Amt available to transfer to states constrained: YV Reddy

Under the 14th Finance Commission, the share of states in taxes has gone up. Reddy says the government is now obligated to transfer excess to states under divisible pool. However, he adds that the amount available to transfer to states has been constrained. "The divisible pool share has been increased but transfers from the government has been reduced," he says.

Below is the verbatim transcript of YV Reddy's interview with Latha Venkatesh on CNBC-TV18

Q: The Union government itself is saying that they had to swerve from their given desirable targets of 3.6 because of the downside risks posed by the Finance Commission, so let me come to that recommendation of the Finance Commission which has captured headlines that you have transferred instead of 32 percent, 42 percent of the divisible pool to the states. Have you restricted the availability of money for the Centre?

A: There are two ways of answering it, yes and no.The Union government is obligated to transfer taxes under divisible pool as recommended by the Finance Commission. So, to the extent that has been increased from 32 to 42, so the Union government is now obligated to transfer more resources to the states under the formula. To that extent, this has been in favour of the states and more importantly states’ freedom and it restricts the fiscal freedom available to Union in aggregate but Union government’s Budget has two components. One is what it spends itself, second is what it transfers to the state.

Now, it is the decision of the Union government to decide how much to transfer to the states and how much to keep for itself. Now, when we did our exercise and technically it was the discretion how much they want to transfer because it was not binding. So, in that sense there is a restriction of fiscal space but what did we do in our assumptions because we have to make our assumptions both for the states and the Centre. In our assumptions we expected that given the fiscal position of the Union government, they may not be able to transfer in aggregate more than what they have been transferring which means there is an implicit assumption in the Fourteenth Finance Commission (FFC) that the transfers outside the Finance Commission will be reduced to the extent the transfers are happening under the Finance Commission but that is an assumption for our projections, but the ultimate decision is for the Union government to decide how much that freedom continues.

Q: Let me come to an issue which we don’t often raise. We all tend to bleed for the states, that is the public image. Now state government’s Budget are not really combed and watched by rating agencies, FIIs, the press, the more evolved press as much as the central government is. Now if you are going to transfer much more discretion to the states is it not possible that there will be more mis-spend because there is less public glare on those funds?

A: That is an assumption. But there are two or three ways in which you can look at it. One, does the constitution envisage that the Centre should transfer money to states to discharge its own functions, no. The constitutional spirit and the spirit of federalism is that in responsibilities assigned they will be able to do it, second. Third, in terms of efficiency of implementation the difference is state government deciding where to spend the money, the central government says that you spend it on the central-sponsored schemes (CSS) but who is spending it. So implementation efficiency will still be there, so all you are doing is taking away the allocation of certain amount to certain schemes from the states to the Centre.

On the ground that is "efficient". Then again the issue is that there has to be set off against the possibility that one size fits for all comes in but this can never be resolved. Let me explain so therefore both from the constitutional point of view and from the evidence point of view we can not proceed under the assumption that states as a whole are less efficient or are more efficient. We are not permitted to proceed under assumption; you can not make a judgment.

Even assuming that you want to make - some one will be above, some one will be less efficient than the average so therefore that is not the way this finance commission went about. So what we did is by taking a total view of all the transfers there was an analysis of various schemes under which the money is being transferred from the Union to the state. We came to the conclusion that there are many transfers that are occurring which are not strictly justifiable either in terms of the constitution or in terms of the first principles and therefore we have to apply that. Now finally whether it is true that Centre spends more efficiently and less efficiently the jury is still out.

Q: That is true but you have transferred more discretion to a set of entities who are less in the public glare and whether it is the Bihar fodder scam or freebies given in Tamil Nadu down to the extent of mixers; starting with slippers and ending with mixers – they are also guilty of a lot of freebies. By extending the discretion it is not necessarily a more noble thing to do.

A: If you insist on evidence, let me explain, remember all the schemes. The many schemes undertaken in the last 10 years were first experimented in the states. They were criticised by the Union government that they are populist and a waste. Mid-day meal scheme, rural employment guarantee, public distribution, everything which gained respectability, gained respectability after the states were criticized for taking it.

Second, if you take the total expenditure on capital worth, the capital worth is more illustrious than the Centre.

Three, even if the central government is giving some money as a proportion of the total expenditure spent by a state, if a state is spending x money on education and if the central government is giving 0.14 because it is primarily the responsibility of the state.So, therefore we felt that in this commission that whether it is Panchayat or anything whatever is statutorily assigned, whoever is accountable is accountable, a higher attire does not necessarily mean that there is a supervisory role or a greater capacity; that is how the law is and that is how it should be unless there is evidence that will prove the contrary.

