मिसेज़ शर्मा, मिसेज़ वर्मा एंड द रिटर्न ऑफ़ कोरोना 

शाम के छे-साढ़े छे बजे हैं. सूरज ढल चुका है. कोरोना की दूसरी वेव का प्रकोप शहर में फैल चुका है. ऐसे माहौल में, मिसेज़ शर्मा और मिसेज़ वर्मा अपने अपने घर के सामने छोटे से बगान में बैठी हुईं, सोशल डिस्टन्सिंग बनाये हुए, एक दुसरे से बातें कर रही हैं. 
आईये सुनते हैं. 
“और आप सूई ले लीं? मिसेज़ शर्मा ने पुछा. 
“अब क्या बताएं,” मिसज़ वर्मा ने जवाब दिया. “अरे परसों मिस्टर और हम गए थे. अस्पताल पहुंचे तो Compounder मिस्टर से बोलिस, आज तो ख़तम हो गया है सर.” 
“ख़तम, ख़तम कैसे हो गया?”
“हम भी वही बोले.” 
“तब तो टीका उत्सव चल रहा था न.”
“हम भी वही बोले.” 
“मोदी जी दिन में 18 घंटे काम कर रहे हैं और ई सब compounder लोग से दू ठो सुई नहीं संभल रहा है.”
“हम भी वही बोले,” मिसेज़ वर्मा ये बोलकर जैसे अटक सी गयी. 
“और आपका चुन्नू ठीक है?” मिसेज़ शर्मा ने पुछा. 
“हाँ ठीक ही है,” मिसेज़ वर्मा का जवाब आया. 
“और इशू–विशु के बारे में कुछ सोचा कि नहीं?”
“अरे क्या बताएं,” मिसेज़ वर्मा बोलीं. 
“ऐसे अभी तो टाइम भी सही था,”  मिसेज़ शर्मा बोली. 
“मतलब?”
“सबका वर्क फ्रॉम होम चल रहा है.”
“हाँ तो?”
“अरे आदमी घर से काम करता है तो थकता कम हैना. ज़्यादा ताकत रहता है ” 
“अच्छा समझे.”
“ऐसे तुमको एक बात बोलेंगे, बुरा मत मानना.” 
“अरे नहीं बोलिये, बुरा काहे मानेंगे, ” मिसेज़ वर्मा ने कहा. 
“हमारी मंझली दीदी का लड़का हैना.”
“कौन बबलू?” 
“हाँ. तो वो भी बहुत दिन तक इशू नहीं किया.” 
“अच्छा फिर?”
“फिर क्या, दवाई का आदत लग गया. बहुत मुश्किल से हुआ.” 
“अरे बाप रे.” 
“इस लिए समय रहते कर लेना चाहिए,” मिसेज़ शर्मा ने कहा. “हर चीज़ का एक उम्र होता है.” 
“ऐसे हम परसों ही पूछे उससे कि क्या प्लान है,” मिसेज़ वर्मा ने कहा. 
“क्या बोला?”
“बोला, मम्मी ऐसी दुनिया में बच्चा लाकर क्या मतलब.”
“मतलब?”
“हम समझाये, के बेटा, बच्चा कोई मतलब के लिए थोड़े पैदा करता है. बच्चा पैदा करना होता है, इसलिए पैदा करता है.”
“अच्छा. फिर क्या बोला?” मिसेज़ शर्मा ने पूछा. 
“बोला, मम्मी तुम समझ रही हो क्या बोल रही हो.”
“ओह, ऐसा बोल दिया.” 
“हाँ.”
“हम तो तुमको बोले थे, जेनयू वेनयू मत भेजो. बच्चा लोग घर से बहार डॉक्टर इंजीनियर बनने के लिए निकले तो अच्छा लगता है. हिस्ट्री पढ़ने के लिए इतना मेहनत…” 
“हाँ आप तो बोली थी. और हम भी मिस्टर को बोले थे. पर वो उधर से बोले, कब तक अपने पास बांध के रखोगी,” मिसेज़ वर्मा ने कहा.
“ऐ माँ, गाय है क्या जो बांध कर रखेंगे.”
“सही कहीं आप.” 
“हमारी बड़ी दीदी का लड़का…”
“चिंटू?” 
“हाँ. वो भी जेनयू गया था, करीब दस साल पहले.” 
“अच्छा.” 
“बस बंगाली लड़की से शादी कर लिया.” 
“अरे बाप रे. बहुत एग्रेसिव होगी वो तो?”
“हैये है कि. कच्चा चबा गयी अपनी सास को,” मिसेज़ शर्मा ने कहा.
“दीदी और जीजाजी आपके मान कैसे गए?” मिसेज़ वर्मा ने पूछा.
“शुरू में नहीं माने थे. फिर चिंटू बोला, शादी कर रहे हैं, आना है तो आईये, नहीं तो भाड़ में जाईये.”
“बच्चा लोग के सामने आदमी मजबूर हो जाता है.”
“एकदम. हम तभी राजू को जेनयू नहीं भेजे. बोले यहीं रांची यूनिवर्सिटी में पढ़ लो.” 
“एकदम ठीक की.” 
“तभी मोदी जी कहते हैं, हार्डवर्क इस मोर इम्पोर्टेन्ट दैन हारवर्ड,” मिसेज़ शर्मा ने कहा. 
“कहेंगे नहीं. वो तो पूरा पोलिटिकल साइंस पढ़े हैं,” मिसेज़ वर्मा ने कहा. 
तभी मिसेज़ वर्मा के घर के अंदर से आवाज़ आयी. “शीला, गप मारना ख़तम करो. भूक लगी है. डिनर दे दो.” 
“मिस्टर बुला रहे हैं लगता है?” मिसेज़ शर्मा ने कहा. 
“हाँ.”
“पर पौने सात बजे डिनर?”
“अब क्या बताएं.” 
“क्या हुआ?”
“अरे छोटी बहु बोल दी है कि पापा आपका तोंद निकल गया है. अच्छा नहीं लग रहा है.” 
“ओह चुन्नू की मिसेज़ ऐसा बोल दी.” 
“हाँ.”  
“तो?”
“इसलिए, आजकल जल्दी खा रहे हैं…उसको का बोलते हैं.” 
“इंटरमिटेंट फास्टिंग.” 
“हाँ वही करने की कोशिश कर रहे हैं.”
“अच्छा.”
“इनको न हमेशा से मन था कि एक बेटी भी हो,” मिसेज़ वर्मा ने थोड़ा शर्मा के कहा. “इस लिए छोटी बहु का बात इतना ध्यान से सुनते हैं.” 
“अच्छा.”
“तीन लड़का के बाद, बोले एक बार और ट्राई करते हैं, हो सकता है इस बार बेटी हो जाए.” 
“अच्छा.” 
“पर हम हाथ खड़ा कर दिए.”
“अच्छा.” 
“बोले, और ताकत नहीं है.” 
“अच्छा.” 
“पहले ही तीन बच्चा संभालना…” 
“शीला,” मिसेज वर्मा के घर के अंदर से फिर आवाज़ आयी. 
“अच्छा तो हम चलते हैं,” मिसेज़ वर्मा ने कहा. 
“फिर कब मिलयेगा?” मिसेज़ शर्मा ने पुछा. 
“जब आप कहियेगा.” 
“जुम्मे रात को?”
“नहीं आधी रात को.”
 

Only 1.7% of Central Govt Petrol Taxes Shared with States – Where Has Cooperative Federalism Gone?

Note: Detailed analysis takes time. Like this piece took three weeks to write. Hence, please continue supporting this effort. Every rupee helps. 

Chintan Patel and Vivek Kaul

The devil, as they say, is always in the detail.

Nevertheless, in an era of instant digital journalism, where you, dear reader, are constantly bombarded with information, the real story, or should we say stories, often get buried under numerous headlines, lazy journalism, government press releases and the false news that is the flavour of the day.

But if one is willing to do some basic number-crunching, like we are, some interesting details and narratives can emerge.

