India as a monetary union…how does it work?

Well, this thought never really came to mind till the European crisis. There are many comparisons between how EU is not an optimal monetary union (as in lacks the main features of a mon union – labor mobility, fiscal union etc) and how US is closer to the optimal mon union. (see this and this for some recent discussion). Canadian Blog pointed to some comparisons between CMU and EMU as well

But what about India? How does India fare as a monetary union? Barring some posts by Gulzar there is hardly any mention of bringing this monetary union debate in India’s context.

India is as diverse as Europe (could be much more) as we have such different  state identities and cultures. The economies of the states will also be different and effected by different shocks (see this paper by Arvind Subramanian which shows open states suffered more in the crisis). Deepak Mohanty of RBI has been enlightening us on economies of different states. We have a common central bank in form of RBI. In case of asymmetric shocks, how do things work?

There have been some recent developments which have made this a mouth-watering  research topic. West Bengal and Orissa were in a duel over centre’s help for their states. First, central govt promised WB for some financial help under its Backward Regions Grant Fund. Orissa government objected saying it needs funds as well and accused government of  favoritism . This was challenged by the centre saying to show how much funds Orissa got when NDA (as the Orissa government ruling party was an ally of BJP run NDA in 1999-04) was in power. Here are the links:

Today I came across this BS story which said Union Budget could look at fiscal help for few state governments facing financial difficulty:

Bailout packages for fiscally stressed states are in the works, as the government seeks to garner political backing for the key policy reforms it plans to fast-track after the five state elections. A senior finance ministry official involved in the process told Business Standard a high-level committee under expenditure secretary Sumit Bose had held consultations to identify measures to help West Bengal, Punjab and Kerala.

West Bengal Chief Minister Mamata Banerjee has been demanding a bailout package from the Centre to improve the fiscal situation of the severely debt-ridden state. The Trinamool Congress leader’s blocking of foreign direct investment in multi-brand retail and other policy measures of UPA-II is being seen, among other things, as a reaction to the delay in a bailout package for West Bengal.

The state government is scheduled to present its first Budget immediately after the Union Budget. The official said since it would be difficult for the Centre to help just one state, a comprehensive package for other states in trouble was being worked out. It would be developed keeping in mind the tight fiscal space available with the Central government, he said.

Hmmm. WB remains the same and we have new additions in Kerala and Punjab:

West Bengal is reeling under Rs 15,093 crore of interest payments and Rs 6,900 crore of prepayments for 2011-12. State finance ministry officials say the situation can’t be tackled by raising tax revenues. “The bigger picture is not manageable easily, with the state’s total debt at Rs 2 lakh crore — that can’t go away easily,” said an official.

“This unmanageable financial scenario inherited by my government can only be corrected by a large infusion of liquidity, particularly for non-Plan expenditure, in the form of a grant-based financial package,” Banerjee had said at a National Development Council meeting on October 22, 2011.

The fiscal situations of Punjab and Kerala also indicate the two states have financially deteriorated considerably (see chart). In the case of West Bengal, the government was likely to allow additional borrowing, proportionate to the borrowing the previous state government had done, and set a liberal fiscal deficit target, said the official associated with the process.

“Aid for Naxal-affected areas on the lines of the backward region grant fund for infrastructure development can also be part of the package,” he said. The centre is also considering writing off a part of high-cost borrowings from the National Small Savings Fund.

For most all this is plain political news. But for followers of the EMU crisis, all this is very interesting stuff.  It gives you examples over working of Indian fiscal union.

I just pointed to how US fiscal union has come about historically. It was a combination of many events which shaped the fiscal union of today.

It will be fascinating to read any paper/research on Indian fiscal union. How does it work? What are the rules (are there any?) under which centre gives funds to troubled states? How does this whole political economy work? If visitors have something useful reading  this, please share..


One Response to “India as a monetary union…how does it work?”

  1. One size fit monetary policy for US?? « Mostly Economics Says:

    […] EMU episode makes one look at all the countries. What about India? Here states are so different but RBI makes monetary policy for pan-India. It will be a nice […]

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