what is called a second generation reforms to grapple with the structural features of the Indian Economy. The structural adjustment programmes advocated by some in the nineties called for changes rather sweeping in character across many sectors of the economy. This faced the unwillingness of the elected government to rush into many areas with hasty legislations. Clarifying that the first generation reforms initiated in the early nineties were mainly administrative in character and the second generation reforms called for legislative changes in several areas which are marked by difficult contentious and controversial issues, the Union Finance Minister Sri.Yeshwant Sinha argued that India cannot be hustled into globalization and that it was the responsibility of every government to manage globalization properly. There is much merit in such a moderate approach, and some of the factors mentioned are equally valid for fiscal restructuring. What has been said about global prescriptions for change and their suitability for application in India and other developing countries, appear to be relevant to formulations in the fiscal sector and their applicability to different states with pronounced diversity in resource endowment, levels of development and availability of social and economic infrastructure.

Recommendations

While these considerations call for careful attention, in the context of a national body making specific prescriptions of cost and performance norms, for adoption in all states, and there are, at the same time operational difficulties in prescribing state or region specific cost norms which may have greater applicability and acceptability, the Twelfth Finance Commission may consider whether prescriptions if any should be brought about in stages. As the first step in fiscal restructuring, the Commission could bring about certain uniformity in administrative procedures, financial rules and delegation of financial powers to administrative, technical and other sub-ordinate agencies of various State Governments. There is at the moment a bewildering variety of structures and vast differences in the rules and regulations, methods of accounts to regulate budgetary provisions and releases of

Section-II 543

funds. Introduction of uniformity may enable better control over utilization of funds. Methodologies for estimating economic growth which vary from state to state, need to be standardized to permit inter-state comparison. The levels of expertise to make qualitative and quantitative appraisals of schemes and projects vary from state to state. Suitable prescriptions of appraisal and scrutiny procedures, and ensuring training for State Government personnel can help in preventing costly errors in estimation and wasteful expenditure.

A group of Finance Secretaries and other public administration experts can be constituted to review the rules for delegation of financial powers and procedures as also to consider changes in the treasury and PWD codes. The RBI has attempted to enhance transparency in states’ fiscal position by constituting an Advisory Group on Fiscal Transparency and the Core Group on Voluntary Disclosures norms for state budgets. The Commission may review the extent to which the recommendations of these groups have been adopted by the State Governments and may also consider prescribing a time schedule for their adoption. Once the ground realities are improved, through systemic changes, it may be time for the second stage of prescription of cost norms and performance standards at the micro level. The prescription of cost norms and other conditions will be effective only if conditions conducive to their ready adoption are available in most of the states.

B. Economy and Efficiency – Revisiting Concepts

The terms of reference for the various Finance Commission have specified considerations for “economy” and “efficiency” and “equity”. There is, in some circles misgiving that emphasis on efficiency involves disregard for considerations of equity. As the Tenth Finance Commission clarified these are not mutually exclusive. But we need to keep in view the conceptual difference between efficiency and economy. As pointed out by Sri. A.Premchand and cited earlier. Efficiency refers to the process of gaining more outputs for a given quantity of inputs and Economy refers to using fewer inputs to gain a specified level of outputs. It is also been pointed out that the existing system of expenditure management has many features that make the pursuit of economy and efficiency extremely difficult.

While all organizations including government need bench marks or standards by which performance could be measured one may need to consider, in the context of examining the scope for using federal transfers as a lever in improving public services in the domain of State Governments, some questions like (i) whether, efficiency as defined and as commonly under stood is in itself an adequate goal and measures of efficiency as evolved and prescribed in various other contexts, are appropriate for all spheres of activity with which the Union and the State Governments are concerned.(ii) Whether the lessons from past experience in India and elsewhere that government structures can easily frustrate the best efforts of policy makers and specialists, should lead us to consider structural reform as a basic pre condition for prescription of performance standards and cost norms.

The first question becomes relevant, as students of management readily appreciate, management concepts, organizational orientation and objectives have been changing over time even for the business enterprises and that a similar change cannot

Section-II 544

be ruled out for governments. Philosophies, economic and political get so inter-twined in governmental operations that any attempt to bring about change in isolation without considering the inter relations of social, economic and political factors may have to be content with less than optimum results. And as should be noted, the very basis of “Economic Reforms” in India during the Nineties brought about such a change in orientation as compared to the earlier reforms.

Some Management Concepts

In the context of prescription of performance standards with the objective of improving efficiency in public services, while ensuring equity in distribution of resources, it may be useful to make a rapid survey of management concepts and take note of the changes over time, in the objectives advocated and the methods adopted. One can broadly discern three phases, with advocacy moving from “efficiency”, to “effectiveness” and then to “excellence” as the objectives to be pursued by organizations.

During the early decades of this century say upto 1930 when Scientific Management School of Frederic W.Taylor, Henry Gant, Harrington Emerson and others and the Administrative School of Management of Henry Fayol, Lyndal Urwick, Max Weber, Chester Barnard and others led the field, the orientation and emphasis was on “Efficiency”. This implied doing things rightly, getting most out of given resources, reducing if not eliminating waste. Emphasis was on input output equation in which inputs included human resources, material machine use and methods of work. While output was measured mostly in terms of physical units, not taking into account the psychological and sociological values like satisfaction, equity and human development.

This was followed by neo classical and modern approach adopted during the period, 1930-1980 by

a. Behaviourial Management School (Mary Parker Follett Elton Mayo, Douglas Macregor).

b. Quantitative Management School (Robert Markland, P.M.S.Blackett, Arthur D.Little)

c. Systems Theorists (James E.Rozenzeweig, Bertalanffy, George P.Huber )all of which emphasized effectiveness, which implied doing right things with adequate concern for the society and environment of business.

While Behaviourial Management school argued that performance was affected mostly by environmental factors internal to the organisation, the Quantitative School emphasized external environmental factors which influenced effective performance levels and the Systems Theorists viewed organization as a social sub system within the larger social system and indicated that the effectiveness of performance was determined by, the degree of integration of sub units within the organization and of the organization with the social system. Effective performance has quantitative and qualitative dimensions and can compass individuals, group, organization and society in its coverage.

Section-II 545

Since the 1980s, the emphasis has been on Excellence (Thomas J.Peters Robert H.Waterman and Nancy Austin and others ). Pursuing excellence implied an attempt to be meritorious to excel and surpass others by out performing them. According to Tom Peters, “ Excellence happens when high purpose and intense pragmatism meet”, and “involves personal group and organizational commitment.”

