Archive for September 25th, 2012

One Europe, Many Tribes

September 25, 2012

A superb piece on Europe:

Italy, unified in 1870, is newer than Nevada. Spain was split down the middle by a civil war as recently as the 1930s. And reunited Germany, dating back only to 1990, is younger than two of the Jonas Brothers. Just a reminder that, for all their claims to antiquity, many of the nations of Europe have been nations for only the briefest of times. For most of history they were rivalrous territories, kingdoms, duchies, principalities, and city-states. They were bound by language and culture—and riven by tribalism.

As Europe’s financial crisis drags on, the tribes have returned with a vengeance. It’s not just Greece vs. Germany. Today it’s Sicily vs. Lombardy, Berlin vs. Bavaria, Andalusia vs. Catalonia. Keep this in mind as optimists point to the successes of the campaign for “more Europe,” such as the European Central Bank’s agreement on Sept. 6 to support the bonds of hard-pressed countries that comply with deficit reduction agreements. Europe is boiling over with regional grievances. Money is the issue—who gives it and who gets it. The 1999 launch of the euro has forced an unwanted intimacy on Europeans in flagrant disregard for Robert Frost’s poetic dictum: “Good fences make good neighbors.” And the euro entices separatists to strike out on their own, figuring even small nations can survive if they share a currency. (Malta, a euro-zone nation, has fewer people than Dublin or Dresden.)

The more you read on Europe politics and history the more intriguing and interesting it is..

Recent Evolution of India’s Fiscal Federalism

September 25, 2012

Fiscal union is nothing but Federalism by another name. It has become a huge area of interest for this blog. The idea is to understand the Indian federal system and figure how the union works. So expect a lot of posts on the matter going ahead.

In this regard, I found this superb speech by Dr Vijay Kelkar. Who better than Dr Kelkar who headed the 13th Finance Commission.  The speech is full of insights:

While describing federalism, people have described it in many ways. For instance, some scholars have described federalism as administrative federalism;” some have argued for “market preserving federalism” and some others have described it as “coming together federalism” vs. “holding together federalism”. Countries like USA are supposed to be examples of “coming together” federalism while India is supposed to be an example of “holding together” federalism.

In my view, the important feature of Indian federalism is what in India we call the “cooperative federalism” feature with formal and informal rules for maintaining the political system as well as for the peaceful change management. This is the feature that gives the “flexibility” to our Federation.

I think that it is this “flexibility” which helped the country to maintain unity while strengthening the democracy and I do believe that the democracy is one of the deep determinants of India’s growth performance. The U.S. constitution, over its 200 years or more of existence, has been amended only 27 times while in India, we have amended the Constitution 94 times in the first sixty years. In my view, this is the strength and not weakness of our system.


He explains the fiscal and horizontal imbalances. FinCom exists to ease these imbalances:

Since 1982, in the Canadian constitution, there is a clear mandate for horizontal “equalization”. Section 36(2) of the Canadian Constitution commits the federal government to the “principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonable levels of public services at reasonably competitive levels of taxation” and this exercise is done annually. In India, the Constitution does not give such clear instructions.

To meet these fiscal challenges of vertical and horizontal imbalances, our Constitution has created an institution called the Finance Commission, which is an independent Constitutional body, appointed every five years and which reports to the President of India.

Unlike the Constitutions of Canada or Australia, Indian Constitution does not give any precise guidance to the Finance Commission as to how horizontal equalization is to be achieved. In the absence of such guidance, each Finance Commission works out its own approach, devising a formula for sharing of the taxes, i.e. for vertical sharing and horizontal distribution. The recommendations are usually based on the Commission’s overall judgement for vertical devolution which takes into account the resource availability and needs of the Union government for fulfilling its own functions such as defence, internal security, debt repayment etc.

 How changes in FinCom assessment helped in 1991 reforms. Before 1991, basically the sharing formula was specified for indiv taxes like income tax, corporate tax etc. This created problems when economy was opening up:

Over time, India’s fiscal federalism has been flexible enough to change its structure. For instance, till 15 years ago, the Constitution envisaged sharing of revenues tax-wise; in other words, share could be at different rates for corporate tax, personal income tax or manufacturing taxes or import duties. This feature created a perverse incentive structure for India’s tax policy. For instance, this gave no incentive for central government to reduce import duties as constitutionally, it could retain all earnings from such import tariffs. When India embarked on its new economic policy in 1991, the Tenth Finance Commission recommended the pooling of all these taxes and have a common sharing formula in order to rationalize the fiscal system. In my view, this paved the way for India’s tariff reforms which saw one of the most dramatic reduction in tariffs when they came down from 150 per cent to 10 per cent. Similarly, the support to the third tier through Finance Commission grants has also given momentum to effective decentralization programme in India.

He then mentions how GST will help address the vertical imbalances..

Superb primer..Though lots to follow and read

Financial engineering is back: A feeling of Deja-vu..

September 25, 2012

It is deja-vu all over again. In the latter phase of UPA-I we had oil, fertilizer and food bonds. All these bonds were neatly kept off the government balance sheet masking the true fiscal deficit. Now we  have power bonds which will be structured differently and pose different challenges. In context of power sector, we had similar attempts in 2001 as well when we broke up utilities into generation, transmission& distribution legs. However, nothing much has changed since and we have another round of losses.

The new idea is a fascinating piece of financial engineering like earlier ideas. I was trying to make sense of the release. From whatever I could make out here it goes:


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