ASIA-PACIFIC

INDIA

FEDERAL COUNTRY

BASIC SOCIO-ECONOMIC INDICATORS

INCOME GROUP: LOWER MIDDLE INCOME

LOCAL CURRENCY: INDIAN RUPEE (INR)

POPULATION AND GEOGRAPHY

  • Area: 3 287 259 km2 (2018)
  • Population: 1 380.004 million inhabitants (2020), an increase of 1.0% per year (2015-2020)
  • Density: 420 inhabitants / km2
  • Urban population: 34.9% of national population (2020)
  • Urban population growth: 2.3% (2020 vs 2019)
  • Capital city: Delhi (8.0% of national population, 2020)

ECONOMIC DATA

  • GDP: 8 975.5 billion (current PPP international dollars), i.e. 6 504 dollars per inhabitant (2020)
  • Real GDP growth: -7.3% (2020 vs 2019)
  • Unemployment rate: 6.0% (2021)
  • Foreign direct investment, net inflows (FDI): 64 362 (BoP, current USD millions, 2020)
  • Gross Fixed Capital Formation (GFCF): 27.1% of GDP (2021)
  • HDI: 0.645 (medium), rank 131 (2019)

MAIN FEATURES OF THE MULTI-LEVEL GOVERNANCE FRAMEWORK

The Indian Union Government governs the union of states and eight Union Territories (UTs). India is a constitutionally democratic federal republic (Bharat) with a parliamentary system of government. The 1950 constitution, amended several times, includes a list of fundamental rights and “directive principles” of state policy, and defines the structure of the government.

At the national level, the President is the head of executive of the Union and is elected through indirect suffrage for a five-year term by the elected members of the parliament and the elected members of the Legislative Assemblies of the states. The Prime Minister is appointed by the President and is the head of government. The parliament of the republic is composed of two chambers with the President of India acting as their head. The upper house is the Council of States (Rajya Sabha) and the lower house is the House of the People (Lok Sabha). The Council of States consists of 12 members nominated by the President, and no more than 238 members indirectly elected by members of legislative bodies of the federated entities for a term of six years. The number of members for each state depends on its population. The House of the People cannot have more than 552 members – 530 members representing the states, 20 members representing the UTs and 2 members nominated by the President from the Anglo-Indian Community. Currently, the House of the People is composed of 543 members directly elected by the citizens of India for five years by universal suffrage, and of two members nominated by the President from the Anglo-Indian Community. The members of the House of the People represent parliamentary constituencies across the country.

At the state level, federated states have their own legislative and executive branches, mirroring the structure of the federal government. Each state has its own legislative assembly (Vidhan Sabha), and executive power is vested in the state governor, who acts as the representative of the President of India. The governor is assisted and advised by a council of ministers led by a chief minister, who is the leader of the state assembly.

Union Territories (UTs) are “federal territories” ruled directly by the central government and have special rights and status. Most of them do not have their own legislature and are administered by a Lieutenant Governor who is appointed by the federal government. Two territories have a special status and powers: Delhi and Puducherry (Pondicherry). These two territories closely ressemble states and have an elected legislative assembly, an executive council of ministers and carry out state-like functions. In addition, Delhi has been redefined as the National Capital Territory of Delhi (NCT), incorporated into a larger area known as the National Capital Region (NCR).

Part IX and IXA of the constitution refer to “local bodies“, comprising both rural local bodies (Panchayats) and urban local bodies (UBLs, or municipalities). Local bodies have been granted statutory recognition as a third-tier of government (below the federal and state levels) in 1992, following the 73rd and the 74th Constitutional Amendment Acts. These two amendments also ensure protection to local government. They contributed to strengthening functional responsibilities at the municipal level.

According to articles 243g and 243w of the constitution, states devolve powers, authority and responsibility to their “local bodies”. Each state is free to develop its own local legislation, known as the “state municipal/municipal corporation act” for ULBs and the “Panchayati Raj legislation” for Panchayats. Therefore, local governments often vary from one state to another in terms of status, powers, responsibilities, funding mechanisms, fiscal powers and, therefore, degree of decentralisation.

In recent years, several initiatives have been taken at the national level to further the decentralisation process in India. This has been achieved in particular through urban development initiatives that promoted a participatory approach at the subnational level, and more flexibility for states and local governments to set local priorities. For instance, the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) is a federal government initiative designed in 2005 to foster greater efficiency and transparency in the functioning of urban local governments, in particular in urban renewal and provision of basic services in urban areas.

The government recently developed a new federalism paradigm consisting of cooperative and competitive federalism, in order to shift from a top-down/planning approach to a bottom-up approach that promotes experimentation and the sharing of experience across states. This is done through several vertical coordination arrangements: the Inter-State Council (ISC); the National Institution for Transforming India (NITI Aayog); and the Finance Commission of India. The ISC, in particular, is specified in the constitution as a platform for strengthening Centre-State and Inter-State relations. The NITI Aayog, established in 2015 to replace the former Planning Commission, aims to foster cooperative federalism, both between the federation and the states, and between states and local bodies. The Finance Commission makes recommendations to the President about the distribution of the net proceeds of taxes between the Union and States, among the States themselves, and more generally about the financial relations between the Union and the States.

