Editorial 1: The New Sharing
Context:
The Union government is gearing up to constitute the Sixteenth Finance Commission in November this year to recommend the formula for sharing revenues between the Centre and the States for the five-year period beginning 2026-27.
Status and Challenges of Indian Fiscal Federalism:
- Misutilisation of funds: The diversion of a State’s own funds to centrally sponsored schemes, thereby depleting resources for its own schemes, violates constitutional provision. For instance, to meet its debt obligations and revenue and fiscal deficits.
- Conflicting Recommendations with other Bodies: Overlap with GST Council in Decision Making on matters of revenue and taxation.
- High Revenue Deficit (RD) Burden - The reduction in fiscal deficit has not resulted in corresponding reduction in revenue deficit. The all-state share of Revenue Deficit in Fiscal Deficit for 2023-24 is expected to be at 27%. All-State Revenue Deficit - 0.78% of GSDP.
- Concerning Fiscal Deficit Situation: At the Union level, the fiscal deficit declined from 9.1% of GDP in 2020-21 to 5.9% in 2023-24. All State fiscal deficit declined to 3.24% of GDP in 2022-23 from 4.1% of GDP in 2020-21. For the major States, fiscal deficit is expected to be at 2.9% of GDP in 2023-24.
- High Debt to GSDP Ratios- Most States also have large debt to GSDP ratios. This creates a fiscal imbalance which has long-run fiscal implications.
- Increase in cess and surcharge- The effective share of States in the Centre’s gross tax revenues (GTR) averaged close to 31% in 2020-21 to 2023-24 which was significantly lower than the corresponding share of nearly 35% during 2015-16 to 2019-20. This is due to inordinate increase in cess and surcharge from 12.8% in 2015 to 18.5% in 2020.
- Poor GST collection- An issue of concern in recent years has been the poor performance of the Goods and Services Tax (GST) and the consequent decline in total divisible pool. GST collection in last 2 years have maintained good buoyancy, there is still a need to restructure GST to good and simple tax.
- Income weightage- Income distance criterion (45%) gives larger share to relatively lower income states, many rich states have argued to lower the weightage in the criterion.
- Inability to Meet FRBM Targets: The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003. It led to the framing of FRBM Rules in 2004 that sets targets for the Central government to ensure fiscal discipline. Amendment - In 2018, the Centre is mandated to take appropriate steps to limit its fiscal deficit to 3% of GDP by March 31, 2021 although this is an operational target. The mandated target pertains to the Centre’s debt-GDP ratio which is to be brought down to 40%.
- Role of States: State mobilises more than one-third of total revenue, spend 60% of combined government expenditure. Around 40% in Government borrowing is shared by the states of India.
Way Forward:
- Ensure Regional Fiscal Balance: Through rationalisation of the criteria of population share as to address the grievances of the southern states.
- Regular Setting up of State Finance Commission: State governments need to set up Finance Commissions (SFC) at regular intervals to decide the assignment of taxes, fees and revenues to local governments.
- Maintain State Fiscal Deficit- The Finance Commission should be strict with states in maintaining Fiscal Deficit (FD) within limits. It can include fiscal performance of the states as a criterion in horizontal distribution. If the states exceed FD limit then act to the extent of the borrowing allowed for the states.
- Limit Cess and Surcharge- Freeze the share of Cess and Surcharge to some base number.
- Scrutinise Subsidies- The 16th Finance Commission should examine the subject of non-merit subsidies in detail.
- Loan Council- It is an independent body recommended in 12th finance commission to oversee the loan magnitude and profiles of the Central and State governments.
- Income criteria- It may be useful to freeze the weight to income distance criterion at the current level (45%) or even reduce it to 40%.
- Need of equalisation principle- In the overall scheme of resource transfers there is a need to prioritise equalisation of education and health services provisions and make it destination based.
- Efficiency of GST Collection be increased.
Conclusion:
- The 16th Finance Commission has a challenging task to not only maintain balance between the rich southern and the poor northern states but also the ensure fiscal discipline among the states through constructive utilisation of tax devolution function which is pivotal to maintaining India’s fiscal federalism and continued growth path.
