Centre, RBI, FC should work together to enforce fiscal discipline in states: Report

The Centre, RBI and Finance Commission (FC) should work together to enforce fiscal discipline in states, a research paper by the National Council of Applied Economic Research (NCAER) said.

The paper titled ‘The State of the States: Federal Finance in India’ further said heavily indebted states could be given some debt relief in return for conceding to the Central Government’s oversight.

“The RBI should review its policies of intervening in the markets to cap spreads on the bonds of heavily indebted states. Limiting such intervention would strengthen market discipline,” the paper said.

According to the paper, there may be reluctance to move in this direction on the grounds that states should be treated equally, on borrowing costs just like other conditions, and for fear of contagion from the bonds of poorly performing states to the bonds of others that are innocent bystanders.

“But without market discipline, there can be no fiscal discipline,” it emphasised.

The paper also pointed out that the horizontal devolution of taxes among states, awarded by the Finance Commission every five years, does not provide incentives for fiscal rectitude.

“FCs are mandated to allocate more resources to states with larger revenue deficits, which is an obvious source of moral hazard,” it noted. The paper also suggested that there may be room for a fiscal “grand bargain,” where heavily indebted states receive a modicum of debt relief in return for their conceding to additional Central oversight.