This is one such story of the central government taking both the states and the common man, for a ride and that too in broad day light. At the risk of stretching the metaphor a bit too far, the scene of the crime is the petrol pump and the motive, the dire state of the economy.

But to do this story full justice, we need to set up the background with some dry, academic points as well as digress into some adjacent details.

So, kindly bear with us. While sensational things might get you excited and help us get a few more clicks, but as we said at the beginning, the devil is in the detail.

And here’s presenting the detail.

What’s the point?

Over the years, the central government has been sharing less and less of the overall taxes that it collects, with the state governments. This is the main point we make in this piece. 

The annual budget of the central government is presented in February ever year. The budget is analysed by the media in minute detail.

However, amidst all the analyses, one subject that is often ignored is the financial relationship between the central government and the state governments. After all, much of the services that the government provides are in fact delivered by local and state governments.

It is worth remembering that while the central government collects the bulk of the taxes in the country, it’s the states that the taxes ultimately come from. And given that, this money in one way or another needs to go back to the states.

But does it? The short answer is no. And there is a longer answer which explains the reasons, has some nuance and which forms the heart of this piece.

This piece is divided into three sections. The first section provides a background on how tax revenue is transferred from the central government to the state governments and the role of the Finance Commission.

The second section focuses on a special tax category – cess and surcharge, their increased prominence in recent times, and how that raises prices of petrol and diesel.

The third and final section examines the trend of total transfer of funds from the central government to the state governments.

This is an opportune time for such an analysis, since this year’s Union budget was accompanied by the unveiling of the 15th Finance Commission’s report for the period 2021-22 to 2025-26.

So, read on, to find out.  

Who Gets How Much?

The Constitution stipulates how taxes are collected and split between the central government and the state governments. It empowers the central government as well as the state governments to raise revenues from different sources of taxation.

The central government gets to collect more taxes while the state governments end up with the bigger portion of the expenditure, leading to a mismatch. This mismatch of money that is earned through taxes and other routes and money that needs to be spent, is referred to as a “vertical imbalance”.

Take a look at Figure 1. In 2018-19, the Union Government raised 62.7 per cent of the aggregate resources raised by both the Union and states, whereas the states spent 62.4 per cent of the combined aggregate expenditure. While Figure 1 shares data for just one financial year, what’s true for 2018-19 has also been true for other financial years.


Figure 1: Vertical imbalance (2018-19)

           Source: 15th Finance Commission Report. 

To offset this imbalance, the Constitution provides mechanisms for intergovernmental transfers – the transfer of funds from the central government to the state governments. A key player of this setup is the Finance Commission.

The Finance Commission (FC) is an advisory body that is appointed by the President every five years and which evaluates the state of finances of the central as well as the state governments, and determines how taxes collected by the central government are to be distributed between the central government and the state governments, and among the state governments.

Over and above this, the FC also recommends grants to states based on revenue needs, grants for local governments and grants for specific purposes e.g. health sector grants etc. Thus, there are two broad channels of transfer of funds under the FC umbrella – i) devolution of taxes, and ii) grants. 

At the heart of the idea of intergovernmental transfers and tax devolution is the concept of ‘divisible pool’. The divisible pool is the portion of the taxes (technically referred to as the gross tax revenue) collected by the central government, which is distributed between it and the state governments. What this means is that all the taxes collected by the central government aren’t shareable with the state governments.

Till the tenth FC which tabled its report in 1995, only union excise duties and personal income taxes made up the divisible pool. Under this arrangement, 85% of the personal income taxes and 40-45% of excise duties were shared with the state governments.

In 2000, the tenth FC recommended a constitutional amendment to expand the divisible pool to all central taxes. The central government accepted this recommendation and the 80th Amendment was passed making a certain portion of  central government taxes shareable with the state governments, effective retrospectively from April 1, 1996.

Further, the portion of the divisible pool that is shared with the states is referred to as the devolution of taxes and is determined by the FC. Before the14th FC which came into effect from April 2015, 32% of the divisible pool was shared with the states.

The 14th FC increased the share of the state governments in the divisible pool to 42%. At the same time, the sector-specific grants were eliminated. This decision was primarily in response to grievances expressed by the state governments. State governments prefer funding through devolution since such transfers are unconditional.

Other transfers of money, whether they are through FC grants, or through channels outside the FC (like schemes from central government ministries) impose policy priorities set by the central government over the state governments, compromising the latter’s fiscal flexibility or the ability to spend money as the state government deems fit.

To give an example, a FC health-sector grant can only be used for health spending by the states, or funds transferred to the states under Pradhan Mantri Gram Sadak Yojana can only be used to make roads.

When state governments have more flexibility in allocating funds for various initiatives, they can craft policy that is more responsive to the needs on the ground than having to blindly follow policy that is framed in New Delhi.

The 14th FC recognised this and increased the state share of the divisible pool from 32% to 42%. The intent behind this increase was not to increase the amount of transfers but rather change the composition of the transfers – from diverting conditional funds to diverting unconditional funds, to state governments.

The 15th FC tabled in 2021 lowered the divisible pool marginally to 41%, from the earlier 42%. The is because Jammu and Kashmir is no longer a state and the money allocated to it has not been counted as transfer to a state government. Given this, the 15th FC has kept the divisible pool distribution unchanged.  

And now we come to the most important point of this write up. A key detail in this entire discussion is that the only tax revenue that is excluded from the shared divisible pool are different kinds of surcharges and cess.

As we shall see next, this exclusion has proved to be the back door that the central government has been using to divert funds from the states governments’ kitty to its own.

A Tale of Two Taxes

Before we get into the details, let’s first try and understand what surcharge and cess actually are.

A cess is tax on a tax imposed by the central government attached to a specific purpose. For example, an education cess collected should be utilised only for financing education and not for any other purpose. It is worth remembering here that the education cess is imposed on the total income tax and not on the total taxable income.

Hence, as explained earlier, it is a tax on a tax. Examples include infrastructure cess on petrol and diesel, krishi kalyan cess, health and education cess on Income Tax, etc.

In theory, money collected under a cess is to be spent on the specific purpose for which it is collected but that’s not always the case.

A Comptroller and Auditor General (CAG) report for 2018-19 indicates that only Rs 1.64 lakh crore of the Rs 2.74 lakh crore or around 60% of the amount collected from cess and surcharge during 2018-19 had been transferred to their respective funds. Around 40% was still retained in the Consolidated Fund of India, which is the general-purpose fund of the Indian government.

The provision of levying a cess was intended to be used for shorter specific purposes. So, the procedure for introducing a cess is comparatively simpler than introducing new taxes, which usually require change in the law.

Coming to surcharges, a surcharge is also a tax on a tax, but is not tied to a specific purpose like a cess is. Let’s take the example of the surcharge on income tax. It is an added tax on the taxpayers having a higher taxable income during a particular financial year. So, an individual having a taxable income  between Rs 50 Lakhs and Rs 1 crore pays an income tax surcharge of 10%.

Further, an individual with a taxable income between Rs 1 crore and Rs 2 crore, pays an income tax surcharge of 15%, and so on.

Note that this surcharge is only on the base income tax, not on the income itself. So, if an individual earning Rs 1 crore in a year needs to pay an income tax of Rs 20 lakhs, the applicable surcharge would be Rs 2 lakhs (10% of 20 lakhs).

A surcharge can be utilised for any purpose of the government, without having to bend the rules, like they do sometimes for cess collections.

In the last few years, these surcharges and cess, which do not need to be shared with the state governments, have become the central government’s go-to tools to address the tax revenue shortfall.

Take a look at Figure 2a, which basically plots the total amount of surcharges and cess collected by the central government over the years, along with the surcharge and cess it hopes to collect during 2021-22, the current financial year.

Figure 2a: Total cess and surcharge revenue (in Rs crore).

Source: Union budget documents.  

Figure 2a clearly shows that the general trend is upwards, with small blips in 2017-18 and 2018-19. The government expects to collect total surcharges and cess of Rs 4,45,822 crore (revised estimate) in 2020-21.

