236 India Infrastructure Report 2003 9 RURAL INFRASTRUCTURE 9.1 IRRIGATION SUBSIDIES A. Vaidyanathan Huge and soaring subsidies, mostly in the form of unrecovered costs of goods and services provided by the public sector, are among the main causes underlying the fiscal crisis confronting the central and the state governments. In 1994–5, according to a recent National Institute of Public Finance and Policy (NIPFP) study, the total subsidies (implicit and explicit) of the central and the state governments amounted to Rs 1,27,400 crore (Srivatsava and Sen, 1998). By comparison, the public sector plan outlay in that year was Rs 98,200 crore and the gross fiscal deficit Rs 71,600 crore. The critical importance of reducing subsidies for restoring the fiscal health of the public sector hardly needs any emphasis. Subsidies under the head ‘irrigation’ amounted, in 1994–5, to around Rs 14,000 crore or about one-eighths of the total. Roughly half of this is on account of minor irrigation works and flood control and drainage projects. Major and medium projects, which are the focus of this section, account for somewhat over half of this figure. Up to the end of that year cumulative investments in this sector—mostly by state governments—amounted to around Rs 45,000 crore. Operating costs (including operation and maintenance (O&M), depreciation, and interest on capital) amounted to Rs 7600 crore, of which, only Rs 440 crore were recovered from users, leaving a loss of Rs 7200–7300 crore to be borne by their general budgets. This paper was discussed at a Conference on Fiscal Policies to Accelerate Economic Growth organized by the National Institute of Public Finance and Policy, May 2001. The author thanks the NIPFP for their permission to publish it in this report. SUBSIDIES AND THEIR ORIGIN Historically, under colonial rule, the government invested in irrigation only if it could provide a reasonable rate of financial return after covering operating costs. This policy had undergone a gradual change. Initially this criterion was relaxed for ‘protective’ works in areas liable to severe droughts and recurrent famines. Subsequently social benefits of irrigation by way of increased agricultural production and their indirect beneficial impact on the rural economy and government revenues came to be accepted as justifying investment in irrigation. Under planning, social cost–benefit analysis came to be officially accepted as the basis for public investment decisions in this sector. The requirement regarding a minimum financial return was dropped. At the same time it was recognized that beneficiaries of public irrigation projects should meet the costs incurred for providing water. Besides water charges based on area and crops irrigated in each season, most states had also passed legislation requiring beneficiaries to pay a betterment levy to capture a part of the increase in productivity and capital value of land due to irrigation. The betterment levies did not yield much, mainly because the law was not enforced. Diluting Recovery In the early 1970s, a National Irrigation Commission, appointed by the Government of India (GOI, 1972), argued that accepting social cost–benefit evaluation as the basis for investment decisions does not minimize the ‘importance of securing an adequate return from investment to irrigation projects’ and recommended that ‘the financial return of a Rural Infrastructure 237 project should also be examined at the time of approval and, if found inadequate to cover working expenses and indirect charges, water rates should be raised.’ In the event, the state governments did not comply with these guidelines and losses incurred on account of public irrigation increased rapidly. This trend was noted with concern by several official committees and, in particular, successive Finance Commissions. While emphasizing the necessity for improving cost recovery, they also progressively diluted the standards of cost recovery. Thus, the interest charges to be recovered from beneficiaries was lowered from 2.5 per cent of investment recommended by the Fifth Finance Commission to 1 per cent by the subsequent two commissions. Faced with failure to meet even this target, the Eighth Finance Commission chose to dilute it further and exhorted the states to ensure that at least the maintenance costs be recovered. But few states were willing to comply even with this. Thus, in 1977–8, revenues from water charges under1 major, medium and multi-purpose works were around Rs 100 crore which fell short of working expenses (costs of O and M) by nearly Rs 30 crore. Inclusive of interest on accumulated investments in that category of works up to that year (at the average interest rate on the outstanding debt of state governments as a whole) and depreciation (at 1 per cent of the cumulated investment, the loss amounted to Rs 420 crore). By 1994–5 the latest year for which data on revenue and operating expenses are available—total recurring costs (inclusive of depreciation and interest) had increased fourteen-fold but revenue realizations increased somewhat less than four-and-a-half times. Overall losses in 1994–5 were around Rs 7,000 crore compared to Rs 430 crore in 1977–8. Since then the situation has certainly has deteriorated further2. and allowances. In fact there is widespread complaint that increased salaries have cut into the amounts available for carrying out maintenance and repair works. Inadequacy of funds for this purpose is invariably cited as the reason for deterioration of the systems and the quality of service they offer. Capital costs rose because of three factors: general inflation; new projects being in more difficult locations; and higher costs of borrowing. According to Central Water Commission (CWC) estimates (GOI, 1998), between 1976–7 and 1993–4, there was a four-fold increase in construction costs due to increases in prices of material and labour. Adjusting for inflation, the average investment per hectare of addition to irrigation potential rose two-anda-half to three times.3 Since interest on investments outlays during the construction of a project—and large irrigation projects take several years to complete—are not included in project costs, these figures understate the cost of irrigation projects to a significant extent. The average cost of government borrowing, which was less than 4 per cent in the early 1970s, has also risen sharply following change in the government’s interest-rate policy in 1974. It averaged 5.6 per cent in 1977–8 and was a shade more than 12 per cent in 1993–4. Revenues have not kept pace with costs: collections which were just under Rs 100 crore in 1977–8 rose to Rs 140 crore in 1987–8 and an estimated Rs 490 crore in 1994–5. In 1977–8 revenues covered three- fourths of the ‘working expenses’ but only a sixth of the total cost (including interest and depreciation). By 1987–8, revenue covered barely a quarter of working expenses, and 6 per cent of total cost. The position has vastly worsened since: the recovery rates in 1993–4 fell to less than 15 per cent of working expenses and 5 per cent of the total cost. Cost Inflation The main reason of course is that water rates have become a political hot potato and (along with electricity) a major focus of competitive populism. Raising water rates is seen as an invitation to electoral disaster and few governments, irrespective of party affiliation, are willing to take the risk. The Committee on Pricing of Irrigation Water (GOI, 1972) noted: Revision of water rates has been infrequent, hesitant and very much less than the increase in costs. For instance, water rates in Tamil Nadu were last revised thirty years back. In Punjab, Kerala, Haryana, Jammu and Kashmir, Both working expenses and capital charges have increased at a rapid pace. Working expenses have increased from around Rs 130 crore in 1977–8 to an estimated Rs 1700 crore in 1994–5 partly due to expansion in the number of staff but mostly on account of the steep rise in salaries 1 It is not clear whether cesses on irrigated crops are fully covered by this estimate. In some cases (for example, Tamil Nadu) areas irrigated by old projects do not pay a separate water fee. Instead it is integrated into the land revenue assessment which is not included in the above figures. Revenue from sale of water from irrigation projects for non-agricultural uses is also not covered. The degree of underestimation on these accounts is, however, unlikely to be large at the national level but could be significant in some states. 2 NIPFP is currently in the process of updating the estimation up to 1988–9. ‘Populism’ 3 At a rough estimate cumulated capital investment in major and medium irrigation at current prices increased 7 ½ times between 1977–8 and 1994–5 and by about 3 ½ to 4 times in constant prices. During that period irrigation potential of these projects increased from 24.7 mha to 31.8 mha, that is, by about 30 per cent. 238 India Infrastructure Report 2003 Table 9.1.1 Estimated Losses on Account of Major and Medium Irrigation and Multi-purpose River Valley Projects, India (Rs crore) 1977–8 1 2 3 4 5 6 7 8 9 10 Gross Revenuea Working expenses a Depreciation b Interest on Capital c Total cost (2+3+4) Deficit (5-1) Cumulative investments in major and medium multipurpose river valley projects d Total outstanding debt of states e Total interest payments f Average interest rate period (9)/(8)*100 1987–8 1994–5 97 127 60 336 523 426 6000 139 493 223 1787 2500 2361 22300 440 1700 450 5330 7480 7040 44900 4700 822 560 60720 4879 800 160000 19410 12010 Notes: aCWC estimates. Figures for 1977–8 and 1987–8 as cited in GOI, 1992 for 1994–5 as cited in Srivatsava and Sen, 1997 p. 7. Planning Commission estimates for working expenses in 1994–5 is Rs 2970 crore which seems primafacie high. We have used a lower figure based on the assumption that working expenses of major and medium works grew at the same rate as total revenue expenditure on all Irrigation and flood control projects. b1 per cent of cumulative investments up to end of each year. cComputed by applying an interest rate (row 10) to corresponding figures in row 7. dCWC 1998, p. 267, investment in 1994–5 estimated at Rs 4500 crore. e&f various issues of RBI’s annual reports on Currency and Finance. The estimated losses in this table differ from those given in other sources notably GOI, 1992, Mundle and Rao, 1991 and Srivatsava and Sen, 1998. The estimates of the Committee on Irrigation Pricing (GOI, 1992) for capital charges are based on cumulated investments up to three years before the year indicated in each column while the figures in this table are based on cumulated investments up to and including each year. There are also some differences in the estimated average interest rates. Estimates of Srivatsava and Sen cover not only major, medium and river valley projects but also minor irrigation, flood control, drainage and command area development. Estimates of capital charges by CWC (1998) and that of Planning Commission for 1994–5 (cited in Srivatsava and Sen, 1998) do not include depreciation and use lower interests rates. and Himachal Pradesh, there has been no change since the mid-1970s. Several (including Andhra Pradesh, Bihar, Gujarat, Karnataka, Madhya Pradesh, Orissa, Rajasthan, Uttar