TERRITORIAL ORGANISATION

MUNICIPAL LEVEL INTERMEDIATE LEVEL STATE LEVEL TOTAL NUMBER OF SNGs (2019)
262 771 rural local bodies (Panchayat) and 4 657 urban local bodies (Municipalities) States and Union Territories
Average municipal size:
5 058 inhabitants
267 428 36 267 464

OVERALL DESCRIPTION: India has a two-tier subnational government structure, based on a state level (composed of states and Union Territories) and a local government level, comprising more than 267 000 entities.

STATE LEVEL: The division of the country at the state level includes states and eight Union Territories (UTs). Among the 8 UTs, only the two territories of Delhi and Puducherry are considered subnational governments.

States have very diverse geographic, demographic, economic, social and cultural characteristics. Uttar Pradesh, the most populated state (with an estimated population of around 213 million in 2022, i.e. 17.4% of all India) is 352 times more populated than the smallest state (Sikkim, 658 000 inhabitants). In seven states, the urban population accounts for less than 20% of the total population while in six states it accounts for more than 40%. The 11 mountainous states in the north and northeast differ markedly from the rest and are therefore designated as “special category” states. Inequalities across states are high by international standards and have increased. In 2020, output per capita in the poorest state (Bihar) was only 10% the level of Delhi, one of the richest territories.

MUNICIPAL LEVEL: Local government units are comprised of rural (panchayats) and urban local bodies (ULBs). As of 2020, there were a total of 267 428 local government bodies across the country, of which 262 771 are rural and 4 657 are urban municipalities.

The local government structure is complex and differs according to each state. In rural areas, the system of local self-government (Panchayati Raj) often comprises three levels: i) the village (Gram Panchayat, the basic level), ii) the Development Block (Mandal Parishad or Block Samiti or Panchayat Samiti), and iii) the district level (Zila Panchayat). The Panhayat system has existed for several centuries but was formalised in 1992 by the 73rd amendment to the Indian Constitution. The system exists in almost all states (some have a two-tier or a single-tier system such as Nagaland, Meghalaya, Mizoram, Goa, etc.) and in all Union Territories except Delhi. They all have a council elected for a term of five years, elected directly (in villages) or indirectly (in blocks and districts) by the villagers.

In urban areas, local urban bodies are classified in three categories, according to their size. There are designated municipal corporations in large metropolitan areas, i.e. population of more than 1 million inhabitants (Nagar Nigam/Mahanagar Palika), municipalities in urban areas comprising between 100 000 and 1 million (Nagar Palika), and city councils (Nagar Panchayat/Nagar Parishad) for smaller towns, i.e. areas in transition from rural to urban (population between 11 000 and 25 000 inhabitants). They are headed by mayors elected directly or indirectly, depending on the state, for either one or five year terms. Metropolitan areas have highly fragmented municipal bodies with very limited coordination. According to the last census of 2011 (2021 was a census year and the Modi government decided not to conduct it due to the COVID-19 pandemic), there were 53 metropolitan areas of more than 1 million people (which represents 16% of total Indian population), including 45 with a population ranging from 1–5 million, five with populations ranging between 5–10 million and three megacities (Delhi, Kolkata and Mumbai) with populations above 10 million.

Local urban bodies are all subdivided into wards. Ward committees are chaired by the local ward councillor. Coucillors are elected in each ward for a term of five years but, in certain instances, members can be nominated.

HORIZONTAL COOPERATION: The 74th Amendment contains an important provision in relation to the establishment of Metropolitan Planning Committees (MPCs) within metropolitan areas. However, various approaches have been adopted in the establishment of MPCs within different states. In parallel, states have established “urban development authorities” to improve coordination at the metropolitan area level.


Subnational government responsibilities

The separation of powers and responsibilities between the Union and states is laid out in Schedule VII of the constitution. The constitution divides the powers of the federal and state governments into three “lists” or groups of compentences: a Union list (100 items including defence, foreign affairs, interstate trade and commerce, census, audit, etc.), a state list (61 items including public order, public health and sanitation, agriculture, local government, etc.) and a concurrent list on which both governments can legislate (52 items including criminal law and procedure, labour welfare, economic and social planning, etc.). The importance of concurrent powers explains why India’s national government is frequently referred to as the “central” government, illustrating the centralised nature of India’s federal structure and the power that the national government wields vis-à-vis the states. The division of powers to the states is asymmetric: the Indian Constitution makes special provisions for 12 states (Article 371 A-J), in order to meet the specific needs and aspirations of these state, to protect cultural and economic interests, to deal with local challenges and to protect their customary laws.

