Accommodative Politics, A Key To Reduce Fiscal Strains

K.T. Jagannathan & Dr. S.K.Prakash 

Abstract

Does fiscal federalism require a accommodative re-jig with the emerging reality in India? The
answer is a suggestive `Yes’ if one were to take into account the unfolding political dynamics
in the country. Whenever a general election is held in any state, one gets an education on the
advantage of a double-engine government. What do we make of this? Well, even a casual dip
into the usual construct of fiscal federalism will give one a clue or two to the fissures in the
existing arrangement. The attempt here is to mirror the ground situation arising out of the
vastly-changed political landscape in the country.
Key words: Fiscal, Federalism, Imbalance, Centre, States, Social, Policies
Introduction
What is fiscal federalism? Simply put, it is all about putting in place an institutional
mechanism that facilitates decision-making that involves and pertains to both the Centre and
the States. Typically, these decisions relate to demarcation of powers between them for
taxation, spending, regulations and the like.
Fiscal federalism is a broad-spectrum subject. It encompasses a host of issues. Who levies
taxes? Who spends the money? Who collects money? Who distributes money? How these
functions are divided between the Centre and the States? What falls under whose domain and
responsibility? It encompasses a host of issues related to revenue and expenditure
assignments in a federal system.
Correcting imbalances
Also, it has to address vertical and horizontal imbalances in finances of a federal system
comprising various member-states. What is vertical imbalance? Well, this happens when
own revenues and expenditures of various states within a federal system are unequal. What is
horizontal imbalance? It occurs when fiscal capacities of various States of the same level
differ. How are these imbalances removed? This is sought to be erased through a variety of
transfer and borrowing mechanisms. The objective is simple: to let the States do their
assigned tasks in conformity with the national policy framework.
“The vertical fiscal gap is generated by the expenditure and revenue assignments. However,
individual policy choices also play a significant role in determining the resulting ex-post
vertical gap. If a lower level of government chooses to increase spending or not raise
assigned taxes, the vertical gap would increase. Thus, if transfers were designed solely to
close the vertical gap, there would be little incentive for the lower levels of government to
raise own account revenues or restrict or manage expenditures efficiently. Unless there are
objective criteria for the determination of transfers, “gap filling” to finance sub-national
deficits is likely to lead to macro-economic difficulties as well as indeterminate “bargaining”
between the centre and lower levels,”according to a paper presented by Ehtisham to IMF e-
LIBRAY in September 1992.
All these are sought to be addressed by creating a robust constitutional mechanism which
defines every facet of the aforementioned aspects in a federal system. Ipso facto, such a
mechanism should also be in a position to provide conflict resolution solutions.
Cause of friction
The moot point is: how effective or how practical is the existing mechanism? The question
here is not about the mechanism per se. The concern is more about the propensity or
willingness of the political system to fairly use the available mechanism for conflict
resolution. That is is largely absent, triggering quite a convulsion in the fiscal federalism. The
political system as whole does not hesitate to play spoilsport in fiscal federalism. There are a
dime a dozen political parties in a federal system like ours. Not just that. Many states are
ruled by regional parties whose policies and priorities are very much tuned to the needs and
aspirations of people in their respective regions. As opposed to this, a Central government has
to look at the larger national picture and care for all the regions – developed, not-so-
developed and under-developed. Fiscal federalism is all about understanding these different
objectives and managing multiplicities in terms of aspirations and requirements of different
regions, nay states. More often than not, conflict situations arise in a federal system like the
one in India more due to deep politics, in general, and positioning strategies of parties (both
at the Centre and in States), in particular. With the political system as a whole turning out to
be not-so accommodative, the conflict situation gets exaggerated and turns uglier at times. Is
the existing fiscal federalism mechanism capable of fixing a solution to problems in a
constantly metamorphosing relationship between the Centre and the States?
Role of States
Why do conflicts occur in a federal system? To understand the why of them, it is imperative
to recognise the responsibility of States in providing local public services. Willy-nilly, this
pre-supposes a certain amount of freedom for the States to spend. This can happen only if
they are allowed the leeway to raise funds through tax and other means. What does it mean?
Simply put, it means that the ability to raise funds – either through taxation or other means – is 
a sine quo non for States to roll out adequate local public services. The fiscal federalism
mechanism has a crucial role to play here. It should support the states’ fund needs. At the
same time, it should ensure that they don’t turn profligate. Understandably, the fiscal
federalism mechanism has built some checks and balances to avoid such situations. Can the