This is surprising given that overall tax collection during the year is expected to come down. In comparison to the years before 2020-21, the collections for 2021-22 are also expected to be at a very high Rs 4,48,821 crore.

The collections of cess and surcharge surged from Rs 2,53,540 crore in 2019-20 to Rs 4,48,822 crore (RE) in 2020-21, an increase of a whopping 77%. This huge increase is almost entirely due to increased cess and surcharge on petrol and diesel – in particular, the road and infrastructure cess and the additional duty of excise on motor spirit (which is a surcharge), which increased by Rs 1,92,792 crore. Motor spirit is the technical term for petrol.

The increased reliance on cess and surcharge is also seen in Figure 2b below, which plots the total cess and surcharge earned by the central government as a proportion of the Indian gross domestic product (GDP). This is done in order to take the size of the Indian economy into account as well.

Figure 2b: Cess and surcharge revenue expressed
as a proportion of the GDP (in %).

Source: Union budget documents.

The above figure makes for very interesting reading. The total amount of cess and surcharges earned by the central government went up from 1.25% of the GDP in 2019-20 to 2.29% of the GDP in 2020-21, a massive jump of 104 basis points. Some of this jump was obviously because the size of the economy or the GDP is expected to contract in 2020-21. Nevertheless, the fact that cess and surcharges collected by the government went up in a year when the economy contracted, does come as a surprise.

In Figure 3, let us look at the breakdown between cess and surcharges earned by the central government over the years. Looking at the below figure it is evident that cess collections form the bulk of the total revenue.

Figure 3: Cess and surcharge breakdown (in Rs crore).

Source: Union budget documents.

Clearly, cess is bringing in more money for the central government, though the contribution of surcharges has also jumped up since 2019-20.

Now let’s try and understand, why has the central government increasingly become more dependent on earning money through cess and surcharges, and in the process it is sharing lesser proportion of taxes with the state governments.

This increased reliance on cess and surcharges in the last two years can be understood when one looks at what is happening with the total tax revenue. Figure 4 plots the total taxes earned by the central government or gross tax revenue as a proportion of the GDP.

Figure 4: Gross tax revenue as a proportion of GDP (in %).

Source: Union budget documents 

While the negative economic impact of the covid pandemic has been a telling blow, the downward trajectory in tax collections of the central government had started as far as back as 2018-19. The twin economic debacles of PM Modi’s first term – demonetisation and a shaky GST implementation – meant the economy was already tottering before the covid pandemic hit.

An obvious casualty of this slowdown has been a declining tax revenue as a proportion of the GDP. In the normal scheme of things, this would have meant that the central government would have ended up with lesser taxes for itself, after sharing with the state governments.

But this fall has been cushioned with the central government earning a higher amount of taxes through cess and surcharges (as can be seen from Figure 5).

Figure 5: Cess and surcharge as a proportion of total central government taxes. 

Source: Union budget Documents
RE = Revised Estimate
BE = Budget Estimate

 In 2019-20, the total taxes earned by the government or the gross tax revenue had stood at Rs 20.1 lakh crore. In 2020-21, it is expected to fall by 5.5% to Rs 19 lakh crore. The net tax revenue of the central government (what remains after sharing taxes with the state governments) in 2019-20 was at Rs 13.59 lakh core.

This is expected to fall to Rs 13.45 lakh crore in 2020-21, a fall of 0.9%, which is much lower than the 5.5% fall in gross tax revenue. While, the total gross tax revenue is expected to fall by Rs 1.1 lakh crore (Rs 20.1 lakh crore minus Rs 19 lakh crore), the net tax revenue is expected to fall by just Rs 14,000 crore (Rs 13.59 lakh crore minus Rs 13.45 lakh crore). 

In percentage terms, in 2019-20, the central government kept 67.6% of the taxes for itself in 2019-20. This shot up to 70.8% in 2020-21. 

Clearly, the state governments have been short-changed here, with their share of taxes falling from Rs 6.51 lakh crore in 2019-20 to Rs 5.5 lakh crore in 2020-21, a fall of a little over Rs 1 lakh crore or 15.5%, in such economically difficult times.

This is primarily because the share of cess and surcharge in total taxes collected by the central government has jumped from 12.67% in 2019-20 to 23.46% in 2020-21. Do remember that cess and surcharges are outside the divisible pool.

So, when the inflow of these taxes increases, the central government gets to keep all the revenue, as opposed to sharing 41% (15th FC guideline) with the state governments. So, it is far more efficient for the central government to increase cess and surcharge when it needs to increase tax collection. 

This overuse of cess and surcharges by the central government has not gone unnoticed. In fact, the chairman of the 15th FC, NK Singh has talked about introducing a constitutional amendment to include them in the divisible pool.

As he said

“I see no viable solution except a constitutional amendment. If that constitutional amendment is introduced, recognizing some proportion of cess and surcharge to the divisible pool, it will certainly allow greater flexibility to the successive Finance Commissions subsequently to be able to calibrate a framework.”

Ultimately, as we said at the very beginning, whatever might be the term used, a tax, or a cess or a surcharge for that matter, it is being paid by people. And hence, the money thus collected should be shared with the state governments.

How does all this affect you, dear reader?

If you have managed to make it thus far, many of you by now would be like how much gyan are these guys going to give. Why can’t they tell me straightaway how does all this impact me or the world at large or the aam aadmi?

Well, sometimes it is important to take a look at the bigger picture first and then arrive at how it impacts all of us.

The government’s increased reliance primarily on cess actually has had a direct impact on most citizens – in the form of increased prices at the petrol pump.

The biggest contributor to the spike in cess collection over the last two years has been cess collected on the sale of petroleum products. The figure below charts the total cess collected on petroleum products (crude oil, petrol and diesel) over the last five years. While the cess on petrol formed at least 50% of total cess each year, it was as high as 69% of the total cess revenue in financial years 2019-20 and 2020-21. 

Figure 6 clearly shows that the government has resorted to taxing petrol and diesel to make up for revenue shortfalls. This conclusion is hardly a revelation to anyone paying attention to prices at the pump, but the numbers help understand the government’s motivation.

Figure 6: Total cess on petroleum products (in Rs crore).

Source: Union budget documents

There is another way of looking at the cess on petrol and diesel. Table 1 below gives a breakdown of the union taxes on petrol and diesel for 2020-21 and 2021-22. Note that the table below only analyses central excise tax and excludes customs duty. There are technical complications in figuring out the per litre customs duty.  

Table 1: Central government tax breakdown on petrol and diesel.

Source: https://www.ppac.gov.in/content/149_1_PricesPetroleum.aspx

 

The total union excise duty on petrol and diesel, in 2021-22 are Rs 32.90 per litre and Rs 31.80 per litre, respectively, which are marginally lower than the previous year. All taxes other than basic excise duty, including special additional excise duty, which is a surcharge, are exempt from the divisible pool.  

1) For 2021-22, only ~5% of the excise taxes on petrol and diesel will go to the divisible pool. The rest (~95%) will be kept by the central government. In 2020-21, this portion was at around 91% for petrol and 85% for diesel. Clearly, the government is keeping a greater share of petrol and diesel taxes for itself.

2) The above point does not clearly bring out the gravity of the situation. Let’s do a simple calculation to show that. In 2021-22, the total excise duty on petrol stands at Rs 32.90 per litre. Of this, the basic excise duty of Rs 1.4 per litre is the only part which is a part of the divisible pool and hence, will be shared with the states. It is worth remembering only 41% of this or around 57 paisa per litre needs to be shared with the state governments.

What this means is that just 1.7% of the total excise duty earned by the central government per litre of petrol will be shared with the state governments. It was at 3.8% in 2020-21.

3) Now let’s carry out the same exercise for diesel. The total excise duty earned by the central government on the sale of one litre of diesel will be Rs 31.80 during 2021-22. Of this only Rs 1.8 per litre will be shareable with state governments. 41% of this amounts to around 74 paisa per litre.

This amounts to around 2.3% of the total excise duty of Rs 31.8 per litre earned by the central government per litre of diesel. It was at 6.4% in 2020-21.

