Figure 3: Per Capita Transfers via Centrally Sponsored Schemes

* indicates significance at the 10 percent level

A possible compromise between the opposing perceptions of the Centre and the States is that the CSS should continue, but the schemes should be made much more flexible, by allowing for (a) modification of general guidelines to suit state-specific conditions and (b) providing a flexible portion within the allocation for the state which would permit completely innovative departures even from the state specific guidelines at the option of the state within the broad purpose intended for which the scheme is intended. The Twelfth Five Year Plan has endorsed this approach and modifications along these lines are currently being processed. It is hoped they will be introduced in the year 2013-14.

While most Centrally Sponsored Schemes deal with particular sectors of the economy, there is one initiative of the Central Government, which specifically addresses the problem of development of backward regions. This is the Backward Regions Grant Fund, which provides resources to districts within states and most recently also to individual states. The BRGF has evolved over time into its present form in a series of steps. Its origins can be traced to the idea first mooted by Prime Minister Rajiv Gandhi, in the late 1980s, that we should find a way of providing special central support to the three districts of Kalahandi, Bolangir and Koraput (KBK) in Odisha, which were at the time affected by famine conditions. (The three districts have since been sub-divided into eight). The KBK programme was finally launched in 1995-96. It was later expanded, in the Tenth Plan, into a larger programme named the Rashtriya Sam Vikas Yojana (RSVY), which covered 147 backward districts. This in turn was expanded in the Eleventh Plan to 250 districts, and renamed the Backward Regions Grant Fund. District funding under the BRGF goes to projects identified by the panchayati raj institutions (PRIs).

A state-level component for Bihar was added to the erstwhile RSVY after the undivided state of Bihar was bifurcated into Bihar and Jharkhand in 2000. The Bihar State Reorganisation Act provided that the Planning Commission would provide special assistance to Bihar to compensate for the loss of resources consequent to the separation of Jharkhand. Accordingly, a state-level component was included in the RSVY, in addition to the normal central assistance which Bihar received, which itself reflected an element of progressiveness given Bihar’s low income level. However, whereas the normal central assistance is not tied to specific projects, the funds provided under the Bihar Special Plan were tied to specific infrastructure development projects which were expected to help overcome the state’s backwardness. Subsequently, two other state components were added to the BRGF. One was the Bundelkhand package announced in 2009-10 (covering six districts in Madhya Pradesh and seven districts in UP) to deal with the acute water scarcity in this area. The other was a West Bengal component announced in 2011-12, responding to demands from the state for assistance in view of its exceptionally high debt burden. In both cases, resources provided under these components are for identified projects.

In 2010-11, a new component, called the Integrated Action Plan (IAP) for the development of tribal and backward districts was added, covering sixty districts initially, which were later expanded to eighty-two. The IAP districts broadly correspond to the area, which has seen a spread of extremism and alienation of the local population. Unlike the normal district component of the BRGF, where the projects are chosen by the PRIs, these funds were to be allocated to projects chosen by a committee of officials representing the district administration, the police and the forest department, giving priority to those activities which might be most effective in containing the growth of left wing extremism.

Central Sector Programmes

In addition to the two channels listed above – Block Grants and Centrally Sponsored Schemes –the Central Government also contributes to redressing regional imbalance through the deployment of its own Central Sector investment a large part of which is backward states and areas. For example, the National Highway Development Programme (NHDP), through its various phases, is making a contribution by opening up hitherto poorly connected areas. NHDP-I which consists of the Golden Quadrilateral connectivity Delhi-Mumbai- Chennai and Kolkata, which carries 40 per cent of the traffic on the entire national highway network, not only connects the well established commercial centres, but also less developed parts of the country to the network. NHDP II, which was superimposed on the Golden Quadrilateral to establish north--south and east--west connectivity, opened up new connectivity for many less developed areas. NHDP III, which links all district capitals with the national highway network, is another major central sector project which will directly open up areas that were previously inadequately served, and help spread economic activity more widely.

The Special Accelerated Road Development Programme for the North East (SARDP-NE) is another central sector programme contributing to the development of the North Eastern States, which suffer from poor connectivity to the rest of the country. It will open up huge market opportunities for movement of horticultural and floricultural produce from the North East. Similarly, the ongoing programme to extend rail connectivity to each of the North Eastern states and ensure an airport in each of the state capitals, exemplify Central Government programmes which do not figure as transfers to the states, but which directly address the problem of backwardness.