Local governments derive their powers and responsibilities from their respective state’s legislation. As an overall guidance, Schedule XII of the federal constitution provides a basis for the state legislatures to guide the state governments in the assignment of municipal responsibilities to local bodies. It outlines 18 functions that may be entrusted to the municipalities (including water supply, construction and maintenance of public streets, lighting and watering of public streets, maintenance or support of public hospitals, etc.). In the end, some states have a high level of decentralisation while others hardly devolve functions and spending assignments to the local level, limited to the provision of basic public services (for instance, the states of Karnataka and Kerala have chosen to treat the 29 expenditure functions of local government named in the constitution as concurrent, and not exclusive, local government functions). In addition, functions may vary according to the type of local government and within each category (between municipal corporations, municipalities and city councils and between villages, blocks and districts).

Main responsibility sectors and sub-sectors

SECTORS AND SUB-SECTORS State level Municipal level
1. General public services (administration) General Public Administration; Civil status register; Oversight of Local administration, electoral register Production of public administrative statistics; Registration of births and deaths
2. Public order and safety Public Order; Police; Fire protection; Civil protection. Public safety including fire services
3. Economic affairs / transports Agricultural Production; Industries and Minerals; Roads; Public transport; Urban roads; Ports; Airports; Local economic development, tourism Economic development planning; Roads and bridges (ULBs and districts); Public transport (ULBs); Regulation of slaughterhouses and tanneries
4. Environment protection Parks Environmental protection; Promotion of ecological initiatives; Urban forestry
5. Housing and community amenities Management of Land rights; Irrigation; Housing, town planning; Regional planning; Water and sanitation; District heating; Gas service Sanitation and solid waste management; Urban and town planning; Regulations of land use and construction of buildings; Water supply; Urban forestry; Urban amenities (parks, green spaces); Burial and cremation facilities; Public amenities (street lighting, parking lots); Housing to low-income residents.
6. Health Primary care; Hospitals; Health protection Primary and health protection (ULBs)
7. Culture & Recreation Theatres; Museums; Libraries; Sports; Leisure activities; Religious facilities Theatres; Museums; Libraries; Sports; Leisure activities; Religious facilities
8. Education Pre-schools; Primary and secondary schools; Vocational and technical training; Higher education, adult education Pre-schools (optional for ULBs, Districts and Blacks); Adult education (ULBs)
9. Social Welfare Family welfare services; Welfare homes, social security Planning of social development; Protection of the disabled; Urban poverty alleviation; Slum improvement; Welfare homes (optional).


Subnational, state and local government finance

Scope of fiscal data: the States and Union territories, and their respective local government bodies (NB: the breakdown of the public finance data between the states and the local governments is not available) DEA India Availability of fiscal data:
Low
Quality/reliability of fiscal data:
Low

GENERAL INTRODUCTION: States account for most subnational government expenditure and revenue, as compared with local bodies. However, it is important to note that states depend heavily on federal funding (grants and tax-sharing arrangements among different states are determined by the Finance Commission of India, as mentioned in article 243Y of the constitution). The constitution recognises that the assignment of tax powers and expenditure functions creates imbalances between expenditure needs and the ability to raise revenue, both vertically (among different levels of government) and horizontally (within a single subnational government level).

Recent measures have given more financial autonomy to subnational governments. In 2015, the 14th Finance Commission increased the share of the states in the Union pool taxes by 10%, up to 42%, for the 2015-20 period, enhancing the financial autonomy of the states. However, in 2020, the 15th Finance Commission recommended to decrease this share by -1%, to reach 41%, in order to adjust to the transformation of a former state into two.

Local governments have a relatively weak discretionary and decision-making power over revenues and expenditure. National statistics do not make the distinction between local government and state government finance, and there is a lack of reliable and comparable data at the local level. Overall, local bodies rely on transfers from the central and state governments to meet their expenditure requirements.

Subnational, state and local government expenditure by economic classification

Dollars PPP / inhabitant % GDP % general government % subnational, state and local government
- SNG State Local SNG State Local SNG State Local SNG State Local
Total expenditure 1 075 - - 16.1% - - 62.5% - - 100% - -
Inc. current expenditure 898 - - 13.5% - - 62.5% - - 83.5% - -
Compensation of employees 0.00 - - 0.0% - - - - - 0.0% - -
Intermediate consumption 323 - - 4.8% - - 60.4% - - 30.1% - -
Social expenditure 449 - - 6.7% - - 83.2% - - 41.8% - -
Subsidies and current transfers 9 - - 0.1% - - 14.7% - - 0.8% - -
Financial charges 104 - - 1.6% - - 36.3% - - 9.7% - -
Others 13 - - 0.2% - - 77.5% - - 1.2% - -
Incl. capital expenditure 177 - - 2.7% - - 62.8% - - 16.5% - -
Capital transfers 5 - - 0.1% - - 35.7% - - 0.4% - -
Direct investment (or GFCF) 172 - - 2.6% - - 64.1% - - 16.0% - -

