People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 11

March 18, 2007



The Changing Nature Of Centre-State Relations


Prabhat Patnaik 


IN the late seventies and early-eighties, there had been a massive upsurge in the demand for a re-ordering of centre-state relations, for greater fiscal autonomy for state governments through much larger non-discretionary devolution of resources from the centre to the states, and for a more authentic realisation of the federal spirit of the Constitution. This upsurge was led by the Left, but it had the support of most state governments and a large number of political parties, especially the regional parties. The Left governments of the time played a key role in this upsurge, and organised a number of conclaves, including the famous Srinagar conclave. The Left governments of the time, especially the West Bengal government, were facing acute fiscal difficulties. But these difficulties, far from deterring either the Left governments or other state governments, spurred them on to demand greater autonomy.


Matters today are vastly different. State governments, including the Left governments, are again facing acute fiscal crises. But there is hardly a murmur of protest. On the contrary, most state governments are vying with one another to be in the good books of the central government whose level of interference in state government affairs has reached unprecedented levels. The question naturally arises: why this difference between the two situations? The answer lies in the current triumph of neo-liberalism over our economy. The old struggle was over the fiscal resources at the command of state governments. Now, fiscal resources at the command of the state governments do not seem to matter much, as they vie with one another to attract private investment, and access external donors, always waiting in the wings with loans and “conditionalities”, to supplement fiscal resources. “Conditionalities” in turn do not arouse much hostility since the current triumph of neo-liberalism makes them appear necessary and even desirable.




Neo-liberalism in short has brought about a re-ordering of centre-state relations. At the same time however a re-ordering of centre-state relations was a precondition for the triumph of neo-liberalism. In short we have here a dialectical process which was initiated with the adoption of “reforms” in 1991. Let us try and capture this process.


In 1990-91 the ratio of the total tax revenue of the centre (net of states’ share) in Gross Domestic Product at factor cost was 8.4 per cent, while that of the tax revenue of the states and the Union Territories (including tax revenue transferred from the centre) was 8.8 per cent. In 2000-01 the corresponding ratios were 7.1 per cent and 8.7 per cent respectively. Throughout the decade of the nineties in other words it is the centre that was slackening its tax effort while the states were maintaining theirs. But at the end of the decade virtually all the states were in dire fiscal straits. There were two basic reasons for this paradoxical situation: first, there was a decline in the relative magnitude of central transfers to the states; and secondly, there was a substantial increase in the interest rate charged on central loans, including Plan assistance, to the states. In most cases, the interest rate charged exceeded the nominal rate of growth of the Gross State Domestic Product of the states, which is a condition for entrapment in a debt-trap.


The centre did not just impose a fiscal crisis on the states. It also used the Finance Commission to enfeeble state governments, by imposing “conditionalities” upon them. The Eleventh Finance Commission started the process. While giving to the states what is legitimately their due under the Constitution, which after all is what the Finance Commission is set up to decide, it set out a number of “conditionalities” that had to be fulfilled before the states could access a part of the devolved resources. These “conditionalities” included power sector reforms which are not a matter for the Finance Commission at all; moreover these “conditionalities” had to be fulfilled to the satisfaction of the central government! A neo-liberal agenda was thus thrust upon the states through the illegitimate use of a Constitutional body, the right to appoint which had been usurped by the centre for a long time.


The Twelfth Finance Commission followed in the footsteps of the Eleventh. It made debt-relief to states “conditional” upon their passing Fiscal Responsibility legislation which put a 3 per cent ceiling on their fiscal deficit relative to GSDP (and similar other caps) to be achieved by a certain target date. The centre too had enacted a Fiscal Responsibility and Budgetary Management Act placing a similar ceiling on its own fiscal deficit. This fiscal conservatism, which was a continuation of the doctrine of “sound finance” practiced during the colonial period, and which was invariably demanded by finance capital in its effort to push the State back from its role as an investor and provider of welfare services to the people, was thus imposed on the entire system, both the centre and the states, as a part of the generalised adoption of the neo-liberal agenda.


