Dynamics of Centre-State Relations: Emerging Trends

M. Govinda Rao

Introduction:

Intergovernmental relationships in every multilevel system are governed by the

institutional framework in which these are conducted, the developmental strategy followed and
the nature of polity including ruling and opposition political parties. In India too, the first 40
years after the adoption of the Constitution, the centre-state relationships were shaped by the
public sector dominated import-substituting development strategy and a single party dominated
governance in both centre and States. Centralized planning is a negation of federalism and not
surprisingly, states’ role in development was limited. The centripetal bias in the Constitution did
not hinder the conduct of business though there were several instances of misuse of the power by
the centre in dismissing the elected state governments by invoking Article 356 of the
Constitution1. At the same time, the single party rule made consensus building easier and centre-
state and inter-state conflicts were few and could easily be resolved. In this scenario, the
intergovernmental relationships were harmonious, conducted in the framework of co-operative
federalism.

Recent developments in both politics and economics have changed the centre-state
relationships. However, the systems and institutions evolved under the dirigisme policy regime
and a single party rule have continued to provide enabling competitive environment to the states
in the globalizing environment and persisting inter-state inequalities have accentuated the
tensions. At the same time, the emergence of coalition government at the Centre, regional
parties as partners in coalition and governments led by opposition parties in the states on the one
hand and declining time horizon of the political parties and politicians on the other has put severe
strains on implementing policies for long run growth. The changes in centre-state relations
demand changes in policies and institutions and accelerating India’s economic growth and
ensuring its inclusiveness over the medium and long term and this requires significant reforms in
both policies and institutions.

Being aware of the need for a comprehensive review, the Government of India appointed
the Commission on centre-state relations under Justice R. S. Sarkaria which submitted its
recommendations in 1988. Subsequently, a National Commission to Review the Working of the
Constitution was appointed under the Chairmanship of Justice M. N. Venkatachaliah and more
recently, another Commission on centre –state relationships was appointed under Justice M. M.
Punchhi which made its recommendations in 2009. While these Commissions have made far
reaching recommendations, there has been a lag in implementation. Many of the
recommendations of Sarkaria Commission are yet to be implemented and some of them have not
1
After the Supreme Court decision establishing the justiciability of this decision in the S. R. Bommai versus the
Union of India case ([1994] 2 SCR 644 : AIR 1994 SC 1918 : (1994)3 SCC1),there has been some restraint in
dismissing the state governments.
been implemented in the spirit in which they have been made. The consequence has been that
the policy and institutional changes necessary to deal with economic and political changes have
not been accomplished with adverse consequences on both governance and development of the
country. This paper attempts to explore some of the important issues pertaining to centre-state
relations in India.

Evolution of Centre-State Relations

The developments of the 40 years have shaped the institutions of governance and
development of the country. The allocation of resources under planned development strategy
was supposed to ensure a balanced regional development and the focus of intergovernmental
transfers had greater emphasis on resolving horizontal imbalances and much less on equalization.
As intergovernmental relationships were conducted broadly in the framework of co-operative
federalism, the systems and institutions were not geared up to deal with competitive relationships
between the centre and states on the one hand and among different states on the other. Similarly,
after the 1991 reforms, transition from plan to market in a globalizing environment exacerbated
inter-state disparities and this requires much greater focus on designing and implementing
intergovernmental transfer system to enable ‘comparable levels of public services at comparable
tax rates’ which would promote healthy inter-state competition in attracting investments2.

There have been two important developments in the federal landscape in India impacting
on Centre-state relationships, one on the economic and another on the political side. The change
in the economic side is the paradigm shift in development strategy. Transition from the public
sector dominated, heavy industry based import-substituting industrialization to the one with
market based resource allocation requires a shift in the roles and relationships between the centre
and states as well. In the new regime, private investments will flow to states with market
friendly policies and competitive levels of infrastructure. Inclusive development in this regime is
possible when the centre assists the fiscally disadvantaged states to offset their fiscal disabilities
either by appropriately designing the federal transfer system or through regional policies. This is
particularly important when there are significant impediments to population mobility.
Economic dynamism from intergovernmental competition requires ensuring a measure of
‘competitive equality’ and ‘cost-benefit appropriability’ (Breton, 1987, 1996).