Pradesh and West Bengal) announced revisions during 1981–6. But the implementation was held up in some (eg. Gujarat, Karnataka) by the government. In the case of Andhra Pradesh stay orders from courts prevented implementation. The rate increases were themselves rather modest and no state has accepted, much less implemented, the Irrigation Commission recommendations by reviewing and adjusting rates every five years. Only Maharashtra has, within the past year broken from this pattern both in terms of magnitude of increase in rates and announcing a graduated increase every year for the next five years. More recent information compiled by the Planning Commission4 shows that the situation has not changed materially. Uttar Pradesh and Bihar announced revisions in 1995 and Andhra Pradesh in 1997. Maharashtra has maintained its policy of graduated increase over several 4 Thanks are due to B.N. Navalwala, Adviser, Planning Commission, for making this information available. years. But at least one state, Punjab, has decided to give water free. There is no authenticated data on their implementation or impact on revenues. Whether even these revisions in states like Maharashtra and Andhra Pradesh will be large enough to meet soaring costs (narrowly defined to cover working expenses with adequate provisions for routine maintenance and repair works but excluding capital charges) is in doubt. Not only were rates not raised, but experience has also shown that enforcement of the prescribed rates is far from strict. There is ample scope in the existing arrangement for collusion between officials and farmers leading to understatement of area irrigated, especially of area under crops carrying higher rates. Laxity in assessment is compounded by laxity in collection. The committee on Pricing of Irrigation Water found that actual revenue collection fell short of demand (that is, assessments) in a majority of states. During the late 1980s there was little or no shortfalls in Haryana and Punjab. They were marginal in Uttar Pradesh and substantial (ranging from 27 to 70 per cent) in the others. Accumulated arrears—which do not include remissions and waivers granted by governments Rural Infrastructure from time to time—were found to be nearly as large as the annual demand in some cases, and three to four times in several states. Little wonder that losses on account of irrigation have recorded a phenomenal increase.5 IMPROVING COST RECOVERY The situation is clearly untenable and unconscionable. Untenable because of the huge and mounting fiscal deficits of the state, which have severely constrained their capacity even to maintain, let alone increase, investments in expansion and improvement of social and economic infrastructure. Unconscionable because a good part of the unrecovered costs is in the nature of continuing subsidies to farmers whose income increase substantially as a result of irrigation. Moreover, a large proportion of benefits go to relatively better-off farmers. The resulting squeeze on public resources means less investments in extending and improving irrigation, education and health facilities, and other schemes for the benefit of other, less fortunate, groups. Measures to reduce the un-recovered costs of public irrigation are therefore imperative. Raising water rates has to be an essential and important component of these measures but not the only one. A number of other related issues need to be clarified before deciding the extent and pattern of increases in water charges. Beyond O&M Recovery The notion that it is enough to recover (O&M) costs is ill founded. Amortization and interest on capital invested in the projects are as much part of the cost of providing irrigation as the working expenses. Governments can afford to consider bearing part or all of it if they have substantial revenue surpluses in their budgets. Even then, whether beneficiaries of public irrigation systems are more deserving of subsidies than others is questionable. The case for such subsidies is totally untenable when indiscriminate subsidization of public services, financed almost entirely out of borrowings at high interest rates, are the major reason for governments budgets being in the red. So long as the revenue budget is in deficit and public investments cannot be maintained at levels needed to sustain a reasonable rate of overall growth, the principle of full cost recovery must apply to irrigation and indeed to many other goods and services provided by the public sector. Exclusion of Waste from Cost Assessment But fairness also requires that users be charged on the basis of investments required, at reasonable levels of efficiency, 5 For details see chapter 6 in GOI, 1992. 239 to provide them with water. This means that investments in ongoing works, which are yet to begin delivering water, must be excluded while fixing rates. More important, users must not be required to bear the costs of over- capitalization due to over design, poor design and inefficiencies/leakages in construction. There are innumerable instances where the actual area irrigated turns out to be much less than expected because of over-estimation of water availability, failure to enforce crop patterns on the basis of which the project was designed, and because transmission and distribution losses are higher than assumed. It is difficult to assess, even approximately, the magnitude of the adjustments to allow for these factors. In the absence of an independent and objective assessment of what a reasonably well-designed and efficiently executed project would cost, adjustments will necessarily be arbitrary. The suggestion by the Committee on Irrigation Pricing whereby the basis at tim (t) is taken as the cumulated investments up to year (t – 3) is one way. Another will be to leave out investments which have not yet resulted in additional irrigation. Either way the base for estimating capital charges to be recovered for users will be substantially smaller than the total cumulated investments to date. As for working expenses, establishment costs are high because of over-staffing, and relatively high salaries. The sharp increase in salary level in the last two decades has been a major reason for the rapid increase in working expenses. On the other hand there are complaints that the number of staff for maintenance and water regulation at the ground level as well as outlays on maintenance/repair works is grossly inadequate and that the works done are costly and of poor quality. What the optimum level of expenditure on regular maintenance should be depends to a significant extent on the manner in which the activity is organized and managed. The present system depends entirely on the state beauracracy which, besides being expensive, has little incentive to manage costs. With appropriate autonomy and financial responsibility, a significant difference in maintenance and performance can be expected especially if users have a stake and actively participate in management. While users at present have little financial stake in the systems which supply them water—and this situation is unlikely to change significantly—experience (notably in Andhra Pradesh) has shown that entrusting responsibility for state-funded maintenace works to water-user associations makes a significant improvement in terms of relevance and appropriateness of works as well as their quality and cost. Making users associations bear the responsibility for both funding and execution of maintenance and repair below the outlet level could be one way of improving cost recovery6. 6 For a case study of water users managing the distributories of the irrigation system in Orissa see Chapter 9.2 by Binayak Rath in this report. 240 India Infrastructure Report 2003 This is neither novel nor radical: local irrigation systems in India have a long tradition of user management and users meeting the cost of maintenance, repair and beneficiary contributions in the form of labour, cash and material besides involvement in the organizations. Even after adjusting for all the above factors, current levels of revenue realized are likely to fall well short of required level. Full cost recovery in 1994–5 (with capital charges based on cumulated investments up to the end of 1991–2) calls for a ten-fold rise in actual collections over current levels. It is clearly difficult to get politicians to even consider, leave alone implement, a steep revision in one go. A graduated approach is thus essential. The first step would be to rationalize the existing area-based rates on the basis of the relative irrigation requirements by season and crop in different regions. It would approximate to a volumetric charge without actually having to measure volumes delivered to individual users. This could be followed by the strategy adopted by Maharashtra whereby a progressive increase in rates over a five-year period is announced in advance. This way users can be given clear advance signals of the government, long-term aims regarding the level of cost recovery, as well as reasonable time for them to adjust their use patterns accordingly. Indexation of Tariffs The aim should be to give a clear indication that full cost recovery is to be achieved over a period. For this purpose, governments should adopt a policy of automatic indexation of water rates to O&M costs or product prices. If such a policy had been followed from the 1970s, the increase required to meet capital charges would have been more manageable. Thus, the Wholesale Price Index (WPI) in 1993–4 was nearly four times the level in 1977–8. Assuming no change in collection efficiency, indexing water rates to the Wholesale Price Index would have raised revenues to Rs 2100 crore by 1993–4, compared to the actual realization of Rs 450 crore. The required realization for full cost recovery would have been only 2½ times the collection on the basis of indexed rate which is far less formidable compared to the ten-fold rise needed on the basis of current realizations. Graduated additions over the indexed rate could then be made in such a way that capital charges can also be recovered fully over a specified period of ten years. The credibility of the government’s intention about its goal and its seriousness about fairness to users will be enhanced if a mechanism is created for an independent review of reported investments in all projects to allow for over-design and inefficiencies in determining the base for determining capital charges. Such an approach has, however, to contend with the argument that an increase in rates should not be disproportionately large in relation to the increase in productivity due to irrigation and that steep increases will not be justified unless the quality of irrigation service improves significantly. In this connection, it is worth noting that on the average, during the early 1980s, a hectare of irrigated land produced Rs 2400 more than a hectare of rain-fed crops.7 Assuming that on the whole, average productivity per hectare has been rising at the same rate on both categories of land, the difference, at 1986–7 prices, in the early 1990s would be around Rs 3200 per hectare. Adjusting for price changes—WPI for agricultural commodities roughly doubled between 1986–7 and 1994– 5—the differential in 1993–4 would be around Rs 