4) In 2021-22, a new agriculture infra cess has been introduced. It amounts to Rs 2.5 per litre on petrol and Rs 4 per litre on diesel. This has led to the reduction of basic excise duty on petrol from Rs 2.98 per litre to Rs 1.4 per litre and that on diesel from Rs 4.83 per litre to Rs 1.8 litre. As mentioned earlier, only the basic excise duty needs to be shared with the state governments.

Hence, by introducing a new agriculture infra cess, the central government has ensured that state governments get an even lower share of taxes from petrol and diesel in 2021-22.

The general public is quite sensitive to price rise at the petrol pump since it is a highly visible and recurrent cost. That the government has still resorted to this strategy for increasing revenue, speaks to the lack of better options – a fact that is a direct consequence of the tepid economic scenario even before the pandemic began. Of course, the covid pandemic has only made things more difficult for the government on tax front.

Nonetheless, things are even more difficult for state governments, which don’t have many avenues to raise tax. Clearly, this amounts to the centre shortchanging the state governments during difficult economic times.

Oh wait, there is more – Total intergovernmental transfers

Other than the divisible pool of taxes, there are other channels of intergovernmental transfers between the central government and the state governments. So, to get the complete picture on the flow of money from the central government to the state governments, it is instructive to examine the total intergovernmental funds transferred in more detail.

Before diving into those details, a brief overview of intergovernmental transfers would be useful. Figure 7 below is a good graphical representation of all the ways in which the central government can transfer funds to the state governments.

Figure 7:  Vertical fiscal transfer channels. 

Source : Asian Development Bank

Broadly speaking there are two instruments of fund transfers.

1) Finance Commission funds: As discussed earlier, this includes the 41% of the divisible pool revenue, general-purpose grants for states with weak revenue raising capacity and specific purpose grants for funding local governments (panchayats and municipalities) and funding certain specific initiatives (eg. health-sector grants by the 15th FC). Most of the funds provided via the FC channel are not conditional and don’t require state government contributions.

2) Funds from central ministries: In addition to the FC funds, the central government also gives specific purpose grants through the respective ministries. These funds are transferred either through centrally sponsored schemes or central sector schemes. Central sector schemes are entirely funded by the central government. Some examples include the free LPG connections provided to poor households, crop insurance scheme etc.

The centrally sponsored schemes require a matching component from the state governments i.e. they have to fund a portion of the scheme. Examples of this include the Pradhan Mantri Gram Sadak Yojana, the Swachh Bharat Mission etc.

As Figure 7 shows, the mechanism of intergovernmental transfer underwent a major transformation in 2015. Two things led to this. Firstly, the 14th FC gave its recommendations for increasing the devolution share of state governments from 32% to 42% and eliminating a host of specific purpose grants. The underlying rationale was to change the composition of state transfers to increase the “no-strings-attached” outlays and reduce conditional grants to give state governments more financial headroom.

Secondly, the newly elected NDA government disbanded the Planning Commission and replaced it with the NITI Aayog. While the NITI Aayog has some shades of resemblance with the Planning Commission, the five-year plans, which was the responsibility of the Planning Commission, were scrapped.

The five-year plans would have their own grants for states in the annual budget of the central government. The establishment of the NITI Aayog and the approval of the 14th FC recommendations were two initiatives that formed the basis the oft-cited “cooperative federalism” mantra of the NDA government, especially in the early years.

The argument put forth to claim this catchphrase was that the Modi-led administration was reversing the centralising tendencies of earlier governments and ushering in an environment where states had greater fiscal autonomy.

Does the data corroborate these claims? Let us examine. Figure 8 below charts the tax devolution to states as a portion of the gross tax revenue.

Figure 8: Tax Devolution vs Gross Tax Revenue (in %).

Source: Union budget documents

  

Some interesting observations can be made from Figure 8.

1) The first few years after the 14th FC came to effect (April 2015) saw a significant increase in the portion of taxes devolved to the states.

2) This increasing trend of devolution peaked in 2018-19 when the devolution was 36.6%. The last three years have seen this number come down, with the 2020-21 figure (~29%) close to the pre-2015 levels. So, all the talk about cooperative federalism has gone for a toss, in the last few years.

3) Note that these numbers don’t reflect the 32% (pre-2015) or 42% (post-2015) devolution share prescribed by the FC since cess and surcharge revenue is not devolved. This also explains why the devolution percentage has dipped sharply in the last two years, a period when cess revenue has had a corresponding increase (as shown earlier in Figure 5).

While the 14th FC may have been the catalyst, the Modi government can rightfully claim credit for strengthening fiscal federalism, at least in its first term. However, most of these gains have been reversed in their second term. This justifies N.K Singh’s lament

“ It should not be a cat and mouse game that every finance commission raises the devolution number and it then neutralised simultaneously by an increase in cess and surcharge leaving the states where they were, nor the opposite way.”

Next, in Figure 9, let us look at the total transfers made to state governments in recent years, not just tax devolution. The total transfers to states includes tax devolution, finance commission grants, centrally sponsored schemes, central sector schemes and other miscellaneous items listed as state transfers in the union budget.

The figure below charts the total transfers made to states as a percent of the total expenditure of the Union government.

Figure 9: Portion of total expenditure of central government
transferred to state governments (in %).

Source: Union budget documents

 There are two caveats on the chart above.

1) Starting 2014-15 there was a change in how expenditure for central schemes was routed to the states. The figures for 2013-14 have been adjusted to make the comparisons with the subsequent years correctly.

2) We have excluded loans made to states from the total transfer amounts and only included grants and devolution, since loans do need to be repaid.

That said, these figures also lead to similar observations made from Figure 8. The period from 2015-16 to 2018-19 (roughly co-incident with NDA’s first term) had a significant increase in funding to the state governments.

While the increased devolution of taxes could be attributed to the recommendations of the 14th FC, the increase in total transfer of funds was certainly government policy. The last two years (and the projections for the next year) show a steep decline in the intergovernmental transfers.  
The huge spike in cess and surcharge collections which are not shared with states and declining tax revenues during this period contributed to this effect.

There are two other conjectures one can make based on the trends seen above. First, when Narendra Modi won in May 2014, he was a sitting chief minister and his perspective on governance was heavily biased towards the challenges of governing a state.

Hence, financial outlays were perhaps favourable to the states. In the second term, he was well-entrenched as a national leader and the instincts were now honed favouring centralisation.

Second, the Bhartiya Janata Party has adopted an increasingly overt approach favouring homogenisation of the country. Whether it is the abrogation of Article 370, the passage of national farm laws, or flirtations with one-nation-one-language, it is evident that impulse is towards uniformity and centralisation. In this context, the trend of holding back funds from states, seems a natural accompaniment. 

Bihar’s APMC Story Does Not Inspire Much Confidence

This is the third piece in the agriculture reform series. You can read the first two pieces here and here. While this piece stands on its own, for a better context on the overall issue, it makes sense to read the two pieces published earlier, before reading this piece.

Chintan Patel and Vivek Kaul

The Farmers’ Produce Trade and Commerce (Promotion and Facilitation) Act 2020 became a law on September 27, 2020. It is one of the three farm laws passed by the Modi government that has been met by stiff opposition from farmers. The law supposedly creates a mechanism allowing the farmers to sell their farm produce outside the Agriculture Produce Market Committees (APMCs).

As we pointed out in an earlier article, the fate of the APMCs or mandis, under the new laws is a topic of much debate. Proponents of the bill claim that allowing farm trade outside the APMCs will encourage competition and help farmers get better prices for their produce. The idea being that there will be more competition for agriculture produce and in the process, farmers will make more money. QED.

Farmer organizations opposing the bill argue that unregulated transactions outside the APMCs will actually result in a price squeeze for the farmers, given the asymmetry or the huge difference of negotiating power between the individual farmer and corporate-backed buyers. As is often the case, both sides can lay claim to a logically coherent argument backed by economic theory. So, which argument has higher odds of manifestation?

