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Globalizing Federal Finances Is Imperative, Granting States A Larger Stake In Investment Portfolios – IMPRI Impact And Policy Research Institute

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Globalizing federal finances is imperative, granting states a larger stake in investment portfolios

TK Arun

As the world continues to globalise, accommodating new geopolitical alignments, technological paradigm shifts, and climate imperatives, the role of governments in their national economies is rising, both through policy and expenditure.

States’ Financial Landscape in India

In India, of the total government expenditure of 30% of GDP, two-thirds is carried out by state governments (see Table 2.7 of Economic Survey 2022-23, Statistical Appendix), including some spending financed by the Centre. To hobble state finances, in this context, is to express a strong death wish. Indeed, foreign portfolio investors (FPIs)in government debt can invest in state government debt, but they do not. They have utilized hardly 2.6% of the permissible limit for state government securities.

Migrant Remittances and Financial Opportunities

Why, then, is the Centre chary of letting state governments aggressively market a part of the debt they are eligible to raise abroad, particularly to migrants from their states?
India is the world’s biggest recipient of migrant remittances, $125 billion in 2023. Mexico, the second-highest, got about half as much.

Non-Resident Indian deposits have been the mainstay of emergency foreign borrowings for India, time and again: remember the Resurgent India Bonds to tide over the post-nuclear test isolation of 1998, the Millennium Development Deposits of 2000 and the foreign currency non-resident special deposits to tide over the taper tantrum of 2013? Migrant workers have a calculus that is a little more generous than that of FPIs, when it comes to investing in their home states. Why prevent state governments from tapping into this fount of generosity?

Leveraging Migrant Contributions for Infrastructure Development

Kerala’s Calicut International Airport faced a peculiar problem. Built as it is on top of a hill, to extend the runway to accommodate large aircraft, enormous amounts of earth had to be piled literally hill-high, along the cliff-edge, to create additional land on which to extend the runway. This would not have passed anyone’s test of commercial viability. But the migrant workers from Kozhikode’s hinterland, who wanted international flights to take off and land as close to home as possible, to ferry them to their places of work in the Persian Gulf and back, were willing to spend the money needed to build an earth mound as big as the hill on which the original airstrip had been built.

Those who hail Vinod Khosla’s endowment of his alma mater, IIT-Delhi, should not frown when smaller-scale migrant successes are offered an opportunity to help their hometown, district or state acquire vital bits of new infrastructure. Kerala sold Masala bonds to raise money for infrastructure projects in Kerala, including a low-cost, statewide broadband network.

This has come in for severe strictures from the Union government. This reflects a closed-economy mindset.Every state has its own credit rating, and the yields on state government debt vary, depending on the issuer’s creditworthiness. True, off-budget borrowing via financing vehicles raises contingent liability. But that is precisely how the Centre has been financing its successful highway construction. Why assume the Centre has some special fiscal virtue that the states lack?

Shifting Dynamics in Inter-State Finances

Gone is the time when the Centre outspent the states. The states, together, spend more than the Centre does. Their debt is some 25% of GDP, while the general government debt is some 80% of GDP. This means that the Centre’s debt, at 55% of GDP, is almost 69% of general government debt.

States drive growth, luring investment offering infrastructure, incentives, and favourable policy. Why impair their ability to perform this task by curtailing their resource mobilization efforts via borrowing from expats willing to bear the currency risk on such borrowing?

Reassessing Revenue Distribution and Taxation Policies

As per the Finance Commission norm currently in force, 41% of the personal and corporate income tax collections belongs to the states. But they have zero say on fixing the rates of these taxes, or doling out concessions on these taxes. Even as the Centre has slashed the rates of tax on corporate profits, it has replaced a large slice of the excise duty on petro-fuels, shareable with the states, with cesses, which are not shared with the states. The Centre, in other words, has been dipping into the states’ pocket to finance its own largesse.

Ignoring the Global Implications in Fiscal Planning

The Finance Commission, too, has been remiss, when it comes to appreciating the globalized dimension of federal finance. It takes developed manpower to remit large amounts back home. Kerala has traditionally devoted large chunks of its Budgetary outlay to education and healthcare, and followed a socio-political culture that spares migrant workers, regardless of gender, any stigma for toiling far from home.

The remittances they send back home boost spending in the state, but also contribute to macroeconomic stability, by reducing India’s current account deficit and stabilizing the rupee. In the horizontal distribution of taxes among states, the Commission could give some weight to this contribution, but it does not.

Take the hit Punjab takes on its finances by subsidizing power and irrigation for its farmers to produce grain that has a ready export market. Do these export earnings, benefitting the nation as a whole, find any reflection in the Finance Commission’s reckoning? The 15th Commission is as insular as the first had been to the global dimensions of the Indian economy, and their implications for federal finance. Indians celebrate the will to thrive, not any death wish.

TK Arun is a senior journalist.

The article was first published in The Economic Times as Federal finance must globalise, with states allowed a bigger share of investments on March 5, 2024.

Disclaimer: All views expressed in the article belong solely to the author and not necessarily to the organisation.

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Acknowledgment: This article was posted by Nikita Saha, a research intern at IMPRI.

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