Fiscal Policy, Decentralization and Economic Growth in India

ABOUT THE BOOK

When the Indian economy faced an unprecedented macroeconomic crisis in 1991, fiscal consolidation constituted a major objective of the policy response. For this purpose, it became necessary to (a) enhance tax and non-tax revenue, (b) curtail current expenditure growth, (c) restructure public sector undertakings, (d) improve fiscal-monetary co-ordination and (e) deregulate financial system. The need for improvements in budgetary practices led to the enactment of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 which ushered the Indian economy in an era of fiscal consolidation based on fiscal policy rules.
The passage of the Constitution (Seventy-third Amendment) Act, 1992 marked a watershed in the history of modern India. With this amendment, a uniform structure of panchayats emerged throughout the country. Similarly, the passage of the Constitution (Seventy- fourth Amendment) Act, 1992 was a landmark in the history of municipal administration in India. Resultantly, panchayats and municipalities are now constitutional bodies forming third tier to the federal polity of India. This decentralisation initiative poses challenges and offers opportunities.
To counter the negative fallout of the global meltdown on the economy, Indian Government took prompt action by providing substantial fiscal stimulus.
This book provides an account of fiscal developments in India during the post-liberalisation period, with particular emphasis on decentralization initiatives. It also examines prospects and challenges facing the Indian economy. An appendix included in the book contains Fiscal Policy Strategy Statement presented to Parliament by Shri Pranab Mukherjee, Minister of Finance, on February 26, 2010.

About Author

Dr. Pradeep S. Chauhan, a noted economist, is based at South Asian Study Centre, St. Antony’s College, University of Oxford, UK as a Fellow. He is M.Phil. (Gold Medallist) and Doctorate in Economics. He has taught in many world- known universities and institutions in his 17 years of academic career. His scholarship ranges over the fields of international economics, economics of climate change and economic theory. His illustrious academic career includes a prestigious French Government Fellowship for which he pursued his research and teaching at Paris School of Economics, Paris. He was awarded Agatha Harrison Memorial Fellowship to pursue his research at the University of Oxford, UK.
Dr. Chauhan has published many books and completed a number of research projects. He is member of many national and international academic bodies including Kastler Foundation, France, International Forum of Young Scientists, Hungary and Indian Economic Association. He has presented papers at many national and international. conferences and seminars.
 

Contents

       About the Book
       Author’s Profile
     Preface
     1. Fiscal Policy: Theoretical Framework
          1.1 Introduction
          1.2 Keynes on Fiscal Policy in General Theory 1.3 Post-Keynesian Views
     2. Fiscal Policy and Economic Growth
             2.1 Introduction
            2.2 Allocative Efficiency and Growth
            2.2.1 Tax Policy
           2.3 Public Expenditure Policy
           2.4 Budget Policy
           2.5 Stability and Growth
               2.5.1 Tax and Expenditure Policies
           2.6 Income Distribution and Growth
           2.7 Concluding Remarks
    3. Indian Fiscal System
        3.1 A Brief Prelude
       3.2 Fiscal Consolidation
       3.3 Fiscal Sector Development at the Central Level
           3.3.1 Taxation Developments
          3.3.2 Disinvestment, Privatization and Restructuring of Public Sector
          3.3.3 Borrowings by Government
          3.3.4 Expenditure Reforms Commission
       3.4 Fiscal Sector Development at the Level of States
          3.4.1 RBI Initiatives on State Finances
            3.5.1 Global Financial Crisis and Set Back to Fiscal Consolidation
     3.6 Robust Economic Growth and Buoyant Tax Revenue
           3.6.1 Indirect Taxes
          3.6.2 Tax Expenditures
          3.7.1 Interest Payments
     3.8 Subsidies
     3.9 Government Debt
    3.10 Eleventh Plan on Government Finances
     4. Fiscal Reforms in India
       4.1 Fiscal Responsibility and Management Act
             4.1.1 FRBM Act and Transparency of Budgetary Policy
            4.1.2 Implementation of FRBM by States
           4.1.3 FRBM Act and Check on Public Debt
       4.2 Tax Structure Reforms at the Central Level
              4.2.1 Introduction of CENVAT
              4.2.2 Exemptions Causing Distortions
              4.2.3 Tariff Reductions
              4.2.4 Proposed National Goods and Services Tax (GST)
        4.3 Modernisation of Public Pension System
       4.4 Introduction of VAT at the Level of States
       4.5 Effectiveness and Transparency of Subsidies 4.6 Summing Up
       5. Fundamentals of Fiscal Decentralization
           5.1 Introduction
          5.2 Historical Basis of Fiscal Centralization
         5.4 Conventional Fiscal Decentralization Theory
             5.4.1 Primary Responsibility of Stabilization
             5.4.2 Redistributive Function
             5.4.3 Allocation Function
        5.5 Relevance for Developing Countries
       5.6 Decentralization and Economic Development
       5.7 Macroeconomic Effects of Decentralization
       5.8 Growth-retarding Effects of Fiscal Decentralization
       5.9 Fiscal Decentralization and Distribution
      5.10 Fiscal Decentralization and Revenue Generation
      5.11 Fiscal Decentralization and Accountability of Local Participation
      5.12 Elements of a Good Fiscal Decentralization Programme
           5.12.1 Adequate Enabling Environment
            5.12.2 Assignment of Appropriate Functions to Local Governments
            5.12.3 Assignment of Appropriate Revenues to Local Governments
            5.12.4 Appropriate Inter-governmental Transfer System
            5.12.5 Adequate Local Access to Investment Capital
       6. Fiscal Decentralization and Economic Growth
           6.1 Introduction
           6.2 Decentralized Government Expenditure and Growth
           6.3 Estimation of Relationship between  Decentralization and Growth
           6.4 Direct and Indirect Linkages between Decentralization and Growth
           6.5 Linkage between Efficiency and Measured Growth
           6.6 Sub-national Governments, Competition and Development
           6.7 Corruption and Fiscal Decentralization
           6.8 Summing Up
      7. Fiscal Decentralization in India
         7.1 The Indian Polity
         7.2 Distribution of Powers between the Centre and the States
         7.3 Centrally Biased Constitution
         7.4 Extent of Fiscal Devolution to State Governments
         7.5 Mechanism of Transfer of Resources from the Centre to the States
         7.6 Controlling Debt of States by Central Government
         7.7 Significant Role Played by Postal Savings System
        7.9 Local Bodies Remain Underdeveloped
       7.10 Assessment of Effectiveness of Local Bodies 7.11 Summing Up
    8. Progress, Prospects and Challenges of Indian Economy
         8.1 India’s Development Experience: Pre-reforms Period
         8.2 Economic Policies in the 1980s
         8.3 Initiation of Economic Reforms in Early 1990s
         8.4 Fiscal Consolidation in the Indian Economy
         8.5 Response of the Economy to Reforms
         8.6 Gains in Labour Productivity: Main Driver of Growth
         8.7 Total Factor Productivity Growth and
         8.8 Sterling Performance of Services and the IT Sector
        8.9 Special Economic Zones (SEZs)
       8.10 Faster Growth in Relatively Developed States
       8.11 Prospects and Challenges
       8.12 Need for Further Deregulation
      8.13 Employment Aspect of  Accelerated Growth
      8.14 Need for Enhanced Efficiency of the Financial System
      8.15 Reorientation of Public Expenditure
      8.16 Modernization of Tax Structure
      8.17 Centre-State Financial Relations
      8.18 High Demand for Infrastructure Services
      8.19 Urban Renewal and Development
      8.20 Summing Up
Appendix
Fiscal Policy Strategy Statement, as Part of the
Budget Papers, Presented to Parliament by
Shri Pranab Mukherjee, Minister of
Finance, on February 26, 2010
Bibliography
Index
 