While the Management concepts indicated above, do illuminate the process through which improvements can be secured in enterprises and organizations, the performance of services in some parts of the Governmental System, may face limitations and pose problems for widespread adoption. This aspect becomes important if the standards are to be imposed along with federal devolution, as social, economic and financial consideration are so closely interwoven in Governmental Services that it is difficult sift these and evolve measures for performances. The soico economic conditions and resource endowments of the states in India vary so vastly that application of these measures become extremely difficult.

It has been argued that “ Conventional Management analysis with emphasis upon hierarchy, uniformity and efficiency was found to have little applicability in organizational environments characterized by ambiguity, interdependence, multiple commitments and political uncertainty. To study these environments, it was necessary to draw upon concepts from the literature of corporate strategy, inter organizational theory and social change.” (John C.Ickis of Institute of Central American Administration, Nicaragua in respect of Rural Development strategies of Latin America in “Bureaucracy and Poor –Closing the Gap”, Asian Institute of Management, Manila 1981). This argument appears to be of relevance to our study of fiscal reform and restructuring. The basic argument is that “the observed failures to achieve goals were due to a corresponding failure of structures to adapt to new strategies.”

The interdependence between structure and strategy needs to be appreciated. One may perhaps recall that Alfred Chandler, had, in his study of growth of American industrial enterprises pointed out that “Strategic Growth resulted from an awareness of the opportunities and needs – created by changing population, income and technology – to employ existing or expanding resources more profitably. A new strategy required, a new or atleast refashioned structure if the enlarged enterprise was to be operated efficiently”. Chandler also suggested that, “ growth without structural adjustment can lead only to economic inefficiency” (Strategy and Structure, Cambridge, Masachusetts,1962,pgs:15-16 ). It has also been argued by some Harvard Research Scholars, on the basis of some empirical studies, that “the congruence of strategy and structure have led to higher economic performance” For example Richard Rumelt, (Strategy, Structure and Economic Performance).

The question is whether the results of research into performance of organizations in the industrial and business fields can be applied to fiscal performance by governments. Lessons from a different area namely the evaluation of strategies for rural development pursued by Latin American Governments, (in Costa Rica, Honduras, Nicaragua, El- Salvador and Guatemala) may appear to be relevant. The strategies that were evaluated were a) Growth strategies aiming at rapid increase in the economic value of output of the farmers in the region (b) Welfare strategies directed towards improvement in the well being of the population through schemes

Section-II 546

for rural health and nutrition, and (c) Responsive strategies with focus on attention to the self defined needs of the rural population through self help efforts. The evaluation pointed out to the limitations in the implementation stage and revealed that, “growth strategy tended to widen the disparities of wealth and poverty, that the welfare strategy created dependencies and required resources that were beyond the means of governments,and that the responsive strategies appeared to be attractive in limited areas but recognized to be very idealistic and impractical for wide spread application. The results of the evaluation led the international aid agencies to realize the need to adopt new strategies which combined some elements of earlier approaches and intended to achieve simultaneously the goals of growth, equity well being and beneficiary participation. The new strategy described as the holistic strategy called for higher levels of social intervention capability, institutional leadership and systems management. This has relevance for the strategies for fiscal restructuring to be proposed for consideration in India.

Sector Specific or State Specific

Measurement involves specification of bench marks from which further progress can be measured and specification of standards by which success/ achievement can be measured. Seeking productivity gains, Government of India and the State Governments, moved from simple staff inspection units, ‘O and M’ cells to performance budgeting, management by objectives and goal setting techniques etc. The late seventies and early eighties were marked by training programmes for various levels of officers, to gear them up for improved administration and better management of projects and schemes. Review of the changes that were brought about showed that, far too often objectives have been specified and goals set in terminology borrowed from the corporate environment for use in some parts of governments where they have some applicability, and later extended to other parts of government without necessary application of mind to their suitability or relevance. Improvements were therefore patchy and could not be sustained over a long period or across the states and region. The question is, whether change strategies should be department specific, sector specific or region specific in a country like India.

It must be remembered that for business organizations a single measure like profit was considered sufficient to measure its success at one point of time, but even there, while it was common to consider profit maximization as a key measure of achievement, it was argued by Herbert A.Simon that organizations do not always try to maximize profit and try to “satisfice” because of what he called “bounded rationality”. Because it is difficult to achieve perfect rationality, corporate decision making can be characterized by satisficing rather than maximizing. To clarify, ‘satisficing’ is the search for workable solutions based on the concept of bounded rationality. In other words in certain circumstances, the search for a solution ends with a workable one although it may not be the best.

In governmental organizations, one finds far too frequently the approach is for a workable solution rather than the best solution. ‘Effectiveness’ defined as “ the ability of an organization to achieve all of its purposes is often set as a goal and government as an organization seeks to marshal and deploy its resources in a manner that the goal is achieved. A critical measure of effectiveness is whether the service was provided at the proper place and to the proper person specified. Judged by the standard, several departments can be considered to have performed well. But if the

Section-II 547

evaluation is carried to a deeper layer and questions are raised whether the service was performed for the primary beneficiary group or whether all the objectives have been achieved, there could be indications of failure. Management theories have often advocated that to apply the measure of effectiveness, an organization must have an exact understanding of its goals and that the presence of multiple goals can complicate the process of measurement.

In respect of fiscal restructuring, the Eleventh Finance Commission suggested several goals,(i) growth of tax revenue (ii) growth of non tax revenue (iii) containment of salary growth (iv) interest payment and (v) reduction of subsidies without indicating the relative priority amongst them as to which one should be considered the primary objective and which are subsidiary. The State fiscal reform facility (SFRF) scheme however specified a single objective of improvement in the revenue deficit/surplus as the criteria for the release of incentive funds. Even with this, the utilization of the ear marked funds has been poor in the first few years. Multiplicity of objectives set by the Eleventh Finance Commission may have resulted in reluctance of State Governments to take the scheme seriously even though the scheme as notified, prescribed only a single indicator. The scheme has not been ‘effective’.

The standards of performance could also be set in terms of ‘efficiency’, which defines the relationship between expenditure as an input and results achieved as output and insists on positive result. This implies that both the input and the output can be measured in specific terms. Measures of efficiency are more easily prescribed for engineering and production organizations in which both inputs and outputs lend themselves to precise measurement. This is difficult in fiscal matters, even if the obvious unit of measure is financial. In governmental operations there are difficulties in measuring the input as also the output, and it is even more difficult to establish a cause and effect relationship, and much more for this to be quantified. Among the difficulties of measurement are those related to time lag and differentiation. In Governmental operations there is a time lag of 2 to 4 years between the allocation decision and release of funds, and emergence of results in the field. While budget allocations and expenditures are indicated in a single financial year, the release of funds and utilization may spillover to the succeeding financial year and implementation may take a longer period. It is difficult to establish a precise relationship between budgetary provisions and the efficiency with which it has been utilized to provide public services of even the approved standard. There are logical and accounting difficulties involved in measuring the results of government expenditure. One may have to be satisfied with an assessment of the outcome of a government expenditure programme as and when it emerges.

