Author: B2B

Non-Performing Assets

An NPA is a loan or advance for which the principle or interest payment remained overdue for a period of 90 days.

Banks are further required to classify NPA into:

Key Facts about India’s NPA Problem

• The financial position of India’s Public Sector Banks has deteriorated sharply since 2011.
• Gross NPA has risen to 9.5 percent of total advances in 2015-16.
• Gross NPA has expected to rise further and touch 11.5 percent in coming years.
• At the aggregate level, PSBs reported a loss of 17672 crores in 2015-16.
• Most of the loans were made during the boom period of 2004-2008.
• The banks inspired by the boom kept on lending to business houses without inspecting the projects.
• When Global Crisis happened, the projects become unviable, and losses started to happen.
• Healthy Banking relies on healthy debt contracts. A debt contract is an agreement between a borrower and a lender, where the borrower promises to repay the lender principle with interest as per scheduled timeline. If the borrower can not repay, he is in default.
• In India, most of the defaulters in recent years are not the small retail borrowers but are large borrowers and corporate houses.
• Across the World, when a borrower defaults irrespective of how big he is, the borrower has to make sacrifices if he defaults. Sacrifices can be in terms of asset confiscation, taking over of firms etc.
• The biggest problem in India’s Banking system is lack of incentives the big borrower has to repay the loans back. They do not have to make many sacrifices if they default. This is the single most major reason of the NPAs in Public Sector Banks.
• In much of the Globe when large borrower defaults they are filled with guilt and desperate to convince their lenders that they should continue their trust in them.
• In India, however, large borrower insists on their divine right to stay in control despite their unwillingness to put in new money. The firms and its workers, as well as past bank loans, are taken as hostages in this game. The promoters threaten to run the enterprise into the ground unless the government do not bail them out.

Reasons for NPAs

How to Tackle Problem of NPAs

Resolving the NPA Problem

• The legacy of the NPAs must be resolved as quickly as possible so that banks can focus on resuming lending.
• Some assets that are classified as Loss assets should be written off from banks books.
• The new Bankruptcy code can be a game changer but will take time to operationalise.
• In many cases, the projects can be turned around through a combination of fresh capital from investors and new management.
• RBI has devised two schemes in this regard: the Strategic Debt Restructuring Scheme, which allows the bank to convert their debts into equity, take control of the company and then induced a new management to turn it around.
• Action has been initiated under the SDR, but no successful revival has been completed so far.
• The second RBI scheme is the Scheme for Sustainable Structuring of Stressed Assets (S4A) under which bank can offer existing management an opportunity to rehabilitate the project by dividing the debt into two parts: a “sustainable component” which can be serviced by the project based on some assumption by revenue and the “excess component” which can be converted into equity or redeemable preference shares.
• Sustainable debt must be more than 50% of the total debt.
• S4A leaves the project in the hands of existing managements and also gives the banks more flexibility in the time taken to resolve the problem. A key issue is how large a part of the debt is deemed to be sustainable. Management and banks are bound to differ on this issue.
• There is much talk of selling assets to privately managed asset reconstruction companies (ARCs), which can then organize the turnaround.
• Another idea is that the proposed National Infrastructure and Investment Fund (NIIF), operating with private partners, provide both equity and new credit to stressed infrastructure projects going through the SDR mechanism.
• The problem could be solved by creating a government-owned “bad bank” which purchases problem loans from the banks and concentrates on turning the projects around, possibly with the help of private ARCs.
• Bank managements will be much more willing to sell assets at a discounted price to another public sector company, which will then undertake the task of negotiating the best deal with potential new owners. The terms of reference of the new entity can be sufficiently clarified to encourage it to negotiate the best possible deal with new private managements. It could work in partnership with ARCs to fulfil this mandate.

Improving the Quality of Lending

• The quality of lending by PSB must be improved in future so that the same problem does not arise again.
• To provide Public sector banks with greater autonomy the shareholding of the government can be reduced to less than 50 percent or 33 percent.
• The P.J. Nayak committee had suggested that if the dilution of shareholding is not acceptable, it should be possible to distance the government from the managements of the banks by creating a public sector holding company and vesting the government’s shares in the holding company. Some statements have been made that this may be acceptable and the newly created Banks Board Bureau is the first step in this direction.
• There are two key elements in any effort to distance government. One is that the public sector banks should deal with only one regulator, RBI, and the extensive quasi-regulatory control exercised by the department of financial services should be ended. The role of the government as the owner would be performed by the holding company, and the government would deal only with the holding company on all issues.
• A second requirement is that public sector banks should become board-managed institutions, with the board responsible for all appointments, including that of the chief executive officer (CEO). If the shares of the government are actually transferred to a holding company, then decisions regarding appointments could be taken by the board of the new company on the recommendation of the board of the bank.
• The objective of creating a genuinely commercial environment in which public sector banks can function and managements are made accountable can only be achieved if the government is willing to step back from exercising direct control. Unless strong action is taken along these lines, we can assume that things will continue as they have.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

Banking Sector Reforms

First Narasimhan Committee Report – 1991

To promote the healthy development of the financial sector, the Narasimhan committee made recommendations.

Recommendations of Narasimhan Committee

1.    Establishment of 4 tier hierarchy for banking structure with 3 to 4 large banks (including SBI) at the top and at bottom rural banks engaged in agricultural activities.

2.    The supervisory functions over banks and financial institutions can be assigned to a quasi-autonomous body sponsored by RBI.

3.    A phased reduction in statutory liquidity ratio.

4.    Phased achievement of 8% capital adequacy ratio.

5.    Abolition of branch licensing policy.

6.    Proper classification of assets and full disclosure of accounts of banks and financial institutions.

7.    Deregulation of Interest rates.

8.    Delegation of direct lending activity of IDBI to a separate corporate body.

9.    Competition among financial institutions on participating approach.

10.  Setting up Asset Reconstruction fund to take over a portion of the loan portfolio of banks whose recovery has become difficult.

 Banking Reform Measures of Government: –

On the recommendations of Narasimhan Committee, following measures were undertaken by government since 1991: –

1.    Lowering SLR and CRR

• The high SLR and CRR reduced the profits of the banks. The SLR had been reduced from 38.5% in 1991 to 25% in 1997. This has left more funds with banks for allocation to agriculture, industry, trade etc.
• The Cash Reserve Ratio (CRR) is the cash ratio of banks total deposits to be maintained with RBI. The CRR had been brought down from 15% in 1991 to 4.1% in June 2003. The purpose is to release the funds locked up with RBI.

2.    Prudential Norms: –

• Prudential norms have been started by RBI in order to impart professionalism in commercial banks. The purpose of prudential norms includes proper disclosure of income, classification of assets and provision for Bad debts so as to ensure that the books of commercial banks reflect the accurate and correct picture of financial position.
• Prudential norms required banks to make 100% provision for all Non-performing Assets (NPAs). Funding for this purpose was placed at Rs. 10,000 crores phased over 2 years.

3.    Capital Adequacy Norms (CAN): –

• Capital Adequacy ratio is the ratio of minimum capital to risk asset ratio. In April 1992 RBI fixed CAN at 8%. By March 1996, all public sector banks had attained the ratio of 8%. It was also attained by foreign banks.

4.    Deregulation of Interest Rates

• The Narasimhan Committee advocated that interest rates should be allowed to be determined by market forces. Since 1992, interest rates have become much simpler and freer.
• Scheduled Commercial banks have now the freedom to set interest rates on their deposits subject to minimum floor rates and maximum ceiling rates.
• The interest rate on domestic term deposits has been decontrolled.
• The prime lending rate of SBI and other banks on general advances of over Rs. 2 lakhs has been reduced.
• The rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled.
• The interest rates on deposits and advances of all Co-operative banks have been deregulated subject to a minimum lending rate of 13%.

5.    Recovery of Debts

• The Government of India passed the “Recovery of debts due to Banks and Financial Institutions Act 1993” in order to facilitate and speed up the recovery of debts due to banks and financial institutions. Six Special Recovery Tribunals have been set up. An Appellate Tribunal has also been set up in Mumbai.

6.    Competition from New Private Sector Banks

• • Banking is open to the private sector.
  • New private sector banks have already started functioning. These new private sector banks are allowed to raise capital contribution from foreign institutional investors up to 20% and from NRIs up to 40%. This has led to increased competition.

7.    Access To Capital Market

• The Banking Companies (Acquisition and Transfer of Undertakings) Act was amended to enable the banks to raise capital through public issues. This is subject to the provision that the holding of Central Government would not fall below 51% of paid-up-capital. SBI has already raised a substantial amount of funds through equity and bonds.

8.    Freedom of Operation

• Scheduled Commercial Banks are given freedom to open new branches and upgrade extension counters, after attaining capital adequacy ratio and prudential accounting norms. The banks are also permitted to close non-viable branches other than in rural areas.