6400 per hectare. The realization of irrigation charges from major and medium works in that year averaged around Rs 200 per hectare which amounts to about 3 per cent of the incremental productivity of irrigated land. Full cost recovery, which calls for a ten-fold rise in revenue, would mean that farmers will have to pay nearly 30 per cent of the incremental productivity of irrigated land as water charge. This would naturally be considered unreasonably high. However, one must also bear in mind the following factors which reduce effective incidence even at current low rates: (1) The above estimates of the differential between irrigated and rain-fed productivity is understated; (2) there is considerable under recording of total area irrigated by major and medium works, especially of area under crops carrying higher rates; and (3) the assessed dues are not fully collected. They underscore the importance of scrupulously strict assessments of crop-wise areas irrigated and of ensuring that dues are collected fully and promptly. In both respects the quality of governance of irrigation systems leaves much to be desired. Convergence to Full Cost Recovery The extent of rate increases will obviously depend on the incidence of under-assessment and leakages. The extent of the latter is not known; they are also likely to vary a great deal between regions. It is, therefore, essential to commission a systematic and objective assessment for each system of the area actually receiving irrigation, the area under various crops and their productivity. Even after these adjustments, there is no doubt that full cost recovery will mean a substantial increase in the incidence of water charges relative to output at current levels of water use efficiency and productivity. Phased raising of rates must, therefore, go along with measures to make fuller, more effective use of available 7 This is based on a simple average of estimated productivity of irrigated and rain-fed cropped areas. They relate to the period 1979– 83 and valuations are at 1986–7 prices. For details, see Vaidyanathan et al., 1994. Rural Infrastructure water and for managing its allocation and scheduling to achieve higher output per unit of water use. That there is much scope for both is widely recognized but seldom quantified. Data on actual water deliveries and area irrigated for a number of projects (Table 9.1.2) suggest that the amount of irrigation water used is in most cases far in excess of the deficit of rainfall relative to crop water requirement. Rules and criteria for allocation/scheduling are fuzzy and enforcement notoriously lax. Systems are not equipped with engineering structures to permit effective regulation of water distribution according to such rules as there are; water delivery is amenable to change through influence and pressure; and few systems can ensure that timing and quantum of water supply is so managed as to achieve the maximum impact on productivity. There is large scope and need for a major overhaul of the distribution network, repairing and installing devices for regulating water deliveries to different segments and redesign of the networks in the light of actual experience in respect of water yield, losses in conveyance and application, crop patterns, and conjunctive use of water. This needs to be accompanied by reformulation in clearer and more precise terms of rules regarding crop pattern and delivery schedules as well as a restructuring of the organization to achieve greater transparency and tighter management. These measures, which together should make a substantial difference to the productivity of water, need to be accompanied by measures to ensure stricter assessment and collection of dues. All this will reduce the effective incidence of full cost recovery rates in relation to output and income of the beneficiaries of irrigation and help make the case for rate enhancement stronger and more persuasive. 241 Committee on Irrigation Pricing It is on the basis of the above reasoning that the Committee on Irrigation Pricing stressed the necessity to view the strategy for reform of water pricing as part of a larger programme of modernization of irrigation systems and the restructuring of their management. Large investments will of course be needed for physical improvements; and they should command higher priority than construction of new systems. The planning of these works also needs considerable improvement based on the experience of the National Watenr Management Projects (NWMP) projects and using better data and more sophisticated analytical tools. But far more challenging is the task of restructuring the management. Experience has amply demonstrated that the present system, whereby the government assumes the responsibility from conception through design, evaluation, financing and construction of irrigation systems as well as their continuing management, wholly through its bureaucracy, is incapable of achieving the above objectives. The entire process at every stage is far too opaque, open to interference and manipulation, without any effective incentive or mechanism to ensure economical use of resources in construction and management or to ensure that costs are fully recovered. Besides introducing transparent criteria and procedures to judge the soundness and viability of projects before they go on stream, the management of systems must be insulated from external interferences from politicians, the bureaucracy, and the local power centres. Users Involvement Beneficiaries of projects (new ones as well as modernized old ones) must be required to contribute a share of the Table 9.1.2 Frequency Distribution of Irrigation Depth in Selected Projects/States State Andhra Pradesh Karnataka Madhya Pradesh Tamil Nadu Season Kharif Rabi Kharif Rabi Kharif Rabi Kharif Rabi PET minus 80% of rainfall1 Nil or NA .135 .497 .164 .496 .138 .369 .342 .357 – – 2 8 9 2 7 – No. of Projects by Depth of Irrigation in Metres 0–0.2 – – – – 2 1 – – 0.2–0.4 1 – 1 1 2 2 – – 0.4–0.6 – – 2 2 – 3 1 1 0.6–0.8 1 4 5 5 3 8 3 6 2 1.0-1.5 1 2 6 4 – 3 4 6 <1.5 6 3 3 2 2 2 1 3 Notes: 1Maximum estimated values among different agro-climatic zones of each state computed from annexure 7 of GOI, 1992 2Computed from Annex 4.1 of GOI, 1992 3Kharif 15 June–15 October 4Rabi 15 October–15 March 242 India Infrastructure Report 2003 costs (which is necessary to give them a sense of stake and ownership).8 This can take the form of direct contributions in the form of labour, cash or materials for the project as a whole; entrusting the responsibility for constructing field channels and preparing lands below the outlet level for irrigation; or compensating the displaced people by giving a part of their land. The sense of stake will be enhanced by ensuring that potential beneficiaries as well as those adversely affected are consulted in deciding the basic operational rules (governing the damarcation of areas to be benefited, compensating project-affected people, allocation between different uses, permissible crop patterns and scheduling of water under different contingencies). The continuing management should be entrusted to autonomous organizations with powers to make, change and enforce rules, levy and collect water rates on condition that they become financially self-reliant. Table 9.1.3 Illustrative Calculations of Increase in Collections for Full Cost Recovery in 1994–5 Rs crore Costs Working expenses Depreciation1 Interest ALL Revenues Actual realization Potential revenues with index rate at current level of enforcement2 Potential revenues with index rate and strict enforcement 3 1700 340 4080 6120 440 1850 2310 Notes: 1Based on cumulated investment up to end 1991–2 (Rs 33,700 crore). 2Wholesale price index in 1994–5 was 4.2 times the 1977–8 level 3Assuming 20% leakage due to under-assessment and laxity in collection, this was the average shortfall as per cent of demand in 10 states during 1986–90 (GOI, 1992: chapter 5). The internal structures of these organizations must be such that user representatives participate in all levels and functions of management. While contribution to capital costs gives them a sense of ownership, involvement in management provides them space and opportunities to evolve generally acceptable allocation rules/criteria, monitor the actual performance of the system and resolve conflicts through a process of internal negotiation and compromise. It also provides a better mechanism for adapting rules in the light of changing conditions. The intention behind the suggestion to have user associations at different tiers and the insistence 8 The subsequent suggestions are essentially a summary of the detailed recommendations of the Committee on Irrigation Pricing. on well-defined contracts between them and the system management defining their respective entitlements and obligations, is also aimed to create strong internal incentives for efficient and accountable management. PROSPECTS FOR REFORM To outline a plausible, coherent package of reforms is one thing and getting it implemented is quite another. Political parties are still, for the most part, unwilling to confront the issue of cost recovery in water (or, for that matter, in most other sectors), much less to seriously discuss raising user charges. They continue to see any attempt to do so as suicidal. At the same time there are signs that the perilous condition of state finances and the inability to find resources for socio-economic infrastructure to support growth and poverty alleviation is forcing at least a few of them to address the issue. There are also signs—as yet limited and diffused— of farmers taking active interest in improving the quality of irrigation. The creation of water-user associations and the declared commitment of the governments to ‘turn over’ management to users seems to have kindled both awareness and interest in these matters among the farming community. Properly mobilized through persistent and patient efforts on the part of the media and the political leaders to explain the necessity and rationale for reform—could build a strong grassroots, pressure for reform. Turning Point? Fairly wide-ranging organizational reforms are already on the agenda of several states: Andhra Pradesh, Orissa and Tamil Nadu have enacted legislation envisaging major changes in the organization for water development. Some—notably Andhra Pradesh and Maharashtra—have taken significant and, given the current political situation, bold steps to raise water rates. Andhra Pradesh has perhaps gone the farthest in implementing reforms: It has legislated water-user participation at all levels of each major and medium irrigation system; and legislation has been followed by elections. It also shows that given strong backing from political leaders in government, the attitude of the bureaucracy can be changed from one of cynical indifference to a positive and active interest in reforms and serious engagement in addressing the problems they throw up. As already noted, entrusting maintenance and repair to the local WUAs rather than contractors has given a strong sense of involvement on the part of users resulting in speedier completion of works at lower cost and better quality than under the earlier dispensation. However, as yet, much remains to be done. The precise functions of the management committees at the higher levels of each system, the relative roles of the government officials and user representatives in decisionmaking, the powers of the system-level boards in deciding Rural Infrastructure operational rules, procedures, rates, etc. and the relation between the system-level organization and the government remain ill-defined. There is still reluctance to committing the 243 government to the principle of full cost recovery and a clear time-frame for achieving the objective. The really difficult task of restructuring irrigation management still lies ahead. 