When the future is uncertain, the past is often a reliable guide. Using that rationale, it is instructive to look deeper at the Bihar experience vis-a-vis APMC markets. Bihar had done away with APMC markets in 2006. But before we get into the specifics, let’s zoom out a little and take a look at the bigger picture first.

Bihar’s Backdrop

Bihar is India’s poorest state. Given below are tables that chart the per capita income of India’s richest and poorer states.

Source: https://statisticstimes.com/economy/india/indian-states-gdp-per-capita.php

Source: https://statisticstimes.com/economy/india/indian-states-gdp-per-capita.php

As the above tables show, Bihar has the lowest per capita income in the country. It is about 18 percent of the income of Haryana and less than 10 percent of the income of Goa. Ironically, Bihar is endowed with abundant natural resources, especially fertile soil and groundwater, and yet it continues to remain one of the poorest states in the country.

The state has a population of 11.52 crore (2016), with a very high population density of 1,218 per square km as compared to the national average of 396 per square km. It is largely an agrarian rural economy with approximately 88.5 percent rural population out of which 74 percent of the workforce is reliant on the agriculture sector for a livelihood as per the 2011 Census.

Even accounting for shifts in the economy away from agriculture and migration out of rural areas since the last Census, the poverty in Bihar is closely linked to state of its farmers.

The high population density is clearly reflected in the land holding pattern in Bihar. Compared to other states, Bihar has highly fragmented landholdings. As the same piece of land has got divided among more and more family members over the generations, the average holding has fallen dramatically. Even though quite a few migrate to the cities, they still keep their farmland. This also stems from the fact that selling agricultural land in India is not easy.

As the table below indicates, marginal holdings of less than one hectare (around 2.47 acres) constituted about 91.2 percent of all land parcels in 2015-16, compared to the national average of 68.5 percent. Additionally, 97 percent of all holdings are  less than 2 hectares in Bihar. This high skew towards small land holdings is an important statistic, as agricultural marketing policies affect small and marginal farmers differently from those with larger holdings.

Land holdings in Bihar.

APMC Abolishment in Bihar

In 2006, the Nitish Kumar state government made the decision to abolish its state-level APMC Act allowing private players to directly purchase agricultural produce from farmers. Under the erstwhile Bihar APMC Act, both farmers and buyers would pay 1 percent of the sale price to municipal bodies. After the APMCs were abolished, the government introduced Primary Agriculture Credit Societies (PACS). PACS are panchayat level cooperatives with farmer members that fulfil 3 roles in Bihar.

1) Help farmers borrow money for buying farm equipment, farming inputs such as seeds, fertilizers, etc., or to tide through losses. PACS in turn are given credit by cooperative banks which are funded by the state government.

2) A one-stop shop for high-quality seeds, fertilisers, and other inputs.

3) Most importantly, PACS are responsible for procurement of grains particularly rice-paddy and wheat from the farmers at the government-announced minimum support price (MSP). Thus, PACS act as an intermediary between the farmers and the eventual purchasers of wheat and rice – which can be any of the following; Food Corporation of India (FCI), state procurement agencies or private mills, for that matter. For other produce (other than rice and wheat), farmers interact directly with private traders.

Upon procurement of the crop, especially in the case of paddy, it goes to the Bihar State Food and Civil Supplies Corporation, and then on to the Food Corporation of India, who direct it to the Public Distribution System or ration shops as they are more popularly known. The payment is expected to reach the farmer within 48 hours of selling the crop at PACS.

It should be noted that PACS exist nationwide and have long been a part of the cooperative banking system in India, formed to provide credit to rural areas. Bihar however is unique in that it expanded the scope of PACS to b) and c) above. As we shall see later in the article, PACS have not been able to deliver effectively on these objectives.

The deregulation of agriculture market transactions in Bihar in 2006 shares significant similarities with the Farmers’ Produce Trade and Commerce (Promotion and Facilitation) Act 2020 . Although the central law does not call for the closure of state APMCs or creation of PACS-like entities, the core idea of deregulating agriculture trade outside of APMCs is the same.

Thus, there is merit in examining the outcomes of what has happened in Bihar over the last decade and a half,  to form expectations from the new law.

Several leaders of the Bhartiya Janata Party including prime minister Narendra Modi  and other supporters  of the new laws have touted Bihar’s abolition of APMCs to make their case. At the same time, critics have invoked Bihar as a cautionary tale of deregulating agriculture market.   So, the same scenario is being presented to suit diametrically opposite arguments.

What gives? As is often the case, the truth lies somewhere in between two extremes.

Prices

The bane of Indian agriculture is the price difference between the first transaction – what the farmer gets for a commodity, and the last transaction – what you and I pay for the same commodity.  Any changes to agricultural markets like the abolition of APMCs in Bihar needs be assessed against its impact on prices.

The government recognizes the importance of collecting data on prices. Each year, the Ministry of Agriculture and Farmers Welfare publishes data on farm gate prices based on data received from the state governments “to facilitate fine-tuning of agriculture policies aimed at farmer welfare”  .

The average wholesale price of a commodity (e.g. wheat, rice, etc.) at which the farmer sells to a trader at the village site during the specified marketing period after the harvest of each commodity, is termed as the Farm Harvest Price (FHP) for each commodity.  The next few charts track both the FHP and MSP of four commodities (paddy, wheat, maize, and ragi) from 2000- 2017. The central government announces MSPs for 23 agricultural crops during the course of any year, but primarily buys only rice and wheat directly from farmers.

Source:  https://eands.dacnet.nic.in/

The above chart shows that for rice paddy, the MSP has always been higher than the FHP. From 2001-02 to 2006-07, the average difference between MSP and FHP was around 26 percent. This basically means that  the FHP was 26 percent lower than the MSP on an average. From 2006-07 to 2014-15, the average difference reduced to around 18 percent. 2015-16, onwards the difference has inched up to around 24 percent, for the last two years for which the data is available.

                                                                            Source:  https://eands.dacnet.nic.in/

For wheat, the difference between MSP and FHP has been less stark than that for rice paddy.  From 2001-02 to 2006-07, the average difference between MSP and FHP for wheat was around 7 percent. From 2006-07 to 2014-15, the average difference barely moved up to  around 8 percent . However, for the last two years 2015 to 2017, for which data is available, the difference has spiked to around 17 percent.

Source:  https://eands.dacnet.nic.in/

For maize too, the difference between MSP and FHP has been less stark than for paddy but higher than that of wheat.  From 2001-2 to 2006-07, the average difference between MSP and FHP for wheat was around 19 percent. From 2006-07 to 2014-15, the average difference reduced to around 12 percent . However, for the last two years 2015 to 2017, the difference has spiked to around 18 percent.

Source:  https://eands.dacnet.nic.in/

Finally, for ragi, the difference between MSP and FHP has been quite high and has kept increasing.  From 2001-02 to 2006-07, the average difference between MSP and FHP for ragi was around 26 percent. From 2006-07 to 2014-15, the average difference increased to around 31 percent. Finally, for the last two years, 2015 to 2017, the difference has increased to around 37 percent.

The following table summarises the data from the above four charts.

Price Trends Summary
Source:  https://eands.dacnet.nic.in/

What can we infer from the above charts. Let’s take a look pointwise.

1)  The span from 2001 to 2017 can be divided into three periods : 2001-06, 2007-13, and 2015-17. Farm prices improved for paddy in the second period (around 18 percent lower than the MSP)  compared to the first period (around 25 percent lower than the MSP). Of course, they were lower than the MSP during both the periods.

Similarly maize prices improved in the second period (around 12 percent lower than the MSP) from the first period (around 19 percent lower than the MSP). Of course, they were lower than the MSP during both the periods.

For wheat, difference between the farm prices relative to MSP stood at 7 percent during the first period and at 8 percent during the second period. Hence, the difference increased though marginally.

Rice, wheat and maize are the three major cereals produced in Bihar and make up for 80 percent of the cropping area. The difference in prices between the FHP and the MSP, largely came down in the seven year period after the removal of the state level APMC Act. This finding weakens the argument that market deregulation will necessarily lead to lower prices, even though the farmers did not get the MSP.

