The price of persistent federal frictions

Centre-State ties have become increasingly fractious, leading to underinvestment by States, fiscal competition between Centre and States, and inefficiencies due to 'parallel policies'. Interdependence between Centre and States is inevitable and must be preserved to ensure successful implementation of laws and policies.

Disputes between the Centre and States regarding economic policies have a long history in India. However, in recent years the frequency and intensity of such disputes have increased and assumed the character of ‘persistent frictions’ in the federal system.

The current context of economic relations between the Centre and States is very different from the 1980s and 1990s. Continuing economic reforms since 1991 has led to the relaxation of many controls on investments, giving some room to States, but the autonomy regarding public expenditure policies is not absolute as State governments depend on the Centre for their revenue receipts. Several States have recently pushed back as a result of which the ‘give and take’ equation between the Centre and the States has given way to a more hardened stand by both, leaving little room to negotiate. The increasingly fractious Centre-State ties have chipped away at the edifice of cooperative federalism.

Apart from issues around resource sharing, there are other areas that have emerged as sites of conflict. These include the homogenisation of social sector policies, functioning of regulatory institutions and the powers of central agencies. Ideally bulk of the policies in these spheres should be at the discretion of States, with an apex central body overseeing the process of resource allocation. However, the apex bodies have often attempted to increase their influence and push States in directions that are amenable to the Centre.

There are three important economic consequences of these incursions. First, the spread of the Centre’s span of activities leads to a situation where the Centre starts crowding out the States in terms of investments. An interesting case is that of infrastructure development in recent years. The Centre launched the PM Gati Shakti, a digital platform, to incorporate schemes of various Ministries and State governments to achieve integrated planning and coordinated implementation of infrastructure connectivity projects. All States and UTs had to prepare and operationalise a State master plan in line with the national master plan for seamless implementation. However, the flexibility of States in formulating their master plan is curtailed by the centralisation of planning and implementation of the national master plan. This leads to underinvestment by States as is evident from the fact that the combined capital expenditure (capex) of the 16 large States, which account for 80% of the country’s gross domestic product, on roads and bridges fell to 0.58% of the gross state domestic product. At the same time in absolute terms, the centre’s capex on roads increased at a compound annual growth rate of 32.3% since 2015-16, whereas the growth in States has just been 11.2%. Furthermore, spending has become more concentrated within the three largest States of Uttar Pradesh, Maharashtra and Gujarat, accounting for nearly half of the expenditure by 16 States between 2021-22 and 2023-24. Data for 25 States shows that a total of ₹7.49 lakh crore was budgeted for by these States but they spent only ₹5.71 lakh crore which is 76.2% of the total. Investment by these States is important in terms of their impact on regional economies as they induce more local level linkages while national infrastructure projects forge more linkages with the global economy.

The second outcome has been a peculiar form of fiscal competition between the Centre and States. In a federal system, fiscal competition manifests between different regions/States. However, in a scenario of frictions with the Centre, State governments will engage in competition with other States and with the Centre. Welfare provisioning is one such area. The Centre with enhanced fiscal space has more spending power, while States’ revenues, especially non-tax revenues, remain flat as possibilities of raising non-taxes are confined to a smaller sphere due to the direct provisioning of many utilities and services by the Centre.

The third important outcome is the inefficiencies associated with ‘parallel policies’. Federal abrasions lead to either the Centre or the States duplicating the other’s policies. The case of pension reforms is one such example of parallel policies developed by the States. The National Pension System (NPS) changed the architecture of the pension system in India from a defined benefit scheme to a defined contribution scheme. The scheme, mandatory for all central government employees, enlarged its scope and coverage with most of the States joining at different points of time. Though States joined the NPS initially, some States have started to roll back to the old pension scheme as the fiscal cost of reverting would be visible only after 2034 when most of the newly joined employees retire. The emergence of such parallel schemes is mainly due to the trust deficit prevailing in the federal system, the fiscal costs of which have long run consequences on the economy.

For securing the implementation of many of its laws and policies, the Centre depends on the States, particularly in the concurrent spheres. The States also entrust their executive functions, with the consent of the Centre, to the government or agencies of the Centre (Article 258A). Such interdependence is inevitable, especially in a large, diverse, developing society and needs to be preserved.