9.  Local Area Banks (LABs)

• In 1996, RBI issued guidelines for setting up of Local Area Banks, and it gave Its approval for setting up of 7 LABs in private sector. LABs will help in mobilizing rural savings and in channelling them into investment in local areas.

10.  Supervision of Commercial Banks

• The RBI has set up a Board of financial Supervision with an advisory Council to strengthen the supervision of banks and financial institutions. In 1993, RBI established a new department known as Department of Supervision as an independent unit for supervision of commercial banks.

Narasimham Committee Report II – 1998

In 1998 the government appointed yet another committee under the chairmanship of Mr Narsimham. It is better known as the Banking Sector Committee. It was told to review the banking reform progress and design a programme for further strengthening the financial system of India. The committee focused on various areas such as capital adequacy, bank mergers, bank legislation, etc.

It submitted its report to the Government in April 1998 with the following recommendations.

1. Strengthening Banks in India : The committee considered the stronger banking system in the context of the Current Account Convertibility ‘CAC’. It thought that Indian banks must be capable of handling problems regarding domestic liquidity and exchange rate management in the light of CAC. Thus, it recommended the merger of strong banks which will have ‘multiplier effect’ on the industry.
2. Narrow Banking : Those days many public sector banks were facing a problem of the Non-performing assets (NPAs). Some of them had NPAs were as high as 20 percent of their assets. Thus for successful rehabilitation of these banks, it recommended ‘Narrow Banking Concept’ where weak banks will be allowed to place their funds only in the short term and risk-free assets.
3. Capital Adequacy Ratio : In order to improve the inherent strength of the Indian banking system the committee recommended that the Government should raise the prescribed capital adequacy norms. This will further improve their absorption capacity also. Currently, the capital adequacy ratio for Indian banks is at 9 percent.
4. Bank ownership : As it had earlier mentioned the freedom for banks in its working and bank autonomy, it felt that the government control over the banks in the form of management and ownership and bank autonomy does not go hand in hand and thus it recommended a review of functions of boards and enabled them to adopt professional corporate strategy.
5. Review of banking laws : The committee considered that there was an urgent need for reviewing and amending main laws governing Indian Banking Industry like RBI Act, Banking Regulation Act, State Bank of India Act, Bank Nationalisation Act, etc. This up gradation will bring them in line with the present needs of the banking sector in India.

Apart from these major recommendations, the committee has also recommended faster computerization, technology up gradation, training of staff, depoliticizing of banks, professionalism in banking, reviewing bank recruitment, etc.

C.Nachiket Mor committee

The Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households, set up by the RBI in September 2013, was mandated with the task of framing a clear and detailed vision for financial inclusion and financial deepening in India.

In its final report, the Committee has outlined six vision statements for full financial inclusion and financial deepening in India:

The Committee further lays down a set of four design principles namely;

1. Stability,
2. Transparency,
3. Neutrality, and
4. Responsibility,

• The principles will guide the development of institutional frameworks and regulation for achieving the visions outlined. Any approach that seeks to achieve the goals of financial inclusion and deepening must be evaluated based on its impact on overall systemic risk and stability, and at no cost should the stability of the system be compromised.
• A well-functioning financial system must also mandate participants to build completely transparent balance sheets that are made visible in a high-frequency manner, accurately reflecting both the current status and the impact of stressful situations on this status.
• In addition, the treatment of each participant in the financial system must be strictly neutral and entirely determined by the role it is expected to perform in the system and not its specific institutional character.
• Finally, the financial system must maintain the principle that the provider is responsible for sale of suitable financial services to customers and ensure that providers are incentivised to make every effort to offer customers only welfare-enhancing products and not offer those that are not.
• At its core the Committee’s recommendations argue that in order to achieve the vision of full financial inclusion and financial deepening in a manner that enhances systemic stability, there is a need to move away from a limited focus on anyone model to an approach where multiple models and partnerships are allowed to emerge, particularly between national full-service banks, regional banks of various types, non-bank finance companies, and financial markets. Thus, the recommendations of the Committee seek to encourage partnerships between specialists, instead of focussing only on the large generalist institutions.
• In the spirit of the RBI’s approach paper on differentiated Banks, the Committee recommends that the RBI may also seriously consider licensing, with lowered entry barriers but otherwise equivalent treatment, more functionally focused banks like Payments Banks, Wholesale Consumer Banks, and Wholesale Investment Banks.
• Payments Banks are envisaged as entities that would focus on ensuring rapid out-reach with respect to payments and deposit services.
• The Wholesale Consumer Banks and Wholesale Investment Banks would not take retail deposits but would instead focus their attention on expanding the penetration of credit services.
• The Committee also recommends that the extant Priority Sector Lending norms be modified in order to allow and incentivize providers to specialise in one or more sectors of the economy and regions of the country, rather than requiring each and every bank to enter all the segments.
• Finally, the Committee proposes a shift in the current approach to customer protection to one that places a greater onus on the financial services provider to provide suitable products and services.
• The committee has suggested a fixed term of 5 years for the chairman/managing director of a bank and a term of 3 years for a whole-time director.

PJ Nayak Committee

Key Observations

Specific Recommendations made by the committee.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

Statutory bodies are established by acts which Parliament and State Legislatures can pass. These bodies are entities shaped by an Act of Parliament or state legislatures and set up by the government to consider the data and make judgments in some area of activity.

Basically, a statutory body is an organization of government which is not demarcated in Constitution of India but it gets its powers, service rules, authority by an act of parliament or state legislatures. They are generally established to perform specific functions which a government considers effectively performed outside a traditional departmental executive structure.

They fulfil the requirement for some operational independence from the government; funding arrangements that are not dependent on the annual appropriations processes; or to establish a separate legal body. Statutory bodies are normally set up in countries which are ruled under parliamentary democracy form of political setup.

Under the law, statutory bodies are organizations with the authority to monitor that the activities of a business and check whether these institutions are legal and follow official rules. For example, the General Medical Council is the statutory body which regulates doctors.

The statutory bodies may be established to permit a certain level of independence from government, the government is still accountable to guarantee that taxpayers funds expended in the operations of statutory bodies are spent in the most, effective and economical way.

These bodies are subject to varying degrees of ministerial control which are identified in the statutory body’s enabling legislation. Ministers are accountable to Parliament for the operation of all government boards and agencies within their portfolios and are necessary to table their annual reports in Parliament. State representatives have authority for many reasons such as transparency, accountability, effectiveness, and bipartisanship.

The meaning of a ‘statutory body’ may change depending upon the legislation. For example, a local council is not a statutory body for the purposes of the Financial Accountability Act, but it is for the purposes of the Statutory Bodies Financial Arrangements Act.

All statutory bodies are established and operate under the provisions of their own enabling legislation, which sets out the purpose and specific powers of the agency.

The enabling legislation may also include provisions for the levels of fees to be charged for services/products provided by the statutory body, the power of the statutory body to borrow or invest funds, whether the board can delegate powers to officers of the statutory body and whether the body represents the State.

The example of statuary body is The University Grants Commission, a statutory organization established by an Act of Parliament in 1956 for the coordination, determination, and maintenance of standards of university education. Apart from providing grants to eligible universities and colleges, the Commission also recommends the Central and State Governments on the measures which are necessary for the development of Higher Education.

It functions from New Delhi as well as its six Regional offices located in Bangalore, Bhopal, Guwahati, Hyderabad, Kolkata, and Pune.

Important Statutory Bodies

1. National Human Rights Commission
2. National Commission for Women
3. National Commission for Minorities
4. National Commission for Backward Classes
5. National Law Commission
6. National Green Tribunal
7. National Consumer Disputes Redressal Commission
8. Armed Forces Tribunal

Lead Bank Scheme

After the Nationalisation of the commercial Banks, the government took the initiative for extending banking facilities in rural areas.

Prof D. R. Gadgil, chairman of National Credit Study Group, recommended the adaptation of an “area approach” to evolve plans and programs for the development of an adequate  banking and credit structure in rural areas.

As a sequel to this “area approach”, recommended by DR Gadgil study group, the Lead Bank Scheme was introduced in December 1969.

The Lead Bank Scheme: Under this scheme, a particular district is allotted to every nationalized commercial bank. The allotment of districts to the various banks was based on such criteria as the size of the banks, the adequacy of their resources for handling the volume of work.

The lead banks initially conduct basic surveys in their respective lead districts and prepare district credit plans designed for the purpose of estimating credit needs of the concerned district so that physical and manpower resources available may be utilized properly.

The district credit plans are linked with the development programs and are based on the integrated development of the concerned district with a special emphasis on the development of rural and backward areas. Since the introduction of lead bank scheme, notable progress has been achieved by commercial banks in respect of branch expansion, deposit mobilization and credit deployment.