2) As can be seen from the above table, starting in 2015, difference between FHP and MSP has increased for all the four commodities. Let’s take the case of maize. Between 2007 and 2014, the difference had stood at around 12 percent. It has since jumped to around 18 percent, almost back to pre-2006 levels.

A similar trend can be seen for the other three crops as well.

The official government data is only available till 2017, but this divergence between FHP and MSP is also reported in recent articles discussing the farmer situation in Bihar.

An article from People’s Archive of Rural India on Feb 20, 2021  reports  that “In 2019, a farmer sold his stock of raw paddy at the rate of Rs. 1,100 per quintal – this was 39 percent less than the MSP (minimum support price) of Rs. 1,815 at that time”.
Another article from December 2020 reports that “Paddy has sold for Rs 900-1,000 a quintal in Bihar, almost half the Rs 1,868 fixed by the Centre as MSP”.

The farm prices at which farmers sell continue to be depressed compared to the MSPs and given that difference has only increased in recent years, weakens the argument forwarded by supporters of the new farm laws which extrapolates deregulation to improved price realization for farmers. Economic theory doesn’t always fall in line with things actually happening on the ground.

A key underlying rationale behind dismantling of the APMCs in Bihar was that it would lead to an increase in the number of buyers in the marketplace. A similar argument is also being made in the case of the new farm laws. However, that is not how things have worked out, in markets across Bihar.

In fact, anecdotal evidence from newsreports emanating from Bihar suggests that sales to private traders are often distress sales since farmers don’t have access to a sizeable pool of local buyers .

A 2019 paper by the National Council of Economic Research makes a similar observation: “Despite the abolition of the Agricultural Produce Market Committee (APMC) Act in 2006, private investment in the creation of new markets and strengthening of facilities in the existing ones did not take place in Bihar, leading to low market density. Further, the participation of government agencies in procurement and the scale of procurement of grains continue to be low. Thus, farmers are left to the mercy of traders who unscrupulously fix lower prices for agricultural produce that they buy from farmers..”

Of course, there are other reasons that push farmers to make these distress sales such as a deficient transport network, poor storage facilities, and lack of capital. All of these are exacerbated for small and marginal farmers who form the bulk of agriculturists in Bihar. Given these harsh conditions, it is unsurprising that farmers are unhappy with the present system.

The disillusionment of the Bihar farmer can also be understood looking at incomes of farmers, because ultimately the proof is in the pudding.

Income of Farmers in Bihar

 Source: Study on Agricultural Diagnostics for the State of Bihar in India, 2019 report by NCAER

                                   
The above chart shows that while the net income of farmers in Bihar rose from 2007 to 2010, nevertheless, it has been declining continuously since 2010, up to the point we have data for. The declining income is explained by a rise in costs of agriculture inputs (seeds, power, labour, fertilizers, cost of finance, etc.) without a commensurate increase in sales revenue. The net income per hectare farmed, has moved alarmingly towards zero.

Government procurement of foodgrains 

Farm prices and farmer incomes are significantly affected by the level of government procurement of foodgrains in Bihar. The Central Government extends price support to paddy and wheat through the Food Corporation of India (FCI) and state procurement agencies across the country.

As per this policy, state governments are supposed to purchase paddy and wheat (conforming to certain specifications) from farmers at the declared MSP. Farmers have the option to sell their produce to private traders if they can get better prices in the open market. The objective of foodgrains procurement by government agencies is to ensure that farmers get remunerative prices for their produce and do not have to resort to distress sale. The central government accepts the responsibility to fund the procurement operations.

The next two tables give a breakdown of foodgrain procurement in the recent few years for major rice and wheat producing states.

State wise FCI Procurement of rice-paddy 
Source: Food Corporation of India.

State wise FCI procurement of wheat

Source: Food Corporation of India.

Procurement of paddy in Bihar is around 20 percent of the state’s total production, and that of wheat is almost negligible (less than 1 percent). Compare this to Punjab and Haryana, where procurement levels for paddy are over 80 percent and that of wheat are over 60 percent. This is primarily because of historical reasons, in order to promote the green revolution in the states.

This is one of the reasons for the disparity of wealth between Bihar and the other states. Since government buys paddy and wheat at MSP rates, low levels of government procurement in Bihar negatively impact the FHP for wheat and paddy, and in the process farmer incomes.

If the government purchased 100 percent (hypothetically speaking) of the paddy grown in the state, the FHP for paddy would more than likely be the same as the MSP. At 2016-17 prices, that would mean the farmer would get Rs 1,510 per quintal instead of Rs 1,147 per quintal for paddy – an increase of around 32 percent or Rs 363 per quintal. This additional revenue would directly pass-through as added income for farmers. This explains why procurement at MSP rates is a pressing demand by farmers during any policy debates on improving farmer incomes.

Low procurement of foodgrains by the state of Bihar can be attributed to two main reasons: a) inadequate funding by the state and b) Poorly functioning PACS.

There are several deficiencies in how PACS operate including restrictive registration requirements which limit who can sell to PACS, limited windows of procurement, sub-optimal timing of procurement, rejection of crop by the PACS due to excessive moisture content, and excessive delays in payment.  In fact, the number of PACS  in Bihar has declined by over 82 percent, from 9,035 in 2015-16 to 1,619 in 2019-20.

While the specific problems of PACS are less relevant to the national debate on the farm bills, they point to an important fact. The success or failure of market deregulation is highly dependent on the alternate systems that emerge in that environment, which will be unique for each state. Hence, the “vocal for local” mantra should also be applied when implementing policy solutions that strengthen federalism over a one solution-fits-all approach.

Conclusions

1) The so-called opening up of the agriculture market in Bihar to private players has not fundamentally altered the state of the Bihari farmer. The data on farm prices and farmer incomes is mixed after dismantling the APMCs. The difference between FHP and MSP for commodities like paddy and maize did decrease after APMCs were abolished, but those gains have reversed since 2015. The lived experience of farmers as reported by ground reports and the data on farmer incomes and prices paint a grim picture.

2) The PACS created by the state government for procuring food-grains have proven to be inefficient and non-responsive to farmer needs.

3) The government procurement at MSP continues to be a key contributing factor in improving FHPs and farmer incomes. This underlines why MSPs continue to be a key issue for farmers protesting the new farm laws.

4) The Bihar experiment is pertinent to the 2020 Farm Laws, but extrapolating the outcomes in Bihar to the current farm law debate needs some nuance. The data can be presented selectively, both by opponents and proponents of the farm laws to further their argument. But based on the analysis presented here, it is clear that deregulating agriculture markets in Bihar, did not cause prices to crash, though the difference with the MSPs has risen in the recent years. Neither did it usher in a wave of private buyers vying for agriculture produce, buoying up farmer incomes and prosperity in its wake.

It must be noted that the total output of an agrarian economy is affected by a host of factors including crop yield (how much crop is produced per unit area), land usage (how much area is used for cropping), cropping patterns (choice of high-value vs low-value agricultural produce), and prices . Of these, only prices are affected by the new law.

The other factors are influenced by variables such as irrigation, power availability, fertilizer usage, seed quality, rainfall, weather events, mechanization, among others. In a 2017 paper on agriculture in Bihar, the authors identify the following factors as drivers of agricultural growth. These are, irrigation, flood protection, energy for agriculture, roads, procurement system and agriculture markets.

While government policy has a role to play in shaping some of these variables, Bihar’s APMC abolishment law in 2006 and the central laws in 2020, are limited to procurement and agriculture markets. Thus, commentary correlating the abolishment of APMCs in 2006 with changes in macroeconomic metrics in Bihar such as total agricultural output or agricultural growth is disingenuous.

PS: Such a detailed data dive takes a lot of time and effort and you won’t see it anywhere in the mainstream media. Given this, our work needs your constant financial support. 