- The NK Singh committee (set up in 2016) has already recommended that the government should target a fiscal deficit of 3% of the GDP in years up to March 31, 2020, cut it to 2.8% in 2020-21 and to 2.5% by 2023. The Finance Commission must ensure that the FRBM targets are met and the fiscal consolidation path is adhered to especially in the post-COVID era.
- There should be a synergy between Finance Commission (FC) recommendations and the GST Council actions to ensure better implementation of the FC devolution.
About:
What is Finance Commission?
- Article 280 of the Constitution of India provides for a quasi-judicial body, the Finance Commission. It is constituted by the President of India every fifth year or at such earlier time as he considers necessary. The recommendations made by the Finance Commission are only advisory in nature and hence, not binding on the government.
- Goods and Services Tax (GST): GST Regime introduced in 2017 is based on concurrency of indirect taxes where every transaction attracts central as well as state GST and interstate transactions are levied an Integrated GST. It is a consumption-based tax applied on the destination instead of production-based tax applied on the origin. This ensures that consuming poor states benefit instead of the producing rich states.
15th Finance Commission – It was constituted in 2017 by President under the chairmanship of N.K.Singh.
- Tenure- 5 years (2021-22 to 2025-26)
- Vertical Devolution- It is the devolution of taxes to the states by Union. 41% of the divisible pool is recommended (1% adjustment is made due to bifurcation of Jammu and Kashmir into Union Territories.
- Horizontal Devolution Criteria- It is devolution of taxes between states.
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Criteria |
Percentage |
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Demographic performance |
2.5% |
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Income |
45% |
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Population and area |
15% each |
|
Forest and ecology |
10% |
|
Tax and fiscal efforts |
2.5% |
Performance based incentives and grants to states
Other grants provided: Revenue deficit grants, State specific grants, Grant to local bodies, Disaster risk management
Key Recommendations in 15th Finance Commission:
- Centre’s debt to GDP ratio is 58.7% and Fiscal Deficit to GDP ratio 9.2%
- There is a need to reduce States debt-GDP target to 20%.
- It recommended to re-examine the 2018 amendment to Fiscal Responsibility and Budget Management Act (FRBM).
Editorial 2: India’s Supply Chain Opportunity
Context: At the recently-concluded G20 summit, India and the United Arab Emirates (UAE) announced the launch of a new trade corridor connecting India to the Middle East and Europe through land and sea routes. Analysts say it will be a direct challenge to China's Belt and Road Initiative (BRI) and major medium of economic integration between India, West Asia and Europe.
Concept:
- India-Middle East-Europe Economic Corridor (IMEC) is a planned rail and shipping economic corridor that aims to bolster economic development by fostering connectivity and economic integration between Asia, the Arabian Gulf, and Europe.
- The 'India-Middle East Europe Economic Corridor' is part of a Partnership for Global Infrastructure and Investment (PGII).
- PGII is a collaborative effort by G7 nations to fund infrastructure projects in developing nations. PGII is considered to be the bloc’s counter to China’s Belt and Road Initiative.
- On 10 September 2023 the MoU (Memorandum of Understanding) was unveiled during the 2023 G20 New Delhi summit by the governments of India, the United States, the UAE, Saudi Arabia, France, Germany, Italy; and the EU.
- The corridor will include a rail link as well as an electricity cable, a hydrogen pipeline and a high-speed data cable. Project is also called "a green and digital bridge across continents and civilizations."
- While the agreement signed did not have any binding financial agreements among the partners, the parties agreed to draft an action plan within 60 days for the corridor.
Geographical Route:
- Ship leaving India's western port and heading towards Gulf of Oman. It docks in Dubai and then the cargo takes a rail route to move across Saudi Arabia, Jordan and Israel, again taking the sea route from Haifa to reach Europe. After touching Cyprus, it reaches Greece. The animation then shows a truck that takes the cargo via land route to Serbia and Croatia in southeastern Europe. The cargo then enters Austria and ends the journey in Germany.
Advantages of the Corridor:
Economic Advantages
- Revival of Ancient Linkages: It will lead to a resurgence of the ancient maritime and overland commercial linkages between the countries of the Arabian Sea and the Mediterranean Sea region.
