Topic 1 : Grand bargain 2.0
Introduction: Recently, two state governments of Karnataka and Kerala blamed the union government for discriminating in devolving funds to these states. This has brought the tussle in Indian federal units to the surface.
How Kerala and Karnataka are reacting?
- One state’s chief minister hit the national capital’s streets, along with his cabinet colleagues, against the Centre’s alleged discrimination in devolution of tax revenues and non-release of drought relief funds.
- Another state’s CM followed suit, having already moved the Supreme Court against the Centre imposing limits on its borrowing powers.
- The fact that both of them, Karnataka and Kerala, are Opposition-ruled and the timing of the protests, ahead of Lok Sabha elections, may make these seem purely political in nature.
Are the moves of these states political?
- The fiscal irresponsibility of these states may also cause strain on exchequers.
- The ruling Congress in Karnataka should have thought twice before announcing its five assembly poll “guarantee” schemes, which are costing the state exchequer an additional Rs 52,000 crore per year.
- The Kerala government has, likewise, sought to circumvent its normal net borrowing ceiling, of 3 per cent of GDP fixed by the Centre, by resorting to off-budget loans raised by two state-owned entities.
There is a genuine fiscal imbalance between states and union governments
- The political motivations notwithstanding, there are genuine concerns with regard to both the letter and spirit of fiscal federalism that need addressing.
- To start with, the Centre accounts for more than 60 per cent of the gross tax revenues collected together with the states.
- On the other hand, the states have well over a 60 per cent share when it comes to total government spending.
- The disparity between revenue generation capacities and expenditure responsibilities imparts an inherent vertical fiscal imbalance.
- That imbalance would only have widened with the implementation of the goods and services tax (GST), which has replaced the value added tax and a host of other levies that were major sources of revenue for the states earlier.
- But the states accepted the apparent loss of fiscal sovereignty through a grand bargain that was a result of consensus building and addressing apprehensions of revenue loss, if any, from the new nationwide non-cascading indirect tax regime.
- The high point was the setting up of the GST Council, comprising the finance ministers of the Centre and all states, to decide on tax rates, exemptions and any regulatory changes.
A council similar to the GST cousin is required for tax devolution
- A similar compact is required today in matters of tax devolution and other resource transfers, both vertical (Centre to states) and horizontal (among states).
- Karnataka, for instance, is justified in asking why its share in the divisible tax pool was reduced from 4.713 to 3.647 per cent between the 14th and 15th Finance Commission awards.
- The next commission should frame clear and transparent rules for the distribution of the Centre’s tax proceeds and grants-in-aid.
Conclusion: As part of a Grand Bargain 2.0, the Centre must desist from levying non-sharable cesses and surcharges on taxes, just as states should be made to strictly adhere to deficit targets and borrowing limits.
Topic 2 : Holding the line
Introduction: In line with expectations, the Monetary Policy Committee of the Reserve Bank of India voted in its February meeting to keep interest rates unchanged. The repo rate stands at 6.5 per cent.
What is Monetary policy?
- Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act.
- The primary objective of the RBI’s monetary policy is to maintain price stability while keeping in mind the objective of growth.
- Price stability is a necessary precondition to sustainable growth.
- The amended RBI Act, 1934 also provides for the inflation target (4% +-2%) to be set by the Government of India, in consultation with the Reserve Bank, once in every five years.
What did RBI say?
- The committee also decided to remain focused on the withdrawal of accommodation.
- In his policy statement, RBI Governor Shaktikanta Das noted that “the job is not yet finished” and that policy must “continue to be actively disinflationary to align inflation to the target of 4 per cent on a durable basis”.
The recent trend in inflation
- In December, retail inflation, as measured by the consumer price index, had edged upwards to 5.69 per cent, up from 5.55 per cent the month before.
- However, this rise in inflation, driven by rising food prices, was not unexpected.
- On the other hand, core inflation, which excludes the more volatile food and fuel components, had dipped lower to 3.8 per cent in December.
- The central bank now expects inflation to trend lower to 5 per cent in the fourth quarter (January-March).
- For the next financial year (2024-25), assuming a normal monsoon, it expects inflation to moderate further to 4.5 per cent. However, the outlook is uncertain.
Factors that led to the status quo of policy rates by RBI
- As the RBI notes, adverse weather events which could impact food prices, and geopolitical tensions and conflicts which could lead to supply chain disruptions, could heavily influence the trajectory of inflation.
- Governor Das also sounded a note of caution, saying that policy needs to be “vigilant about new supply shocks that may undo the progress made so far.”
RBI is optimistic on growth rates
- On growth, the RBI Governor sounds optimistic, expecting the economic momentum to continue in the coming financial year (2024-25) as well.
- Das points to industrial activity “gaining steam”, while the services sector “is expected to remain resilient”.
- He sees rural demand continuing to gather pace, even as urban consumption remains strong, with investment activity also “gaining steam” on the back of a sustained push in government spending.
- Based on these trends, the central bank expects the Indian economy to grow at 7 per cent in 2024-25.
The minority view among monetary policy members
- The monetary policy committee’s decisions were, however, not unanimous.
- MPC member Jayanth Varma disagreed with other members of the committee on both interest rates and the policy stance.
- Varma, in fact, voted for reducing the repo rate by 25 basis points and for changing the policy stance from remaining focused on the withdrawal of accommodation to neutral.
- In the past as well, Varma has argued that monetary policy should be less restrictive.
- However, hostilities in the Red Sea and uncertainty regarding the trajectory of food prices are likely to have an outsized influence in the immediate term.
Conclusion: RBI keeps interest rates unchanged. If inflation evolves along expected lines, it could open up space for rate cuts.