Bad structure, irresponsible politics behind India's poor fiscal governance

Instead of municipalities and states depending on transfers from the Centre, it should be the other way around

What hope does fiscal responsibility have in India with our kind of political parties? Two things tell their own story.

First, all of a sudden, a problem everyone thought had been solved forever has come back with a bang. This is the problem of pensions for government employees.

Until 2005 it was a pay-as-you-go system. Then it was turned into a contributory system. Now, some of the non-BJP parties, mainly the Congress, which had implemented the new pension scheme in the first place, want to revert to the old pay-as-you-go system.

Rahul Gandhi is silent on this issue. This underscores the extraordinary irresponsibility of political parties in India, even though this is fiscally wholly and utterly disastrous, as we can see from the fate of the two states that had not implemented it then, namely Tamil Nadu and West Bengal. Both depend on transfers from the Centre just as municipalities do on transfers from the state government.

And therein lies the even more significant second problem of the system that we have of top-down fiscal governance rather than the other way around.

A counterexample for a country of India's size can be found in China, which has a bottom-to-top system. There the local bodies send money to the central government. In the old days, this was called the payment of tribute. The result has been very efficient local bodies that govern smaller areas effectively.

The contrast with India is shaming, as a recent report by the Reserve Bank of India has pointed out. The underlying theme is the failure of local governance, and the unspoken message is the irresponsibility of the political parties.

Essentially, says the RBI, India has the weakest local governance in the world because the state governments hobble them. They have virtually no autonomy in the things that such bodies have in other parts of the world.

"The absence of buoyant (local) revenue, excessive reliance on grants from the central and state governments, and inability to autonomously access capital markets have weakened the ability of ULBs to fulfil their mandated functions," says the report. In short, these local governments are broke and depend on transfers from the state governments.

The RBI examined the finances of 201 municipal corporations and found that there has been "no distinct rise in overall municipal revenue in India which remained broadly unchanged from 1946-47". Imagine that. That's 76 years! Municipal revenues and expenditures have stagnated at around 1 per cent of GDP since 2010. In Brazil, the corresponding figure is 7.6 per cent, and it is 6 per cent in South Africa.

This has led to the suggestion that the Centre and the states should "share one-sixth of their GST revenue with the third tier," the report said.

The RBI also thinks that, as in China, the local bodies of India should consider creating special purpose vehicles (SPVs) to raise funds. "For example, China's Local Government Financing Vehicle (LGFV) is an investment company that sells bonds in the bond markets for financing real estate development and other local infrastructure projects."

However, all is not lost because, according to the RBI report, nine municipalities have issued municipal bonds and raised around Rs 3,840 crore since 2017. These are the municipalities of Ahmedabad, Andhra Pradesh Capital Region Development Authority, Bhopal, Ghaziabad, Greater Hyderabad, Indore, Lucknow, Pune, and Surat.

But how is all this to be repaid? The report says, "with the power to tax residents to pay bondholders." That's a good idea but a distant dream because our politicians won't allow it. That's not how our politics works.