Modi’s Rs 2.5 lakh cr Asset Sale Plan Needs a Transparent Approach

The Prime Minister Narendra Modi has set a target of monetising 100 government-owned assets across sectors. As he said: “We have a target of 100 assets from oil, gas, airport, power, which we plan to monetise. This has the potential for investment opportunities of Rs 2.5 lakh crore.”

This is in continuation of the idea that the finance minister Nirmala Sitharaman had presented in her budget speech on February 1, 2021. As she had said:

“Idle assets will not contribute to Atmanirbhar Bharat. The non-core assets largely consist of surplus land with government Ministries/Departments and Public Sector Enterprises. Monetising of land can either be by way of direct sale or concession or by similar means.”

Hence, a lot of this idle assets are government owned land or will involve land in some form or other. This is a good and an innovative idea which some of the previous budgets lacked.

Many large Indian cities have a lot of government land lying idle while the cities on the whole are stretched for land. Hence, freeing up some of this land and earning some money in the process is a good idea.

Let’s look at this greater detail pointwise.

1) If you are the kind who likes walking around India’s big cities, you would definitely see a lot of government land lying unused bang in the middle of cities. Close to where I live in central Mumbai is the Bicycle Corporation of India, in one of the by lanes of Worli. In the one and half decades I have walked past the company, I haven’t seen any economic activity happening. Peepul trees now grow from the walls.

This is land bang in the middle of Mumbai, some of the most expensive real estate in the world, lying unused. This is criminal to say the least. Another great example of unused real estate are all the MTNL offices, all across Mumbai and Delhi.

The Heavy Engineering Corporation (HEC) in the city of Ranchi where I was born and raised, has acres and acres of land lying unused, while the city itself hardly has any land going around. This is land that has been lying unused for decades and needs to be put to some use.

2) It’s not just the big cities that have all this excess land lying unused. Even a place like Ooty, has acres and acres of land lying unused thanks to the Hindustan Photo Films Manufacturing Company Ltd., which is largely not functional. There are quite a few such public sector enterprises which are no longer relevant, all across the country.

Given this, one of the first things that the government needs to do is to make an inventory of all this land and put it up in the public domain on a website. It needs to do so with all the other assets that it plans to monetise as well.

Of course, this inventory is not going to be made overnight and will take time. But it is important that this is done in the most transparent way, given that corruption/crony capitalism and land/asset sales, almost go hand in hand.

This is even more important because the government considers this route as an important source of revenue in the years to come. As the finance minister said in the budget that over the years the government hopes to earn more money “by increased receipts from monetisation of assets, including Public Sector Enterprises and land”. Hence, getting the process right is very important.

This becomes even more important given that there will be great opposition to the process from those who benefit from the status quo and even otherwise. The government selling its assets to raise money to do other things is not seen as a good thing. Hence, even a hint of corruption or any other controversy can threaten to derail the entire process, something the government cannot afford at this point of time.

3) In cases where the land was taken from state governments to start a public sector enterprise, it is important that the land be returned to the state government and let the state government decide what it wants to do with it. In the years to come, state governments will also be running short of money to meet their expenditure.

Also, this is the right thing to do. The state government can also use the land to attract more investment into their state. In some cities where there aren’t enough public parks, some land can even go to develop such infrastructure. The aim shouldn’t be to maximise the money earned all the time, but maximise the general well-being.

Again, this is something that will need some amount of thinking and the government’s thinking on this should be clear and out in the public domain.

4) There is another factor that needs to be kept in mind here. Real estate prices in most big Indian cities have remained and continue to remain high. One of the major reasons for this lies in the fact that the land prices remain expensive across Indian cities. Hence, it is important that some of this land be sold to build affordable housing. Only if land prices come down, will home prices come down.

And by affordable housing I mean homes which can be sold profitably in the range of Rs 10-20 lakh per unit and not affordable housing as the way the RBI defines it, which isn’t really affordable housing at all, but just a fancy moniker to help banks meet their priority lending targets.

Other than helping people buy affordable homes to live in, the real estate sector has the ability to create a large number of jobs very quickly. It also has the capability to have a multiplier effect across many other sectors. Building real estate requires cement, sand, steel, bricks, pipes, etc., and so on. Once real estate has been built in, moving into a home requires its own set of purchases. Buying homes also gives a fillip to the home loan business. And of course, people living in homes they own, enhances general well-being.

5) Finally, it is important that the money earned through this route be used for a specific purpose and not just for bringing down the fiscal deficit, which has ballooned to Rs 18.49 lakh crore or 9.5% of the gross domestic product (GDP) this year. Even in 2021-22, the fiscal deficit target has been set at a high Rs 15.07 lakh crore or 6.8% of the GDP. Fiscal deficit is the difference between what a government earns and what it spends and is expressed as a percentage of the GDP.

It is important that money coming from land sales be allocated towards specific infrastructure projects, preferably in the very state where land is being sold. This will make it easier to sell this idea to the state governments, whose cooperation is very necessary to make this idea a reality.

To conclude, the monetisation of excess government land in particular and other assets in general, is a good idea. Having said that, it needs to be executed in a proper process driven and transparent way.

This is an updated version of an article that first appeared on Firstpost on February 2, 2021.

How to Run Public Sector Banks Well Without Privatising Them. And Why That’s Not Going to Happen

As of March 31, 2020, the total bad loans of public sector banks stood at Rs 6,78,318 crore. This is a drop of 24.3% from a peak of Rs 8,95,600 crore as of March 2018. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

So how did bad loans of public sector banks come down by nearly a fourth? First and foremost, as of March 31, 2018, IDBI Bank, the worst performing bank when it comes to bad loans, was a public sector bank. From January 21, 2019, the bank was categorised to be a private bank. Accordingly, its bad loans moved to the overall bad loans of private banks. But we need to remember IDBI Bank is owned by the Life Insurance Corporation of India, that makes it as close to being a private bank, as Indian Chinese food is close to the real Chinese food.

As of March 31, 2020, the overall bad loans of IDBI Bank were Rs 47,272 crore. If we add this to the bad loans of public sector banks, the real bad loans of public sector banks work out to Rs 7,25,590 crore (Rs 6,78,318 crore + Rs 47,272 crore). This means that the real fall in bad loans of public sector banks in the two-year period has been around 19% and not 24.3%, as we originally calculated.

So, bad loans worth Rs 47,272 crore came down, simply because IDBI Bank got recategorised as a private bank.

Let’s move to the next point. Take a look at the following chart, which basically plots the bad loans of public sector banks over the years. The bad loans of IDBI Bank are included in this chart.

India’s Manhattan

Source: Centre for Monitoring Indian Economy and Indian Banks’ Association.

As I elaborate in detail in my book Bad Money, the RBI practiced regulatory forbearance between 2011 and 2014 and did not force public sector banks to recognise their bad loans as bad loans, even though they had started to appear by then. In simple English, regulatory forbearance, essentially means the central bank looking the other way from the problem.

An asset quality review (AQR) was launched in mid 2015 and this forced banks to recognise their bad loans as bad loans. As you can see in the chart, the overall bad loans of public sector banks take a huge jump post 2014-15. This was the AQR at work.

Now loans which have been bad loans for four years can be dropped from the balance sheet of banks by way of a write-off. Hence, many loans which had been categorised as bad loans in 2015-16 would have spent four years on the balance sheet by 2019-20.

Accordingly, they got written off from the balance sheet of banks. Of course, before such bad loans are written off, a 100 per cent provision needs to be made for these bad loans. This means that banks need to set aside money to meet the losses arising from these loans. This essentially led to the overall bad loans of banks coming down as well.

And over and above this, the banks would have managed to recover a portion of the bad loans (which includes bad loans that have been written off as well). The overall recovery rate for banks through various recovery channels during 2018-19 was around 15.5% of the amounts involved. (Numbers for 2019-20 aren’t currently available or at least I couldn’t find them anywhere).

In fact, a bulk of the current accumulated bad loans will disappear from the balance sheets of public sector banks over the next two to three years, thanks to the fact that bad loans can be written off after they have spent four years on the balance sheet.