SNG expenditure by economic classification as a % of GDP

  • Compensation of employees
  • Intermediate consumption
  • Current social expenditure
  • Subsidies and other current transfers
  • Financial charges + other current expenditures
  • Capital expenditure
  • 20% 16%
  • 12%
  • 8%
  • 4%
  • 0%
  • caché
  • 4.8%
  • 6.7%
  • 1.7%
  • 2.7%

SNG expenditure by economic classification as a % of GDP

  • Compensation of employees
  • Intermediate consumption
  • Current social expenditure
  • Subsidies and other current transfers
  • Financial charges + other current expenditures
  • Capital expenditure
  • 20% 16%
  • 12%
  • 8%
  • 4%
  • 0%
  • caché
  • 4.8%
  • 6.7%
  • 1.7%
  • 2.7%

EXPENDITURE: In 2018, SNG expenditure in India accounted for 62.5% of public expenditure and 16.1% of GDP, well above the OECD average for federal countries (50.1% of public expenditure in 2018). As a share of GDP, however, subnational government expenditure is below the OECD average for federal countries (19.3% of GDP in 2020). SNG expenditure is primarily comprised of current expenditure (83.5%) leaving a small share to total capital expenditure (16.5% of total SNG expenditure).

Participatory budget mechanisms exist in some Indian states and municipalities since 1996. This type of mechanism allows citizens to deliberate and have a say in the distribution of public resources by subnational and/or national governments. Kerala was the first Indian state to implement participatory budgeting at the subnational level. It was implemented through the Kerala People’s Campaign under the Ninth Plan (1997-2002), which ran until 2001, and ensured that citizens decided on the allocation of expenditure accounting for up to 40% of the state budget. Since then, the model has been adopted in all state planning. At the local level, Bengaluru became the first Indian city to experiment with participatory budgeting in 2001, and this was officially implemented by the municipality of Pune in 2005, which renews this on an annual basis. Citizens can propose policies in sectors such as street lighting, water and sanitation, parks and green areas, and public transport.

DIRECT INVESTMENT: Subnational public investment accounted for 2.6% of GDP in 2018, which is above the OECD average for federal countries (1.9% in 2018) but is quite low compared to other BRICs and emerging economies. States and municipalities play a major role in public investment, accounting for almost two-thirds of public investment, which is slightly higher than the OECD average for federal countries 62.6% in 2018). However, state play the most prominent role, as most urban infrastructure projects undertaken by municipal local governments depend predominantly on funds from state governments and state government agencies.

Despite substantial public investment over the last 25 years, infrastructure supply remains poor, both in terms of quantity and quality, especially in urban areas, and coordination across sectors and levels of government is lacking, with overlapping powers between the central government and the states in many sectors. This results in several shortcomings: in 2015, it was estimated that around 680 million Indians (approx. 56% of the population), lacked the means to meet their essential needs and that around 40% of the population did not have proper access to health care, water and sanitation. The availability of basic services at the district level is uneven: Bihar had the highest level of deprivation (the average resident lacked access to 62% of basic services) followed by Uttar Pradesh, Jharkhand, Madhya Pradesh and Assam. Himachal Pradesh had the lowest access deprivation rate (28%) together with Punjab, Uttarakhand, Kerala and Tamil Nadu among the big States.

The Government of India has made infrastructure upgrades a top policy priority. It has developed several programmes to support subnational investment. PPPs are also strongly encouraged, in particular in the framework of the JNNURM. The JNNURM programme was the Indian government’s first initiative to foster PPPs in urban sectors such as solid waste, water supply, sewage, and urban transport. It was estimated by the former Planning Commission that between 13% and 33% of urban sector investments could potentially be made using the PPP model. The Twelfth Five Year Plan (2012–2017) also promoted the “4P” framework—People–Private–Public–Partnerships. However, since the Planning Commission (to be replaced by the NITI Aayog) was dissolved, no more formal plans have been made, making 2012-2017 the latest, and its implementation remains hard to assess.

Subnational, state and local government expenditure by functional classification

2018 Dollars PPP / inhabitant % GDP % general government % subnational, state and local government
- SNG State Local SNG State Local SNG State Local SNG State Local
Total expenditure by economic function 1 075 - - 16.1% - - - - - 100% - -
1. General public services 194 - - 2.9% - - 46.7% - - 18.1% - -
2. Defence 0 - - 0.0% - - 0.0% - - 0.0% - -
3. Security and public order 55 - - 0.8% - - 76.4% - - 5.1% - -
4. Economic affairs/transports 330 - - 5.0% - - 66.5% - - 30.7% - -
5. Environmental protection 0 - - 0.0% - - - - - 0.0% - -
6. Housing and community amenities 52 - - 0.8% - - 93.2% - - 4.8% - -
7. Health 72 - - 1.1% - - 86.2% - - 6.7% - -
8. Recreation, culture and religion 0 - - 0.0% - - - - - 0.0% - -
9. Education 170 - - 2.6% - - 86.7% - - 15.9% - -
10. Social protection 202 - - 3.0% - - 65.8% - - 18.8% - -