The second major development relates to political changes. The end of single party rule
at the Centre and States has changed the nature of relationship between the two levels of
government from one of extreme cooperation to often confrontationist and acrimonious. The
emergence of coalition governments at the centre with regional parties as pivotal members of the
coalition although has weakened the decision making, it has increased the tendency to extend

2
Breton (1987, 1996) argues that an important precondition for healthy intergovernmental competition is to
ensure competitive equality and cost-benefit appropriability of jurisdictions.
patronage to the states in discretionary manner depending upon the dispensation of the parties
ruling in the states towards the ruling coalition at the centre. This has also led to initiating
several developmental schemes by the Centre in the States’ domain though specific purpose
transfers, often giving grants directly to the local governments and implementing agencies
bypassing the state governments with the states losing incentives and accountability even on the
programmes in their own domain. These changes in the political configurations have also led to
changes in the ethos. Lack of getting elected has led to shorter time horizon for elected
representatives and both politicians and political parties resulting in losing interest in pursuing
long term developmental projects and pursue short term and populist agenda.

Shortcomings of Systems and Institutions:

Unfortunately, systems and institutions relating to Centre-state relations have not kept
pace with the challenges posed by political changes and paradigm shift in development strategy.
The political developments described above have clearly brought out the inadequacies of the
institutions in dealing with the complexities arising from coalition government at the centre,
emergence of regional parties as pivotal members of central coalition and shortening time
horizons of the political parties and politicians. Firstly, the single party rule for a considerable
period of time after independence and towering personality of the Prime Minister and the various
leaders governing the country in the initial years ensured cooperative and informal framework
for all Centre-State and inter-State negotiations and disputes. In the event, formal institutional
mechanism for negation as well as dispute resolution did not develop and this remains a major
institutional vacuum in Indian federation. The setting up of Inter-State Council for the purpose
based on the recommendations of the Commission ion Centre-State Relations (1988) headed by
Justice Sarkaria, however, has not served the purpose. The Council is housed in the Union
Home Ministry and as such cannot be expected to be a negotiator for the States or the arbiter in
the disputes with the States. Nor has the central government given the necessary importance to
this institution to elevate it to the required level. Lack of an appropriate institution for
conducting negotiations and resolving disputes between the centre and States on the one hand
and among the states on the other is a major shortcoming in the Indian federation.

In the absence of a proper institutional arrangement for negotiation, bargaining and

dispute resolution, it has not been possible for the central government to enforce the rules of
federalism. The glaring example of the inability of the federation to resolve conflicts is in the
area of river water disputes. The solution to have a tribunal has not solved the problem and
judgements by the Supreme Court cannot deal with the emotional issue of water sharing
satisfactorily. Similarly, it has not been possible for the central government to ensure a seamless
factor and product markets in the country. The states have continued to follow protectionist
policies of one form or another. Similarly, the rules and their implementation have not been able
to satisfactorily deal with the problem of regionalism.
 On the economic side, changes in the institutional changes to reap maximum benefit from
liberal and open economic policies. The regional policies continue to favour more developed
states. The regional spread of central government expenditure on social and economic services
netted for the cost of providing these services shows that the states with higher per capita
incomes were able to incur larger per capita expenditures. On the transfer side, although the
overall impact of transfers shows an equalizing trend, they have failed to offset the fiscal
disabilities of the states satisfactorily and not surprisingly, per capita development expenditure
(on social and economic services) in the state with the lowest per capita (Bihar) was just about
49 per cent of the all-state average in 2009-10. Per capita state level public spending was
significantly lower in the less developed states on both social services including education and
healthcare and economic services such as promotion of agriculture and allied activities, industry,
transport and other services. This is in spite of the fact that concerted attempt was made by
Bihar since 2004-05 to catch up with the spending levels in other states and the growth rate of
development expenditures in the state was the highest. Thus, although the transfer system helped
the fiscally disadvantaged states to augment their expenditures, there was still a significant
difference in per capita developmental expenditures between the low income and high income
states. SAs this has been the trend over a long period of time, the relatively low levels of
infrastructure is a major impediment in attracting private investment to these states.

