Covid fight will leave states exhausted. India needs to re-think its funds transfer system

Graded lockdowns are placing differing financial constraints on states. It is critical to re-consider the design of current inter-govt fiscal transfers.

At a UP quarantine facility | By special arrangement

States are at the frontlines in the battle against COVID 19. The key areas which need significant short and medium term interventions – health, agriculture and social protection – are state subjects. However, states are stymied by the lack of resources. In the last weeks, several options for increasing finances to the states have been tabled. This includes loosening fiscal responsibility limits on states, increasing ways and means advances, including making available a special zero interest window for a fixed period, a special COVID 19 grant window, as well as, speeding up and increasing central transfers for existing schemes.

The last route has not received adequate attention in the current debate on Centrally Sponsored Schemes (CSS) and Central Sector Schemes (CS). These sources of financing are critical because they are the primary means through which states spend in two key areas of expenditure relevant to dealing with the COVID-19 crisis – health and social protection. In health expenditure for instance, a significant proportion on non-salary expenditure (Salary expenditure accounts for upto 80 per cent of state budgets in some states) is financed through the National Health Mission (NHM). Similarly, key programs for social protection – like the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS), Mid-Day Meals, Integrated Child Development Services (ICDS), to name a few are financed through this window.

Need better financing model 

There are two challenges with this current mode of financing.

First, for most CSSs, states have to contribute a significant share of funds for the scheme from their own budgets (up to 50 per cent for supplementary nutrition under ICDS and 40 per cent for NHM). This puts a strain on state budgets.

Second, this scheme based model of financing functions on the principles of a centrally designed, one-size fit all model, which even in ordinary times, results in administrative fragmentation (there are over 600 CS schemes alone) and undermines state flexibility. Fragmentation is also an impediment to designing a portable social protection mechanism for migrant workers as multiple schemes are mapped to multiple ministries with different fund flow and targeting requirements.

Further, this centralised and fragmented financing does not accommodate for the specific challenge that COVID-19 presents. COVID-19 outbreaks will be localised within states, placing differential financial needs linked to state specific health capacities and socio-economic profiles.

Moreover, the economic impact of periodic lockdowns (even in a graded lockdown approach) will place differing financial constraints on states. Responding to COVID-19 thus requires a differentiated but co-ordinated response to all aspects of the crisis from health to social protection, akin to a pooled financial system.

NEED Council

Against this backdrop, it is critical to re-consider the design of the current inter-governmental fiscal transfer system for responding to the health and social protection needs of COVID 19. We propose a reformed architecture, based on the principles of decentralisation, consolidation, and convergence. The institutional foundations of this reformed fiscal structure will lie in the creation of a new emergency council, within the fold of the currently moribound Inter-State Council.

We thus propose the establishment of a National Empowered Emergency Disaster Council (NEED Council).

This is envisaged as a political body of Chief Ministers, the Prime Minister and senior central ministers. The composition is similar to that of the Interstate Council (ISC). One can conceive of a mechanism where the ISC functions as the NEED Council, in the same manner as the Election Commission of India takes over the administration, during an election.

The NEED Council should be supported by the National Disaster Management Authority and a COVID specific, NEED funding window should be created through the NDRMF (the NDRMF could be temporarily redesigned for COVID 19). The NEED Fund should include three elements:

1. A base fund (fixed % of GDP) that is immediately accessible to both Centre and states (this should include NDRMF allocations)
2. Funds received from repurposed CSS expenditure. The extent of repurposing can be in tranches, based on the severity of the crisis. The centers’ current relief package, which is being implemented through individual CSS should be subsumed into this structure.
3. New funds made available through deficit financing, new tax revenue (e.g., increased excise on petroleum), international institution loans, e.g. from multilateral financial institutions

Specifically, for social protection related programs, we propose a technical sub-group that will be constituted under the NEED council. This group will be responsible for arriving at a consensus on a broad basket of core social protection schemes , agree upon fiscal transfer formula, devise a coordination mechanism for handling payments linked to inter-state migrants (this would include reconciling invoices raised by destination states to the states of domicile) and sharing best practices.

The NEED council will also be the primary body for monitoring and reporting on expenditure.

Once the functioning of the council has been established, the formulae must be revisited linked to the nature of the COVID 19 outbreaks and specific economic hardships being experienced in states.

Repurposing CSS and CS

Against the backdrop of the COVID-19 crisis, the focus needs to be on three key areas of grant support to states: health, both to deal with the immediate crisis, as well as to ensure non-COVID related health shocks do not occur (we are already seeing a famished Tuberculosis campaign); food to provide basic food security for vulnerable populations; and cash, for everything else.

The current approach adopted by GoI for financing relief measures is through the Pradhan Mantri Garib Kalyan Yojana. An alternative approach is to support states by buttressing their efforts through an untied grant window in the NEED council.

This can be achieved by bundling together the CSS and CS into an untied grant fund for states to draw from, without being constrained by central guidelines and line item budgeting.

The state share could be redesigned as a long term zero interest loan from the center to states, to be repaid in the fiscal year 2021-22 (or when the crisis abates).

Pooled central scheme funds can be re-allocated to three specific thematic grant windows:

1. Health:Current NHM budget (Rs. 34,115 crore) can be supplemented by temporary expenditure switching from infrastructure related CSS such as PMAY, SBM, JJM and PMGSY. All non-salary funds from these programs for the first 2 financial quarters of the current FY should be additionally allocated to ensure adequate health infrastructure in states, including for upgrading health and wellness centers and PHCs to operate as fever clinics.
2. Food Security and Livelihoods:The critical input to food security is coming from state governments, many of whom have set up community kitchens for migrant workers, expanded mid-day meal schemes and other state specific feeding programs. These need additional funds. To provide these funds, the PMGKY should merge all targeted food and dry ration related schemes (Mid-Day Meals, supplementary nutrition component of ICDS) in to a single food security window that states can draw from to supplement their own food related initiatives. This will be in addition to enhanced provisions made through PDS.
3. Cash for social protection:Rather than the current fragmented approach of the PMGKY (providing Rs. 500 in to Jan Dhan Accounts,) funds currently allocated across scholarships, pensions, maternity benefit and wage payments under MGNREGS (for places where work sites aren’t open – either because of difficulties in opening sites with social distancing or in places where districts are declared hotspots) should be pooled into one single bucket to ensure additional cash directly to beneficiaries (to all JDY and MGNERGS bank account holders, or alternatively, go universal in spatially targeted poor areas).

NEED’s institutional home

The institutional home for NEED raises important caveats that need consideration in the long term. The ISC is the obvious home, because it is a political body of CMs and activities such as this fall firmly within its mandate.

Regardless of what the final institutional anchor for the NEED council is, a few core principles must guide its institutionalisation and functioning. These are:

*Establish expectations of the mechanism in advance, in order to ensure consensus building is possible.

*Establish collective executive leadership of the process and the institutions involved.

*Share power and responsibility across States and political parties, to ensure it is seen as non-partisan.

*Establish principles of transparency and participation in the process and functioning of the council.

This article has been extracted from a research note prepared by the Center for Policy Research. Read the full report here.