Framework for Fixing Debt & Deficit

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It is an enormous challenge to design a scheme for fiscal transfers for a country as heterogeneous as India. But when C Rangarajan, the Chairman of Prime Minister’s Economic Advisory Council and doyen of Indian economy and D K Srivastava, the director of Madras school of Economics who has several studies on inter-governmental fiscal transfers and state finances under his belt – arguably two of the best brains on economy – decide to take it up, the consequence is a treat for students, scholars, teachers of public finance, policy makers and development agencies. 

The book compares the Indian design of fiscal transfers with two of the oldest federations – Australia and Canada – and emphasises the need for an institutional arrangement to keep the growth of central and state debts within prudent limits. 

Interconnected with the underlying theme of fiscal federalism and its theoretical underpinnings and application to India’s complex empirical setting, the volume looks at the principles that have guided the determination of fiscal transfers from the centre to the states and the distribution of these transfers amongst the states, given the large differences in fiscal capacities and service standards across states in India.

It dissects Australia’s comprehensive approach to equalisation where fiscal capacity equalisation is supplemented by a detailed analysis of cost differentials across provinces in providing public services and notes that despite the differences in size, heterogeneity and the scale of problems it has much relevance for India. Lauding Australia for allowing its states to raise loans in the market subject to agreed limits, it advocates for a similar approach in India arguing that this would make market-based discipline more effective. 

From the Indian perspective, the volume concludes, the major lesson to be drawn from the Australian experience is the need for a clearer enunciation of the equalisation objective and its translation in practice. It advises full equalisation ‘at least in respect of merit services like health and education.’ Unlike India where the Finance Commission determines a large part of the transfers in the form of tax devolution under global sharing and grants, in Australia the transfer is not in the hands of the Commonwealth Grants Commission. Instead, it gets determined automatically by the amount of revenues collected under the goods and services tax (GST) and supplemented by the special purpose grants that are also in the hands of the Commonwealth (Federal) Government. 

Applauding the maintenance of per capita expenditures of select services at comparable levels among states in Canadian system of inter-governmental transfers, the writers argue that it is worth pursuing in the case of India. They, however, are not so impressed by the Canadian system that aims at equalised transfers. At the same time, they conclude that though the Australian system is sound in principle but the methodology adopted, particularly with respect to equalising expenditure disabilities, has made it unduly complex. 

For delineating the equalising component of transfers, the hardback suggests their decomposition into (i) the vertical component of transfers indicating per capita transfers to all states including the highest income state; and, (ii) equalising transfers indicating the component of transfers only to the states with a fiscal capacity less than the defined benchmark capacity.

The writers advise for setting up an autonomous supervisory body like Loan Council to maintain fiscal discipline consistent with requirements of macroeconomic stability. They are of the view that working of the Australian Loan Council may have relevance for India.

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