- Rise in Infrastructure and Communications: It would increase infrastructure among the lower and middle-income countries involved through an increased flow of investment, energy and digital communications.
- Reduce Dependence on Suez Canal: Currently, trade has to go through the Suez Canal, which is longer. This corridor will bring down the dependency of Suez Canal.
- Efficient and Eco-friendly Trade: With a rail link, that will make trade between India and Europe 40% faster. In addition to cutting shipping costs, times, and fuel usage and improving trade facilitation, the corridor is intended to enhance efficiency, secure regional supply chains, and reduce greenhouse emissions.
- Building Supply Chains: Across the corridor, we envision driving existing trade and manufacturing, and strengthening food security and supply chains.
- Investments and Employment: Our approach aims to unlock new investments from partners, including the private sector, and spur the creation of quality jobs.
Strategic Advantages
- Peace in Middle East: It could help “turn the temperature down” on “turbulence and insecurity” coming out of the Middle East.
- It will provide smaller and poor countries, an alternative to the Chinese debt trap linked to its Belt and Road Initiative.
- It will help provide counterbalancing China’s growing influence in the Middle East region.
- It will provide India, an alternate feasible trans-regional commercial route to replace the sluggish Chabahar route for the International North-South Transit Corridor.
- Better Indian Bonding with the Middle East: Three innovations- the establishment of a food corridor (food supply chain), an integrated hydrocarbon value chain, and green energy and innovative technology manufacturing value chains- will invigorate and reconfigure India’s economic and strategic bonding with the Middle East for the success of India’s Look West policy.
- Isolating Pakistan: Growing economic and strategic ties with the United Arab Emirates (UAE), and Saudi Arabia- the two old trusted allies of Pakistan will ensure Pakistan’s continued isolation in the region.
- Benefit to Indian Diaspora: Moreover, the project, with the support of approximately 8.5 million Indian diasporas in the Middle East, carries immense potential for serving a market for Indian goods.
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India Middle East Europe Corridor (IMEC)
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Belt and Road Initiative (BRI)
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Challenges for the Corridor:
- Dissent of Turkey: Turkey opposed the new corridor calling that there is not Middle East without Turkey. Turkey is already part of Chinese Belt and Road Initiative.
- Conflict in Common Countries: Some IMEC signatories are also part of BRI, including Italy, Saudi Arabia and the UAE. Italy has signaled that it aims to pull out of the BRI.
- Geopolitical Tussle and Division: Global division into two parts may lead to problems for the IMEC as the project needs cooperation.
- Issue of Investment: The PGII faces challenges such as raising investments on the scale of the BRI and securing political consensus within G7 countries.
- Private sector participation is not assured.
- Challenge of Consensus: Implementation of the project will involve extensive consultation between member countries to reach a consensus on techno-economic, operational and legal issues.
- Problems of Indian Shipping: Indian shipping industry will have to address challenges including environmental regulations, timely digitalisation across partner countries, global and domestic political stability, rising shipping costs and security issues.
Way Forward:
- Governing Board: Participating sovereigns can set up a Governing Board at the Ministerial level, with the leadership from Multilateral Development Banks like World Bank, Asian Development Bank, Islamic Development Bank, and European Investment Bank, etc as invitees.
- Use of Global Best Practices: It can utilise the Africa’s One Stop Border Posts Program and learnings from the BRI initiative.
- Focus on reorientation of our shipping infrastructure plans specifically around ports of exit/entry.
- Domestic Policy: Promotion of export oriented Foreign Direct Investment, open door policy in manufacturing, bringing SEZs in PPP mode, Ease of Business and competitive incentives is key to participating in supply chains. Promoting private sector and investment in education will be pivotal with upscaling key programmes like Make in India.
- Signing FTAs with Neighbours: Free Trade Agreements with neighbours will help bring South Asia as a hub of global trade when connected to such global supply chains.
Conclusion:
- There is a need to work upon the broader aspects of the reforms in the domestic policy to reorient according to the newly proposed IMEC to secure national interests and promote India’s economic growth to achieve the goal of Developed India by 2047.