Undoubtedly, the scheme is a major step towards banks fulfilling their new social objectives and holds promise for making banks as an effective instrument for bringing about the economic development of the allotted districts.

Objectives of Lead Bank Scheme

Why the Scheme Failed

Nationalisation of Banks

In a Free Market economy, business houses operate as per the invisible hand of the market (responding to demand and supply conditions) with the sole objective of profits. The case of commercial banks is no different. In a capitalist economy, they operate only for profit and not for any social purpose.

In a poor country like India which lacks resources and has inequitable wealth distribution the access to credit to all is an important bottleneck. In a poor country, the Profit making Banking can lead to following problems:

To avoid all such problems the Government decided to Nationalised Commercial Banks in 1969. The major Rationale of Nationalisation was the following;

The Timeline of Bank Nationalisation

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

Development Finance Institutions

The Need of DFIs

Classification of DFIs

All India Development Finance Institutions

Investment Institutions

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

The budgetary procedure in India involves four different operations that are

• Preparation of the budget
• Enactment of the budget
• Execution of the budget
• Parliamentary control over finance

Preparation of the budget

The exercise of the preparation of the budget by the ministry of finance starts sometimes around in the month of September every year. There is a budget Division of the Department of Economic affair of the ministry of finance for this purpose.

The ministry of finance compiles and coordinates the estimates of the expenditure of different ministers and departments and prepare an estimate or a plan outlay.

Estimates of plan outlay are scrutinized by the Planning Commission. The budget proposals of finance ministers are examined by the finance ministry who has the power of making changes in them with the consultation of the prime minister.

Enactment of the budget

Once the budget is prepared, it goes to the parliament for enactment and legislation. The budget has to pass through the following stages:

• The finance minister presents the budget in the Lok Sabha. He makes his budget in the Lok Sabha. Simultaneously, the copy of the budget is laid on the table of the Rajya Sabha. Printed copies of the budget are distributed among the members of the parliament to go through the details of the budgetary provisions.
• The finance bill is presented to the parliament immediately after the presentation of the budget. Finance Bill relates to the proposals regarding the imposition of new taxes, modification on the existing taxes or the abolition of the old taxes.
• The proposals on revenue and expenditure are discussed in the Parliament. Members of the Parliament actively take part in the discussion.
• Demands for grants are presented to the Parliament along with the budget These demands for grants show that the estimates of the expenditure for various departments and they need to be voted by the Parliament.
• After the demands for grants are voted by the parliament, the Appropriation Bill is introduced, considered and passed by the appropriation of the Parliament. It provides the legal authority for withdrawal of funds of what is known as the Consolidated Fund of India.
• After the passing of the appropriation bill, finance bill is discussed and passed. At this stage, the members of the parliament can suggest and make some amendments which the finance minister can approve or reject.
• Appropriation bill and Finance bill are sent to Rajya Sabha. The Rajya Sabha is required to send back these bills to the Lok Sabha within fourteen days with or without amendments. However, Lok Sabha may or may not accept the bill.
• Finance Bill is sent to the President for his assent. The bill becomes the statue after presidents’ sign. The president does not have the power to reject the bill.

Execution of the budget

• Once the finance and appropriation bill is passed, execution of the budget starts. The executive department gets a green signal to collect the revenue and start spending money on approved schemes.
• Revenue Department of the ministry of finance is entrusted with the responsibility of collection of revenue. Various ministries are authorized to draw the necessary amounts and spend them.
• For this purpose, the Secretary of minister’s acts as the chief accounting authority.
• The accounts of the various ministers are prepared as per the laid down procedures in this regard. These accounts are audited by the Comptroller and Auditor General of India.

Parliament Control over Finance

• There is a prescribed procedure by which the Finance Bill and the Appropriation Bill are presented, debated and passed.
• The Parliament being sovereign gives grants to the executive, which makes demands. These demands can be of varieties like the demands for grants, supplementary grants, additional grants, etc.
• The estimates of expenditure, other than those specified for the Consolidated Fund of India, are presented to the Lok Sabha in the form of demands for grants.
• The Lok Sabha has the power to assent to or to reject, any demand, or to assent to any demand, subject to a reduction of the amount specified. After the conclusion of the general debate on the budget, the demands for grants of various ministries are presented to the Lok Sabha.
• Formerly, all demands were introduced by the finance minister; but, now, they are formally introduced by the ministers of the concerned departments. These demands are not presented to the Rajya Sabha, though a general debate on the budget takes place there too.
• The Constitution provides that the Parliament may make a grant for meeting an unexpected demand upon the nation’s resources, when, on account of the magnitude or the indefinite character of the service, the demand cannot be stated with the details ordinarily given in the annual financial statement.
• An Appropriation Act is again essential for passing such a grant. It is intended to meet specific purposes, such as for meeting war needs.

Merging Railway budget into Union budget – Pros and Cons

After 92 years of seeing them separately, the year 2017 witnessed the Railway budget being merged into Union budget. This move is being lauded for it will be beneficial for the economy at large and there will be positive influence in the development in railways.

During the British reign, having a separate Railway budget made sense because a larger part of the country’s GDP depended on railway revenue. The tradition of having the budgets separately continued when India gained freedom even though the revenue from railway continued to go lower than most of the organizations in the public and private sector.

Pros
1. The scores: During the British rule Railways took up to 85 percent of the yearly budget while now it has gone down to about 15 percent only. Having separate railway budget stopped making sense long ago but the old tradition was not done away with. Scrapping the old for the renewed and better is always a positive change to look upon.

2. Better policies: Now that the Railway budget will be introduced along with the union budget, there will be less wastage of time when a new policy is to be initiated and implemented. Keeping them separate resulted in a lot of drawbacks and hindrances that had to be faced by the railway ministry before it could decide upon a solution.

3. Party politics: Minority parties fighting to meet their intentions and ministers of certain states arguing new railways and trains for their region has always been known to result in an everlasting brawl. There will be less of political pressure on the Railway budget and the centre will have the ultimate hold of the decision making.

4. Goodbye to annual dividend: When Rail budget had to be introduced separately, the railways needed to pay an annual dividend to render its budgetary support to the government. The railways will be free of this now and the same fund could now be used in better ways for development the conditions of Indian railways.

5. The huge loss: Our railways are running on loss. There are lesser funds for development plans and most of them are wasted in wrongful manner when there emerges a demand from the regional MLA who promised new trains and stoppages for their location during the time of election. When it goes into the hands of finance ministry, it would mean and absolute end to this and a more commercialized distribution of resources.

Cons

1. The rise and fall: Henceforth, the distribution and allocation of funds to various departments will all go under the finance ministry, which will take decisions according to rise and fall of budget. A fall in the annual budget will mean a similar cut in the railway and other budgets. This will be something unusual for the railways and they might not react supportively to that.

2. Conditions of government departments: The depleting conditions of the various departments under the government have always been prominent. There is lesser attention paid to the responsibilities and everyone is busy sorting out their own means. Railways might see drastic disadvantage if the merging doesn’t reap the desired result.

3. Goodbye to privatization: There have previously been talks of privatization of Indian railways in order to improve and develop them with world class facilities and cleanliness. It was not well received earlier and after the merging, there will a complete end to any future chances of privatization. At the efficient hands of government employees, nothing big could be expected.

4. Loss for the railways: We know how much our parties love making promises and then reducing price to earn the favor of the voters. Not in their wildest dreams would they want to hike the railway prices and lose the vote bank that flows from commuters. Lesser hikes in price might pose loss for the railways department.

There have been mismanagement of the highest order in Indian railways and if there are chances of seeing it improve, merging it with the Union budget is just the solution that could help. The falling revenue and more projects for new trains and stoppages have been a difficult project for the railway ministry which took the right step by merging the two budgets.

Budget advancement:

The objective behind this move is to have the Budget constitutionally approved by Parliament and assented to by the President, and all allocations at different tiers disseminated to budget-holders, before the financial year begins on April 1.

• The proposal for a change in the budget presentation date was first mooted by some of the government’s senior most bureaucrats as part of a ‘Transforming India’ initiative in January 2016.

Presenting the budget earlier comes with both advantages and disadvantages.

Advantages:

• In the existing system, the Lok Sabha passes a vote on account for the April-June quarter, under which departments are provided a sixth of their total allocation for the year. This is done by March. The Finance Bill is not passed before late April or early May. If the Budget is read in January and passed by February-March, it would enable the government to do away with a vote on account for the first three months of a financial year.
• Retired and serving officials say the biggest plus would be that the Finance Bill, incorporating the Budget proposals, could be passed by February or March. So, government departments, agencies and state-owned companies would know their allocations right from April 1, when the financial year begins.
• It would also help the private sector to anticipate government procurement trends and evolve their business plans. And, civil society could deliberate on and give feedback in time for the parliamentary discussions. 