Q: Don’t you think this 14th Finance Commission has been lucky in that? At the moment the central government is headed by someone who has been a chief minister for 10 years, a successful chief minister and knows where the shoe pinch is and therefore you were favorably received. Another central or previous regime would have led to a lot of friction isn’t it?

A: I can’t speculate but when we started the work and when we ended the work we had no view, number one. Second point is that traditionally whenever the Finance Commission gave their award it was binding as far as the financial part of it is concerned. So, we proceeded with the assumption that it will be binding whichever is the government.

Q: Let me come back to the fiscal limits and the Fiscal Responsibility and Budget Management (FRBM) targets of the 14th Finance Commission. What I found new was that you are not just setting a percentage of fiscal deficit to gross domestic product (GDP) but you are also asking the Center to pass a law whereby there is a debt ceiling, public debt in India compared to comparable BBB- countries is much higher. We are well over 60 percent of GDP, public debt to GDP whereas comparable countries are under 40 percent. You want that tendency to get corrected, that is something new that you have brought in?

A: It is something more fundamental. If you see the structure of accountability to the parliament of the budgetary system in India - no taxation without representation, no expenditure without alternate sanction, then the issue is borrowing. Where is the parliamentary accountability? Does it set a borrowing limit? No.

This matter was discussed in the Constituent Assembly and one point made was that every borrowing should say I am borrowing for this purpose. There was an opposition saying that a sovereign should have right to borrow for development. Then there was reconciliation; the reconciliation was by Dr Ambedkar. Dr. Ambedkar made a statement and in fact he said ‘I cannot vision a situation where a parliament will not pass a law imposing a ceiling on the total debt that can be incurred’. So, there is a constitution provision which says Parliament may by law prescribe a limit to the debt.

Q: And for 75 years parliament has not done it?

A: Because it said ‘may’. So, some people wanted ‘shall’ then Ambedkar said I cannot imagine somebody will not do it but that has not been done. In a sense the whole thing has to center around the debt because it is for the future generation and for the sovereigns. So, ideally the totality of the FRBM should have been brought under this constitutional provision. If you bring it under that constitutional provision it will have a certain legitimacy and possibly also can be questioned in terms of its compliance with the totality of the constitutional system; that was not done. 

So the point that we were making is when you are replacing FRBM in the light of our recommendations please see if that can be done so that it gets a respectability and legitimacy more than what it is existing. Then we felt that while exports, that is supposed to be something which has not been notified, at least let the Budget be examined therefore consistent global practices we have recommended a fiscal council.

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Q: Would you say that this independent fiscal council and debt ceiling is perhaps the biggest recommendation of the Finance Commission?

A: Very important things are institutions and this is creation of institutions which I think will be critical to demonstrate the commitment of the government to fiscal responsibility, as it defines. We are not saying it should be 3 percent.

Q: What is your opinion of the monetary policy framework? Will this ensure better inflation targeting and more discipline?

A: First let me repeat what NT Rama Rao told me once. He said when the media asks questions, they are paid to ask questions, I am not paid to answer.

Q: So, I am expecting evasion?

A: No, not necessarily. I would not go into monetary policy or anything but it is appropriate perhaps to say what are the possible implications or risks to fiscal management of the next five years as a result of possible change in framework in the monetary policy and public debt. Normally it is assumed that an independent monetary policy with inflation targeting will be successful if there is no financial repression or if the transmission is smooth and the fiscal position has to be strong. Actually if you see the recent writing when the debt to GDP ratio is high, even fiscal deficit is high, then coordination between monetary and fiscal authorities becomes extremely critical and therefore the way forward for the type of consolidation that is happening, then the issue is the sequence so, therefore, I would say that any arrangement that is being considered has to be seen in the light of importance of sequencing and risks of wrong sequencing.

Q: Your sequence is that first the Union government should achieve the fiscal targets and then we should embark on a monetary policy framework?

A: Even fiscal targets — one, achieve the fiscal targets and second, be in a position to finance its borrowings.

Q: Without forcing the banks to put 22 percent of their deposits.

A: Then you are not dependent, you do not become an independent debt office because you declare your independence. You should be able to raise money independently.

Q: The monetary policy framework would have had a better chance of success if it had come after the Fiscal Responsibility And Budget Management Act (FRBM) succeeded?