The shift to lower levels of deficit meant expenditure curtailment on the part of the states, and since committed expenditures, like interest payments, pensions and salaries (which increased in most states in the wake of pay revisions that sometimes preceded and sometimes succeeded central pay revisions), could not be curtailed, the axe invariably fell on plan outlays. This of course was exactly what the neo-liberal agenda demanded. As state governments increasingly became incapable of fulfilling their role of being an investor and provider of welfare services, they perforce had to rely on private, including external, agencies to play this role. For undertaking investment in social and economic infrastructure they had to entice private capital, and enter into Public-Private Partnership arrangements which the central government encouraged through “viability gap financing” (i.e. meeting a part of the project cost that the private investors were unwilling to meet). For undertaking investment in education and health, they had to approach agencies like DFID of the British government or the World Bank. 


Of course, to the extent that these agencies gave loans, such loans were counted as part of fiscal deficit, and hence were subject to the “Fiscal Responsibility” ceilings; but the adding of a grant component to such loans made them irresistible from the point of view of the state governments, even though all such social sector schemes carried with them the “conditionality” of enhancing user charges that necessarily put a burden on the poor. And once the tendency to rely on the private sector and external donors had taken root, it became the preferred option for most state governments, since state government bureaucracies became increasingly infused with neo-liberal ideas acquired from their colleagues at the centre and from the several World Bank training programmes they were made to participate in.




The reliance on private investment and external donors gave rise to a bizarre situation. Since all the states were in a similar predicament, they desperately competed against each other to attract private investment or to climb on to the World Bank/DFID bandwagon. The defenders of capitalism usually locate its virtue in the fact of competition between the capitalists, which prevents them from extracting illegitimate monopoly gains. Here we had the very opposite situation: it is the state governments that were competing against one another to attract capitalists to invest on their respective soils, and, since substantial investments could be undertaken only by a few large capitalists, offering them larger and larger social “bribes” for doing so. The competition was not between capitalists but between state governments; the competition was not against monopolists but in favour of the monopolists. Neo-liberalism had triumphed.


All these phenomena are amply evident in the case of Kerala. Even though Kerala is in some ways unique, having a cash crop economy hit by an acute crisis, having embraced neo-liberalism with unusual gusto, and having an unusually poor revenue-raising record during the previous administration, nonetheless its travails are similar to those of other states, only magnified. Its fiscal conservatism (it passed in 2003, before being asked to do so, Fiscal Responsibility legislation restricting the size of the fiscal deficit to 2 per cent of GSDP), together with its unwillingness to raise any additional revenue (the tax-GSDP ratio of Kerala has remained absolutely stagnant since 2002-03 while it has increased for all states taken together and also for other south Indian states), has resulted in such a drastic squeeze on its plan outlays that not more than 75 per cent of the tenth plan outlay will be realised. It has also led to significant dependence on foreign loans, which has entailed shortfalls in utilisation, cost and time over-runs, a devaluation of planning and a loss of administrative élan. What is more, public expenditure on education and health, which had sustained the famed “Kerala Model”, has declined as a proportion of GSDP between 1999-2000 and 2005-06, as has the expenditure on social services and water supply and sanitation. The same is true, in varying degrees, of other states as well.




What, it may be asked, can be done about this situation in a particular state, within the overall context of the neo-liberal policies being pursued by the centre? Apart from the fact that resistance on specific issues can be mobilised along with other states, e.g. on the “conditionalities” being imposed by the centre under JNNURM for a reduction in Stamp Duty, or on the curtailment of the central share in Sarva Shiksha Abhiyan to 50 per cent from 75, or for introducing a degree of flexibility on VAT rates, or on preventing cut-throat competition among states for attracting private investment, there is also scope for action within the state itself. Central to any such action is additional resource mobilization from the affluent sections, for which there is plenty of scope. If additional resources are mobilized, if these are used at least for improving the state of public education and health-care and on some measures of amelioration of peasant distress, and if the neo-liberal predilection of the bureaucracy is kept in check, then the beginnings of a movement for an alternative trajectory would have been made.