Disadvantages:

• One big disadvantage of advancing the Budget preparations is lack of comprehensive revenue and expenditure data. Currently, work on the Budget begins in earnest by December. By the time it is finalised in mid-February, data on revenue collections and expenditure trends is available for the first nine months of the financial year, i.e April-December. Based on which, projections for the full year can be made.
• To read the Budget in January, the centre will have to start preparing it by early October. To go by less than six months of data and making projections for the full year and the next year, based on such an incomplete picture, will be an impossible task.
• Advancing the Budget dates would be fraught with practical difficulties. Effective Budget planning also depends on the monsoon forecasts for the coming year, making the advancing the whole exercise even more difficult.
• Besides, whether the chambers of Parliament and its standing committees will get adequate time to deliberate on the budget is a moot point. The standing committees of Parliament, whose charter is to examine the justification of the ministry-wise allocations and funding needs of concomitant programmes included in the Budget, undertake their scrutiny during a two to three-week gap within the budget session period, when the houses are adjourned. This scrutiny is an essential element in the parliamentary budget approval system.

Way ahead:

Advancing the presentation of the Budget, so as to allow Parliament to vote on tax and spending proposals before the beginning of the new financial year on April 1, is a good idea. It would do away with the need for a vote on account and allow new direct tax measures to have a full year’s play. Members of Parliament now will have to work hard over two months to vet Budget proposals, for this to work. 

Conclusion:

These reforms make sense, but Budget reform has to go further, to incorporate a multi-year time horizon and shift to outcome-linked expenditure management, as had been recommended by a committee headed by C Rangarajan in 2011.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

• India embraced an economic model which has the features of both free market capitalism and socialism. The policy makers called this a model of ‘Mixed Economy’.
• The reason for adopting such a hybrid model was to raise people’s standard of living and reduce income inequality.
• India embraced an economic model that uniquely combined free market capitalism with that of State intervention in essential sectors of the economy.
• The record of India’s successive governments in providing social welfare is at best mediocre.
• The Government must build a comprehensive welfare state with a strong emphasis on redistribution of resources to poor along with provisions of social services (Public Health, Education, Equitable Institutions, Un-Employment Benefits, Old Age Pensions etc.) financed through taxation.
• In today’s changing World of high technology, the Government must do a lot of public spending on investment in human capital and research and development.
• On Jobs creation front, the government must adopt a judicious mix of labour market institution that includes a fairly flexible labour market allowing easy hiring and firing of employees along with strong labour associations to safeguard the interest of employees.
• On the External front, the government must embrace globalisation, openness to trade and investment but with risk sharing approach. The government should share the risk arising out of globalisation, by training and skilling those who have suffered from the negative impact of globalisation. The process of risk sharing will make globalisation acceptable to all.
• Adopting the above features will allow India to achieve high growth along with high social ambitions/indicators.
• Therefore, in a nutshell, the future of India’s rapid and sustainable development lies in the following:

Functions of Government

Allocation Function

• The government provides certain public goods and services which the private sector fails to provide because there exists no market for them.
• Example: National Defence, Public Parks and National Highways etc.
• The reason of government providing such goods is the nature of public goods. The public goods are by nature non-rival and non-excludable.
• Non-Rivalry means, the consumption of the good by one individual does not stop another individual from consuming the same good. The goods remain available to all the citizens.
• Non-Excludability means the government cannot exclude any person from enjoying the benefit of the good whether they pay or not. The goods are non-excludable in nature.

Distribution Function

• The government through its tax and expenditure policies attempts to bring out income redistribution in the society that is fair to all.
• The government transfer payments from one citizen to other through taxation policy.
• Example: Old age pensions, Social sector initiatives for the poor. Through these programs, the government provides income support to those individuals who do not have any source of earnings. The funds for running these programs comes from progressive taxation. Those with higher income paying higher taxes.
• The idea of distribution is not to rob the rich by forcing them to pay high taxes or to discourage people from earning more but to make just redistribution which will be equitable for all.
• Think like this, the per capita consumption of common resources will be higher for rich individuals as compared to the poorer individual (who survives on bare necessities). Thus they must pay a higher price for its provision. Space taken by an SUV or Sedan on the road is much higher than the space taken by Bicycle. Thus, the SUV owner must pay a higher price/ tax for the construction of the road as compared to bicycle owner. The above example explained the concept Progressive taxation.
• Similarly, the old age pensions are not grants by the government but are right of those individuals who have worked endlessly during their productive years. Thus, the government must take care of them by providing them old age benefits.

Stabilisation Function

• The economy tends to undergo periods of instability and fluctuations. The periods of fluctuations require the government to play an active role in removing it.
• The year of 2008-09 witnessed the Global Financial Crisis. The GFC led to a decline in GDP growth rate along with employment. To help recover economy from the GFC, the government provided Fiscal Stimulus package for the industry.
• Let’s understand the channel

• Similarly, the economy may at times overshoot when expenditure becomes greater than output. In such a situation when consumers are spending more than what producer are willing to supply. Inflation happens. To remove inflationary pressure from the economy, the government intervenes through tight fiscal policy.

Balance Budget versus Unbalanced Budget

Zero Based Budgeting versus Traditional Budgeting

 Outcome Budget

If was first introduced in the year 2005. Outcome budget analyses the progress of each ministry and department and what the respected ministry has done with its budget outlay.

The Outcome Budget will comprise scheme or project wise outlays for all central ministries, departments and organizations during an annual year listed against corresponding outcomes (measurable physical targets) to be achieved during the year.

It measures the development outcomes of all government programs. Which means that if you want to find out whether some money allocated for, say, the building of a school or a health center has actually been given, you might be able to. It will also tell you if the money has been spent for the purpose it was sanctioned and the outcome of the fund-usage.

Gender Budgeting

• Gender Budgeting is a powerful tool for achieving gender mainstreaming so as to ensure that benefits of development reach women as much as men.
• It is not an accounting exercise but an ongoing process of keeping a gender perspective in policy/ programme formulation, its implementation and review.
• Gender Budgeting entails dissection of the Government budgets to establish its gender differential impacts and to ensure that gender commitments are translated in to budgetary commitments.
• Experts defines Gender Budgeting as “Gender budget initiatives. To analyse how governments raise and spend public money, with the aim of securing gender equality in decision-making about public resource allocation; and gender equality in the distribution of the impact of government budgets, both in their benefits and in their burdens.
• The impact of government budgets on the most disadvantaged groups of women is a focus of special attention.
• The rationale for gender budgeting arises from recognition of the fact that national budgets impact men and women differently through the pattern of resource allocation.
• Women, constitute 48% of India’s population, but they lag behind men on many social indicators like health, education, economic opportunities, etc. Hence, they warrant special attention due to their vulnerability and lack of access to resources.
• The way Government budgets allocate resources, has the potential to transform these gender inequalities. In view of this, Gender Budgeting, as a tool for achieving gender mainstreaming, has been propagated.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

Revenue Account

• The revenue account shows the current receipts of the government and the expenditure that can be met from these receipts.
• Revenue Receipts: RR are receipts of the government incomes which cannot be reclaimed back by the citizens from the government.

Revenue Expenditure

• The expenditure incurred by thegovernment that neither creates any physical/financial asset nor reduces the liability of the government. The Revenue expenditure relates to thedaytoday functioning of the government.
• Revenue expenditure is expenditure for normal running of the government department and various services, interest charges on debt incurred by government, subsidies and so on.
• Example: Salaries of employees, Interest payments on past debts, grants given to state governments etc.

The Expenditure under Budget is divided into two subheads.

• With the demise of Planning Commission, the Central Government has decided to do away with the classification of plan and non-plan expenditure. The 2018-19 Budget will not contain any such classification.

The Capital Account

• The capital budget is an account of assets as well as liabilities of the central government.
• Capital Receipts: All those receipts of the government which either creates liability or reduces financial asset are capital receipts.
• Examples: Market borrowings by thegovernmentfrom the public, Borrowings from the RBI, Borrowings from commercial banks or financial institutions through thesale of T-BILLS, loans received from foreign governments or international financial institutions, post office savings, post office saving certificates and PSU’s Disinvestment.
• Capital Expenditure: All those expenditures of the government which either result in thecreation of physical/financial assets or reduction in financial liabilities.
• Examples: Purchase of land, machinery, building and equipment’s; investment in shares; loans and advances by the central government to state governments and UTs.
• Capital Expenditure is also classified as plan and non-plan capital expenditure. Plan expenditure relates to central Five-yearPlan and Non-Plan relates to expenditure not covered under theFive-year

The Distinction in a Nutshell

Measuring Government Deficits

When a government spends more than it collects by way of revenues, it incurs deficits. There are various kinds of deficits incurred by thegovernment, and each has its own implications.

Let’s understand the concepts of deficits through a simple hypothetical household example of Robinson Crusoe.