SNG expenditure by functional classification as a % of GDP

  • General public service
  • Defence
  • Public order and safety
  • Economic affairs / Transport
  • Environmental protection
  • Housing and community amenities
  • Health
  • Recreation, culture and religion
  • Education
  • Social protection
  • 20% 16%
  • 12%
  • 8%
  • 4%
  • 0%
  • 2.9%
  • 4.9%
  • 2.6%
  • 3%

SNG expenditure by functional classification as a % of SNG expenditure

  • General public service: 18,06%
  • Defence: -
  • Public order and safety: 5,08%
  • Economic affairs / Transport: 30,72%
  • Environmental protection: -
  • Housing and community amenities: 4,81%
  • Health: 6,74%
  • Recreation, culture and religion: -
  • Education: 15,85%
  • Social protection: 18,75%

SNG expenditure by functional classification as a % of GDP

  • General public service
  • Defence
  • Public order and safety
  • Economic affairs / Transport
  • Environmental protection
  • Housing and community amenities
  • Health
  • Recreation, culture and religion
  • Education
  • Social protection
  • 20% 16%
  • 12%
  • 8%
  • 4%
  • 0%
  • 2.9%
  • 4.9%
  • 2.6%
  • 3%

SNG expenditure by functional classification as a % of SNG expenditure

  • General public service: 18,06%
  • Defence: 0%
  • Public order and safety: 5,08%
  • Economic affairs / Transport: 30,72%
  • Environmental protection: 0%
  • Housing and community amenities: 4,81%
  • Health: 6,74%
  • Recreation, culture and religion: 0%
  • Education: 15,85%
  • Social protection: 18,75%

In 2018, subnational governments allocated 30.7% of their total budget to economic affairs and transports, which stood at 66.5% of total public expenditure and 5% of GDP. Social protection was the second biggest economic function, representing 18.8% of total subnational government expenditure, 65.8% of total public social protection expenditure and 3% of GDP. This shows that subnational governments play a major role in the provision of social services.

In addition, total public expenditure in housing and community amenities, education (including culture due to the current classification) and health are mostly carried out by state and local governments.

Subnational, state and local government revenue by category

Dollars PPP / inhabitant % GDP % general government % subnational, state and local government
- SNG State Local SNG State Local SNG State Local SNG State Local
Total revenue 885 - - 13.3% - - 67.5% - - 100% - -
Tax revenue 629 - - 9.4% - - 59.1% - - 71.1% - -
Grants and subsidies 187 - - 2.8% - - - - - 21.1% - -
Tariffs and fees 62 - - 0.9% - - - - - 7.0% - -
Income from assets 7 - - 0.1% - - - - - 0.8% - -
Other revenues 0 - - 0.0% - - - - - 0.0% - -

% of revenue by category

  • 100% 80%
  • 60%
  • 40%
  • 20%
  • 0%
  • 71.1%
  • 21.1%
  • 7%
  • 0.81%
  • -
  • Tax revenue
  • Grants and subsidies
  • Tariffs and fees
  • Property income
  • Other revenues

SNG revenue by category as a % of GDP

  • Tax revenue
  • Grants and subsidies
  • Tariffs and fees
  • Property income
  • Other revenues
  • 15% 12%
  • 9%
  • 6%
  • 3%
  • 0%
  • 9.4%
  • 2.8%

% of subnational, state and local government revenue by category

  • 100% 80%
  • 60%
  • 40%
  • 20%
  • 0%
  • 71.1%
  • 21.1%
  • 7%
  • 0.81%
  • 0%
  • Tax revenue
  • Grants and subsidies
  • Tariffs and fees
  • Property income
  • Other revenues

SNG revenue by category as a % of GDP

  • Tax revenue
  • Grants and subsidies
  • Tariffs and fees
  • Property income
  • Other revenues
  • 15% 12%
  • 9%
  • 6%
  • 3%
  • 0%
  • 9.4%
  • 2.8%

OVERALL DESCRIPTION: The constitution contains complex arrangements relating to the distribution of fiscal powers and revenues between the federal and state governments. In addition to some own taxes, states are allocated a share of centrally-levied taxes, as well as direct grants from the central government through the Consolidated Fund of India. Tax revenues represented the bulk of subnational government revenues in 2018 (greater than two-thirds of total SNG revenues), well above the average for federal countries in the OECD (47.8% in 2018). At local level, municipalities and Panchayats depend mostly on federal and state grants (although official statistics are missing).

Tax sharing arrangements and allocation of grants among different states are determined by the Finance Commission of India, an independent quasi-judicial body enshrined in the constitution (article 280), appointed by the President of India every five years. The Finance Commission can make recommendations regarding the measures needed to increase the Consolidated Fund of a State, to supplement its municipal and Panchayats’ resources. State finance commissions - whose role is similar to that of the federal Finance Commission of India - exist in each state to provide fiscal advice on state-local government relations.

The SNG financing system is evolving, following the 2017 Goods and Service Tax (GST) reform and the recommendations of the Fourteenth Finance Commission (FFC - 2015-2020). The FFC recommended to increase the percentage of national tax revenues allocated to states from 32% to 42% and improve the grants system to provide more fiscal autonomy and incentives to the states.

