WHO will bell the cat? This is the question and the refrain in the highest echelons of the bureaucracy as it looks at dire state economic data and plans on how to respond to the Supreme Court’s prod for suggestions in the wake of the
spoke to key officials in the Union Ministry of Finance; state Finance Ministers; Election Commission of India, Fifteenth Finance Commission, Niti Aayog, the Reserve Bank of India, and the Comptroller and Auditor General and found a consensus on three key issues.
One, both the Centre and the states have been liberal with handouts — support to poor by a state is called a freebie by Centre, and vice versa. Two, existing laws and mandates do not allow ECI, CAG, Niti Aayog, and the Finance Commission to step in.
And, three, the Centre is wary that any unilateral curbs on states will allow political leaders there to blame Prime Ministerfor not letting them “do good” for the people.
ECI officials said it would be an “overreach” of laws governing the poll body to regulate decisions of winning political parties. For the Finance Commission whose main responsibility is to decide on sharing of resources between the Centre and states, its terms of reference will need a substantive expansion. This will be seen as impinging on the federal structure of the polity. RBI’s dominant focus as well as its mandate is controlling, and Niti Aayog is more of a think tank now.
“Under Article 293 of the Constitution, states need to take the Centre’s consent for fresh loans if they are indebted to the Centre. This is a powerful tool in the hands of the Centre or the Union Finance Ministry. But using it will expose the ruling party in the Centre to the risk of being branded anti-poor by state leaders,” said a former Union Finance Secretary, explaining the Centre’s dilemma.
“The biggest of all freebies is electricity – free power to huge sections of the society is crippling the states,” said a senior Central official. As on May 31, 2022, at a consolidated level, dues of state distribution companies to generating companies is Rs 1.01 lakh crore; that of the state government to distribution companies is Rs 62,931 crore; and the subsidy receivable by the distribution company from the state is Rs 76,337 crore.
A few freebies by states here and there is never a problem – but too many handouts on top of electricity subsidies preclude or displace other productive spending.
“This is problematic because certain states are left with little to spend… For example, 86 per cent of Punjab’s expenditure is committed, accounting for payments towards salaries, pensions and interest on past borrowings. Its capital outlay (spending for creating productive assets like roads, schools, hospitals, etc) is just 7.5 per cent,” said an official.
Some states, however, view the Prime Minister’s views on freebies as more political rather than economic. Acknowledging that reckless handouts could lead to problems, Tamil Nadu Finance Minister Palanivel Thiaga Rajan told The Indian Express: “It was Prime Minister Modi himself who in February 2018 launched the scheme giving Rs 25,000 to working women, covering 50 per cent of a two-wheeler cost. Is this not a revadi? Does it not reek of hypocrisy?” The scheme launched by the ADMK government in Tamil Nadu was, incidentally, scrapped by MK Stalin-led DMK government in August 2021.
The Centre’s concerns over state finances are not unfounded. In a meeting with Chief Secretaries of various states in June this year, Union Finance Secretary TV Somanathan is understood to have raised a red flag over huge borrowing by some states by mortgaging assets – even Collectors’ offices and district court premises, and escrowing future revenues (giving the first charge on revenue receipts towards debt raised).
Similarly, very high off-budget borrowings, excessive guarantees and contingent liabilities of some states towards funding populist schemes have deepened concern at the Centre.
Some economists push back. “When the rich really rip off the banking system, with huge NPAs and write-offs, and a rent-seeking bureaucratic culture, can we say the poor are too pampered with these freebies?” said Maitreesh Ghatak of the London School of Economics. “In behavioural economics, we call it the ‘endowment effect’. It is impossible to do away with benefits once given, it always results in loss aversion. Hence, the concern is a real one. Nothing is free, someone pays for it – taxpayers,” he said.
According to data shared with states by the Union Finance Ministry, between 2019-20 and 2021-22, Andhra Pradesh borrowed Rs 23,899 crore, Uttar Pradesh Rs 17,750 crore, Punjab Rs 2,879 crore and Madhya Pradesh Rs 2,698 crore, by mortgaging assets and escrowing future revenues.
With limits placed on market borrowing (3.5 per cent on GSDP), states have resorted to off-budget borrowings. State PSUs or other agencies raise debt, and this does not reflect in the books of the state. In the period 2019-20 to 2021-22, the top five states in terms of off-budget borrowings were: Telangana Rs 56,767 crore, Andhra Pradesh Rs 28,837 crore, Uttar Pradesh Rs 24,891 crore, Kerala Rs 10,130 crore and Karnataka Rs 9,981 crore.
Similarly, guarantees and contingent liabilities of states have also jumped. For Telangana, it stands at about Rs 1.35 lakh crore (11 per cent of GSDP), Andhra Pradesh Rs 1.24 lakh crore (10 per cent of GSDP), Uttar Pradesh Rs 1.73 lakh crore (8 per cent of GSDP) and Rajasthan Rs 90,000 crore (7 per cent of GSDP). The Centre’s guarantees, in contrast, are less than 0.5 per cent of GDP.
“Some states are in a perilous position,” said Fifteenth Finance Commission Chairman NK Singh. “They are entering a fiscal trap, and will find it difficult to meet their debt obligations. Macroeconomic stability is a hard-won battle of this government. But unbridled populism – a new phenomenon – puts such stability at risk.”
While fiscal conservatives, including those in the government, do not distinguish between’s electricity subsidy to the poor and PM Kisan (Rs 6,000 a year to every farmer), Singh said there is a need to distinguish merit subsidies from freebies. “Support to education and farms are meritorious subsidies and have larger externalities. Free electricity is environmentally unfriendly, and distorts cropping patterns,” he said.
Even Ghatak admits the need for a rethink. “(The PM) won 2019 despite economic headwinds, and then there are the recent UP election results. So, when the PM talks about freebies/ ‘revadi’ culture, there is some truth to it but he can afford to say that, like the need for sportsmanship coming from the winning team’s captain. But there is a chance of shifting equilibrium on this and from that point of view, his argument should be taken seriously.”