The Revenue Side of Robinson Crusoe HHs:

Robinson Crusoe HHs has 5 members with a monthly family income of $1000. The family pays a rent 0f $2000, buys grocery worth of $3000, pays interest of student education loan $2000 and other expenses of $4000. Now examine the expenditure and receipts side of HHs of Robinson Crusoe. The monthly salary of the HH is $10000 (Revenue Receipts). The monthly expenditure of the HH is $11000. The expenditure of the HH is recurring expenditure and the salary also come every month. This means the HH is neither creating any assets or reducing its liabilities. But since the HH expenditure is more that its receipts; its running a deficit of $1000. Which is known as revenue deficit.

1. Deficits on Revenue Account or Revenue Deficit

• The revenue deficit happens when revenue receipts fall short of revenue expenditure.
• RD = Revenue Expenditure – Revenue Receipts
• Implications: When a government incurs revenue deficit, it implies that the government is not able to cover its day today expenses from its current receipts.
• It also implies that the government is using its past saving to finance its current consumption expenditure.
• The implication is the government will have to borrow in future to finance its current consumption expenditure. This will lead to building up of government debt and rising interest payments in future.
• Increase in interest payment obligations will again lead to increase in revenue expenditure and hence revenue deficits.
• The vicious circle of RD will continue until government start cutting on its wasteful expenditures.

The Capital Side of Robinson Crusoe HH.

Let’s assume now, the Crusoe family, owns an ancestral land worth $5000. The ancestral land is an asset. The family decides to sold this land, the proceeds from the selling of land is a capital receipt. Also, the selling of the land is a onetime process, thus it’s a onetime receipt. Since, the selling of the land has nor created any debt, it is also called Non-Debt Creating Capital Receipt(NDCR).

The family has also taken an education loan worth $2000. The loan is a liability since they have to return it. It’s a debt on the family. Since the loan is creating debt it is known as debt creating capital receipt. Together they both constitute Capital Receipts of the Robinson HH.

The Robinson family decides to buy a small shop ($5000) to supplement its family income. The buying of shop is leading to creation of an asset (the family can sale it latter or derive monthly income out of it by renting it out). This constitute the capital expenditure side of the HH.

The Fiscal deficit of the Robinson family will be:

{$11000(Revenue Exp) + $5000 (capital exp)} minus {$10000 (revenue rec) +$5000(NDCR)}

= $1000

1. Fiscal Deficit

The fiscal deficit is the difference between the government’s total expenditure (both revenue and capital) and its total receipts excluding borrowings.

• FD= Total Expenditure- (Revenue Receipts+ Non-Debt Creating Capital Receipts)
• Non-Debt Creating Receipts are those receipts which are not classified as borrowings and do not give rise to debt.
• Examples Disinvestment proceeds from Public Sector Undertakings and recovery of loans by the central government.
• Implications: Fiscal deficits has to be financed through borrowings, thus indicating total borrowing requirements of the government.
• Alternatively, FD can be seen as FD= Net borrowing at home+ Net borrowing from RBI+ Net borrowing from Abroad.
• Fiscal Deficit reflects the health of the economy; A large FD indicates the economy is under stress.
• A large FD can create inflation in the economy.
• A large FD makes the country unattractive to foreigners.
• A large FD can lead to outflow of capital from the country.
• A large FD crowd out/reduces private investment from the economy.

If a large part of FD is due to revenue deficit, it implies the government is borrowing to finance its consumption requirement. This is a dangerous situation, and soon thegovernment will go bankrupt.

2.   Primary Deficit

• The borrowing requirement of the government includes interest obligations on accumulated debt.
• The goal of measuring primary deficit is to focus on present fiscal imbalances.
• To obtain an estimate of borrowing on account of current expenditures exceeding revenues, we need to calculate what has been called the primary deficit.
• It is simply the fiscal deficit minus the interest payments
• Gross primary deficit = Gross fiscal deficit – Net interest liabilities

The Capital Account

• The capital budget is an account of assets as well as liabilities of the central government.
• Capital Receipts: All those receipts of the government which either creates liability or reduces financial asset are capital receipts.
• Examples: Market borrowings by the government from the public, Borrowings from the RBI, Borrowings from commercial banks or financial institutions through the sale of T-BILLS, loans received from foreign governments or international financial institutions, post office savings, post office saving certificates and PSU’s Disinvestment.
• Capital Expenditure: All those expenditures of the government which either result in the creation of physical/financial assets or reduction in financial liabilities.
• Examples: Purchase of land, machinery, building and equipment’s; investment in shares; loans and advances by the central government to state governments and UTs.
• Capital Expenditure is also classified as plan and non-plan capital expenditure. Plan expenditure relates to central Five-year Plan and Non-Plan relates to expenditure not covered under the Five-year

The Distinction in a Nutshell

Measuring Government Deficits

When a government spends more than it collects by way of revenues, it incurs deficits. There are various kinds of deficits incurred by the government, and each has its own implications.

Deficits on Revenue Account or Revenue Deficit

• The revenue deficit happens when revenue receipts fall short of revenue expenditure.
• RD = Revenue Expenditure – Revenue Receipts
• Implications: When a government incurs revenue deficit, it implies that the government is not able to cover its day to day expenses from its current receipts.
• It also implies that the government is using its past saving to finance its current consumption expenditure.
• The implication is the government will have to borrow in future to finance its current consumption expenditure. This will lead to building up of government debt and rising interest payments in future.
• Increase in interest payment obligations will again lead to increase in revenue expenditure and hence revenue deficits.
• The vicious circle of RD will continue until government start cutting on its wasteful expenditures.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

Goods and Services Tax

The Goods and Services Tax (GST), the biggest reform in India’s indirect tax structure since the economy began to be opened up 25 years ago, at last, becomes a reality.

The Working of GST

The Manufacturing Stage:

Step 1) Imagine a Producer of Shoe. He buys raw materials like leather, cloth, thread etc., worth Re 1000. The Re 1000 includes a tax of Re 100. He manufactures a pair shoe using these raw materials.

Step 2) The manufacturer by converting raw material into a finished good (Shoe) has added value to the product. The raw leather is being converted into the wearable shoe.

Step 3) Let us assume that the value added by the manufacturer is Re 300 (After conversion the shoe is sold in the market at Re 1300). The gross value added of the shoe will be now Re 1300 (1000+300).

Step 4) Prior to GST, assuming an excise duty of 10%, the tax that the manufacturer has paid would be Re 130 (10/100*1300).

But under GST, the manufacturer could set off Re 130 as input credit as the tax already paid by him on inputs Re 100(SEE Step 1)

The effective tax paid by the manufacturer under GST regime is thus, Re 30 (130-100) only.

The Wholesale Stage:

Step 1) The Wholesaler purchases the shoe from the manufacturer at Re 1300. The Wholesaler adds value to the shoe (his profit margin) of Re 200. The gross value of the shoe has now become Re 1500 (1300+200).

Step 2) Assuming a tax of 10% on purchase of shoe, the tax that the wholesaler has paid prior to GST regime would be Re 150 (10/100*1500).

But under GST, the wholesaler also could set off Re 150 as input credit as the tax already paid on the purchase of shoe from the manufacturer Re 130.

Thus, the effective GST paid by the Wholesaler under GST regime is Re 20(150-130) only.

The Retail Stage

Step 1) The Retailer buys the shoe from the wholesaler at Re 1500. The Retailer adds value to the shoe (his profit margin) of Re 500. The gross value of the shoe has now become Re 2000 (1500+500).

Step 2) Assuming a tax of 10% on the sale of the shoe, the tax that the retailer has paid prior to GST regime would be Re 200 (10/100*2000).

But under GST, the retailer also could set off Re 200 as input credit as the tax already paid by him on the previous stage Re 150.

Thus, the effective GST paid by the retailer under GST regime is Re 50 (200-150) only.

Step 3) Thus, the total GST on the entire value chain from the raw material/input suppliers (who can claim no tax credit since they haven’t purchased anything themselves) through the manufacturer, wholesaler and retailer is, Rs 100+30+20+50= 200 only.

Pre and Post GST a comparison

Taxes to be subsumed under GST

The Three Tier Structure of GST

The Parliament and the state legislatures will have the power to levy GST. There will be complete separation of power between Centre and State.

The centre will have the power to levy GST when it comes to interstate trade and exports, imports. The sharing of IGST between centre and state will be based on the views of GST Council.

Suppose a trader in Maharashtra sells goods to another trader in Maharashtra itself. In this case, the trade is of intrastate in nature. If the applicable GST rate is 18%, then 9% will go to the centre as CGST, and 9% will go to the Maharashtra as SGST.

Now, suppose the same trader in Maharashtra sells goods to a trader in Tamil Nadu. In this case, the trade is off interstate nature. If the applicable GST rate is 18%, then the entire 18% GST will be charged as IGST.