Other examples of central sector projects which promote regional balance is the expansion in central higher education institutions (IITs, IIMs, central universities, etc.) to areas hitherto uncovered, and also the establishment of central medical institutions such as the new AIIMSs.

We now turn to consider whether the current scale of transfers to the poorer states is sufficient to promote regional balance. In practice, this boils down to two questions: first, can the total size of the transfers, excluding the Central Sector Schemes, be increased further and, second, can the total resources available be distributed among states in a more progressive manner?

To assess the scope for increasing the total volume of transfers, it is necessary to take a composite view of the Centre’s fiscal capability in the context of its own expenditure needs. Taking a partial view – such as, for example, arguing for larger transfers through the Finance Commission, or for larger block grants from the Planning Commission – ignores the fact that the Centre’s resources are limited and increased transfers through one channel will only reduce the scope for transfers through other channels.

As shown in Table 3, the total size of transfers (excluding expenditure in Central Sector Programmes) already amount to around 6 percent of GDP. The demand for additional transfers to poorer states can be met by increasing the total size of the transfers, but this is limited by the overall resource constraint within which the Central Government must operate. The extent to which the Central Government can raise additional resources has been examined carefully in the Twelfth Plan. The outcome depends on the success of action in two critical areas. The first is in increasing the tax revenues of the Central Government. The Twelfth Plan estimates the tax: GDP ratio could increase by about 2 percentage points of GDP over the Plan period. The second is a reduction in the expenditure on subsidies as a percentage of GDP. The Twelfth Plan estimates that subsidies should be reduced by around 1 percentage point of GDP.

Both objectives – raising revenues and reducing subsidies as a percentage of GDP – are challenging, and if both are achieved, it would provide the Centre with additional resources of around 3 percentage points of GDP. However, the Plan also requires a reduction in the fiscal deficit by about 2 per cent of GDP over the Plan period, as a critical element of macro-economic balancing which is a pre-condition for the growth of GDP assumed. The net room available for increased expenditures by the Centre is therefore only about one per cent of GDP. Since there are numerous demands for increased funding in the central sector, particularly the key infrastructure sectors which also promote regional balance, only a part of the additional one per cent of GDP could be devoted to an increase in transfers of one kind or another to the states. The scope for increasing the total size of transfers to the states beyond the present level of 6 percent of GDP is therefore limited, at least in the medium term.

If the total volume of transfers cannot be increased significantly, the only way of doing more for the poorer states is by making the transfers more progressive. As noted earlier, both the Finance Commission transfers and the Normal Central Assistance transfers are based on formulae which contain elements which ensure some progressivity. The distribution of CSS resources across states is also progressive, though much less so. However, the fact that these transfers have an element of progressivity does not answer the question: are the transfers progressive enough?

A case can always be made for a greater degree of progressivity in each of the central transfers, or at any rate in the total. This will obviously be supported by the poorer states, but it is also likely to be opposed by the richer states as it implies a reduction in their shares. Many of the richer states complain that they are being penalized for their good performance because many of the centrally sponsored schemes aim at filling gaps which have already been filled in the richer states largely by their own effort earlier.⁵ The real problem is that there is no commonly agreed objective way of determining the degree of progressivity that is appropriate.

Govinda Rao (2013)⁶ points out that one criterion could be that transfers should equalize per capita socio-economic expenditures (mainly health and education) across states. This seems reasonable, but applying the criterion poses several problems in practice. First, determining the scale of transfers on the basis of what is needed to equalize per capita expenditures across states has to be based on some assurance that the state is doing what is possible within its fiscal capacity, and only the gap that remains must be met by transfers. Assuring achievement of a desired level of expenditure without ensuring that an optimal effort is made by the state itself would create incentives for non-performance. It is also difficult in practice to determine what an optimal effort by a state should be. It requires an agreed way of calculating capacity for revenue mobilisation and also an agreed way of determining the minimum other expenditures that need to be financed. Furthermore, fiscal capacity increases over time with growth, so the calculation of the base must take into account what an optimal development policy should have generated in terms of rising revenue resources for the state government. Moreover, the objective of achieving a desired level of socio-economic expenditure also requires some assumption about the time period over which this is to be achieved since increased expenditure needs to be supported by spending capacity which takes time to build up.