While measurement of efficiency specifies a equation between input and output, measurement of effectiveness is an estimate of resource utilized and its outcome. From this point of view an organisation can be effective but not efficient as it may have accomplished its objectives but at a net loss of revenues. Such an organization could not be considered efficient because it did not realize a positive return from its resource use and yet can be considered effective as it had accomplished what it set out to achieve. It may be mentioned that in the Indian context, evaluation studies have moved from cost-benefit to impact assessment in certain sectors. Measures of efficiency have relevance in certain limited areas of

Section-II 548

governmental activity while measures of effectiveness appear to have greater relevance in a much larger area of governmental activity. We are yet to reach the stage where excellence can be prescribed as the objective to be pursued. B.J.Hodge and William P.Antony (Organisation Theory), Allyn and Beckon, Boston 1986 have argued that, effectiveness might be considered a long term measurement while efficiency could be classified as a short term measurement and the definition of efficiency must be carefully established or else the organization can be misled into concentrating on effectiveness at the expense of efficiency. Both effectiveness and efficiency must be considered among the measures of success for governmental organizations, and that the prescription should be tailored to the functions and coverage of the specific departments.

C. Macro Level Efficiency Parameters

The TOR to the study seeks prescription of different macro

level efficiency parameters keeping in view the diversity of the

resource endowment of the states and differences in their levels

of development, and their respective orders of relative priorities.

Such macro level parameters may include budgetary variable

like a) gross fiscal deficit/total expenditure b) revenue

deficit/revenue expenditure c) revenue deficit/gross fiscal deficit

d) debt/gross fiscal deficit e) interest payments/revenue receipts

f) non developmental revenue expenditure/revenue receipts

We have in an earlier chapter drawn attention to the trends

in expenditure management, as reflected in the transactions on

the revenue and capital account of the states and the

classification of total expenditure into, plan and non plan

expenditure and development and non development expenditure.

We had also pointed out the growing revenue and gross fiscal

deficits, and the increasing debt burden and interest payment

liabilities. We had also reviewed the Fiscal Reform Facility,

Section-II 549

established with monitorable indicators to provide incentives for

fiscal reform in the states. We had commented also on the

problems of comparability of budgetary data and the need to

ensure uniformity in procedures for expenditure scrutiny, pre

investment appraisal and delegation of financial powers to

enable inter-state comparison of expenditure management.

Though prescription of macro level parameters for monitoring

efficiency in expenditure management has to take into account

the difficulties in comparing budgetary data of the various

states, we may still consider utilizing

iii) the various ratios of fiscal indicators published by the Reserve Bank of India in its annual studies of State Finances

iv) Ratios published in the CAG’s Annual Reports on the Audit of the Accounts and Finances of State Governments.

The Reserve Bank of India has been studying the budget

documents of the various State Governments, and publishing its

analyses every year. Apart from the budgetary data on revenue

receipts and expenditure, capital receipts and expenditure, and

budgetary item-wise details of receipts and expenditure, the

study presents details of major fiscal indicators in the form of

the following ratios.

1) State’s aggregate disbursements/ aggregate disbursements of all the states

2) Gross fiscal deficit/ gross fiscal deficit expenditure

Section-II 550

3) Revenue deficit/ gross fiscal deficit4) Capital outlay/ gross fiscal deficit5) Net lending/gross fiscal deficit6) Nondevelopment expenditure/aggregate disbursements7) Nondevelopment revenue expenditure/revenue receipts8) Interest payments/ revenue receipts9) State’s tax revenue/ revenue expenditure.10) State non tax revenue/ revenue expenditure11) Gross transfers/ aggregate disbursements12) Debt servicing/ gross transfers

We had suggested that for a meaningful and uncontestable

devolution scheme, it may be advisable to limit the choice of

indicators and keep them relevant to the core purpose of the

exercise and that in respect of fiscal devolution formulae, the

key fiscal factors are a) revenue mobilization b) quality of

expenditure management c) Utilisation of debt funds and

containment of debt service obligations.

Keeping the above in view we would suggest that fiscal

performance of states may be judged by ratios indicating the

following

a) Revenue Mobilisation

i) ratio of states own tax revenue to revenue expenditure and total expenditure

ii) ratio of states own non tax revenue to revenue expenditure and total expenditure

iii) ratio of tax to GSDPb) Quality of expenditure management

i) ratio of revenue deficit to gross fiscal deficitii) ratio of capital outlay to gross fiscal deficit

Section-II 551

iii) ratio of non development expenditure to aggregate disbursements

c) Utilisation of debt funds and containment of debt service

obligations

i) ratio of debt servicing to gross transfers ii) ratio of interest payments to states own revenue and

total revenue expenditureiii) ratio of outstanding liabilities to GSDP

As it is possible that there could be some degree of erratic

movement from year to year, the Twelfth Finance Commission

may devise appropriate methods of evening out extreme values

by taking a three or a five year average. The Tenth and the

Eleventh Finance Commissions have taken three year averages,

but in the context of availability and reliability of budgetary data

of years closer to the award period we would suggest that a five

year average may be taken, utilizing the finance accounts as

reported by the Comptroller and Auditor General.

D. Micro Level Prescriptions

The TOR for the study has sought micro level

prescriptions of per capita expenditure norms for public

services, unit cost for execution of services and prescription of

measures like benefit/cost ratio, net present worth and internal

rate of return of projects.

Section-II 552

This study has sought to draw into its fold issues of macro

economic significance and micro economic importance. Several

manifestations of the fiscal problems faced by the center and the

states have been highlighted and it is essential that they should

be viewed not as isolated issues but more as disaggregated

components that should be considered within the frame work of

the economic and fiscal systems of which they form a part. The

study has also drawn from macro economic and micro economic

concepts and from the data thrown up by the budgetary and

other operations of the Union and State Governments with all

their inadequacies.

One is tempted to cite an old word of caution from

“Manual on Economic Development Projects” published by

United Nations in 1958,- “This manual presents both macro

economic and micro economic concepts. From this it must not

inferred that the manual attempts to offer a combined macro

economic and micro economic theory. It seeks to contribute

more to an appreciation of the problem than to its solution thus

widening the outlook of those who prepare projects so that they

may make the greatest possible compilation of useful data for

their economic appraisal.” While the comparability of the

budgetary data are not of ideal standards for rigourous statistical

analysis, one needs to see how best one can utilize the available

data for a meaningful analysis. We must be conscious of the fact

Section-II 553

that assessment of economic/financial performance call for a

combination of statistical analysis and qualitative judgement.