9.2 PEOPLE’S PARTICIPATION FOR EFFICIENT AND ACCOUNTABLE MANAGEMENT OF IRRIGATION SYSTEMS Binayak Rath While the Irrigation Department regulates the demand and supply of water, the cropping patterns are suggested by the Agriculture Department and the collection of water rates and cess is vested with the revenue administration! This fragmentation leads to none of the departments being fully responsible for revenue collection. Management of public irrigation systems has been problematic, and only a fraction of the gains possible in agriculture are realized. Improper pricing of water has been recognized as one of the key problems in this mismanagement. Recoveries today do not even cover operations and maintenance (O&M) costs. Other aspects of dysfunctionalities in the system are not widely recognized. Recognition of the potential of the participation of farmers and civil society in conceptualization and design as well as O&M of the irrigation networks, which could have made possible easy solutions in management, is only the beginning. In spite of significant physical achievement of acreage covered under irrigation, the country faces the paradox of droughtflood-drought, syndrome that severely affects agricultural production and yields. It is estimated that while one-third of our land is subjected to drought one-eighth of cultivable land is subjected to flood. One can say that the state management of irrigation projects has failed miserably in our country. It was even noted by the Public Accounts Committee on Irrigation (1983): ‘The entire planning process of irrigation project is faulty. There have been serious slippages in major and medium irrigation projects.’ There are instances when the authorities find it difficult to operate and maintain projects with the amount of grant received from the Government budget (Rath, 1993; Mitra, 1998). There is no incentive for efficiency or accountability in the system. In addition to many planning and design-level problems, administrative problems arise during execution and O&M of the projects. In view of these problems, the National Water Policy, 1987, had laid great emphasis on farmers’ participation in irrigation management. In the post-liberalization period, the World Bank, which had supported our irrigation development and funded our Command Area Development Approach (CADA) programmes, have urged the Government of India to bring in a people-centric approach (World Bank, 1993). Since water is a state subject in our federal structure, many state governments have announced their water policies in tune with the National Policy with a focus on participation of farmers through institutional arrangements such as Water Users Association (WUA) Pani Panchayats (PPs). We examine the scope of the PP scheme introduced in 1996 and its impact on efficiency and accountability through a case study of the developments in Orissa. PANI PANCHAYATS Despite Orissa’s endowment of vast water resources in its river systems, almost every year it faces the problem of drought or floods. Proper management of its irrigation and flood control systems could have mitigated these problems. Many of the older irrigation systems operate far below capacity due to poor management. Shortage of funds and poor maintenance have similarly made many irrigation schemes defunct. The present practice of budgetary allocation based on ayacut-certification by the revenue authorities, low water rates, collections in which the department has no role to play, poor incentives for people to use water optimally, are the main causes of poor performance of the irrigation projects. Poor functioning of CADA could not generate enthusiasm among farmers to participate in irrigration management. There was little space for the users, with a natural interest in augmenting water resources, to be brought in. Irrigation systems, including the lower canals and distributories have aspects of common property resources. So, there is prima facie meaning in involving users in management, through appropriate frameworks and institutions. Given the poor condition of much of the irrigation systems, such involvement of users has vast potential to improve incomes and reduce poverty. The Government of Orissa realized the need to take further the agenda laid out by the National Water Policy. Accordingly, it enacted a new State Water Policy that introduced some amendments in the Orissa Irrigation Act (1959), Orissa Irrigation Rules (1961) as well as its Revised Rules (1974). The new policy inter alia envisaged a 244 India Infrastructure Report 2003 reorganization in the structure of administration. The Department of Water Resources (DOWR) was reorganized and a Water Resource Board was created in 1993 to plan, execute and coordinate the utilization of the water resources of the state. The Government of Orissa also approached, in 1994, international funding agencies like the World Bank and the Department For International Development (DFID) for funds to renovate the projects. Through their post- evaluation studies these organizations identified the weaknesses in the system and then advised the government on how to bring about people’s participation in irrigation management. They also advised gradual disinvestment in the irrigation sector. The new policy of the state creates and gives responsibility to the institution of the PP for all aspects of water planning and management. The idea is to hand over the O&M of irrigation systems to the users in due course. PPs were introduced on a pilot basis in 1996 and the scheme’s success led the government to legalize people’s involvement in management through Orissa Irrigation (Amendment) Rules, 1999. For better and sustainable O&M it recognizes the need to involve farmers especially at the lowest level of the distribution system. As a first step to this process of change, it was decided to hand over a part of the network of the canal system for its O&M to appropriately formed PPs WUAs. In the first phase, the government identified four pilot projects, viz., Ghodahada and Rushikulya Distributary No.11 of Ganjam District, Aunli and Derjang Projects of Angul District, and the initiatives for forming PPs started in 1996. Consultancy assignments were given to different non-government organizations (NGOs) to undertake the preliminary spadework as well as to communicate and motivate the farmers to participate in PPs. The selected NGOs and the Water and Land Management Institute (WALMI) of the Government of Orissa demonstrated the benefits of PPs. Minor maintenance activities by farmers eased flow of water up to the tail reaches. They were also helped to organize water distribution, resolve disputes, if any, and adopt their own crop planning, etc in consultation with agronomists. With the help of the NGOs, 50 PPs were registered as legal bodies in the four command areas. Under the new arrangement responsibility for O&M of the reservoir/diversion weir (as the case may be) of dam, spillways, sluices, primary, and secondary distribution networks, etc. rests with the DOWR. But the responsibility for O&M of the tertiary system, that is, below minor/subminor, is vested with the PPs. Box 9.2.1 The 1987 N ational Water P olicy National Policy In 1987, the Government of India announced its ‘National Water Policy’, that recognized water as a prime natural resource and a basic need. It was further envisaged that the planning and development of water and related land resources should be directed to improve the quality of life as well as the environment. The policy laid emphasis on: • Integrated and multi-disciplinary approach to the planning, formulation, clearance, and implementation of projects, including catchment treatment and management, environmental and ecological aspects, the rehabilitation of affected people and command area development. Focus on environmental impact assessment (EIA) during project planning; • Promotion of appropriate organizational structure for management of water resources; • Well-developed information systems; • Maximizing availability of water to the users; • Multi-purpose use of water resources as well as integrated and coordinated development of surface water and groundwater and their conjunctive use; • Proper maintenance and modernization of projects; • Water allocation priorities in rank order: drinking, irrigation, hydro-power, navigation, industrial and other uses; • Water allocation in terms of equity and social justice. Disparities in the availability of water between head-reach and tail-end farms and between large and small farms to be alleviated by adoption of a rotational water distribution system and supply of water on a volumetric basis; • Participation of farmers and voluntary agencies in various aspects of management of irrigation systems (that is, participatory irrigation management (PIM); • Command Area Development Approach to ensure overall optimality; • Fixation of water rates so as to convey the scarcity value of the resource to the users and to foster the motivation for economy in water-use. The rates should be adequate to cover the annual O&M charges and a part of the fixed costs; • Awareness about water conservation should be promoted through education, regulation, incentives and disincentives; • Flood control and drought management as integral to water management; • Training of both officials and users; • Need to equip local government to cope with burdens imposed directly or indirectly by development projects; • Need to move towards decentralized decision-making and eliminate interference that have restricted the authority of regional and local officials in water management. Rural Infrastructure The formal handing over of the system to the people took place in April 2001 for 40 PPs out of the 50 registered till date. All these PPs are enthusiastic in taking up their respective canal systems. For handing over of the remaining systems to the PPs, work is on in full swing. Thereafter, the government plans to extend the PP programme to other areas. It has identified another 29 irrigation projects covering an area of over 3 lakh hectares for its second phase where PP schemes are to be introduced. It is estimated that 688 PPs are to be formed to look after the irrigation system in these projects. The success of the first phase has given much confidence to go ahead and introduce PIM among the farming community more generally. WALMI takes an active part in the training of both officers and farmers. Inaugurating the ‘Awareness Campaign’ of ‘PPs Programme’, the Chief Minister of Orissa, Naveen Pattanaik, has recently reiterated that PPs will open the door to development by ensuring the direct participation