There is also a problem in determining the norm of desirable expenditures which states should be helped to reach. Equalising expenditures across states is impractical since states vary enormously in per capita income levels and social expenditure per capita in the richer states is bound to be higher, reflecting their greater fiscal capacity. This, in turn, raises the national average. Should fiscal transfers to each state aim at covering the gap between the level of expenditure per capita that the state is expected to achieve on its own and the average level in the country or should the target be specified not as the average but some other agreed minimum level? The latter seems more reasonable since it implies a national responsibility to deliver an absolute minimum standard to every citizen while allowing, the more advanced states to achieve higher expenditure levels per capita based on their own resources. This approach seems more reasonable as long as the minimum is fixed at a reasonable level, with the proviso that the minimum should itself be adjusted upward over time.

The problem can be illustrated with reference to Bihar. Per capita social expenditure in Bihar, as reported in Rao (2013) is about Rs 2,900, whereas it is Rs 5,500 for the average of all states.⁷ If the objective is that transfers must make up the difference between the observed level of per capita expenditure and say, the average, it would imply additional transfers (above those already being made) to enable a 90 per cent increase in the scale of Bihar’s social expenditure. Applying the same principle to all states below the average would involve very large transfers to the poorer states, which may not be feasible within the overall resource constraints without drastically reducing transfers to the richer states.

In the absence of objective criteria of the type described above, to judge the appropriateness of the scale of transfers to poorer states, the debate will remain inconclusive. Poorer states will demand higher transfers because they are poorer, but in the absence of a consensus on what scale of transfers is justified, the better-off states will oppose any further reduction in their share. The problem is compounded by the fact that the debate takes place in two different fora – the Finance Commission once in five years, and then in the process of finalising Plan-related transfers in the Planning Commission and the National Development Council.

4. Recent Trends in Inter State Balance

We now turn to consider what the actual experience of growth in different states tells us about inter-state regional balance.⁸ Table 4 summarises the rates of growth of GSDP observed in the major states over the last four Five Year Plans. It is evident that in the earlier Plans, GSDP growth rates were lower in general, but they were especially low in the poorer states. Ashish Bose in the 1980s coined the acronym BIMARU to refer to Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh, the so-called ‘Hindi heartland’, which he claimed lagged behind the rest of the country in the matter of fertility decline and socio-economic development generally. Bose later added Odisha to this group because it shared the same characteristics, changing the acronym BIMAROU, which retained the pun although it diluted linguistic identity!

Table 4 establishes that most of the BIMAROU states performed poorly on growth up to the Tenth Plan, but their performance has improved substantially in recent years:

(i) Bihar was the fastest growing state in the Eleventh Plan period with a growth rate of 9.9 per cent per year. The comparison with the Eighth Plan growth rate of 2.2 per cent must be adjusted to take account of the fact that Jharkhand was part of Bihar in the Eighth Plan period. However, since Jharkhand also grew at 9.3 per cent in the Eleventh Plan, the combined growth rate of the two states taken together is still much higher than in the Eighth or Ninth Plan.

(ii) Madhya Pradesh, the second state in the BIMAROU grouping, performed better than Bihar in earlier years, and it too has improved over time. From a growth rate of 6.6 per cent for undivided Madhya Pradesh in the Eighth Plan period, the two states of Madhya Pradesh and Chhattisgarh grew at 9.2 per cent and 7.7 per cent respectively in the Eleventh Plan period.

(iii) Rajasthan shows variable performance. It grew at a robust rate of 8.0 per cent in the Eighth Plan period, but then lost momentum in the Ninth Plan when growth dipped to 5.3 per cent. However, it improved to 7.1 per cent in the Tenth Plan and then grew fairly robustly at 8.5 per cent in the Eleventh Plan.

(iv) Odisha presents a picture of steady acceleration similar to Bihar. Its growth rate accelerated from 2.3 per cent in the Eighth Plan to 9.2 per cent in the Tenth Plan, the fastest among the BIMAROU states, with a deceleration to 7.1 per cent in the Eleventh Plan.