A: All I am saying is monetary policy framework and monetary independence and accountability in isolation, all over the world, everybody agrees that it should be in sync with an appropriate fiscal policy. So, you have to make sure that the sequencing and transition is very well crafted.

Q: But the fact that they have put their signature and accepted the framework would also be a weight on the Central government to deliver on fiscal plans.

A: Absolutely. That is the hope. So, there are two things, that is the hope. If it happens, wonderful. If it does not happen, what are the risks is all I am saying. Having gone through, always what we do is, that any policy, we examine but what are the chances? It maybe one percent, two percent that will fail. If we fail, how serious are the consequences? Now, that is one.

Second is that what happens to the debt of states? But the whole issue is that the debt of the state, even if the Centre is managing the debt through independent debt office, then will the state also follow an independent debt office? Or do you expect the states to trust the Government of India to hand over the function to the Government of India debt office?

Q: What about the monetary policy committee, now that the framework has been accepted, what would be an ideal monetary policy committee?

A: I would not know anything.

Q: Should there be government nominees?

A: There are a lot of models that there should be from government. For instance the Sebi Board which is considered independent, there are sitting government officials on the board. In RBI it is not there so but Indian situation is different.

Q: The global practice is that there would not be Government officials?

A: The nominations of the members, if it is under law provided they can provide it. So you got various practices of representation of nomination by the Government, by the Cabinet or then you have the other Central Bank governors composition, ex-officio, then whether it is voting or not, consensus or non-consensus, disclosure of what everybody said so that in future account. All these issues, there are different practices, there is a layer of literature on that.

Q: What would be an ideal monetary policy committee? Ideal committee would be one that is chosen by the Reserve Bank itself, the Reserve Bank governor?

A: Let me put it differently, from an analytical angle, the role of the monetary policy committee is the central bank is only the monetary authority, it is very clear. Governor is responsible for the monetary policy, you do not deliver, you go, this is how it is. If, let us say, the central bank is responsible for some other thing then if it does monetary policy well, he can continue, not well - so, the accountability, is it only for one or for others? Does it mean others are subordinate? 

Second, the relationship between the government and the central bank - when the central bank is doing multiple functions will depend on not only monetary policy but all of this. Therefore, we will be jumbling up. These are the two. 

Three, the most important thing at the moment, I think India is unique. I do not think there is anywhere else in the world, if I am not mistaken, the governor can be dismissed without reason. In other countries, where there is accountability, there is tenure. Accountability cannot be one way.

If I look in other countries, they will say, you will be there for five years, you cannot be removed without reason and that reason is you do not do the monetary policy then you will go out and here is the situation where the governor can be sent out one evening for no reason and then again. So, what I am saying is you have to take an integrated view of the role of the central bank. So if you decide it is a central bank, it will be only monetary authority, the governor will be accountable but otherwise there will be security of tenure, then there is one ball-game. But the current debate is not easy because there are no parallels either in theory or in practice. When there are no parallels in theory and practice, you talk in a fluid manner as I am doing.

Q: The other point I want to ask about the current central bank and public finance debate is that the government securities market is in all probability getting shifted to Sebi. Is that wise, any comments on that?

A: As long as the government securities are raised through market mechanisms then it is a good thing. However, the point is that let the government first raise the money on its own.

You think there is a good practise in other countries when there is a particular level of depth.. So, it is a unique situation. I am sure the government is aware of all the circumstances.

Q: The 14th Finance Commission has not got enough laurels for some of the other recommendations it has made notably in electricity. One of the big issues has been that state discoms, power distribution companies have perennially been running high deficits because the state governments don’t cough up their share of the subsidies, you have tried to plug that?

A: This time the FFC was asked to look. Earlier the Finance Commission was often asked to look at the problems of the state governments but this time fortunately the term of reference said pricing of public utilities in general, which means both central and states. So, naturally when you look at the Centre you look at Air India, you look at railways. So, therefore when you compute it is very difficult to say that this problem of the government not funding, subsidising public utilities is not restricted to one government, established. Therefore the Finance Commission took the view that what is fiscally important is to ensure that there is an independent regulator for all sectors including railway etc, please make sure if it is a public utility there is an independent regulator, please make sure that the independent regulator recommendations are implemented. Third, whatever you want to regulate you must measure, you are subsidising without measuring. Free power or water – measure how much you are giving.

Q: So, 100 percent metering of power and water.

A: Limited point is these are preconditions from a fiscal point of view. We cannot take a view whether something is good or bad but please measure so that we know for what the tax payers money is going and to whom it is going. That is the main recommendation.