Per capita Expenditure Norms for public services

Our study revealed wide variations in total and per capita

expenditure of the State Governments between sectors and

across the states. Our analysis was of data thrown up by

budgetary documents, which indicated serious variations

between budget estimates, revised estimates and accounts

figures. This made us hesitate in passing judgements on the

performance and in making inter-state comparisons. However

the analysis of state finances published by the Comptroller and

Auditor General drawing upon the Audited accounts of the

states for the period 1996-2001 appeared to support many of our

conclusions. As this analysis carries the weight of greater

authenticity of data, we adopt the results of the official analysis.

According to the CAG, the per capita plan expenditure,

expenditure on social and economic services and capital

expenditure are marked by disparities across the states and the

disparities are sharp when aggregated in respect of general

category and special category states. This can be seen from the

following Table.14.1

Section-II 554

Table : 14.1 Average per capita Expenditure (Rs) 1996-

2001

Plan

Exp

Expenditure on Capital

ExpSocial

Services

Economic

Services

Section-II 555

General

Category

561 876 702 231

Special

Category

2181 2044 2338 996

All states 606 908 747 253

While the table shows that the average per capita expenditure

for the special category states is higher than those indicated for

general category states in respect of all the four indicators, the

relative growth levels do not appear to have been significantly

influenced by this expenditure pattern except in respect of states

like Nagaland which appear to have improved in the ranking of

states according to HDI. Since these states have been given a

non lapsable central pool of resources, the per capita

expenditure may be high. Twelfth Finance Commission may

like to request the North Eastern Council and Department of

Development of North Eastern Region to carry out a inter-state

analysis in respect of the expenditure of twenty eight

programmes/schemes covered in the Agenda for Socio

Economic Development of North Eastern States, announced in

January 2000 by the Prime Minister.

While assessing the needs of the states in the General

Category, the Twelfth Finance Commission may like to take

into account, the variations in the per capita expenditure in Plan

and Capital expenditures as also the inter-state differences in the

levels of expenditure on social and economic services.

Section-II 556

(Table.14.2) The point that emerges strongly in all the inter-

state comparisons is that the attempts of the successive Finance

Commissions to direct flow of Central Resources towards

enhancing the ability of poorer states in General and special

category states has not been very successful, and has also

created a dependency syndrome in them.While this dependency

should be reduced, their needs should not be overlooked, in

directing shift towards efficiency ensuring transfers.

Table : 14.2 Average per capita Expenditure (Rs) 1996-

2001

Plan

Exp

Expenditure on Capital

ExpSocial

Services

Economic

Services

Andhra

Pradesh

598 930 821 183

Assam 571 842 483 157

Bihar 264 466 308 101

Delhi 1103 1553 482 459

Goa 1928 3078 3316 1061

Gujarat 901 1243 1486 477

Haryana 785 1267 1086 441

Karnataka 801 1013 961 312

Kerala 800 1155 821 209

Madhya

Pradesh

488 716 646 152

Section-II 557

Maharashtra 680 1140 993 382

Orissa 695 824 593 244

Punjab 580 1070 1172 364

Rajasthan 625 1011 614 339

Tamilnadu 589 1159 785 191

Uttar Pradesh 380 522 427 146

West Bengal 379 821 467 134

All GC

States

561 876 702 231

Special

Category

Arunachal 5423 2864 4812 2616

Himachal 2574 2369 2137 892

J&Kashmir 1460 1619 2533 825

Manipur 2010 1931 1794 1129

Meghalaya 1669 1703 1498 736

Mizoram 4798 3690 4326 1908

Nagaland 2186 2127 2164 978

Sikkim 4982 4236 4346 2181

Tripura 1874 1929 1520 839

All SC

States

2181 2044 2338 996

Section-II 558

Some states had argued that the EFC did not take into account

the differences in the performances of the states, and leaned

heavily in favour of the ‘poor states’. Analysis shows that the

average per capita NSDP of general category states works out to

Rs.11499 and that of the special category is Rs.8681, and for all

the states put together it is Rs.8931. It appears that some of the

special category states are close to the national average and the

poorer states in the general category are far below the national

average. Improving fiscal and developmental performance of the

states requires a balanced approach to transfer of central funds,

covering both devolution and plan assistance. This request can

be judged in the light of the following table which indicates the

per capita NSDP.

Table :14.3 Per Capita Income and FCs Transfers (Rs)

Per

Capita

NSDP*

Finance Commission

Transfer

X FC XI FC

Andhra

Pradesh

9533 497 819

Assam 5772 659 997

Bihar 3294 486 1033

Delhi 24303 - -

Goa 26291 969 1227

Gujarat 13163 374 474

Haryana 13681 286 386

Section-II 559

Karnataka 11257 419 747

Kerala 10141 499 774

Madhya

Pradesh

7520 424 862

Maharashtra 14732 302 401

Orissa 5206 553 1131

Punjab 14881 312 447

Rajasthan 8466 436 835

Tamilnadu 12315 444 696

Uttar Pradesh 5633 445 900

West Bengal 9307 393 878

All GC

States

Special

Category

Arunachal 8807 3488 4248

Himachal 10529 1646 2454

J&Kashmir 7354 1575 3263

Manipur 7726 1941 2691

Meghalaya 8242 1769 2575

Mizoram NA 4386 5697

Nagaland 8922 3299 4472

Sikkim 9958 2831 6052

Section-II 560

Tripura 7912 1884 2734

All SC

States

*Three year Average 1998-99,1999-2000 and 2000-01 at 1993-

94 prices

Prescription of Unit Costs

While considering prescription of unit costs it is necessary

to draw a distinction between projects and plan schemes, and to

appreciate the different requirements of project appraisal, and of

scheme scrutiny, from the points of view of financial and

economic viability of projects and of cost effectiveness of

developmental schemes. A good project proposal requires the

combined application of mind by teams of technocrats and

administrators whose work must be complementary. In the

Indian context, it is an historical verity that the responsibility of

preparation of schemes, programmes and projects vest with field

agencies, but they are not necessarily those empowered to

decide on priorities for approval or on allocation of adequate

resources. It is this systemic defect that militates against

“efficiency of expenditure.” While the viability of projects and

cost effectiveness are in the domain of the Planning

Commission and Finance Ministry, the needs of the

implementing machinery falls in the domain of the Finance

Commission. The maintenance and other requirements of plan

schemes, also come into the reckoning of the Finance

Section-II 561

Commission after the end of the Plan period. Prescription of unit

costs for services is therefore a legitimate concern of the

Finance Commission.