A more disaggregated analysis of intergovernmental transfer shows two important

developments. First, there has been steady erosion in the importance of formula based transfers
from the Finance Commission and normal central assistance given for state plan schemes under
the Gadgil formula. The increase in discretionary transfers from the centre is, in part, a
reflection of the changes in the political landscape in the country discussed above. Second, the
analysis of transfers shows that while the per capita transfers (tax devolution and grants) given
on the recommendations of the Finance Commission and (to a lesser extent) per capita plan
grants under the Gadgil formula have a significant negative relationship with per capita incomes
of the states, high income states received higher per capita discretionary grants given for various
Central Sector and Centrally Sponsored Schemes (Rao and Singh, 2005, Rao, 2009). As the
states have limited tax handles, there are binding constraints in raising more revenues from taxes
assigned to them and their borrowing ability is determined by the fiscal rules adopted to contain
the deficit and in any case decided by the Ministry of Finance in consultation with the Planning
Commission and Reserve Bank of India. When the transfer system does not offset the fiscal
disabilities, there is a real danger that these poorer states lose out in attracting private
investments even if they are well endowed in resources. The objective of inclusive development
cannot be realized unless the fiscally disadvantaged states are able to take part in the
developmental process meaningfully. Furthermore, increasing inter-state disparities, unless a
satisfactory solution is found, can create serious political tensions and can create serious thaws in
the relationship between the Centre and fiscally disadvantaged states. Transition to market based
resource allocation puts a major responsibility on the transfer system to ensure comparable levels
of infrastructure and services at comparable tax rates in the states.
 A major contentious area of Centre-State relations is in the sharing of natural resources.
The Constitution assigns the major responsibility for major minerals to the centre and the minor
minerals are assigned to the States. The States have all along been aggrieved that while the
centre exploits the mineral deposits in these states, they do not get adequate compensation by
way of royalty payments. The royalty rates are kept in specific terms and are revised
infrequently and as a result, the states are not able to reap the gains from increasing prices of the
minerals located in their jurisdictions. Despite the Finance Commissions making
recommendations that the rates should be specified in ad valorem terms, the central government
has continued with specific rates. Similarly, the states with large area covered by forests have
continued their grouse that they have not received adequate compensation for the global public
good they generate, income and taxes they lose on account of preserving the forests and the
additional cost of providing public services on account of forest cover.

Equally important is the need for the states to have a say in international relations.
Although in the Seventh Schedule to the Constitution, “Foreign Affairs” is placed in the Union
List (Entry 10), the implications of international negotiations on economic matters including
trade would have repercussions on the states’ economies by varying degrees. The economies of
the Northeastern for states, for example, depend on India’s relations with Bangladesh, China and
Myanmar. Not surprisingly, the states would like to have their views represented whenever the
negotiations take place particularly on economic matters.

Finally, in a globalizing environment, calibrating policies and undertaking policy reforms

harmonization between the central and State governments (Rao and Sen, 2012). Reduction in
the import duties, for example requires to both the centre and States to undertake tax reforms to
offset the revenue loss from customs duties. Similarly, given that the States have a predominant
role in the provision of social services and co-equal role with the centre in providing physical
infrastructure, it is necessary that the policies at the two levels will have to be calibrated in a
consistent and harmonious manner. This requires the centre to evolve measures at providing
incentives/disincentives to the states and effectively monitor the progress in achieving the
desired results.

Concluding Remarks:

The systems and institutions of intergovernmental governance and finance have evolved
over the years have not kept pace with the changing political and economic developments in the
country. The first quarter century after independence was marked by a single party rule in both
the centre and states and the nature of centre-State relationships underwent a marked change with
the emergence of coalition governments at the centre, regional parties ruling in the states and
regional parties as pivotal members of the central governance. The informal systems of
negotiation, bargaining and dispute settlement was no longer effective and Indian federation
continues to be hamstrung by lack of formal institutions for dispute resolution and bargaining.
While some ad hoc solutions have been found for negotiating reforms such as the introduction of
goods and services tax (GST) by having “empowered Committee of State Finance Ministers”, a
comprehensive solution to bargaining and dispute resolution in Indian federation is necessary.

On the economic front, the centre-state relations will have to gear up to the requirements
of open market economy. This requires enabling the fiscally disadvantaged states to achieve a
measure of equality in competing with other states in attracting investments, providing and
monitoring incentives to the states to calibrate reforms in a harmonious manner and involving the
states in international negotiations where they have significant impact. It is also necessary to
have a fresh look at the Centre-State relations in the management of natural resources.

References:

Breton, Albert (1987), “Towards the Theory of Competitive Federalism” European Journal of
Political Economy, Vol. 3, No 1+2, pp 263 – 328.

Breton, Albert (1996), Competitive Governments, Cambridge University Press, New York.

Government of India (1988), “Report of the Commission on Centre-State Relations”, (Chairman:

Justice R. S. Sarkaria), Government of India, New Delhi.

Rao, M. Govinda and Nirvikar Singh (2005) Political Economy of Federalism in India, Oxford
University Press, New Delhi.

Rao, M. Govinda (2009), A Review of Indian Fiscal Federalism, Research Study submitted to the
Commission on Centre-State Relations; Inter-State Council, Ministry of Home , Government of
India.

Rao, Govinda M and Tapas K. Sen (2012), “Federalism and Economic Reform in India” in
Stephen Howes and M. Govinda Rao (Eds), Federal Reform Strategies in Australia and Asia,
Oxford University Press, New Delhi (Forthcoming).