of farmers in the management of irrigation. Emphasizing the need to transform the PPs into a ‘mass movement’ he has indicated that very soon the ‘Biju Farmers Project’ will be implemented in the state. The estimated budget of the new project is Rs 1000 crore and 80 per cent of the funds will be utilized through PPs. He has further assured that tube-well irrigation would be enhanced and strengthened through the scheme of ‘Operation Trushna’, where, again, PPs would be introduced. Additionally, he has also proposed disinvestment of the state-run ‘Tube-Well Corporation’. IMPACT Our post-evaluation study was undertaken in two project sites, namely, Derajang and Aunli Medium Irrigation Projects of Angul district. Field-work was carried out in June–July, 2001, and again in June 2002. In addition to the secondary data gathered from the Irrigation Department, at Angul, a specially designed questionnaire was canvassed among the members of the PP in a few villages, that is, Gramashree Water Users Association and Swarnprasu Water User Association in the command area of Derjang project. In addition we had extensive discussions with the fieldlevel officials on different aspects of the PP. We fond that the institution of the PP scheme resulted in major economic gains. Some of these are listed below: • Water available at the outlets has gone up. An examination of the water supply data at the outlets and the rainfall for 1995–6 to 1999–2000 for the Derajang project indicate that in spite of 82 per cent less rainfall during the rabi season of 1998–9, water supply in the corresponding period had increased by 47 per cent of the same period in the earlier years. Similarly, though there was a small 245 increase in rainfall during the kharif season of 2000–1 (1.34 per cent) only the water supply at the outlets had increased by 17 per cent. • Higher productivity is noticed in the Derajang command areas. Our field data show that per hectare productivity of paddy in the kharif season had increased by 50 per cent in 1998–9 over that in 1997–8. Moreover, the per hectare productivity of pulses had gone up by 62 per cent, groundnut by 25 per cent, sesame by 5 per cent, and vegetables by 22 per cent. This increase has been maintained since then. • The cropping patterns too have changed. Earlier no sunflower was grown in the command area owing to lack of water, and no information or advice from the Agriculture Department. Now sunflower cultivation has picked up and its yields have risen from 1350 kg per hectare in 1997– 8 to 1620 kg in 1998–9. • In Aunli too, data indicate a rising trend in the per hectare productivity of all the crops after introduction of PPs. The per hectare productivity of paddy has gone up by 35 per cent, pulses by 56 per cent, groundnut by 33 per cent, seasame by 25 per cent, vegetables by 18 per cent and suga rcane has gone up by 20 per cent. • Improved yields have raised benefits from land. The per hectare average annual benefits accruing to farmers increased from Rs 2873 in 1995–6 to Rs 13,258 in 1999– 2000, (that is, a four-fold increase!). This, of course, implies that the water rate paying capacity of the farmers has gone up. • The stipends paid to member beneficiaries who attended training programmes was retained by the WUAs/ PPs to purchase the much needed instruments for use in measurement of water! • The assurance of water has encouraged the farmers to use new high-yielding varieties of seeds. • The wastage of water from the canal/sub-canal head has reduced a great deal, by about 90 per cent. There are other intangible economic and social benefits that have followed the introduction of PPs. • Significant awareness among the farmers regarding the benefits of PP has come about since their participation in the training programmes and meetings organized by the NGO and WALMI from time to time. • PPs have resulted in greater cooperation and coordination among the concerned officials and the member farmers. One of the beneficiaries reported that prior to the formation of PPs, officials did not bother to hear them, when they went with any water-related problems. Then their access to the officials of the Irrigation as well as the Agriculture Department was very limited. But now, since all those officials come to their ‘doorsteps,’ they get ample 246 India Infrastructure Report 2003 opportunity to interact with them and to bring out their grievances and views on better distribution of water. These and similar interactions have enhanced the awareness among the farmers as well as among the officials. Farmers are optimistic and there is a distinct change in the attitude of officials. These would, in the longer term, result in gains that are not evident at present. • Thus, already the accountability of the officials to farmers (in terms of water availability) during the crop seasons as improved. PPs are accountable to their members. Earlier, conflicts between neighbours regarding use of water, were common, and the department officials did not bother to resolve them. Now farmers are able to resolve their disputes themselves. It has generated a sense of ownership among the farmers for the facilities created. A sense of unity and fellowship among the farmers has emerged. • Farmers see the value of training and of workshops to improve their knowledge for their economic gains. • There is much less damage of the minors and the sub-minors. • Political interference in the job contracts for the minors and the sub-minors has also reduced considerably as now the officials of the Irrigation Department ask the respective panchayats to provide the required number of people for the job. • To a large extent the distribution of water is equitable and there is no bias against the tail-end farmers. The ‘quota of water’ is proportionate to the Culturable Command Area (CCA) of the WUA. • Farmers have the right to bring through the Apex Committee their suggestions for improvements in the management of the main canal system, water delivery schedule, etc. at the project level. • Farmers enjoy the freedom of choice with regard to the crops they grow, since the amount of water they receive is proportional to their land. • The officials of the Agriculture Department in their extension activities show much improved working. • The middle and higher level officials of the Irrigation Department are enthused to push forward the idea of PPs because many of them feel that this will result in less political interference in their day-to-day managerial functions, especially with regard to awarding contracts to maintain the tertiary irrigation networks. EMERGING CHALLENGES The PPs have crossed only the first step of PIM, that is, partial participation in O&M of the tertiary system. The next two stages, namely, taking over of minors and subminors for direct O&M, and collections of water rates are yet to be implemented. We have identified a few contentious issues, which ought to be resolved to improve the performances of the PPs and take the institution further. Insufficient Maintenance Fund: As per the agreement between the PPs and the Irrigation Department, in the second phase the PPs will be paid an amount of Rs 35 per hectare per year as maintenance grant out of the existing water rate of Rs 100 per hactare. But this rate sharing is not acceptable to the PPs on the ground that the amount is insufficient to maintain the minors and subminors, since such work also involves the maintenance of inspection roads alongside the minors and sub-minors. The work also involves continual repair of the dykes through the year, and also cleaning of the canal bed at least twice a year to ensure smooth flow of water. Box 9.2.2 Str uctur ani P anchayat tructur ucturee of the ‘P ‘Pani Panchayat anchayat’’ • The PPs are formed on a three-tier system with two informal associations and one formal association on minor/sub-minor basis comprising an ayacut ranging between 300–600 hectares. • Chak Committees per outlet are formed taking farmers, one each from the high land, middle land, and low land areas of the ayacut. A representative from the Chak Committee will be a member of the executive body of the PP. Each PP will have a president, secretary, and treasurer. • Each beneficiary landowner within the ayacut of the concerned minor/sub-minor qualifies to be a member of the concerned PP. • For registering a PP, a minimum of 51 per cent of the beneficiaries, possessing 60 per cent of command area, are required to be members. To be eligible as a member in a PP, a token membership fee of Rs 10, or as is decided by the PP, is charged. • A fund is created in the form of share capital with the contributions made by the members of the PPs proportionate to their land holding plus a part of the water rates (Rs 35 per acre) in order to take up maintenance work of canals or to attend any work of emergent nature. The authorized office bearers of the PP have powers to spend out of these funds. • An ‘Apex Committee’ in each command area, comprising of all the presidents of the WUAs and with invited official members would prepare the canal operation schedules, O&M plans of the system, suggest cropping patterns and undertake the overall co-ordination among the PPs. Rural Infrastructure Difficulty in Collecting Water Fees: As per the policy and agreement, in the third phase the PPs will be responsible for the collection of ‘water fees’ from their members along with the distribution of water and maintenance of the minors and the sub-minors. But, in this respect, the members have expressed their concerns, with regard to the task of collection of ‘water fees’ from all the members. They feel that it will be an uphill task for them and this will lead to conflicts among the office bearers and the irrigators. Their argument is that when the District Magistrate (DM) and his army of officials, who are armed with all the official powers including a police force, have failed to collect the water rates properly under the present system, how can they discharge the same function smoothly under similar circumstances? Many raise questions like: Are PPs more powerful than the DM? Lack of Commitment of the Government: According to the PPs the government has not made any serious effort to fulfil its promises made at the time of the agreement. According to the president of the Apex Committee, though machinery worth Rs 6 lakh had been promised at the initial stage for common use by the farmers, they have not received the same. Constraint of Field Channel: We noted that there are no field channels in the ayacut area. In their absence some farmers have made temporary earthen channels, which break often. The flooding method that this results in leads to wastage of water and reduces the amount that is available to tail-end farmers. Technical Problems: The topography and climate of the command area results in quick growth of weeds inside the main canals that results in the reduced velocity of water and raises the Full Storage Level (FSL) which further obstructs the free flow of water to the minors and sub-minors. Hence, the PPs are apprehensive of the availability of sufficient 247 water to them and they insist that the main canal should be cleaned every month during its operation period. No Effort to Collect Reveneue: The present practice of collection