Reviving the true spirit of federalism in India

Reviving the true spirit of federalism in India: Need for greater decentralisation of power and financial empowerment of states to tackle Covid-19

While States in India have taken a leading role in managing Covid-19 pandemic, federal restrictions prove to be stumbling blocks. Central government should see this pandemic as an opportunity to reaffirm federal spirit through creation of a greater “fiscal space” for states and by reducing their borrowing costs.

The experience from the last one month in the way states are handling the pandemic clearly indicates that they are truly “laboratories of democracy” as paraphrased by former U.S. Supreme Court Justice Louis Brandeis.  However, the constitutionally defined federalism in India is “quasi federal” in nature with a strong unitary bias. The distribution of executive and legislative powers between Centre and States clearly indicates existence of “asymmetry” in the way Indian federalism works.

The actions of the central government have always in the past indicated towards its top-down approach, centralisation and micromanagement from above. The introduction of a Goods and Services Tax (GST) regime in July 2017 was a clear blow to the financial autonomy of states and has made the very survival of the States dependent on the grace of the Union with central government always falling short of providing compensation on time. Furthermore, revoking of Article 370 by division of Jammu and Kashmir into two Union Territories without securing consent from the State Legislative Assembly was yet another attack on Indian federalism.

Recently also, the Union government’s centralising instinct was observed in the way it handled the recent pandemic situation. In case of Covid-19 response action, first phase of lockdown was declared without necessary discussion with the states. Considering the fact that States in India enjoy uneven support structures with varying geographies’ and resource mobilising strategies; simply handing down the lockdown decision to states without their required deliberation was a serious attack on the true spirit of federalism.

Serious problems were created by the sudden announcement of the lockdown on March 24; leaving not enough time for the State to prepare for the crisis situation. The state governments faced the problem of migrant workers who were stranded in their respective states. Further, considering the fact that “health” and “housing” both are state subjects (covered under state list of seventh schedule of Article 246), adequate state’s participation and adherence to the federal principles was inevitable in devising an effective strategy to deal with the corona pandemic.

On fiscal front, Indian states are scrambling for funds to tackle Covid-19 outbreak and their borrowing costs have risen sharply. Even after the RBI cut policy rates and flooded the system with liquidity, the bonds yields have been pushed sharply by the mounting uncertainty, greater risk aversion among investors and raised government borrowing to fund covid-19 expenditure. For instance, in first bond auction of the current financial year on April 7 in which states raised Rs 32,560 crore, as many as nine states raised 10-year bonds at high yields rates between 7.80% and 8%. The highest borrowing rate was paid by Kerala which raised Rs 1,930 crore for a 15-year duration at 8.96 percent.

To give some monetary relief to the states, Central government should release the pending GST compensation to the States as soon as possible which in turn can be used for fighting the Covid-19 outbreak. Centre recently released the second instalment of goods and services tax (GST) compensation to states, of over Rs 14,100 crore, for the October-November period. Pending dues for December and January 2020 should also be released soon to help states in managing rising health expenditure associated with the pandemic.

In addition, under the amendments made to the FRBM Act in 2018, Central government can trigger “escape clause” which allows it to breach its fiscal deficit target at the times of severe stress in the economy. Invoking such a clause by the Centre allows “RBI to participate directly in primary auction of government bonds to monetise union government debt”. Given such leisure available to Central government, such a facility can be made available for state governments too in this covid19 crisis situation by making necessary amendments to the FRBM act. This will not only reduce state’s borrowing costs but will also create a greater fiscal space for state governments to tide over their cash crunch.

Further, at the time when state’s revenue is drying up and their healthcare expenditure is stepping up, Centre should “relax” the cap put on state’s borrowing limits at 3% of its GDP under fiscal responsibility and budget management (FRBM) act. In the event of this emergency situation, states should be given relaxation in their fiscal deficit limit by as much as 1-3% of their respective gross state domestic product (GSDP). Bihar has already raised the issue of raising the FRBM limit to 4%.

Keeping in mind the borrowing needs of the State governments in the present crisis, decision of RBI to increase the WMA limit of states by 60 percent over and above the level as on March 31, 2020 has given some financial respite to the State governments. Nonetheless, an increase in the WMA limit for states by another 30% will ensure more cash inflows to states. RBI’s decision of increasing the overdraft facility to 21 working days from current 14 working days is also appreciable. Nevertheless, further increase of overdraft facility for a month will give state governments more flexibility to time their borrowings.

Lastly, states should be allowed with greater operational flexibility and fiscal autonomy with Union government commanding less and coordinating more. Nevertheless, Covid-19 situation can only be tackled by joint efforts of Central and State governments with greater decentralisation and fiscal empowerment of state governments.