Centre keep away in matters related to provision of local public services? Yes and no,
depending on the kind of local public service. There are instances where a strictly local public
service will have a larger national import or scale implications. In such cases, the Centre has
to get associated (let us say like in the case of Chennai Metro Rail).
“Modern governments provide many services that by virtue of their technologies are
essentially private goods, for example, health, education, and social insurance. Public
provision of these private services is justified on grounds of equity. Since benefits accrue
mainly to residents of separate jurisdictions, such services would be better provided by sub-
national governments. A central government’s involvement is, nevertheless, justified to
ensure horizontal and minimum standards of service in all jurisdictions—such standards for
most services encourage the free flow of goods and services in the nation as a whole,”
according to a theme paper “Emerging Issues in Fiscal Federalism” authored by Anwar
Shah Indira Rajaraman Fernando Rezende.
Status in India
Where does fiscal federalism stand at the moment in India? Well, it has moved to the edge of
an avoidable friction point. The fiscal divide appears to revolve around a few contentious
areas – GST (goods and services tax), welfare spend of States, central schemes and the like.
Though GST has long come into force, it still remains a divisive factor in the Centre-States
relationship. There are differences galore over the GST rate structure, inclusion and exclusion
of commodities in GST, revenue sharing from GST, associated compensation and the like
issues. These differences haven’t done much to bridge the chasm in the federal relationship. 
While GST replaced state-level sales taxes, it has given the Centre a significant control. With
the Centre holding one-third of the voting rights, the structure
of the GST Council effectively grants it the veto power, undermining the promised co-
operative federalism. The federal friction is further precipitated by the interpretation of the
constitution of India. While some call it “union of states”, still others are interpreting it as
“federation of states”. This has obviously led to a constant face-off between the centre and
the states. This interpretation itself is the consequence of nuanced posterings by parties to
assert their regional rights and perhaps automony. The Inter-state council was formed in 1990
to promote a robust institutional framework to usher in and strengthen the co-operative
federalism in the country. Somewhere along, however, this hasn’t got the intended focus. This
has further accentuated the chasm between the Centre and the States. A reading of the ground
situation suggests that these avoidable face-offs are the creation of growing trust deficit and
evaporation of accommodative spirit in a political environment, which has increasingly
turned messier by the day.
Dominating Centre
In the unfolding political environment, tension in fiscal federalism happens when the Centre
dominates. The centrally-sponsored schemes – though intended to bring a lot of good – have
sort of perceived to be a clever ploy to restrict the autonomy of the States. No doubt, they are
jointly funded. Yet, these are seen to limit the leeway of the States in articulating their own
developmental agenda. The funding pattern in a centrally-sponsored scheme is as follows:
60:40 (Centre:State) and 90:10 for 8 North-Eastern and 2 Himalayan States  The initiatives
such as Swachh Bharat Mission, Pradhan Mantri Awas Yojana, Jan Dhan Yojana, Ujjwala
Yojana and the like are seen to give States a subordinate recognition.
This expansionary role of the Centre has a twin fall-out. For one, it crowds out investment
funds for the States. For another, it curtails their flexibility to pursue their own development
agenda. Also, it has given rise to an avoidable parallel policy resulting in duplication of
spending.
Conclusion
What is the inference? Simply put, the rising tension in the federal system appears to be the
consequence of a growing sense of mistrust. This mistrust must be viewed in the context of
intensely competitive politics that is being played out now where the game of one-upmanship
in populism is increasing relied upon. This surely hinders political dialogue and consensus-
building which are crucial for a health co-operative federalism. A consistently polarised
political ecosystem only weakens the presence of institutions such as the Inter-State Council,
GST Council, NITI Aayog, and the like.
Read against this overall scenario, the big push for the `double engine’ theory (where the
governments at the Centre and the State will be by the same party) has injected a lot more
suspicion and, naturally, the trust deficit is only widening.
No doubt, a robust institutional mechanism is critical for a healthy federal ecosystem. That
itself isn’t sufficient, it appears. What is of urgent importance is for the entire political clan in
the country usher in an accommodative spirit to foster a federal system that is beneficial for
all. That, of course, calls for a re-jig in the outlook of the entire political system to align itself
with the emerging compulsions in fiscal federalism.
References
1.. A  paper presented by Ehtisham to IMF eLIBRARY in September
1992. (https://www.elibrary.imf.org/display/book/9781557756633/ch004.xml?tabs=abstract
2. Emerging Issues in Fiscal Federalism” authored by Anwar Shah Indira Rajaraman
Fernando Rezende.
https://www.elibrary.imf.org/display/book/9781557756633/ch004.xml?tabs=abstract
3. Media reports on the Centre-state issues.