However this bristles with difficulties in view of the

following reasons. i) The Finance Commission is a national

level body, appointed once in five years, to determine at the

macro level, the distribution of resources between the Centre

and the states and inter-se among the states. While micro level

details need to be noticed, and taken into account in assessing

the patterns of resource mobilization and expenditure

management, the degree to which Finance Commission should

concern itself with micro level management for prospective

prescriptions is a matter on which there could be more than one

opinion. ii) India is a country of subcontinent dimensions with

diversity of physical conditions so wide as to pose questions of

applicability and relevance to local conditions, in respect of

policies programmes and prescriptions decided at national level.

iii) while state specific standards can be conceived and

prescribed by national level bodies, there is, in the case of

Finance Commission which decides the quantum of flow of

funds, the risk of avoidable controversy, in setting different

standards for different states.iv) while the Finance Commissions

have so far been taking states as the unit for transfer of funds, it

would appear that district is the most appropriate unit for

Section-II 562

standardizing cost norms and performance levels. There could

be intra district differences but this can be taken care of.

However inter district differences within a state are still

considerable in respect of social and technical infrastructure and

administrative services. It is for consideration whether the

Finance Commission should set about its task keeping in view

the existence of 593 districts in the country. It is a moot point

whether it is worth the trouble.

The guidelines issued by the Ministry of Finance,

Department of Expenditure, (Finance Commission Division) for

the utilization of grants recommended by the states, cover the

constitution of Empowered Committees for each state to

examine and approve the action plans prepared by various

grantee organizations, and leaves the tasks of approving unit

costs to these committees. Since these guidelines have been in

force for some time, and imply a measure of decentralization of

decision making to take care of local needs, the same could be

continued by the Twelfth Finance Commission also.

Section-II 563

Setting patterns at the national level militated against the

flexibility required at the field level in view of the wide

diversity of physical conditions in different states and some

times the pattern of financing was itself responsible for poor

implementation of the schemes. Prescriptions of standard limits

for margin money and subsidy, as a percentage of the estimated

unit cost in beneficiary oriented schemes, didnot take into

account, the different capacities of the beneficiaries, and

resulted in either over financing or under financing individual

beneficiaries.

While these issues could be handled, with some attention

to details, the most significant problem will be the need for

revision of unit cost at frequent intervals to take care of cost

escalation and other factors. Since Finance Commissions are

appointed once in five years, the time span should be considered

a little too long for the matter to be left to the next Finance

Commission. Cost indexation could no doubt be indicated but

the frequency and the manner of application would also need to

be settled.

While the points mentioned above flow from operational

experience at various levels, it is also necessary to indicate a

recent experience in 2001 while carrying out evaluation of rural

development schemes. Two examples can be cited of national

Section-II 564

level prescription of unit cost to indicate that this only adds and

reinforces the systemic defect, and add to the problems of field

agencies.

a) Centrally Sponsored Rural Sanitation Programme (RCRSP)

started in 1986 was marked by changes in criteria, norms of

funding, revision of unit cost in 1991, and subjected to further

changes during the nineties, without much to show by way of

achievement. The scheme had to be restructured in 1999-2000,

revising the guidelines for i) individual latrines costing Rs.625

per unit met by contributions from Government of India, State

Government and the beneficiary ii) school sanitation and

iii)construction of sanitary complex for women. The

prescription of unit cost and of the proportion of contributions

by the centre and State Governments and beneficiaries posed

serious problems, as they did not take into account the diversity

of soil conditions and local behavioural pattern. The field level

agencies felt that a flexibility in the pattern with a few choices

could have made difference to the quality of implementation and

success of the scheme. On the other hand officials concerned

with the programme at the state and Government of India level

appeared to feel that flexibility will lead to misutilisation of

funds at the field level. The trade-off between flexibility and

accountability is yet to be settled.

Section-II 565

b) Indira Awaz Yojana, specified the patterns for housing and

offered different cost limits –Rs.20,000 for plain areas and

Rs.22,000 for hilly/difficult areas, with a split up for

construction of house and for infrastructure and common

facility.The Tamilnadu government provided a additional

assistance of Rs.12,000 for construction of houses with RCC

roofing. Though the scheme envisaged kutcha houses and pucca

houses to be constructed with different patterns of financing, the

implementation suffered on account of two problems, patronage

involved in selection of beneficiary, and escalation in the cost of

materials required for construction. Impact study of RD schemes

for Nagapatinam district concluded its evaluation with the

observation “despite heavy investment by government, the

scheme means satisfaction for a few and dissatisfaction for

many.” It does appear that problems relating to availability of

construction materials and different cost levels even within a

district can militate against a well designed scheme providing

type designs of houses and substantial financial assistance and

in some cases flexible patterns of financing involving credit cum

subsidy.

The two examples cited above relate to schemes in which

materials and engineering aspects are covered by schedule of

rates and recognition of inter-district variations. Prescription of

cost norms for various public services can pose problems

Section-II 566

relating to varying scales of pay and other allowances, with

categorization of employees into government, panchayati raj

institutions and NGOs receiving Grants-in-Aid.

In our view, the matters relating to prescription of

standards should be covered by a scheme, whose conditions of

financial assistance are uniformly applicable to all the states,

giving the states a degree of flexibility in determining the locally

relevant cost norms and performance standards and in ensuring

that this secure the approval of the funding agency.

Projects

In our view the Finance Commission can however proceed

with prescribing parameters for projects to be funded by the

state and Central Governments and also laying down the frame

work for project formulation, appraisal and sanction. The

current atmosphere of liberalization and de regulation appears to

have been interpreted by various agencies as grant of freedom

from expenditure scrutiny, and pre-investment appraisal for

schemes and projects, receiving in full or in parts public funds.

It is this area which has been subjected to considerable abuse in

the nineties, with the Government of India, State Governments

and the financial institutions caught in a mode of philosophical

Section-II 567

doubt regarding the specific degree of pre-investment scrutiny

that should be carried out.

The Government of India had from 1965 onwards paid

attention to the guidelines for preparation of feasibility reports,

and improvement of procedures and prescriptions for pre-

investment techno-economic appraisal of projects taken up by

public sector units and departmental undertakings. The

Constitution of the Public Investment Board in 1972, and the

circulation of Planning Commission’s revised guidelines for

feasibility reports in 1975 have improved the quality of project

preparation and their pre-investment appraisal, the failure to

adhere to the time phasing of investment assumed at the

approval stage, and changes in the scope of the project have

been found to result in time and cost overrun.