of water rates from the farmers is replete with many loopholes which need to be urgently reviewed. The present practice wherein the revenue officials certify the irrigation ayacut after a joint verification by the staff of both Revenue and Irrigation Departments provides no challenge for the officials of Irrigation Department. They do not even know how much area is certified by the Revenue Department and how many farmers are charged, and at what rates. The lack of involvement of the irrigation officials in water rate and cess collection is one of the major reasons for the poor health of many irrigation projects in the state. As the DM/Collector is assigned all revenue collection on behalf of the government, he does not bother to know or keep track of the revenue coming from particular heads of account. As soon as his earmarked quota (which is assigned to each DM) is fulfilled, his effort in collecting the rest of the dues wanes. Thus, the present practice of revenue collection is hardly geared towards efficient collection. There are no incentives for improved collections. The rise in crop productivity and the subsequent increase in net income of the farmers indicate that the water rate paying capacity of the farmers has gone up. The government should exploit this opportunity to collect the arrears in water charges from the farmers as their ability to pay has gone up substantially.The water rate collection could be assigned to the irrigation authorities on an incentive system (both individual and collective) where part of any additional collection over the targeted one could be shared by the field officials who are responsible for collection. PIM with the improvements as suggested, especially with regard to collection of water rates, is crucial to the efficient and accountable working of irrigation systems. PIM ought to be extended to irrigation projects over much of the country. 9.3 PANCHAYATI RAJ INSTITUTIONS AND THE STATE FINANCE COMMISSIONS—A REPORT Mukesh P. Mathur Self-governing village communities existed in India from 600 B.C. or even earlier. These village units were the points of contact with higher authorities on matters affecting the village communities (Mathew, 2000). In the postindependence period, the Balwantray Mehta Committee in 1959, first laid down the foundation of local self-government in the rural areas of the country. Based on Gandhian philosophy, this committee emphasized the strong need for an institution such as the Gram Panchayat to look after the interests of the rural population at the grassroot level. The Gram Panchayat was visualized as an implementing agency of the government-sponsored schemes and programmes for orderly development of the rural areas of the country. Rajasthan was the first state of the country to pass legislation on Panchayati Raj Institutions (PRIs), and by 1959, all the states passed Panchayat Acts (Mathew, 2000). 248 India Infrastructure Report 2003 Over the years, however, the local-level governments, especially at the village level, weakened considerably due to the withdrawal of traditional legitimate local functions and a mismatch between the sources of revenue and even the residual local functions. Large numbers of local bodies were superseded, sometimes for periods in excess of a decade. These village bodies failed to function as vibrant units of local self-government. Much of the explanation for their failure lies in the policy and defining framework which did not allow adequate space for their existence. The weakening of local bodies in terms of function, finances and institutional capabilities would have contributed to the poor quality and inadequate levels of services in rural habitats9. But that situation changed in 1992 with the path-breaking 73th Constitutional Amendment Act (CAA) on panchayats. Similarly, the passage of the 74th CAA on municipalities the same year changed the constitutional position of urban local bodies (ULBs). These path-breaking Acts have provided a new dimension to fiscal federalism and decentralized public finance in the country’s federal system. In addition to ensuring constitutional validity to local bodies, these legislations have also broadened the range of powers and functions of local governments. The provisions that concern the constitution of State Finance Commissions (SFCs) aim to rationalize state–local fiscal relations. The new fiscal arrangement has also affected a major change in the scope of the tasks of the Central Finance Commission (CFC), which, until the insertion of item (3– C) to the Article 280, was confined to the distribution of divisible taxes between the union and the states and grantsin-aid to states under Article 275 of the Constitution. The CFC now has also to suggest measures needed to augment the consolidated fund of a state to supplement the resources of the local bodies on the basis of recommendations made by the SFC. Thus there is a positive departure in the state– local fiscal relations from the earlier practices when the system had been ad hoc. It is expected that recommendations of SFCs as well as of the Eleventh Central Finance Commission (EFC) would set norms, conventions and practices relating to fiscal federalism and efficient local governance in the country. All the states of the Indian Union have amended their legislations both for panchayats and municipalities to confer to the provisions of the 73rd and 74th CAAs. PANCHAYATI RAJ INSTITUTIONS TODAY The 73rd CAA provides a three-tier structure to these institutions across the country viz; (1) Gram/Village 9 The situation with regard to urban bodies was no different. Panchayat at the village level; (2) Panchayat Samiti at the intermediate (block/tehsil/mandal/taluk) level; and (3) Zila Parishad or District Panchayat at the district level. All the states have passed legislations in conformity with the 73rd CAA with a view to establishing a three-tier system of panchayats. All the three levels of panchayats have directly elected members with reservation for SCs, STs, backward classes, and women both at the membership level and the executive level. The executive heads of panchayats are designated as presidents elected indirectly by the members of the respective panchayats. The local MLAs/MLCs/MPs are also given membership with voting rights in the Zila Parishad and the Panchayat Samiti. According to the amended Karnataka Panchayati Raj Act of 1993, one-fifth of the village panchayat presidents are to be made ex officio members of the Panchyat Samitis. The chief executive officer, executive officer and secretary, at these three levels of local governance, provide the administrative support to the panchayats. The panchayats have the responsibility of preparing local development plans at their respective levels and implementing them, for which they have to mobilize their own resources in addition to the resources devolved to them from the state governments and the central government. The first round of elections for PRIs and ULBs has been held in most states. A sizeable number of elected representatives (approximately 2,60,000 to PRIs and over 60,000 to ULBs) including women and scheduled castes/ scheduled tribes, have been elected and bear responsibility for taking decisions and giving voice to the needs of the people. As on May 1998, there are 2,34,078 PRIs in the country, classified into three categories of Gram Panchayats (2,27,698), Panchayat Samitis (5906), and Zila Parishads (474). In some of the states rural local bodies are designated as the ‘traditional councils’. These are Meghalaya, Mizoram and Nagaland (Table 9.3.1). FINANCES OF PRIS The finances of the panchayats consist of: (i) Own sources, that is, taxes assigned by the state panchayat acts to the local bodies concerned and levied and collected by them. Own sources also include non-tax revenues such as fee and fines, user charges for services rendered, rent from the properties, etc.; (ii) Shared taxes, that is, are collected by the states with a share of the proceeds being disbursed among the local bodies of the state; and (iii) grants from the state/central government which may be either tied or untied. In some states, certain taxes are statutorily assigned to the local bodies but collected by their respective state governments and made over to local bodies. For example, the surcharge Rural Infrastructure Table 9.3.1 Panchayati Raj Institutions in India: As on May 1998 State/UT Grams Panchayats Andhra Pradesh 21943 Arunachal Pradesh 2112 Assam 2489 Bihar 12181 Goa 183 Gujarat 13316 Haryana 5958 Himachal Pradesh 2922 Jammu and 2683 Kashmir Karnataka 5675 Kerala 991 Madhya Pradesh 30992 Maharashtra 27619 Manipur 166 Mizoram – Meghalaya – Nagaland – Orissa 5261 Punjab 11591 Rajasthan 9185 Sikkim 148 Tamil Nadu 12584 Tripura 525 Uttar Pradesh 58605 West Bengal 3314 A & N Islands 67 Chandigarh – Dadra & Nagar 11 Haveli Daman & Diu 10 NCT Delhi – Lakshadweep 10 Pondicherry 10 All 227698 Panchayat Zila Samitis Parishads All 1098 79 202 725 – 184 110 72 – 22 12 21 55 2 19 16 12 14 23063 2103 2712 12961 185 13519 6084 3006 2697 175 152 459 319 – Traditional Councils Traditional Councils Traditional Councils 314 138 237 – 384 16 901 341 – – – 20 14 45 29 3 – 5870 1157 31426 27967 169 – – – – – 30 17 31 4 28 3 68 17 1 – 1 5605 11746 9453 152 12996 544 59574 3672 68 – 12 2 – 1 1 474 12 – 11 11 234078 – – – 5906 Source: Mathur, O.P. (2000); Decentralization in India–A Report, UMP–Asia Occasional Paper No. 47, Asian Institute of Technology, Klong Luang, Thailand. on duty of transfer of property is collected by the Government of Kerala, and after deducting the cost of collection is transferred to the local bodies of the state. Panchayats also raise loans from the state governments and other financial institutions primarily to finance their developmental works. The resource structure of panchayats is given in Table 9.3.2. It is interesting that the state legislations, which empower the three levels of PRIs, do not give any source of revenue 249 to the first and second tiers of panchayats that is, zila parishads (ZP) and taluk panchayats/panchayat samitis (TP/ PS). In cases where powers to levy taxes, fee and user charges have also been given to ZP or PS, these are being collected by the village panchayats and then transferred to the concerned local bodies. Usually, the taxes and charges levied by the ZP and PS are in the form of surcharge on the taxes and user charges levied by the village panchayats. The finances of PRIs are presented in Tables 9.3.3 to 9.3.7. Panchayats are heavily dependent on the state government to finance their local activities. Income from ‘other sources’ that primarily consist of transfers from the state government that is, grants-in-aid and shared taxes, form an important part of the total revenue receipts of all the three tiers of PRIs in most states. The dependence of Panchayat Samitis (Taluka Panchayats) and District Panchayats on transfers is almost total. Whereas ULBs are generating, on an average, more than 80 per cent of their revenue incomes from their own sources, this proportion is less than even five per cent in PRIs. The dependency ratio of PRIs on state governments varies significantly across states. PRIs of Bihar and Manipur ‘function’ entirely on government grants. The local