The GST Council

The Council will have the representation of both Centre and State.

• The council will be headed by Union Finance Minister.
• The Minister of State for Revenue (Central Government) will be a member.
• The Minister of Finance from each State or Minister nominated by the States will be its member.
• The decision will be made by the majority of 3/4^th members.
• The Centre government will have a 1/3^rd voting share in the council.
• The State government will have a 2/3^rd voting share in the council.

Advantages of GST

Limitation of GST

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

The Summary of India’s Tax Reforms

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

Key Concepts Relating to Taxation

Tax Incidence

The key to imposing the tax is who bears its burden. If the person on whom the tax is imposed have the flexibility to transfer it on to the other person, then we say tax incidence has shifted. The shifting of tax form one person to the other is known as tax incidence.

All indirect tax comes under this category. For all direct tax, the incidence of tax and burden lies with the same person.

The incidence of tax mainly depends on its elasticity. Elasticity is nothing but the responsiveness. Example: If you are walking on the road and suddenly a car comes towards you, you respond quickly to get out of the way. This is your responsiveness towards the speed of the car. The faster you get out the way, the higher is your responsiveness. The same concept is applied to income, demand and taxes. If due to a change in prices, the demand responds at a much faster rate, then we say demand is highly elastic vis-à-vis prices.

Tax Avoidance

It refers to minimising the tax liabilities using an available source of exemptions and tax laws. It is by means of taking advantage of shortcomings of tax structure. It usually happens at the tax planning stage.

Tax Evasion

It refers to reducing the tax liabilities using illegal measures. Tax evasion is a clear case of forgery of accounts as it uses measures which are unforbidden in law.

Cascading Effect in Taxation

A Cascading tax is one, which is not just on final product value but also on the raw materials used as input. The tax is levied at every stage of production and distribution. It is a tax on tax.

For example, resin, rubber and carbon black are necessary for manufacturing tyres. All the three inputs paid tax and the final products namely the tyres also paid tax. So, these three inputs are taxed twice. Then again, the tyre is used in a car, which also is taxed. These three inputs are now taxed thrice. So, the tax element on these inputs goes on increasing with every production and distribution chain. The cascading effect of tax makes the tax rate much higher than the original rate.

Laffer Curve

Laffer curve is named after noted economist Arthur Laffer. Laffer curve shows the relationship between Government tax revenue and tax rates.

The curve is inversely U Shape, representing as the tax rate increases, the government revenue also increases up to an optimum level. Post which, if the government tries to increase taxes, the government revenue will start falling. Thus, a government must maintain an optimum balance between tax rate and revenue.

Tax Buoyancy

Tax buoyancy is a measure of the responsiveness of the tax receipts with respect to GDP.

A tax is considered buoyant when revenue increase by more than one percent if the GDP has increased by 1 percent.

Fiscal drag

Fiscal drag is a concept where inflation and earnings growth may push more tax payers into higher tax brackets. Therefore, fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates.

An example of this would be if a person earns Rs 10 000 per year, and has to pay 20% tax on earnings above Rs 5000 for year one. he would then pay (10 000 – 5000) *0.2, which equals 1000 or 10% of her income.

If the person pay goes up by 10% to R11000 to compensate for inflation, and the government increases the tax threshold by 2% in year two to 5 200, he would pay (11 000 – 5200) multiplied by 0.2 which equals 1160 or 10.54% of her income in taxes.

The proportion of Rahul’s income in taxes has increased. This is fiscal drag or bracket creep. This illustrates that when there is inflation, taxes rise unless the tax rates or tax accordingly.

CESS VS Surcharge

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

Special Category Status to States

Various Chief Ministers across the nation have been demanding special status for their respective states since last few years. This has led to fierce debates amongst the proponents and critiques of the special category status.

The proponents argue that granting special status to these states will bring them at par with those who have developed their industrial base by benefitting through the flawed grant-to-states schemes by the Planning Commission of India over the years.

But not everybody is convinced as the critics argue that development does not come out as a dole. In an era of open competition and liberalization granting special status to States, which do not qualify as per the original criteria under political compulsions would be detrimental to the interest of other deserving states.

The whole idea of a special category state was introduced in 1969 by the Fifth Finance Commission, which as per the Gadgil formula gave special status to the states of Nagaland, Assam and Jammu and Kashmir. Today eleven states in the country enjoy this status including seven north-eastern states, Sikkim, Jammu Kashmir, Uttrakhand and Himachal Pradesh.

As per the Gadgil formula “special status” is to be given to certain states because of certain intrinsic factors which have contributed to their backwardness historically. Some of these factors include:

1. 1. Hilly and difficult terrain;
   2. Low population density or sizable share of tribal population;
   3. Strategic location along borders with neighbouring countries;
   4. Economic and infrastructural backwardness; and
   5. Non-viable nature of state finances

Benefits of Special Category Status

The Planning Commission allocates funds to states through central assistance for state plans. Central assistance can be broadly split into three components:

• Normal Central Assistance (NCA),
• Additional Central Assistance (ACA) and
• Special Central Assistance (SCA)

NCA, the main assistance for state plans, is split to favour special category states: 11 states get 30% of the total assistance, while the other states share the remaining 70%. The nature of the assistance also varies for special category states; NCA is split into 90% grants and 10% loans for special category states, while the ratio between grants and loans is 30:70 for other states.

For allocation among special category states, there are no explicit criteria for distribution and funds are allocated on the basis of the state’s plan size and previous plan expenditures. Allocation between non-special category states is determined by the Gadgil Mukherjee formula, which gives weight to population (60%), per capita income (25%), fiscal performance (7.5%) and special problems (7.5%). However, as a proportion of total centre-state transfers NCA typically accounts for a relatively small portion (around 5% of total transfers in 2011-12).

Special category states also receive specific assistance addressing features like hill areas, tribal sub-plans and border areas. Beyond additional plan resources, special category states can enjoy concessions in excise and customs duties, income tax rates and corporate tax rates as determined by the government.

The Planning Commission also allocates funds for ACA (assistance for externally aided projects and other specific project) and funds for Centrally Sponsored Schemes (CSS). State-wise allocation of both ACA and CSS funds are prescribed by the centre.

Role of Finance Commission

Planning Commission allocations can be important for states, especially for the functioning of certain schemes, but the most significant centre-state transfer is the distribution of central tax revenues among states. The Finance Commission decides the actual distribution and the current Finance Commission have set aside 32.5% of central tax revenue for states.

In 2011-12, this amounted to Rs 2.5 lakh crore (57% of total transfers), making it the largest transfer from the Centre to States. In addition, the Finance Commission recommends the principles governing non-plan grants and loans to states. Examples of grants would include funds for disaster relief, maintenance of roads and other state-specific requests.

Among states, the distribution of tax revenue and grants is determined through a formula accounting for population (25%), area (10%), fiscal capacity (47.5%) and fiscal discipline (17.5%). Unlike the Planning Commission, the Finance Commission does not distinguish between special and non-special category states in its allocation.

Other ways that can be explored without giving the Special Category Status

Even though the Centre cannot grant special status to States based on political demands it can infuse more funds to some non-special category states from its Backward Region Grants Fund. The Centre can also ask the 14th Finance Commission to tweak the formula for determining the transfer of central resources to states.

Centrally Sponsored Schemes (CSS)

In the areas requiring national effort, it is imperative for the Centre to make interventions. The government of India tries to do this through various programmes and policies including the CSS. Central Government has introduced several schemes in areas that are a national priority like health, education, agriculture, skill development, employment, urban development, rural infrastructure etc.

Several of these sectors fall in the sphere of activity of States. The share of all CSS as percentage of GBS has increased continuously in the last three Plans. In the Eleventh Plan it went up to 41.59% as against 38.64% in Tenth Plan and 31% in Ninth Plan States have been raising concerns at various forums about lack of flexibility in CSS schemes and adverse pressure created on the resources of states due to CSS etc., some of them have been addressed below:

1. Inability to provide matching funds: To access the funds from center under some CSS, there has to be a definite percentage contribution from the States. The pattern of assistance to States varies. Generally it is Central Government’s contribution of 90% for North-East States and 75%–100% in different schemes for other States. The number of States, particularly the North-East States, Bihar and Jharkhand have often represented that they have limitation of resources and are not able to provide State’s share to enable them to access the required funds under CSS.
2. Lack of flexibility: An important area impacting on efficient implementation of CSS has been the need for flexibility in many of the schemes. India with its different geographical regions, varied requirements of States, different levels of infrastructure development, demographics and economic growth, requires flexibility for States to plan their development.
3. It is necessary that CSS take into account the ongoing schemes in the States so as to ensure convergence with the existing schemes. For example, if money is provided under IAY for construction of houses and the State Government is also putting its own resources, it may be possible to construct a house with a cement roof, along with a toilet and rooms which have better interior. Another argument to support this is that the cost of project is different in different areas and this needs to be fully taken care of. For example, the cost of buildings in the North-East and in the far- east corners of North-East has great variations.
4. Different accounting procedures: Accounting process is different in different States for the same CSS scheme. It is, therefore, not possible to have an effective Central monitoring and accounting system.