TAX REVENUE: The Seventh Schedule of the Constitution defines in detail the taxation powers of the Union and the states, and assigns several exclusive taxes to the states. The Constitution does not contain a separate list of taxes assigned to local bodies, but it authorises states to devolve the power to levy, collect and appropriate taxes to local governments.

State own-source taxes account for the main share of their tax revenue (40%). The general sales tax is the most important, representing 3.7% of GDP and 28.2% of subnational government revenue. State taxes also include the state excise duties, stamp and registration fees, the motor vehicle tax, tax on electricity, tax on goods and passengers and the recurrent property tax (which can be levied by states or municipalities, depending on the state). Some states also levy a professional tax on individuals, which applies to business owners, individuals working in private companies and merchants. As of 2017, a reform led to the merger of most central and state taxes on goods and services into one single national tax: the new Goods and Services Tax (GST). The GST is a nationwide Value added Tax (VAT). It replaced all indirect taxes levied on goods and services by the Indian Central and state governments, in order partly to mitigate double taxation and facilitate a common national market. The tax rates, rules and regulations are governed by the GST Council which consists of the finance ministers of the central and state governments, which implies that the states must negotiate with the central government on the mechanisms for implementing the GST within their jurisdiction, resulting in a loss of autonomous revenue sources coming from indirect taxes for states.

States receive a share of all central government taxes (excluding surcharges and earmarked taxes, so-called “divisible tax pool”), in particular from the personal income tax (PIT), the corporation tax (CIT), the wealth tax, union excise duties, union custom duties and the service tax. Total shared taxes accounted for 34.1% of subnational government tax revenue in 2018, including 11.5% for the CIT and 9.6% for the PIT. Following the FFC recommendation, new criteria have been taken into consideration for tax distribution (population, demographic changes, area, forest cover, etc.).

At the local level, sources of tax revenue are relatively narrow compared to international benchmarks. The main local taxes are the recurrent taxes on immovable property and the professional tax (if states have devolved to them taxation powers over these taxes) as well as a luxury tax (entertainment, betting and gambling). The property tax is mainly levied by local authorities (although in some states it is levied by the state authorities). It represented 0.9% of total subnational government tax revenue in 2018 and 0.1% of GDP, which is very low (compared to 1% of GDP on average in the OECD in 2020). The municipal revenue base in India suffers from substantial inefficiencies and a low level of collection. Local governments have very limited autonomy to set the bases and rates, and lack the workforce and skills to enforce them. States can decide to abolish main local taxes and some have done so.

GRANTS AND SUBSIDIES: To correct vertical and horizontal imbalances, the constitution provides for statutory fiscal transfers from the federation and the states. There are two types of government transfers: general purpose transfers and specific purpose grants. General purpose transfers are allocated by the Finance Commission to offset the fiscal shortfalls besetting lagging states so they can provide comparable levels of public services at comparable tax rates. These transfers have a strong equalising impact. Special-purpose grants, on the other hand, are conditional grants allocated by sectoral ministries to ensure that certain priority services are delivered to a minimum standard and that services with significant interstate spillovers are carried out.

The FFC has recommended improving the system of central government transfers to the states by notably i) reducing certain conditional grants; ii) streamlining the number “centrally sponsored schemes” (special purpose grants from the central government to states to encourage and motivate state governments to plan and implement programmes that help attain national goals) from 66 to 28; and iii) allocating funds based on more objective and progressive criteria (fiscal capacity was given more weight in the formula). The federal government also aims to increase outcome-oriented transfers in all policy areas, a move monitored by NITI Aayog and the Ministry of Finance. Examples of schemes are the National Health Mission, the Universal Elementary Education Programme, and the Mahatma Gandhi National Rural Employment Guarantee.

Local governments receive grants and subsidies from three main sources: local body grants (as per the recommendation made by the Indian Finance Commission), federal funds for implementation of sponsored schemes, and state transfers. The government’s XIV Central Finance Commission set the amount of grants to local bodies at INR 2.87 lakh crore (USD 36.7 billion) for the period 2019-2024, according to the CLGF. This is an increase of 228% over the previous five-year period. It also recommended that the new local grants be divided in two parts – a basic grant, and a performance grant. In the case of rural local bodies, the basic grant makes up 90% of the local body grant against 10% for the performance grant, versus 80% and 20% respectively for municipalities.

OTHER REVENUE: Subnational governments collect other revenues in the form of property income (development charges, transferable development rights) and user charges and fees on a wide range of services. In 2018, tariffs and fees and property income amounted to 7% and 0.8% of total subnational government revenue, respectively (versus respective averages of 17.3% and 2.6% in OECD federal countries in 2020). User charges do not offset operating and maintenance costs of many services, particularly the provision of electricity and water-related services. Non-tax revenues have been neglected as potential revenue sources in Indian cities and continue to have “untapped potential”, in particular in large agglomerations.