Preface

Fiscal policy is an important instrument of the general economic policy of a government. It is concerned with the use of a government’s taxation and expenditure powers to influence economic activities in an economy at the aggregate level. It also deals with financial relations between different tiers of government in a federal polity. Through the medium of budget, it determines government expenditure, borrowing requirements and issue of new currency. It also determines private spending through taxation measures.
       Fiscal Policy Reforms
It may be recalled that the external payments crisis of 1991, which led to the initiation of economic reforms in India, was the result of deteriorating fiscal situation during the latter half of 1980s. This period was marked by high and persistent fiscal deficits, accompanied by large revenue deficits. This had led to a significant enlargement of Government borrowings from financial intermediaries and increased financing of Government deficit through automatic monetisation which aggravated price rise.
When the Indian economy faced an unprecedented macroeconomic crisis in 1991, fiscal consolidation constituted a major objective of the policy response. This consolidation was to be achieved through reduction in the size of budget deficit and public debt in relation to GDP. For this purpose, it became necessary to (a) enhance tax and non-tax revenue, (b) curtail current expenditure growth, (c) restructure public sector undertaking, including disinvestment, (d) improve fiscal- monetary co-ordination, and (e) deregulate financial system.
 
    Global Financial Crisis and Fiscal Policy
The current global financial situation continues to be uncertain and unsettled. What started off as a sub-prime crisis in the US housing mortgage sector has turned successively into a global banking crisis,
To counter the negative fallout of the global slowdown on the economy, Indian Government took prompt action by providing substantial fiscal stimulus. The Central Government invoked the emergency provisions of the FRBM Act to seek relaxation from the fiscal targets and launched two fiscal stimulus packages in December 2008 and January 2009. These fiscal stimulus packages, together amounting to about 3 percent of GDP, included additional public spending, a farm loan waiver package and salary increases for government staff, all of which should stimulate demand.
        Prospects and Challenges
Recent developments in the World economy have brought forward several new realities that pose severe challenges to macro-economic management, in particular to monetary and regulatory policies globally. Concerns relating to the US slowdown and its intensity have mounted in view of the potential spill over on to the global economy. Threats to the global economy are emanating from advanced economies in sharp contrast to earlier crises which stemmed from the emerging world.
The financing of fiscal deficit is another area, which underwent significant changes in the post-reform period. With the discontinuation of ad hoc 91-day Treasury Bills in April 1997, automatic monetisation of deficits was eliminated. Greater reliance on borrowing at market-related interest rates has led to a substantial lowering of statutory pre-emption of institutional resources for the Government.
 
       Decentralisation Initiative, 1992
The passage of the Constitution Amendment) Act, 1992 marked a watershed in the history of modern India. With this amendment, a uniform structure of panchayats emerged throughout the country.
Article 243G read with Eleventh Schedule of the Constitution explicitly requires the States to devolve powers and authority on panchayats which may be necessary to enable them to function as institutions of self-government.
Similarly, the passage of the Constitution (Seventy-fourth Amendment) Act, 1992 was landmark in the history of municipal administration in India. Article 243W read with Twelfth Schedule of the Constitution provides the illustrative list for the devolution of functions to the municipalities. Many States have amended their municipal laws to ensure conformity with the new constitutional provisions.nsures