The appraisal agencies have generally assessed the project

by working out the a) Benefit Cost Ratio (equal to present worth

of benefits / present worth of costs) b) Net Present Value

(present value of benefits – present value of costs ) c) Internal

rate of Return depending on the discount rate that ensures that

the present worth of benefits is equal to present worth of costs.

These measures have been found to be adequate in the

project appraisals for the central public sector. However the

Section-II 568

State Governments have in recent years been committing

themselves to large projects with capital investments which are

neither subjected to the case by case examination by different

technical and finance departments, nor subjected to pre-

investment appraisal by a competent agency. While the

procedures for approval of projects requiring budget support

were atleast observed in form, there was not even an semblance

of an attempt to scrutinize projects for which the State

Governments offered guarantees to financial institutions, the

cases of co-operative sugar and textile units in Maharashtra is a

case in point. The contingent liabilities built up by the various

State Governments on account of projects in the infrastructure

sectors have become a virtually a mine field for both the

financial institutions and the State Governments. In some states

there is the subterfuge practice of appointing some consultants

who are only too ready to comply with a specified requirement

of “advice” for a fee, without any accountability for results.

Restoration of accountability for use of public funds as also of

sovereign guarantees needs urgent attention.

Recommendations

In view of this, it is suggested that the Finance

Commission may, to start with, prescribe for all the State

Governments, a procedure for investment approval, and insist on

Section-II 569

constitution of appropriately qualified technical body to

examine and recommend approval for projects calling for a

capital investment above a specified limit say Rupees five crores

and more.

The Finance Commission may also like to indicate the

nature of returns, economic and financial that should be

considered adequate for pre-investment commitments by the

State Government either by way of budget support, grant or loan

or guarantee. Since clearance of projects may need prescriptions

of a minimum level of returns and the appraisal agencies would

need to adopt a common standard across the states, the Finance

Commission may also like to suggest the Discount Rates that

could be adopted by the appraisal agencies while evaluating

projects.

The Finance Commission may also consider indicating the

manner in which State Governments can workout capital

recovery factors and depreciation allowances that could be taken

into account.

This can be proposed as an experimental measure, to be

implemented in all the states during the period 2005-10 and to

be confirmed for wide spread and compulsory adoption with

modifications if any required by the next Finance Commission.

Section-II 570

The experience of the previous Finance Commission

recommendations has been that institutional and other changes

suggested, are given adequate attention by the Government of

India and the State Governments. The Eleventh Finance

Commission recorded its feelings in this regard. The Twelfth

Finance Commission may need to draw the attention of Union

and State Governments to this and ensure a mechanism for

implementation of its suggestions.

Section-II 571

Chapter - XVI

Monitoring MechanismThe TOR for this study requires, examination of “the

scope establishing a mechanism for monitoring expenditure

consistent with the constitutional status of the states particularly

the scope of an early warning system in detecting wastage and

leakage of public funds.

The Indian experience in developmental planning in a federal framework has been fairly long, and mechanisms of monitoring expenditure have been in position in respect of both central financial assistance to the state governments, and investments in public enterprises. Frequent reviews of the monitoring systems have also been made. Eighth Five Year Plan (1992-97) document, for instance, observed that “the success of a plan lies in the effectiveness with which the projects and programmes are executed and the efficiency and productivity levels at which various enterprises operate. The nature and problems of implementation of large projects , which are mostly in the infrastructure and industry sector differ from those of development programmes which are mostly in the field of agriculture , rural development and social sectors” and proceeded to focus on “some of the common and general steps to be taken to improve efficiency in the process of formulation, implementation , monitoring and evaluation of projects and programmes”

Monitoring of Projects

Indicating the status of major projects the Eighth Plan document mentioned that as on 1st January 1992, there were 307 Central Sector projects each costing Rs.20 crores or more with total anticipated cost of Rs. 94,500 crores monitored by the Ministry of Programme Implementation. Of these 201 projects had cost overruns with respect to the original estimates and 165 projects , with respect to the latest approved cost . As many as 189 projects had time overruns with respect to their original schedule and 182 projects had time overruns with respect to the latest approved schedule. Thus above two thirds of the major projects under implementation are facing the problems of time and cost over run. The status of state projects mostly in power and irrigation sectors are generally worse” (Eighth Five Year Plan Vol:II ,Planning Commission 1992, p.469)

The Plan document enumerated the deficiencies found in programme implementation, and also identified the factors responsible for time and cost overruns of projects as (i) inadequate investigations and project formulation. Frequent changes in scope and revision of drawings due to inadequate project preparations. (ii) Delay in clearances from various regulatory agencies.(iii) Delay in land acquisition.(iv) Delay in activities such as supply of equipment by suppliers.(v) inadequate release of funds.(vi) management problems such as personal, labour and contract disputes, mismatch

Section-II 572

of equipment.(vii) unforeseeable reasons such as adverse geo-mining conditions and natural calamities etc.

Reviewing the systems of monitoring in position , the Eighth Five Year Plan observed that, “during the Seventh Five Year Plan a monthly “flash report” monitoring system was introduced for all Central Sector projects costing over Rs.100 crores to enable a top level review by the government. Separate systems were established for other central projects and for monitoring of the 20 point programme and infrastructure performance. A separate Ministry of programme implementation was also established for monitoring tasks. Of late the monitoring system at various levels has got into stereotyped mechanism handling routine information.” The Plan Document further declared that “ During the Eighth Plan, efforts will be made to evolve a system of regular flow of information to make monitoring an effective tool of management action at all levels. At present too many agencies demand data from the source agencies. Availability of data in a common data base in the system, which is accessible to various user agencies , can reduce such pressures as in source agencies.” (The Eighth Five Year Plan, p.476).

A review of the status of projects under implementation, made ten years later revealed that the time and cost overruns continue to be a major problem. A recent Report of the Ministry of Programme Implementation indicates the current status of Central Sector projects, in respect of time schedule and cost estimates as follows:

Table : 16.1 Time schedule and cost estimates of projectsTime Schedule

1995 1996 1997 1998 1999 2000 2001 2002

Total 154 170 187 216 197 202 187 190Ahead of schedule

5 5 11 5 9 8 5 4

On schedule 60 59 47 51 33 41 58 68Delayed 83 98 119 111 113 102 65 49No DOC 6 8 10 19 42 51 59 69

Cost EstimateNo. of projects 83 96 119 111 113 102 65 49Original Estimate

38997 42873 58840 56556 58293 52599 25530 31414

Now anticipated

79003 78295 95855 87297 88394 82501 48904 56780

Cost overrun 40006 35522 37015 30740 30101 29902 23374 25366

In spite of the monitoring systems reported to be in place, it is clear that a large number of projects continue to be delayed, and the cost overruns in respect of the delayed projects, indicated above run into thousands of crores.The sector-wise analysis show that the projects which are delayed are in the Coal, Power Railways Surface Transport sectors and analysis at the cost overrun also show that these sectors account for a substantial number of the projects. It has recently been argued by Sebastian Marris (India Infrastructure Report 2003, Public Expenditure Allocation and Accountability , Oxford University Press, 2003) that the “Flash Reports” of the

Section-II 573

Ministry of Programme Implementation were completely ritualized to the point of being irrelevant.

