Economic collapse in States

A fragile federation under strain

Print edition : June 05, 2020

Thermal screening upon arrival at Danapur station, Bihar on May 4. Photo: Ranjeet Kumar/THE HINDU

Outside a deserted wholesale market in Delhi. Photo: Anushree Fadnavis/REUTERS

Amid the lockdown restrictions, State governments find themselves trapped in a fiscal and developmental crisis caused by collapsing revenues, rising expenditures, soaring interest rates and, crucially, lack of support from the Centre.

THE inapposite Central government policy response to the COVID-19 pandemic in India wrought damage in many areas, among them is that on the fragile framework of economic cooperation between the Centre and the States. It is clear that the real task of mitigating the effects of the pandemic on the health and lives of citizens has fallen on the States. That is inevitable. As India prepares to lift the lockdown to stall the economic collapse it has caused, and face the inevitable spike in the number of COVID-19-positive cases, “the key to success… would be the preparedness of local governments in suppressing and managing outbreaks at the community level”, to quote David Nabarro, the World Health Organisation’s (WHO) Special Envoy on COVID-19.

Only State governments and decentralised governance structures can handle the task of managing the pandemic.Yet, the Centre has been presenting itself as leading the battle against the virus. Two moves have been central to that propaganda offensive. The first was the legal sanction the Centre gave itself in its self-assumed role of leader by declaring the pandemic a disaster and invoking provisions of the Disaster Management Act. Armed with those powers, it promptly resorted to the issue of mandatory, but frequently revised, “guidelines”, and followed that by transporting Central teams to monitor the performance of ostensibly recalcitrant State governments. There was to be no doubt as to who was calling the shots. The second move was to declare, with no preparation and warning, a stringent nationwide lockdown, covering badly affected and unaffected parts alike, which has had hugely adverse effects not merely on the economy but on the livelihoods and lives of the poorest sections, especially migrant workers.

Setting aside the debate whether such actions were justified, the least that could be expected of an agency that wants to concentrate in its hands the emergency political powers that it claims are needed in the midst of this crisis is that it also shoulder the collateral responsibilities. Principal among those is the responsibility to hugely hike expenditures from its own budget and to transfer substantial additional resources to the States, which are faced with collapsing revenues and sharply rising expenditures since they are the ones called upon to address the COVID-19-induced crisis on the ground. Most States have made requests for large transfers from the Centre.

Expenditure at the Central and State levels is needed to ensure large-scale testing, tracing and isolation; to ramp up medical facilities needed for those who fall ill; to protect health workers dealing with those who are infected; to provide relief to those who have lost their jobs or all or part of their earnings; to support small and medium businesses threatened with bankruptcy; and to restore employment, stimulate demand and revive economic activity as the lockdown is relaxed. Since it is the States that have to carry much of the burden of dealing with the crisis, the Centre must give priority to mobilising and transferring a large proportion of the additional resources needed to the States.

Support is crucial because even prior to the COVID-19 crisis, over 2019-20 as a whole, slowing growth and a failed goods and services tax (GST) regime had led to shortfalls in the States’ share in Central taxes of more than Rs.1.25 lakh crore and reduced States’ own tax collections by 1.6 per cent relative to the previous year. This meant that many States were approaching, or even exceeding, their fiscal deficit target limit of 3 per cent.

Lack of Central support

With revenues collapsing starting April, this tendency will intensify unless expenditures are reduced precisely at a time when they cannot but increase. Yet, Central fiscal support is near completely absent, to the extent that State governments are required to pick up foodgrains from the Food Corporation of India (FCI) at market prices, and the Centre is not even willing to cover the rail fares of migrants departing from different States as they return home because they have no jobs, no incomes and no places to stay.

The resources required are huge. The State that has been the most successful in addressing the pandemic, among those prone to its spread because of international travel by students, workers and tourists, is Kerala. With its well-developed public health system and experience with dealing with the Nipah virus, Kerala could plan appropriately in order to contain the pandemic. The Kerala government assessed that in the first instance it would need to spend an additional Rs.20,000 crore on containment and relief. Other States, much larger in size, have provided estimated expenditures that are much less, but they will have to significantly step up their budgets as the war against the pandemic continues to be waged.

These are huge sums that need to be spent when there is no support from the Centre and their own revenues have collapsed. Delhi obtained Rs.320 crore as revenues in April 2020 as against Rs.3,500 crore in the same month of the previous year. The corresponding figures for Kerala are around Rs.150 crore and Rs.1,500 crore.