Nevertheless, the question is: even after this can the public sector banks operate in a healthy way where they don’t need to be constantly recapitalised. In fact, once public sector banks get around to identifying post-covid bad loans early next year, their balance sheets are likely to come under stress again.

But the basic problem of public sector banks remains interference by the government. This interference can take several forms. As Viral Acharya and Raghuram Rajan write in a research paper titled Indian Banks: A Time to Reform?: “Interference, including appointing favoured candidates to management, expanding lending just before elections, or directing banks to lend to favoured borrowers is obviously harmful.” (Again, something I discuss in great detail in my book Bad Money).

To ensure that public sector banks do not face this kind of interference it has been suggested that they need to be privatised. Over and above this, there have been news reports which suggest that the government is looking to privatise public sector banks.

This remains a difficult decision politically. Also, in an economic environment like the one prevailing, there will be fairly limited number of firms looking to buy government banks saddled with a huge amount of bad loans and a section of employees not used to the idea of working.

Further, unlike other public sector enterprises, the government has to be even more careful while selling a bank. As Acharya and Rajan write:

“The experience in other countries with allowing corporations to own banks is that it increases the possibility of self-dealing within the group – the bank is used to make risky loans to failing group entities, and the bill is paid by the tax payer when the bank is eventually bailed out.”

They further say that the Indian industry is already heavily concentrated. As a recent McKinsey Knowledge Centre report titled India’s turning point An economic agenda to spur growth and jobs points out: “Our analysis shows that just 20 of the country’s roughly 600 large firms contribute 80 percent of the total profit of large firms.” The report defines large firms as firms with an annual revenue of more than $500 million.

If India’s large corporates end up buying its banks, the industry is likely to get even more concentrated. Hence, while privatisation of public sector banks remains a good idea over a long-term, currently, the government can initiate the reform process through the Axis Bank model, wherein the government is an investor in banks rather being a promoter.

The Committee to Review Governance of Boards of Banks in India (better known as the Nayak Committee, after its chairman, PJ Nayak) which presented its report to the RBI in May 2014, suggested the Axis Bank model.

Axis Bank was originally called UTI Bank. It was set up in 1993. It was owned by the Unit Trust of India (UTI) and a clutch of public sector banks. Even though ownership was 100 per cent in the public sector, the bank got a licence to operate as a private sector bank. The bank was listed on the stock exchanges in 1998. UTI Bank was later renamed Axis Bank.

Even at that point of time, the public sector shareholding continued to be the majority shareholding. In early 2000s, when the Unit Trust of India ran into trouble, the government broke it down into two parts. One part became the UTI Mutual Fund and the other was the Specified Undertaking of the Unit Trust of India (SUUTI).

In February 2003, the shareholding of UTI in the bank was transferred to SUUTI. UTI Bank was later renamed Axis Bank.

As the Nayak Committee Report pointed out:

“The Government-as-Investor stance has characterised the control of the Bank, with SUUTI acting as a special purpose vehicle holding the investment on behalf of the Government. The CEO is appointed by the bank’s board, and because the bank was licensed in the private sector, it sets its own employee compensation, ensures its own vigilance enforcement (rather than being under the jurisdiction of the Central Vigilance Commission), and is not subject to the Right to Information Act. SUUTI appoints the non-executive Chairman and up to two directors on the Board, and there is no direct intervention by the Finance Ministry.”

This means that the bank has been run as a proper banking business, without much intervention from the government. Between March 2003 and March 2014, the share price of Axis Bank rose thirty-two times. Over the years, the government has been able to sell its stake in the bank to raise a decent amount of money.

The point being that even though, as per its shareholding, Axis Bank ‘was for many years a public sector bank’, but ‘fortuitously, the bank was licensed at the commencement of its business as a private sector bank’.

The Nayak Committee Report suggests that the government should look at public sector banks as an investment and not as a business it has to run, and follow the Axis Bank model. This essentially means the government reducing the stake in these banks to less than 50 per cent, and letting the bank’s management and its board do their job, like in the case with private sector banks.

But then as the oft-repeated cliche goes, public sector banks are not just about making money. They also need to keep the social objectives of the government in mind. This is something that even Prime Minister Narendra Modi had suggested at the First Gyan Sangam in 2015 (a meeting of bureaucrats, bankers and insurers). As Modi had said on that occasion, while “government interference was inappropriate, but government intervention was needed to further public objectives”.

It’s this line of thought has driven India’s public sector enterprises for seven decades now and gotten them nowhere in the process.

R C Bhargava, the current Chairman of Maruti Suzuki, who was also an IAS officer for a very long time, writes the following in his book Getting Competitive: A Practitioner’s Guide for India:

“The USSR was the pioneer in attempting industrialization along with creating a communist society. It did not succeed. On the other hand, Japan became a highly competitive and industrialized nation and has a high degree of equality and social justice. The policies for regulating and promoting industrial growth do not have any social content in them [emphasis added]. Social equality was a result of the political and industrial leadership understanding that manufacturing competitiveness would be enhanced if there was greater equality and the bulk of the people were enabled to become consumers of manufactured goods.”

What Bhargava, who has worked for long periods of time, both for the government and the private sector, is basically saying is that social objectives of the government shouldn’t become objectives of its enterprises.

This does not mean that the government should do away with meeting its social objectives. Not at all. But what it should do instead is incentivise banks on this front.

As Acharya and Rajan write:

“Perhaps a better approach would be to pay for the mandates (such as reimbursing costs for maintaining branches in remote areas or opening bank accounts for all) so that both private banks and public sector banks compete to deliver on them. This will distance the public sector banks a little from the government. While public sector banks may be given a slightly different set of objectives than private banks (for example, they may put more weight on financial inclusion), their boards should have operational independence on how to achieve the objectives.”

Competition and incentivisation goes a much longer way in delivering services than a government diktat.

The question is, where will the money for all this come from? Allow me to throw a few numbers at you, before I answer this question.

The market capitalisation of the State Bank of India, India’s biggest bank and the biggest public sector bank, is Rs 1.67 lakh crore. The total assets of the bank as of March 2020 were at Rs 41.97 lakh crore. Now compare this to Kotak Mahindra Bank. Its market capitalisation is at Rs 2.53 lakh crore. The total assets of the bank as of March 2020 stood at Rs 4.43 lakh crore.

Hence, in comparison to the State Bank of India, the Kotak Mahindra Bank is a very small bank. But its market capitalisation is almost Rs 86,000 crore more. Why? Simply because Kotak Mahindra Bank is run like a proper bank and the stock market gives it a proper valuation for the same.

Or take the case of HDFC Bank, which has a market capitalisation of Rs 5.80 lakh crore, which is more than all public sector banks put together. Both these well-run banks have much lower bad loans than public sector banks. The overall bad loans of private banks, Yes Bank notwithstanding, are significantly lower than public sector banks even after adjusting for their size.

The point I am trying to make here is that if public sector banks end up being much better run than they currently are, the stock market will give them a higher market capitalisation. And the government can then finance its social objectives by gradually selling the shares it owns in these banks.

Of course for anything like that to happen, the Department of Financial Services in the Finance Ministry which controls the public sector banks, needs to take a backseat. As Rajan writes in I Do What I Do: “Unless PSBs are run like normal corporations, they will not be competitive in the medium term. I have a simple metric of progress here: We will have moved significantly towards limiting interference in PSBs when the Department of Financial Services (which oversees public sector financial firms) is finally closed down, and its banking functions taken over by bank boards.”

But as we all know, bureaucrats don’t take backseats.

Oh and politicians. Let’s not forget them here. Back in 2000, the Atal Bihari Vajpayee government tried to push through the move and dilute the government stake in PSBs to 33 per cent. And it failed. Why?

Vajpayee’s finance minister, Yashwant Sinha, had introduced a bill to reduce the government’s stake in PSBs to 33 per cent. It never saw the light of day. In a 2018 interview, Sinha said: “The parliament and the people were not prepared for such [a] kind of step”.

In fact, all these years down the line, we are still grappling with the same issue.

The more things change…

And I sincerely hope, I am proven wrong on this.