What should be of significance to us is that several of the deficiencies

mentioned and improvements suggested were in the official circulars of the late sixties .The Ministry of Industry had in a letter of 16th May 1962 called for preparation of detailed project report, to be followed three years later by the Ministry of Finance(Department of Co-ordination) in the Office Memorandum 3878/JS (AM) of 7th October 1965 emphasising the need for careful and detailed investigation in regard to the suitability of the site, availability of required natural resources , other raw materials etc. The Planning Commission had prepared and circulated in May 1966 a Manual of Feasibility Studies indicating the manner in which project proposals should be prepared for consideration and approval by the Government of India. It did take some time for the administrative Ministries to forward this to the various departmental and public enterprises and the Deputy Prime Minister in charge of Finance had wrote to all the Ministries in August 1967 emphasising the need for care in preparation of these reports .

Delegation of financial powers to the subordinate formations and public sector enterprises were also considered after the recommendations in the fifteenth report of the Committee on Public undertakings of Parliament. The Ministry of Finance , Department of Expenditure issued orders in April 1969 in creasing the limits for sanctioning capital expenditure, to ensure early clearances of projects. In the early seventies Government reviewed the procedure for examining capital expenditure and project investments and took a decision to constitute the Public Investment Board in 1972. This high level inter-ministerial body was assisted by the Project Appraisal Division of the Planning Commission , the Bureau of Public Enterprises , and the Plan Finance Division of the Ministry of Finance. In examining the project proposals from various angles before the PIB made recommendations to the Union Cabinet for a decision on the project. Revised guidelines for the preparation of feasibility reports were also issued in 1975 . In respect of schemes and programmes, a slightly different procedure of consideration by the Expenditure Finance Committee was also instituted . With a view to relaxing, what was considered to be the tight grip of the Finance Ministry over the procedures for scrutiny and approval of schemes and projects , maintained through Finance Ministry officials functioning as Associated Financial Advisors to the various Ministries, a scheme of Integrated Financial Advisors, was also introduced, placing the advisor, in the various ministries themselves. It was claimed that the Integrated Finance System will help avoid delays on account of scrutiny procedures.

After fifty years of Planning and of experience in implementation of projects and programmes, the Tenth Five Year Plan , approved by NDC in Dec 2002, states that , “one of the most common reasons for the failure of programmes and schemes is the faulty and incomplete design of the Programme /Project scheme care and attention must be taken to formulate programme , projects and scheme in a more systemic and professional manner.” (Tenth Five Year Plan ,Vol.I, Chapter – VIII , pg 205)

Earlier in Chapter-I the Tenth plan Document pointed out, “ Most infrastructure and industrial investments in India take an unconscionable time to come on stream. Much of this arises from the investor un friendly laws and non transparent

Section-II 574

procedures that have to be gone through prior to launching the project .The hurdles can also come up in the course of execution of the project……”( para 1.41 ). The same document later states that “over statement of capital costs by promoters , with the intention of passing off a higher proportion of the real investment cost to the lenders that is having a higher debt equity ratio than would be otherwise acceptable , is also endemic in India. This arises primarily due to the inadequate capacity of the financial sector to evaluate investment proposals and to a lack of information sharing between different financial institutions due to outdated confidentiality rules. This issue will need to be addressed expeditiously.” (Vol I , para 1.45, p.12).

In Vol III , relating to state plans ,the Document observes that, “projectisation remains as imperfect art in government. The problem is the delinking of project formulation and what in commercial world is called financial closure. A common tendency is to under estimate the magnitude of the projects for Plan scrutiny so as to squeeze them through a constrained resource envelope. Then as the years go by they emerge in their true colours. As a result projects are not fully funded, implementation slips and costs escalate markedly. Comprehensive project configuration, costing and full financial commitment is necessary for proper planning of capital outlays.”

A moot point is whether in the enthusiasm for increased delegation of financial powers to the administrative ministries and project authorities, the necessity for adequate attention to the quality and accuracy of estimates of expenditure and financial viability of projects has been sacrificed. There appears to be some degree of association between the runaway tendency of expenditure management evident from the eighties onwards, and the systemic changes brought about in the late seventies. A review of Integrated Financial Advisory System appears to be necessary to ensure a proper regulation of expenditure in Union Government Departments.

It appears that in respect of projects, whether in the public sector or in the private sector, there is no clarity as to the degree of pre-investment scrutiny of reliability of cost estimates, pattern of financing and time phasing of investment and implementation, that should be insisted upon. The experience of the nineties is that, projects both in the private sector, and the public Sector have been marked by serious cost overruns and failure to adhere to the time schedule of implementation. If the Union and the State Governments faced problems in respect of public sector projects, the investors in the capital market have been taken for a long ride by private sector promoters of power and other projects and the banks and financial institutions face huge volume of non performing assets. It should be noted that while considerable outcry is heard in respect of subsidies to the farmers and food rations to the poor, there is relative silence in respect of the drain on public resources on account of poor project management, in the private sector. That some of these projects received sovereign guarantees is part of the sad story that the Twelfth Finance Commission may need to address and move towards prescribing systems for pre investment scrutiny, and restrictions on contingent liabilities.

Establishment of a monitoring mechanism consistent with the constitutional status of the state governments, or the liberated status of private sector promoters may need to be preceded by a examination of the systems of scrutiny and nature of regulation that should be in position where commitments by the Union and the State

Section-II 575

governments are involved, whether in direct financial terms or of indirect budgetary and financial implications.

Monitoring of Fiscal ReformEarlier Finance Commissions, while recommending tax devolution or

statutory grants have, it appears respected the autonomous status of the state governments, and accorded them the privilege of regulating their expenditure and ensuring proper utilization of funds transferred by the Centre. Doubts if any regarding utilization were left to be dealt in the normal procedure of scrutiny of accounts by the Controller and Auditor General.

It was only in recent years, that the need for separate mechanisms has been felt. It may be recalled that the Ninth Finance Commission had suggested a State Level Committee headed by the Chief Secretary to administer the Calamity Relief Fund. And that the Tenth Finance Commission had in para 3.62 emphasised the need for monitoring maintenance expenditure by a High Power Committee and recommended the streamlining of the reporting system and suggested redesigning of the presentation of accounts. (see para 3.62 and Appendix 3 of the Report of the Tenth Finance Commission).