Moreover, the States are facing difficulty borrowing their way out of the crisis. To start with, there are strict limits on their borrowing, relative to their State Domestic Product (SDP), set by the unequal financial powers given to Central and State governments. But more important, when they choose to frontload borrowing permitted over 2020-21, they find that there is not much enthusiasm for State government bonds in the market, pushing interest rates for borrowing by Kerala, for example, to close to 9 per cent. With revenues collapsing, the Centre not offering the required support and interest rates soaring, the governments that must respond to the COVID-19 pandemic are trapped in a fiscal crisis.

There is an easy way out for the interim when the crisis is faced up to. That is for the Reserve Bank of India (RBI) to print money and buy into the bonds of the State governments at relatively low rates of interest, or for the Central government to borrow from the Central bank and make transfers to the States, which is the easier and better option. Even conservative economists, who normally oppose such “monetisation” of government deficit-spending, now agree that this is the only way to go. But neither the central bank nor the government that de facto controls its decision-making is willing to accept the obvious.

In sum, COVID-19 has severely intensified a disproportionality that is built into the distribution of powers and responsibilities characteristic of the Indian federal arrangement. There has always been recognition that while State governments are crucial players in the design and implementation of economic policy in India, there is considerable disproportionality between the capacity of the Centre and the States to mobilise resources and the responsibilities they have to shoulder in terms of the spending. The Finance Commissions were to decide on what proportion of resources raised by the Centre had to be transferred to the States to address this disproportionality.

As has been repeatedly pointed out, in the process of centralisation of power within India’s quasi-federal framework, two among many tendencies have been operative. First, an effort by the Centre to increasingly mobilise resources through means of imposts that do not require the resulting revenues to be included in the pool of revenues that must be shared with the States. Second, efforts, in violation of what the Constitution originally envisaged, to frame the terms of reference of Finance Commissions in ways that make them agencies that can impose fiscal austerity, defined as “discipline”, by limiting the States’ right to borrow and linking transfers to them to performance with respect to fiscal austerity targets.

That the Centre is failing to fulfill its own direct responsibilities is clear from the fact that the only COVID-19 package it has announced is partly a revamp of already existent schemes and partly a small increase in new expenditures. The combined total of these two sets of expenditures is short of one percentage point of the GDP, which is anywhere between one-fifth and one-tenth of what estimates suggest is actually needed. The Centre has clearly shirked on its direct fiscal responsibility.

Besides shirking its own responsibilities, the Centre is, in the middle of the crisis, holding back on resources that are rightfully due to the States and those that the States need to be provided with, given their dominant role in addressing the adverse impact of the pandemic on health and the economy, and therefore on livelihoods and lives. The Centre has been delaying transferring the statutory share of the taxes collected by the Centre to the States. It has not been paying the States the compensation due to them as per agreement because of shortfalls in GST revenues that accrue to them relative to what was projected for the first five years of the GST regime. The Centre’s justification for reneging on the compensation, that the resources available in the compensation cess fund are not adequate to compensate the States, is without basis given the understanding that in the event of any such shortfall the Centre would borrow money, compensate the States and extend the duration over which the cess is levied in order to garner the funds to pay back the debt incurred.

As if to rub salt into their wounds, when the Centre released, after much delay, a second instalment of Rs.6,195 crore owed to the States as part of the Rs.74,340 crore fiscal deficit grant awarded to them by the 15th Finance Commission in its interim report for 2020-21, the Finance Ministry statement said:“This would provide them additional resources during the Corona crisis.” The fiscal deficit grant had nothing to do with the COVID-19 crisis and was legitimately due to the States. Most recently, the Centre has made clear that it would not cover the States’ share of the expenditure in centrally sponsored flagship schemes, which would bring many of these to a halt. In fact, the Finance Ministry has directed the concerned Central ministries to check whether the States were in a position to cover their share of outlays in order to utilise funds released by the Centre for these schemes. It is only if they are convinced that they have been utilised that additional funds will be allocated.

As a consequence of all this, as of now, as the caseload is set to spike in India, the State governments are collapsing into a fiscal and developmental crisis, and grasping at straws like State levies on petroleum products and alcohol that are still outside the GST regime. But that is small recompense for the revenue losses they are running up, undermining their ability to continue the war against the virus.

The fallout of this Centre-made crisis in the middle of a larger and near-unprecedented health-cum-economic emergency is likely to be threefold. The first is pressure on at least some State governments to contemplate exit from the GST regime that has deprived them not just of revenues but of even minimal fiscal flexibility in the middle of a great crisis. The second is the strengthening of incipient tendencies for States to work around or even break from the social compact established by the Constitution that includes the increasingly fragile power and revenue sharing relationship which no more works. And the third is a huge setback to the small “gain” India has recorded in postponing the main force of the COVID-19 crisis, which was meant to give the country the time to build the wherewithal to test, trace, isolate and treat adequately to slow the pace of infection, while the world awaits the coming of a vaccine.