Subnational, state and local government fiscal rules and debt

2018 Dollars PPP / inh. % GDP % general government debt % SNG debt % SNG financial debt
- SNG State Local SNG State Local SNG State Local SNG State Local SNG State Local
Total outstanding debt 1363 - - 20.4% - - 31.9% - - 100% - - - - -
Financial debt - - - - - - - - - - - - - - -
Currency and deposits - - - - - - - - - - - - - - -
Bonds / debt securities - - - - - - - - - - - - - - -
Loans - - - - - - - - - - - - - - -
Insurance pensions - - - - - - - - - - - - - - -
Other accounts payable - - - - - - - - - - - - - - -

SNG debt by level of government as a % of GDP and as a % of general government debt

  • 40% 32%
  • 24%
  • 16%
  • 8%
  • 0%
  • 20.4%
  • 31.9%
  • % of GDP
  • % of GG Debt

SNG debt by level of government as a % of GDP and as a % of general government debt

  • 40% 32%
  • 24%
  • 16%
  • 8%
  • 0%
  • 20.4%
  • 31.9%
  • % of GDP
  • % of GG Debt

FISCAL RULES: At the national level, a Review Committee set up to evaluate the Fiscal Responsibility and Budget Management Act submitted its report to the finance minister on January 2017, with recommendations on the reinstatement of budget balance rules at the federal level and on “partnering the states”. At the local level, budget rules are defined by the relevant state.

Most state governments have introduced fiscal responsibility laws (FRL) that limited their deficits to 3% of gross state product (GSP). The state of Karnataka was the first to implement it back in 2002. Most of the states enacted their FRLs from 2004 to 2006 and the process was completed in 2010 with the enactment of FRLs by the states of Sikkim and West Bengal. In line with cross-country practices and the fiscal rules implemented by the central government, the state governments also adopted fiscal rules in terms of quantitative ceilings mainly on deficits. Few states also incorporated other targets such as debt limits, guarantees, rationalisation of committed revenue and expenditures, review of the compliance to fiscal targets, greater fiscal transparency and medium term fiscal plan for enhancing fiscal indicators.

More recently, the 10th plan of the Planning Commission of India has highlighted the need for systematic fiscal discipline at the level of the states. The Union Budget for the year 2022-2023, allows the states to incur in a fiscal deficit of 4% of GSP, of which 0.5% will be tied to power sector reforms included in the Electricity (Amendment) Bill proposed in parallel with the budget.

DEBT: According to the constitution, states can issue debt and borrow from the Consolidated Fund, within the limits established by the state legislature on debt inssuance or debt guarantees. States may also borrow from the central governement, and if the loan is guaranteed, the central government can limit the guarantees given. Furthermore, states must seek consent from the central government to issue any additional debt outside of the government in case they already have loans with the governent.

According to the 1914 Local Authorities Loans Act, municipal corporations may borrow with prior approval from their respective state governments. An amendment to the Income Act of 1961 also grants municipalities the right to issue bonds, with and without state guarantees. In addition, state-level municipal laws athorise municipalities to issue obligations or raise loans, and to create a sinking fund for debt service on its debt. These laws also specify from which agencies municipalities are allowed to borrow and if state guarantees are mandatory or not.

The federal government encourages urban local bodies (ULBs) in particular to tap into financial markets. A state-level pooled finance development fund scheme (PFDF) has been established by the Ministry of Housing and Urban Affairs to provide credit enhancement to ULBs wishing to access the bond market. This fund provides credit enhancement grants, through pooled financing bonds issued on behalf of identified urban local governments, which enable them to access market borrowing for investment in urban infrastructure projects. Throughout the process, ULBs are scrutinised through a mandatory rating system when the issue maturity is greater than 18 months. In 2018, more than 140 Indian cities could raise development capital through the issuance of municipal bonds, according to JLL India.

In 2018, subnational government non-consolidated debt reached 31.9% of total public debt, higher than the OECD average for federal countries (31.1% in 2018); yet, subnational government debt stood at 20.4% of GDP, well below the OECD average for federal countries (37.9% in 2018).



The impact of the COVID-19 crisis on subnational government organisation and finance

TERRITORIAL MANAGEMENT OF THE CRISIS: India adopted a proactive response in fighting the COVID-19 crisis, including imposing a nationwide lockdown (from March 25 2020 to May 31 2020), a national plan of economic and social reopening, and scaling up the health system. Based on the broad protocols and guidelines put in place by the Central Government, states and Union Territories (UTs) implemented several practices to enhance the effectiveness of COVID prevention and management initiatives in their local context. For instance, the state of Kerala prepared comprehensive road maps for contact tracing, and the state of Gujarat operationalised mobile vans for testing and providing essential health services to people. Technology was leveraged extensively by several states, UTs and Aspirational Districts in the fight against COVID-19. In Tamil Nadu, a hospital developed a six-layered protection model based on Artificial Intelligence and Robotics for detecting COVID-19 symptoms while in Jharkhand, ‘Co-Bots’ were deployed for delivering food, water, and medicines to patients. Wayanad proactively trained its doctors, nurses, and other frontline workers in COVID-19 management using virtual platforms. Further, the efforts of states and UTs were amplified through partnerships with the private sector and civil society organizations, in order to set up control rooms for COVID-19, enable the delivery of door-to-door food supplies, and mobilize Self-help Groups for manufacturing masks and sanitizers