Way Ahead around CSS

There is a need for reforms in designing of CSS, physical and financial norms, planning, transfer of funds, monitoring and evaluation. There is also a need to meet the concerns of the States on their inability to provide counter-part funds as the States are not able to access these funds.

Distribution of CSS funds amongst different States should be based on transparent notified guidelines. Such guidelines should be put on the website of the concerned Ministries. There is also a need to cut down on the number of CSS. In the current financial year, budgetary provision has been made for 137 CSS. The existing CSS/ACA Schemes in the Twelfth Five-Year Plan have been restructured into 66 Schemes, including Flagship Programmes.

National Counter Terrorism Centre (NCTC)

Background of NCTC

NCTC or National Counter Terrorism Centre is India’s federal anti-terror organization, which gained importance after the 26/11 attacks, as it was felt that India did not have a central agency with real time intelligence input with regards to terrorism. Most of the blame of 26/11 attacks was put on the inability of the States to co-ordinate among themselves and the Centre to share intelligence inputs.

The NCTC would focus on drawing up plans and co-ordinating all actions and integrating all intelligence related to counter-terrorism. The agency has been made under the provisions of UAPA, 1967 (Unlawful Activities Prevention Act). It has been given the power to search, seizure and arrests throughout India to prevent terror activities.

Objections raised by States

1. Public Order is a State subject: States object that policing/public order is a State subject and this is an encroachment on their rights and thus an attack on the federal structure.
2. Control of Intelligence Bureau: States also object that NCTC is a part of Intelligence Bureau, which is controlled by the Home Ministry. As wide powers are given to the NCTC, the agency could be directed solely at the behest of Home Ministry without taking the consent of the State concerned. So, there will be political mileage to be generated in respect of searches and arrests against opponents.
3. Wide Powers: States also object to the wide powers given to NCTC and therefore demand trimming down of powers to search, seizure and arrest.

Way Ahead for NCTC

Keen to push the National Counter Terrorism Centre in the aftermath of the serial blasts in Hyderabad, the home ministry tweaked the proposal in 2013 saying NCTC will inform the chief of state police before conducting any operation in state’s jurisdiction. Besides this introduction of safeguards is necessary so that the NCTC does not get unbridled powers.

The country has to function as one, irrespective of which party is in power. India follows a federal system and this mandates that both the Union and state governments work in tandem. In no way can the Union government impose its will without consulting with the state governments. For a federal system to succeed there is an urgent need to reach a consensus on matters such as terrorism, which is a national concern.

Issues around GST

The GST or the Goods and Services Tax aims to create a common market throughout India without any taxes on inter-state movement of goods. A Constitutional Amendment Bill to facilitate the implementation of GST is currently pending in Parliament. The Goods and Services Tax is being billed as a significant next step in indirect tax reform since VAT was successfully introduced all over India. However, in introducing GST, there are some objections from some State governments.

Objections by States on GST

1. The fiscal autonomy of States: The compensation mechanism for possible revenue loss in future. If the same GST rate is applied to all States and the States cannot impose any other taxes, some States may feel they would lose the power to raise revenues, especially if they require the funds to come good on electoral promises of distributing freebies.
2. Compensation Rates: The Centre is promising to compensate the States for any revenue loss for the first three years after GST is introduced. But, a uniform rate may not compensate the revenue loss for all the States because: some states are more industrialized, some are more agricultural and some are resource-rich.

Therefore, some States feel they should have the power to impose supplementary taxes, and at appropriate rates as necessary, even if a State-level GST is introduced. But, the Centre is not in favor of allowing States this freedom as that would undermine the objective of a single market with a uniform stable tax regime.

3. Disagreement over alcohol, spirits: States demand that alcoholic items should be kept outside GST, whereas the Centre opines it should be under GST in order to remove the cascading effect on GST paid on inputs such as raw material and packaging material

Way Ahead for GST

1. Setting floor rates: In view of the apprehensions of the States, one option is to set a floor rate instead of a single fixed rate for all the States. This is also necessary to prevent unhealthy tax competition among States trying to attract investment, with no real benefits to any State.

If at all a consensus emerges on a uniform rate, then possibly the States will want to retain the power to impose additional duties and cesses, if needed, in the initial years till revenues stabilize. This may be subject to approval from the GST Council or the regulatory body that will have representatives from the Centre and the States.

1. Great Fiscal autonomy: Giving the States some degree of fiscal autonomy is good also because it will force them to be fiscally responsible. Otherwise, some States may blame the Centre for their lack of efforts to raise tax revenue by arguing that their hands have been tied by the Centre as part of the GST deal and hence it is the Centre’s responsibility to bail them out in case of any Budget shortfall.

In making this transition, the paramount objective should be to ensure that the basic federal structure in terms of the relative revenue and fiscal autonomies of the Central and State governments are not disturbed.

Federalism and Foreign Policy

Even though foreign policy is the prerogative of the Central government and the Constitution does not allow the states to take initiatives in these matters, the West Bengal Government challenged the Central Foreign policy on sharing the waters of river Teesta by stalling the bilateral treaty with Bangladesh.

Some of the states have been arguing in favour of a role for the states in the foreign policy of the country, particularly, states with an international border are vocal on issues, which directly or indirectly impact them. Similarly, when the issue of border trade with China came up for discussion, Sikkim’s views were sought. Tamil Nadu has demanded the intervention on the issue of Tamil killings in Sri Lanka every now and then.

The north-eastern States of the country have borders with various countries like Myanmar, Bangladesh, China, Bhutan and Nepal and their proximity of countries east of India demands that their economies should benefit more from the Look East Policy. North Eastern State leaders have been asserting that their views should be sought while conducting negotiations with neighbouring countries on economic and political issues.

There is a case for institutionalizing the process of consultation and involvement of States, which are affected by a particular foreign or security policy measure. Barring Haryana, Madhya Pradesh, Jharkhand, and Chhattisgarh, all Indian States share borders with other countries, or with the international waters of the sea. In that sense, they have interests or issues that may intersect with the foreign and security policies of the country.

Among the various governmental systems, the U.S. is one in which the interests of its federal constituents are taken into account in the formulation and exercise of foreign and security policies. This was part of the large and small States compromise that resulted in its constitution. 

This enables its Upper Chamber, the Senate, to be the lead house on foreign policy issues — ratifying international agreements, approving appointments of envoys and so on. The Senate, as is well known, has a membership which is not based on population — each State, large and small, populous or otherwise, has the same number of Senators.

It would be difficult to graft something like the U.S. system on to the Indian system. Yet, clearly, the time has come when Mizoram and Nagaland also have a say in India’s Myanmar policy, instead of merely having to bear its consequences.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

The Indian Constitution has elaborate provisions regarding the distribution of revenues between the Union and the States.

Article 268 to 293 in Part XII deal with the financial relations. The financial relations between the Union and the States can be studied under the following heads:

• Taxes and duties levied by the Union, but collected and appropriated by the States: Stamp duties and duties of excise on medical and toilet preparations are levied by the Government of India, but collected and appropriated by the States, within which such duties are leviable, except in the Union Territories, where they are collected by the Union Government (Art. 268). The proceeds of these duties levied within any State are assigned to that State only and do not form a part of Consolidated Fund of India. 

Service tax levied by the Centre, but collected and appropriated by the Centre and the States: Taxes on services are levied by the Centre, but their proceeds are collected and appropriated by both the Centre and the States. Principles of their collection and appropriations are formulated by the Parliament.

• Taxes levied and collected by the Union, but assigned to the States within which they are leviable (Art.269):

a) Succession duty in respect of property, other than agricultural land.

b) Estate duty in respect of property, other than agricultural land.

c) Terminal taxes on goods or passengers carried by railways, sea or air.

d) Taxes on railway fares and freights taxes on transactions in Stock Exchanges.

• Taxes levied and collected by the Union and distributed between the Union and the States (Art.270): Certain taxes are levied as well as collected by the Union, but their proceeds are divided between the Union and the States in a certain proportion in order to effect an equitable distribution of the financial resources.

This category includes all the taxes and duties referred to in the Union List, except the three categories mentioned above, any surcharge and any cess levied for specific purposes. The manner of distribution of net proceeds of these taxes is prescribed by the President, on the recommendation of the Finance Commission.