(v) Uttar Pradesh, the largest of the BIMAROU states, shows variable performance. It grew at 5.0 per cent in the Eighth Plan, but then decelerated to 2.5 per cent in the Ninth Plan, recovering again to 5.8 per cent in the Tenth Plan and improving to 7.1 per cent in the Eleventh Plan.

A summary assessment of the impact of these differences in growth rates on inter-state inequality can be seen by constructing an inter-state Gini coefficient for each year as a summary measure of inequality across states ignoring the inequality of distribution within a state.⁹ Figure 4 shows the trend in the inter-state Gini coefficient over time. The pre-liberalization period clearly shows a more or less constant level of the inter-state Gini coefficient, suggesting no increase in inter-state inequality in this period. The first decade or so of liberalisation, i.e., the period from 1992 to around 2003, shows a distinct increase in inter-state inequality. This was clearly a period when the richer states on average did better than the poorer states. The richest state, Punjab, did not but many middle income states, notably Gujarat, Maharashtra, Tamil Nadu and Karnataka were able to take advantage of the liberalized economic environment and forged ahead, and the net result was an increase in inter-state inequality in this period. The period after 2004, shows some stabilization of inter-state inequality, reflecting the fact that the poorer states began to grow faster. Some states, e.g., Bihar, Madhya Pradesh and Odisha even exceeded the growth rate of the country as a whole, but UP, which has a large weight, has yet to achieve this outcome.

Figure 4: Inter-State Gini Coefficient

Source: Chapter 11- Regional Equality, Vol. I, Page no. 306, Twelfth Five Year Plan Document.

This is obviously not an easy outcome to achieve, since the more advanced states have many advantages such as a higher level of human resource development, better infrastructure, especially availability of power, better connectivity to domestic and international markets and also better urban infrastructure. It can be argued that differences in initial endowments only mean higher levels of income in the more advanced states, but not necessarily higher growth, since growth depends on the rate of change in these inputs, and it is easier to achieve faster growth at low levels. This is the basic logic underlying the much discussed hypothesis of convergence of income levels across countries. However, the cross-country literature on convergence also establishes that convergence comes into play only after some critical preconditions have been achieved, e.g., building of essential infrastructure and human resources which can support faster growth. In other words, there is little evidence of convergence, but stronger evidence for conditional convergence.

The experience of the Eleventh Plan suggests that we are not yet in a position to be able to claim convergence in per capita incomes. Some of the poorer states have indeed grown faster than the country as a whole, but since their population growth rates are higher, the differential between their GSDP growth and that of the economy has to be large enough to offset this effect. Only Bihar meets this criterion in the Eleventh Plan.

It is useful to consider what the Twelfth Plan targets for growth in the poorer states imply for convergence. As shown in Table 4, Bihar has targeted the highest growth rate of 10.0 per cent. Madhya Pradesh at 8.8 per cent and Jharkhand at 8.5 per cent are targeting faster growth than the 8.0 per cent national target, but since the growth of population in these states is significantly higher than for the country as a whole, the growth rates of per capita income in these states are not likely to be higher than the national average. Only Bihar, which is the poorest state, will show some convergence in per capita income if it achieves the Twelfth Plan target.

However, the pace at which convergence will be achieved is quite slow as can be seen from the following hypothetical calculation. If the Indian economy grows at say 7.5 per cent per year over the next twenty years (implying some moderation in GDP growth over the longer period compared with the Twelfth Plan target) and the population growth over this period moderates to around 1.2 per cent, the average per capita GDP of the country as a whole would rise by around 6.3 per cent per year. If Bihar achieves 9 per cent growth over twenty years, and its population growth decelerates to, say, 1.7 per cent over this period, its per capita GSDP would grow at 7.3 per cent, a full one percentage point above the national average. Even so, if this process continues for twenty years, Bihar’s per capita GSDP, which is currently around 33 per cent of the national average, will only rise to 40 per cent of the national average at the end of the period. This is the natural consequence of the fact that where initial differences in per capita GSDP are large, and the differential in growth rates is not very large, it will take a long time for initial differences in per capita GSDP to be narrowed.