bodies of Haryana generate a substantial amount of revenue from their own sources, especially by tapping the non-tax resources of their income (62.20 per cent). Tables 9.3.5 and 9.3.6 show that fiscal transfer from the states to panchayats have gone up substantially during the last eight years for which the data is available. In per capita terms, the transfers have gone up from less than Rs 100 in 1990–1 to more than Rs 250 in 1997–8. It is striking that although the share of tax income to total income declined significantly over the years, non-tax revenues have maintained their status in the finances of local bodies. In fact they have recorded a sharp increase of over 12.5 per cent per annum during the reference years. User charges and land based non-property taxes, such as revenue from commercial properties and development of rural housing and entertainment schemes, are some of the promising areas for resource generation from the non-tax sector. Transfers from the state have increased at the highest rate. The revenue at 16.6 per cent has more than kept pace with inflation and population growth, so that PRIs are in a better position than what they were in the 1980s. The tax revenues, though, have grown slower than they could have. Abdul Aziz, presenting the case of Karnataka, concludes that the panchayats have survived primarily on the development grants provided by the state. There was hardly any attempt to generate own resources (Aziz, 1998). John, Oommen in the case of Kerala, notices more or less similar trends. He, however, observed that the financial position 250 India Infrastructure Report 2003 Table 9.3.2 Major Sources of Income for Panchayats in India Sources Major Components Internal/Own sources a. Tax revenue b. Non–tax revenue Building/house tax; taxes on profession, trade, callings and employment; pilgrim tax; tax on fair and other entertainments; tax on advertisements; octroi on animals or goods or both brought for sale (was prevalent in Gujarat and Rajasthan which was abolished recently); vehicle tax (bullock cart/ tractor etc.); land tax (for non-agricultural use); special tax for special works such as construction and public works Fee and user charges levied by the respective panchayats for the provision of services. Water rate, street lighting fee, conservancy fee, street cleaning fee, drainage fee, sanitary fee for public latrines and urinals, pilgrimage fee, fee on sale of cattle, cess on conversion of land use, fee/rent and charges for use of common resources such as panchayats shelter, hospital/ dispensary, schools, gazing land, market and weekly bazaars, etc. External sources a. Shared taxes b. Grants from Stamp duty (duty on transfer of property), land revenue, motor vehicle tax, entertainment tax, seignior government age royalties, forest revenue, etc. General purpose, specific purpose, untied funds for developmental purposes and grants in lieu of taxes such as in lieu of octroi in Gujarat and Rajasthan. of Gram Panchayats is stronger than the other two tiers of PRIs since the taxation powers lie only in the hands of the Gram Panchayats (Oommen, J., 1998). One possible danger of the liberal provisions of grants-in-aid is that the efforts of PRIs to mobilize their own resources could slacken. Many State Finance Commissions have recommended a performance-based grants-in-aid system to local bodies. The Himachal Pradesh State Finance Commission, for example, has recommended release of transfers contingent on local bodies collecting statutory levies (Mathur, M.P., 1999). Table 9.3.3 Sources of Revenues of PRIs, 1997–8 State Andhra Pradesh Assam Bihar Goa Gujarat Haryana Himachal Pradesh Karnataka Kerala Madhya Pradesh Maharashtra Manipur Meghalaya Orissa Punjab Rajasthan TamilNadu Uttar Pradesh West Bengal All India Total revenue (Rs in lakh) Tax 100060 1550 36596 1057 223254 8522 2525 376807 98277 177901 330747 35 1752 64002 13541 152021 42216 88324 48775 1935554 3.18 22.13 Nil 27.53 1.39 5.28 2.69 0.69 8.91 0.66 2.26 Nil 0.27 0.72 0.51 N.A. 7.80 0.98 1.61 1.94 Own sources (%) of total Non-tax Both 2.30 0.20 Nil 9.93 0.42 56.92 Nil 0.11 1.17 1.14 1.14 Nil 17.76 0.37 39.27 N.A. 0.26 4.30 2.41 1.55 5.48 22.33 Nil 37.46 1.81 62.20 2.69 0.80 10.08 1.80 3.40 Nil 18.03 1.09 39.78 2.02 8.06 5.28 4.02 3.49 Transfers (%) of total revenue 94.52 77.67 100.00 62.54 98.19 37.80 97.31 99.20 89.92 98.20 96.60 100.00 81.97 98.91 60.22 97.98 91.94 94.72 95.98 96.51 Notes: N.A.: Not Available Source: CFC (2000), Report of the Eleventh Finance Commission (2000–5), Govt. of India, Ministry of Finance, Department of Economic Affairs, New Delhi. Rural Infrastructure 251 Table 9.3.4 Dependency of PRIs on Higher Levels of Governments Level of PRIs 1990–1 Total Revenue Receipts (Rs crore) Village Panchayats (Village level) Panchayati Samitis (Intermediate level) District Panchayats (District level) All Tiers 1994–5 1997–8 % Transfers from state and centre Total Revenue Receipts (Rs crore) % Transfers Total Revenue from state Receipts and centre (Rs crore) % Transfers from state and centre 1941 83.74 3797 89.69 5452 89.56 15.9 1680 98.98 2968 90.04 4305 99.20 14.4 2992 98.74 5388 98.86 99..22 18.1 6613 94.41 11882 95.98 96.51 16.6 9599 (220.81) 193556 CAGR 1997–8 over 1990–1 (% per annum) Figures in brackets refer to per cent increase in transfers from the state, in absolute terms (base year: 1990–1). Source: CFC (2000). Among the various taxes, building/house tax is the most common and stable source of income for the majority of village panchayats in the country. In Kerala, house/building tax constituted more than 50 per cent of the total receipts from the taxes in 1993–4. The other important taxes are profession tax and entertainment tax (SFC, Kerala, 1996). There is much scope for improvement in the collection of house taxes. Many state finance commissions have, in their reports, given suggestions for improvement in property tax assessment and its administration. Design and construction of houses in the rural areas in states like Tamil Nadu, Andhra Pradesh, Kerala, Karnataka, Maharasthra, Haryana, Punjab, etc., are in no way less impressive and fashionable than in urban areas. In most states, the assessment cycle has not been followed and tax rates have not been revised since long. Wherever properties are taxed, the arrears of taxes are allowed to accumulate due to sheer inefficiency of local authorities, which has a direct impact on the finance of the local bodies concerned. Spending Structure Expenditure on maintenance of the core services such as water supply, street lighting, sanitation, and roads accounted for only 7.43 per cent of the total expenditure of the PRIs in 1997–8. In absolute terms this amounted to Rs 1555 crore for 1997–8, which was a bare Rs 21 per person! This is suggestive of inadequate maintenance. STATE FINANCE COMMISSIONS RECOMMENDATIONS AND THEIR The State Finance Commissions (SFCs), constituted as per the provisions of the 73rd and 74th Amendments in the Constitution of India bore responsibility for examining not only the revenue-sharing arrangements between the state governments and local bodies, but the entire gamut of issues concerning the assignment of taxes, transfers and such other issues for improving the financial health of local Table 9.3.5 Revenue Structure of Panchayati Raj Institutions (All tiers) in India, 1990–1 and 1997–8 Sources of Revenue A. Own Sources Tax Non-tax Sub-total (A) B. Other Revenues (Transfers from the state) Total Revenue (A + B) 1990–1 1997–8 % to total Amount (Rs in lakh) % to total Amount (Rs in lakh) CAGR 1997–8 over 1990-1 (% per annum) 23850 13186 3.60 1.99 37691 30017 1.94 1.55 6.8 12.5 37036 5.59 67708 3.49 9.0 624347 94.41 1867846 96.51 16.9 661383 100.00 1935554 100.00 16.6 252 India Infrastructure Report 2003 Table 9.3.6 Trends in PRI Finances (in Rs) Year Per capita Revenue Receipts Own sources 1990–1 1991–2 1992–3 1993–4 1994–5 1995–6 1996–7 1997–8 5.89 5.47 5.60 6.35 6.98 7.74 8.45 9.27 Per capita Revenue Others (Transfers) All Expenditure 99.30 110.09 132.74 152.74 166.52 186.33 217.89 255.76 105.19 115.56 138.34 159.09 173.50 194.07 226.34 265.03 113.68 128.98 147.32 173.90 189.88 207.84 241.39 286.61 Source: CFC (2000). bodies. They were to cover the basis and method for both distribution of grants and taxes, and also the quantum. They were also to cover the measures to improve the financial position of PRIs and ULBs. The wide-ranging task entrusted to the SFCs as incorporated in Article 243 I and Y and the addition of Article 243 G and W (11th and 12th Schedules) of the Constitution is a landmark development. It opened up a new opportunity to review and streamline the existing state–local fiscal relations. Appendix 9.3.1 provides a brief summary of the recommendations of the selected SFCs with reference to tax assignments, tax sharing and grants to PRIs. Finance Commissions of many states also suggested some changes in the legislative and administrative spheres to strengthen the local government institutions. These are: • A Finance Commission Cell should function in the Finance Department of the state government after the expiry of the SFC’s term to review the implementation of its recommendations (Karnataka, Tamil Nadu and (Kerala). Table 9.3.7 Revenue and Expenditure of Panchayati Raj Institutions (All Tiers) in India (Rs in lakh) Selected States Andhra Pradesh Assam Bihar Goa Gujarat Haryana Himachal Pradesh Karnataka Kerala Madhya Pradesh Maharashtra Manipur Meghalaya Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh West Bengal All India Source: CFC (2000). 1990–1 Total Receipts Total Expenditure 100060 301 359 367 101816 4629 404 131443 9662 23368 104520 34 914 17813 9746 75450 27950 42931 7220 661383 100034 213 13630 207 108097 6787 404 125092 9874 22643 144425 93 1179 17813 9999 74292 21967 43376 12101 714690 1994–5 Total Receipts 158151 371 59164 776 149445 6156 578 245746 19353 30234 204688 73 989 39773 16616 108474 32605 61371 48771 1188298 1997–8 Total Total Total Expenditure Receipts Expenditure 160403 251159 250359 3991 1550 4057 92656 36596 66040 405 1057 763 150919 223254 226881 10825 8522 14643 578 2525 2525 199249 376807 369641 19453 98277 73056 30266 177901 178530 319695 330747 458538 165 35 209 1478 1752 2356 39773 64002 64002 15829 13541 15953 108886 152021 153738 26134 42216 49062 61161 88324 90714 53587 48775 55488 1300495 1935554 2093116 CAGR of 1997–8 over 1990–1 (% p.a) Total Total Receipts Expenditure 14.1 26.4 93.6 16.3 11.9 9.1 29.9 16.2 39.3 33.6 17.9 0.4 9.7 20.0 4.8 10.5 6.1 10.9 31.4 16.6 14.0 52.3 25.3 20.5 11.2 11.6 29.9 16.7 33.1 34.3 17.9 12.3 10.4 20.0 6.9 10.9 12.2 11.1 24.3 16.6 Rural Infrastructure • Periodic service training for the local government employees to increase their efficiency (Karnataka, Punjab, Maharashtra, Tamil Nadu and Kerala). • Establishment of a local development fund for subsidizing interest rates for non-remunerative but desirable service schemes (Kerala). • A Tax Valuation Committee to listen to the objections of the taxpayer regarding PT assessment (Punjab). • One common legislation for all local bodies to avoid confusion regarding the regulations and bye-laws (Karnataka, Kerala, Punjab and Uttar Pradesh). • Privatization for activities like maintenance of street lights and roads and other core