The Eleventh Finance Commission suggested that the recommendation of the Tenth Finance Commission in regard to the monitoring by a high power committee should be actively operationalised. And that the budgetary provisions for the maintenance of capital assets and for committed liabilities on plan schemes may be assessed by the Planning Commission at the time of assessment of the states resources and that the Planning Commission consider devising a suitable mechanism for the purposes. (Report of the Eleventh Finance Commission, Para 5.57)

The implementation of the suggestion of the previous Finance Commissions has suffered on account of the absence of a necessary agency in place.The Tenth Finance Commission suggested the creation of a Finance Commission Division within the Ministry of Finance (para15.15) and the Eleventh Finance Commission suggested that the Finance Commission should have permanent headquarters and a permanent secretariat with a core research staff placed under an officer of the level of additional secretary to the Govt. of India”, and creation of a strong data base on Public Finance with recasting of state budgets on the lines of Central Budget, collection of information on number of employees , a data base on pensioners and review of the implementation of non financial recommendations. There is at the moment, a Finance Commission Division in the Department of Expenditure.

As for monitoring fiscal reforms, it may be noted that, while notifying the states fiscal reform facility, the notification points out that , the States Fiscal Reform facility and the Medium Term Fiscal Reform Programme are essentially the states own Programmes. Considerable flexibility in designing the policy frame work has been left to the initiation of the state governments. However as the fiscal health of the states were considered an important component of nations overall macro economic balance , monitoring of the SFRF and MTFRP became a collaborative exercise between the Centre and the States.

Section-II 576

This led to the appointment of a Monitoring Committee comprising of i. Secretary Expenditure in the Ministry of Finance

ii. Secretary Planning Commissioniii. Deputy Governor Reserve Bank of Indiaiv. Chief Economic Advisor , Department of Economic affairs, Ministry of

Financev. An outside Expert

vi. The Chief Secretary of the State Government vii. Finance Secretary of the State Government

viii. Joint Secretary of Plan Finance, Ministry of Finance(member Secretary)

It was mentioned in the notification that the Fiscal Reform Unit of the Finance Commission Division will be the single window secretariat for monitoring the fiscal reforms programme as well as any other supplementary facility that may be extended to states from time to time , including facilities from multilateral lending agencies.

In the light of the above it can be mentioned that there are monitoring mechanisms in position both in respect of plan schemes and projects in the Planning Commission and in respect of fiscal and financial matters in the Finance Ministry, there does not appear to be any need for a new mechanism. However there is need to ensure that this mechanisms are properly empowered to enable them discharge their responsibilities.

Experience indicates that the enthusiasm evident in proposing or prescribing new mechanisms or agencies for monitoring and reviewing, evaporate once these are set up. The Programme Evaluation Organization of the Planning Commission is a case in point. After it had done some useful field evaluation and came up with critical reports, it has now been made yet another office of routine. The Ministry of Rural Development has in recent years conducted concurrent evaluation of schemes implemented by state governments and further entrusted impact studies to independent organizations. The Comptroller and Auditor General has been conducting both test audits and proprietary audit. The performance audit conducted by the Auditor General have in recent years attracted wide attention.

It must however be mentioned that the end result of these audits, evaluations and impact studies, has only been carping criticism of implementation machinery, some times without even appreciation of the field problems or the ability to propose solutions for the wide range of operational problems at the ground level. This has led in some cases to the abandonment of the schemes covered by audit and introduction of a new scheme with different components or patterns of assistance. Monitoring for the sake of timely application of correctives during the course of implementation appears to be rarity. Mere expenditure review, and ex-post facto audit do not improve efficiency of performance. Concurrent review and application of correctives in the light of feed backs provided by field agencies can contribute to improvement in performance and enhancement of effectiveness.

Section-II 577

Recommendations

Present Systems of monitoring emphasize adherence to procedures and purpose and extent of utilization of funds released. However monitoring for the purpose of ensuring proper utilization of funds related to the physical achievement and proper targeting of beneficiaries do not appear to be universal. The indicators monitored are also subject to frequent changes. For instance reporting on wage employment schemes initially indicated the number of man days of employment created, work-wise and district-wise. This was given up for some time possibly due to doubts regarding their accuracy or reliability and reintroduced later in schemes like food for work .The thrust of the schemes have also been changed from mere employment provision to creation of infrastructure, providing employment in the process. Employment has become a subsidiary objective at the national level, but this is not clear to the field agencies.

The present procedures insist on submission of a certificate of utilization, as prescribed in the General Financial Rules, indicating the amount sanctioned and spent certifying utilization for the purpose sanctioned by the implementing agency. In recent years Chartered Accountant have been authorized to issue such a certificate or counter sign the certificates issued by the implementing agency. This involves only verification of the accounts and no field level physical verification of assets created or benefits conferred. Reporting on the expenditure of Rs. 33,380.17 crores on JRY and EAS schemes between 1992-99 , the CAG in its Report No 3 of 2000 indicates that Rs.3520.23 crores were covered by objections with a following breakup. a) Deposit in personal deposit account/Banks etc –Rs.1747.52 crores b) Misuse or diversion to other activities not related to the programme Rs.430.55 c) amount lying unutilized and unadjusted advances Rs.754 crores d) excessive administrative expenditure Rs.14.50 crores e) suspected misappropriation Rs.9.52 crores f) expenditure on works not permissible Rs.95.41 crores g) contractors margin-Rs. 38.26 crores, h) incorrect reporting Rs.160.47 crores. It is clear that excess expenditure and misappropriation on a very small amount while deposits and diversion to other programmes constitute more than two-thirds of the amount covered by audit objection.

There is at the moment, attention to problems like deposits or diversion of funds for other purposes than to mis-utilisation and misappropriation which need to be prevented. Proper utilization of funds and fulfillment of objectives and targets can be ensured by a performance report covering a) Physical progress, b) Utilization of funds and c) problems of implementation and d) issues for decisions. Monitoring mechanisms can be effective only when the reviewing authority can offer solutions or enforce mid-stream correctives. Improvement in utilization of funds and increase in efficiency in implementation can be brought about if an integrated view is taken of :

i) formats of accounts and of reports for expenditure. ii) enlargement of the reporting format to cover physical progress, utilization of funds and problems encountered. iii) manner of scrutiny of the performance reports and nature of communication of the results of scrutiny to the implementing agencies. iv) periodicity of review, and provision of concurrent evaluation and audit.

Section-II 578