 Cementing Consolidation

It was inevitable. When it finally happened, however, it has thrown up a number of questions and possibilities in running a business in India. When a gusty and aging N. Srinivasan called it quits and sold his dear India Cements to the Birla-owned UltraTech, it exposed the limitations of a man who dominated the cement field in the south like nobody else's business. Why did he give up? Notwithstanding the business and economic reasons, the typical constraints of a family-run business did not help him either. The propensity of the generation next to carry forward is critical for a family business to live long. Family businesses of well-known kinds are dime a dozen in this part of the world.

 What's in a name? What's in a brand? How does history matter? Time can just reduce all these to inconsequential things. As the saying goes, change is the only constant in a dynamic business environment. Nevertheless, it requires enormous courage to let go of something you hold very dear. No doubt, Srinivasan was caught in a compelling situation. Yet, he proved wiser in calling it quits. Srinivasan and his ilk have indeed been compensated well for getting out of India Cements. Did UltraTech get India Cements at the best price? Time alone can answer this.

Going back in time

What does this deal signify? Are we going back in time? It appears so. Small is beautiful, it is often said. Not surprisingly, rulers of the past - both at the Centre and States - assiduously encouraged SMEs (small and medium enterprises). They had been particularly conscious that production should not be concentrated in a few hands. The MRTP (Monopolies and Restrictive Trade Practices) Act was in play to check-mate such concentration of production.

Toward consolidation

 As things pan out - especially in the cement business - the emerging competition of the intense kind is sort of pointing to a reorganisation of an unexpected kind in the cement industry. A consolidation is clearly in evidence and is happening at a hectic pace, especially in the southern cement market. The two dominant players in the country - Adanis and UltraTech - have been on a prowl to expand their cement base. In April, Ambuja Cement, an Adani Group company, had entered into an agreement to acquire My Home Group’s 1.5 million tonne per annum cement grinding unit at Tuticorin in Tamil Nadu. Later, on June 13, Ambuja Cement signed an agreement to acquire Penna Cement Industries (PCIL). The deal is signed ostensibly to help the group expand its presence not only in south India but also gain access to the Sri Lankan market. Shree Cement had announced capacity expansion in Karnataka. Dalmia Bharat was in the process of setting up a cement mill at Ariyalur, Tamil Nadu.

South focus

 Why is South India in focus? The reasons are not hard to find. For one, South India is where much of the country's limestone deposit - critical input for the production of limestone - resides. For another, the industry in the South is largely fragmented with myriad players. Also, the cement demand is much more up North. In the modern context, the southern cement companies - going by their capacities - pale into insignificance when compared to the big players such as UltraTech and Adanis. A player like India Cements can easily fall into the realm of SSIs when pitched against these biggies, who have deep pockets. All these factors have now conspired to make the southern cement industry scene a lot more exciting. The name of the game, all of a sudden, is getting re-defined. Surely, the focus is firmly on being big. If scale defines the new focus, the big consolidation under way points to the return of 'dominant production' ways, a far cry from the diversified cement manufacturing. The fragmented nature of the cement business in the South is an easy facilitation for the biggies to get in. The industry in the south is already abuzz with such talks. A sense of urgency is making the big boys fidgety, and is reportedly forcing them to hasten their action plan in the south. Coming events cast their shadows before them, it is often said. Are we returning to former times where a few dominated production? Well, the cement industry, especially in the South, is set for a lot of action ahead

(This was published in The Hindu BusinessLine on August 8, 2024)