In addition, the Indian Center for Disease Control (CDC) was included in the central government’s Emergency Operations Center (EOC) Expert Committee, which oversees development of the country’s Public Health Emergency Operations Centre (PHEOC). Measures taken by EOC included expansion of PHEOC’s capacity (national and subnational) through development of plans, guidelines, and processes, and through provision of a training package for EOC staff. CDC India worked at the subnational level to support Community Emergency Response Teams on COVID-19 response efforts and recently worked with the Government of India to develop a self-learning training package for Rapid Response Teams, available on the Government of India and World Health Organisation websites.

EMERGENCY MEEASURES TO COPE WITH THE CRISIS AT THE DIFFERENT LEVELS OF GOVERNMENT: Some states overcame the economic consequences of the crisis by carrying out labour reforms. Gujarat, Madhya Pradesh, and Uttar Pradesh in particular have reformed labour laws at the state level. The Gujarat government decided to liberalise labour laws (except the minimum wage, industrial safety rules and employees' compensations) to ensure smooth functioning of industries in the post-lockdown period. The changes in labour laws were approved by the state for a time-period of 1 200 days. The government of Uttar Pradesh, in a move to restart economic activity and protect jobs, approved the “Uttar Pradesh Temporary Exemption from Certain Labour Laws Ordinance, 2020”, in which 38 labour laws have been suspended in the state for three years. The government of Madhya Pradesh reformed several labour laws to give employers more freedom to operate and incentivise new industries and investors into the state.

Additionally, starting in May 2020, the central government supported state governments (USD 8.5 billion in total) through tax repayments, revenue deficit grants, advance release of fund from the State Disaster Response Fund, and a scheme for providing interest-free loans to states for capital expenditure until the fiscal year 2021/22. The Reserve Bank of India (RBI) created a facility to help with state government's short-term liquidity needs. In addition, the central government enhanced the borrowing limit of state governments from 3% to 5% of their gross state domestic product. But only the first 0.5% of this increase was unconditional — a further 1% was permitted only if the borrowing was linked to specific reforms such as debt sustainability, job creation, power sector reforms and urban development. A final 0.5% was permitted only if states achieve key milestones in these areas. As June 3, 2021, key economic measures were launched in the framework of the fiscal and macro-monetary plans, including provision of credit support to businesses (1.9% of GDP), poor households, especially migrants and farmers (1.6% of GDP), distressed electricity distribution companies (0.4% of GDP), and targeted support for the agricultural sector (0.7% of GDP).

IMPACTS OF THE CRISIS ON SUBNATIONAL GOVERNMENT FINANCE: According to the Parliament and Legislative Research Center, states’ revenue declined by 0.6% in fiscal year 2020-21. A similar decline was seen in fiscal year 2019-20. To prevent any drastic cut in expenditure, states were allowed to borrow more in 2020-21. While their total expenditure grew by around 5% in both these years, capital expenditure declined by 5% in 2019-20. In 2020-21, it increased by 1.4%, but remained 4% lower than 2018-19.

On the other hand, due to the compensation guarantee, all states achieved at least a 14% annual growth in GST revenue in the fiscal year 2020-2021 (GST compensation was introduced to compensate the states for the loss of revenue arising on account of implementation of the GST in 2017). States relied on compensation to achieve 23% of the guaranteed revenue in 2019-20 and 36% in 2020-21. Once the guarantee ends in 2022, states dependent on compensation may, however, suffer from a revenue decrease.

ECONOMIC AND SOCIAL STIMULUS PLANS: The Union Finance Minister announced the first fiscal stimulus package on June 28, 2021. The goal of the package was to stimulate growth in credit offtake mainly by providing interest rate concessions with a focus on priority sectors such as healthcare, energy and other infrastructure sectors. The direct stimulus, however, was limited to three main initiatives: (i) the extension of the distribution of free food grains (Pradhan Mantri Garib Kalyan Yojana scheme); (ii) increase in health expenditure (35% of the increase funded by states); and (iii) enhancement of rural connectivity. The package amounts to about 0.5% of estimated GDP for fiscal year 2022.

The central government is also reforming the energy sector, decentralised to the state level, in order to upgrade infrastructure. Under this scheme, the central government plans to gives grants to distribution companies (discoms) each year when they achieve the milestones agreed for the previous fiscal. The plan states that if a utility is found ineligible for grants on a given year, then the gap in funding to complete its projects will have to be met either by the discom or by the state government. Unmet targets for one year get added to the targets for the next year. The scheme is expected to install INR 25 million in smart meters in homes, 10 000 electric feeders and 400 000 km of low-tension overhead lines.

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