• Surcharge on certain taxes (Art.271): The Parliament is, authorized to levy surcharge on the taxes mentioned in the above two categories (Art.369 and Art.370) and the proceeds of such surcharges go to the Centre exclusively and are not shareable.
• Taxes levied and collected and retained by the states: These are the taxes enumerated in the State List (20 in number) and belong to the States exclusively.
• Grants-in-Aid: The Parliament may make grants-in-aid from the Consolidated Fund of India to such States as are in need of assistance (Art.275), particularly for the promotion of welfare of tribal areas, including special grant to Assam.

These are called statutory grants and made on the recommendation of the Finance Commission. Apart from this, Art.282 provides for discretionary grants by the Centre and States both, for any public purposes. The Centre makes such grants on the recommendation of the Planning Commission (an extra-constitutional body).

• Loans: The Union Government may provide loan to any State or give guarantees with respect to loans raised by any State.
• Previous sanction of the President (Art 274): No Bill or amendment can be introduced or moved in either House of Parliament without the previous sanction of the President, if:

1. It imposes or varies any tax in which the States are interested; or
2. It varies the meaning of the expression “Agricultural Income” as defined in the Indian Income-Tax Act; or
3. It affects the principles on which money are distributed to the States; or
4. It imposes a surcharge on the State taxes for the purpose of the Union.

• According to Article 301, Freedom of Trade, Commerce and Intercourse throughout the territory of India is guaranteed, but Parliament has the power to impose restrictions in public interest.
• Although taxes on income, other than agricultural income, are levied by the Union, yet the State Legislatures can levy taxes on profession, trade, etc.
• Distribution of non-tax revenues: Non tax revenues from post and telegraph, railways, banking, broadcasting, coinage and currency, central public sector enterprises and escheat (death of a person without heir) and lapse (termination of rights) go to the Centre, while State receives non-tax revenues from irrigation, forests, fisheries, state public sector enterprises and escheat and lapse (if property is situated in that state).
• Provision has been made for the constitution of a Finance Commission to recommend to the President certain measures for the distribution of financial resources between the Union and the States (Art.280).

Under the situation of emergencies, these financial relations also undergo changes according to the situation and the President can modify the constitutional distribution of revenues between the Centre and the States.

The framers of Indian Constitution made detailed provisions in the Constitution in regard to administrative relations between the Centre and State to ensure minimization of conflict between the two. They have been elaborated below:

a) Directives by the Union to the State governments: Article 256 mentions that the executive power of every state shall be so exercised as to ensure compliance with laws made by Parliament and any existing laws, which apply in that state, and the executive power of the Union shall extend to the giving of such directions to a state as may appear to the Government of India to be necessary for that purpose.

This provision is looked upon with suspicion in many countries.

Dr. Ambedkar explained the aim of Article 256 through two important propositions:

“The first proposition is that generally the authority to execute laws, which are related to what is called the Concurrent field, whether the law is passed by the Central Legislature or is passed by the State Legislature shall ordinarily apply to the State.

The second proposition it lays down is that if, in any particular case, Parliament thinks that in passing a law, which relates to the Concurrent field, the execution ought to be retained by the Central Government, Parliament shall have the power to do so.”

This power of the Union extends to the limit of directing a State in a manner it feels essential for the purpose.

For instance, the Union can give directives to the State pertaining to the construction and maintenance of means of communication, declared to be of national or military importance, protection of railways within the State, the provisions of adequate facilities for instructions in mother tongue at the primary stage of education to children belonging to linguistic minority groups in the State and for the drawing up and execution of the specified schemes for the welfare of the Schedule Tribe in the State.

This is essential to ensure the implementation of Parliamentary laws throughout the country. Non-compliance of the directives might lead to a situation mentioned under Art.365 and then it shall be lawful for the President to hold that a situation has arisen in which the government of the State cannot be carried on in accordance with the provisions of the Constitution.

Thus, the Union can invoke Article 356, for the imposition of President’s rule in the State and take over the administration of the State.

b) Delegation of Union functions to the States: Usually executive powers are divided on the basis of subjects in the lists, but under the constitutional provision of Article 258(1) the President may, with the consent of the State government, entrust (either conditionally or unconditionally) to that government any of the executive functions of the Centre.

Under Art 258(2), the Parliament is also entitled to use the state machinery for enforcement of the Union laws, and confer powers and entrust duties to the State. Under Art 258A, the State can also, with the consent of the Union government, confer administrative functions to the Union. In respect of matters in the Concurrent list, executive powers rest with the State, except when a constitutional provision or a Parliamentary law specifically confers it to the Centre.

c) All India Services: Besides the Central and State services, the Constitution under Article 312 provides for the creation of an additional “All-India Services“, common to both the Union and States. The State has the authority to suspend the officials of All India Services, but the power of appointment and taking disciplinary action against them vests only with the President of India.

The idea of having an integrated well-knit All India Services to manage important and crucial sectors of administration in the country was incorporated in our Constitution. Their recruitment, training, promotion, disciplinary matters are determined by the Central government. A member of the Indian Administrative Service (IAS), on entry into the service is allotted a State, where he/she serves under a State government.

Though, it can be argued that the All India Services violate the principle of federalism, but such an arrangement, wherein a person belonging to the All India Service being responsible for administration of affairs, both at the Centre and States, brings cooperation in administration and helps to ensure uniformity of the administrative system throughout the country. Currently, there are three All India Services, namely IAS, IPS and IFoS (the Indian Forest Service was created as the third All India Service in 1966 by Art.312).

d) Constitution of Joint Public Service Commission for two or more States: When two or more states, through a resolution to that effect, in their respective legislatures agree to have one such Commission, the Parliament may by law, provide for a Joint Commission.

There is also a provision in the Constitution, wherein on request by two or more States, the UPSC can assist those states in framing and operating schemes of joint recruitment to any service for which candidates with special qualifications are required.

e) Inter-State Council: India is a Union of States, wherein the Centre plays a prominent role, but at the same time is dependent on the States for the execution of its policies. The Constitution has provided for devices to bring about inter-governmental cooperation, effective consultations between the Centre and States so that all important national policies are arrived at through dialogue, discussion and consensus.

One such device is the setting up of the Inter-State Council. The President is given powers under Article 263 of the Constitution to define the nature of duties of the Council. The Council is to inquire into and advise upon disputes, which may have arisen between the States.

In addition, it may investigate and discuss subjects of common interest between the Union and the States or between two or more States, in order to facilitate co-ordination of policy and action. The inter-state council was set up under Article 263 of the Constitution in 1990. The ISC has held 10 meetings so far and has taken several important decisions. Some of them are:

1. Time-bound clearance of bills referred for the President’s consideration
2. Approved the Alternative Scheme of Devolution of Share in Central Taxes to States
3. Indiscrete use of Article 356 in the country

f) Inter-State river water dispute: Article 262 states that the Parliament may, by law, provide for the adjudication of any dispute or complaint with respect to the use, distribution or control of the waters of, or in, any inter-state river or river valley and it may by law provide that neither the Supreme Court, nor any other court shall exercise jurisdiction in respect of any such dispute.

Apart from this, Art.355 imposes duties on the Centre to protect every State against external aggression and internal disturbances and to ensure that the Government of every State is carried on, in accordance with the provisions of the Constitution.

In case of National Emergency (Art. 352), the Centre becomes entitled to give executive directions to a State on any matter.

Similarly, during President Rule (Art. 356), the President can assume to himself the functions of State government and the power vested in Governor or any other executive authority in the State.

During operation of Financial Emergency (Art.360), the Centre can direct the States over certain financial matters and the President can give other necessary directions, including reduction in salary of persons serving in the State and the Judges of the High Court.

• The Role of the Governor (Discretionary Power and Appointment Issues), Reservation of Bills for Consideration of President
• Misuse of Article 356
• The Maintenance of Law and Order in States
• Encroachment by the Centre on State List
• The Financial weakness of the State
• Taxation Powers
• Issue of Grants
• Role of Planning Commission
• Question of Autonomy Issue

Article 356 is the most contentious article of the Constitution.It offers for State emergency or President’s rule in State if the President, on receipt of

It offers for State emergency or President’s rule in State if the President, on receipt of report from the Governor of a State or otherwise, is satisfied that a situation has risen in which the Government of the State cannot be carried on in accordance with the provisions of the Constitution.

The duration of such emergency is six months and it can be extended further. In the Constituent Assembly, Ambedkar had made it clear that the Article 356 would be applied as a last option. He also hoped that “such articles will never be called into operation and that they would remain a dead letter.”

Emergency Provision

Article 356 should be used very carefully, in extreme cases, as a matter of last resort. A warning should be issued to the disturbed State in specific terms alternatives must not ordinarily be dispensed with.

It should be provided through proper amendment that nevertheless anything in clause (2) of Article 74 of the Constitution, the material facts and grounds on which Article 356 (1) is appealed, should be made an integral part of the proclamation issued under the Article.

This will also assure the control of the Parliament over exercise of this power by the Union Executive, more effective.