services (Kerala, Uttar Pradesh, Punjab and Tamil Nadu). • Privatization of the maintenance of commercial assets (Tamil Nadu). • Public participation for the maintenance of services (Maharashtra). A close examination of some of the SFC reports show that these Finance Commissions have tried to rationalize the local tax structure by suggesting reforms in assessment and administration of taxes besides giving powers to local bodies. Finance Commissions of Kerala, Karnataka, Tamil Nadu and Uttar Pradesh, for example, have recommended reform in property taxes and have suggested the ‘area based’ or ‘site valuation’ system for assessment of property tax. A majority of SFCs also recommended autonomy to local bodies, particularly village panchayats (VPs) for fixing tax rates and user charges. The West Bengal SFC has recommended a new regime of tax collection in which tax administration works in close cooperation with panchayats and gives a proportion of tax collection as entitlement to these bodies. The Kerala State Finance Commission (KSFC) emphasized the need to develop new sources of revenues besides suggesting principles to rationalize the local tax structure. The Punjab State Finance Commission (PSFC) has recommended autonomy to all the three tiers of PRIs to levy taxes and fees, and also to fix the rates thereof, without the state control that had been imposed following the Punjab Panchayati Raj Act of 1994 (Oommen, M.A., 1998). Some of the new taxes suggested by the KSFC are: a tax on sale of properties, central government properties, entry of transport vehicles10 carrying goods for local sale and consumption, cable TV operators, stamp duty on documents to be submitted to local bodies and library cess. In case 10 Entry taxes fragment markets and the distortions they create are very large, much larger than what their first order effects alone would indicate. The process of growth and transformation in the UK (the first industrial revolution) had the integration of the home market brought about by the abolition of local tolls and taxes as a necessary condition (Editor). 253 of tax on sale of properties, the commission has suggested that Zila Parishads may be empowered to levy a tax on the sale price of all immovable properties within the district, where the price is Rs 25,000 or more at the rate of 1 per cent. The Registration Department has to collect this tax. Three per cent of the total collection should go to the state government as collection charges. Revenue from rural areas of the district is shared in equal proportion between the Zila Parishads and Panchayat Samitis. The distribution of shared revenue among the panchayat samitis will be made on the basis of their population as per the 1991 Census. The Rajasthan SFC also suggested interesting taxes, which could be levied by the village panchayats of the state. These are: tax on dhabas, hotels, motels, automobile servicing and repair shops, petrol/diesel pumps, etc. situated on the national/state highways in their respective jurisdictions. Transfers from the state to local bodies in the form of revenue sharing and grants-in-aid play an important role in the financial structure of local governments. This is more so in the case of rural local bodies. It is significant that prior to the enactment of CAA, grants-in-aid have been the major component of fiscal transfers from the state to local bodies, and the share of state taxes and levies were extremely low. SFCs constituted as per the provisions of CAA have recommended sharing of state-level resources in addition to grants-in-aid to local bodies. Variations, however, have been noticed among different states in terms of scope of resources to be pooled and its sharing principles among the PRIs and ULBs. Whereas the Rajasthan, Tamil Nadu, Uttar Pradesh and West Bengal Finance Commissions recommended the devolution of a set percentage of the net proceeds of only the tax revenues of the states, Andhra Pradesh has suggested for sharing of both from taxes and non-taxes. The Karnataka SFC has adopted a different mechanism by replacing the present system of sharing a portion of the specific taxes levied by the state government by a share in the ‘total non-tax gross own revenue receipts’. Table 9.3.8 brings out the relevant details of only those states where SFCs have recommended the concept of ‘global sharing’ for transfer of state revenues. SFCs of other states have recommended sharing of only specific taxes or awarded a fixed amount for PRIs and ULBs. The SFCs of some states like Punjab and Kerala have suggested the sharing of only specific taxes with the local bodies of the states. The Punjab SFC, for instance, recommended transferring 20 per cent of the net proceeds of the five major taxes to the local bodies. These are: stamp duty, electricity duty, entertainment tax, entertainment tax on cinematography and motor vehicle tax. Distribution among the PRIs and ULBs will be made on the basis of the following criteria: (1) Stamp duty—on the basis of directive principle; (2) Motor-vehicle tax—on the basis of 254 India Infrastructure Report 2003 Table 9.3.8 Recommended Share in State Resource Pool: SFC Award State Net proceeds of state taxes: Rajasthan Tamil Nadu Uttar Pradesh West Bengal Tax and non–tax revenues: Andhra Pradesh Madhya Pradesh Tax revenues: Assam Non-tax revenue: Karnataka Per cent Ratio of PRIs and ULBs Basis of distribution 2.18 8.0 11.0 16.0 1.8 % and 1% 55% and 45% 4% and 7% Break-up not available Rural–urban population Not available Population (80%); area (20%) Population and % of SC/ST/non-literates 39.24 2.91 70% and 30% 85% and 15% Development criteria such as length of roads, etc. Population, area, tax efforts Not available Population 85% and 15% For panchayats—population, area literacy, no. of beds, road length 2.0 36.0 Source: NIRD (2000), Background papers prepared for the National Workshop on Follow-up Measures by State Governments on SFC Recommendations, organized by the State Finance Commission Cell, National Institute of Rural Development, Hyderabad, 3–4 October 2002. proportionate length of roads maintained by the PRIs and ULBs; (3) Electricity duty–on the basis of collections in PRIs and ULBs; (4) Entertainment tax—20 per cent share of collections to PRIs and ULBs; (5) Entertainment tax on cinematography—20 per cent share of collections to PRIs and ULBs. The mechanism of revenue sharing is marked by significant interstate variations. First, with pooling ad hocism would reduce and PRIs and ULBs could look forward to more stable flows. Second, this system provides some incentives for PRIs/ ULBs to use their own sources of revenues by using various tools of resource mobilization and generation. Third, the buoyancy of state taxes and levies will benefit the local bodies. State taxes grow as per the growth in the state economy, and the benefits of economic growth in the state will automatically be transferred to the local bodies. In case of grants-in-aid, usually there are three types of grants: (i) general purpose, (ii) in lieu of taxes and (iii) specific or conditional grants. The general-purpose grants provide local bodies with additional resources the autonomy to use them. The specific purpose or conditional grants, however, are to be used for specific service/programmes or may have some conditions for its use. Grants in lieu of taxes are given as compensatory grants on account of the abolition or withdrawal of certain taxes, such as octroi, in Madhya Pradesh, Uttar Pradesh, Karnataka, etc. Grants sometimes provide for matching provisions and, like other transfers, can help local bodies to address the mis-match between the local resources and their responsibilities. Rationalization of the grants-in-aid system was one of the primary objectives of the first State Finance Commissions. However, this issue has remained unsolved, and grants are still largely ad hoc and have varying basis. Although some of the SFCs have recommended tied, untied as well as performance-based incentive grants, the devolution mechanism between various levels of local governments, both urban as well as rural, has not been addressed properly. Only the Kerala State Finance Commission has recommended grants, both for plan and non-plan activities, with a mechanism for their devolution among different layers of local governments. In a sense, the Kerala Finance Commission has tried to bring in some kind of rationality in the structure of grant-in-aid as also its mechanism for devolution. Appendix 9.3.1 gives a brief overview of the key recommendations of the selected SFCs regarding grants-in-aid. THE ELEVENTH FINANCE COMMISSION As stated earlier, the Article 280 of the Constitution of India stands amended by the Constitution 73rd and 74th Amendment Act of 1992, and a new clause has been inserted in it making it mandatory for the CFC to suggest measures needed to augment the consolidated fund of the state so as to supplement the resources of the local bodies in the state on the basis of recommendations made by the SFC. The CFC has recommended grants amounting to Rs 10,000 crore for local bodies of the states during 2000– 5. Of this, Rs 1600 crore are for the panchayats and Rs 400 crore are for the municipalities for each of the five years, starting from the financial year 2000–1. In per capita terms, the amount recommended for the PRIs is higher than that for the ULBs. This amount will be over and above Rural Infrastructure the normal flow of funds to the local bodies from the states and the amount that would flow from the implementation of SFC recommendations (CFC, 2000). These grants are to be utilized exclusively for the maintenance of civic services in the rural and urban areas and will be distributed among the local bodies of the state on the basis of the principles recommended by the SFC. The grants are to be untied on condition that they are not used for payment of salaries and wages. The CFC has also suggested the levy of a profession tax, rationalization of property/house tax, the levy of a substitute for octori and an efficient system of user charges. The CFC has also recommended the levy of surcharge/cess on state taxes and the delegation of power to PRIs to levy land tax. They also emphasized a need for improvements in budgetary and accounting systems besides capacity building of local governments in various fields of local administration and management. The CFC has recommended a special grant of Rs. 200 crore for development of database on the finances of the PRIs and ULBs and Rs 98.61 crore for maintenance of accounts. The criteria recommended by the CFC for distribution of grants to the PRIs and ULBs have been shown in Table 9.3.9. The Government of India has accepted the recommendations of the Eleventh Finance Commission subject to the following conditions (CFC, 2000): 1. The local bodies should be required to raise suitable matching resources; 2. In case where elected local bodies are not in place, the central government shall hold the share of such bodies in trust on a non-lapsable basis during 2000–5. The central government may also similarly hold back a part of the recommended share in case of such bodies to whom functions and responsibilities have not been devolved; 3. Earmarking of funds for maintenance of accounts, within the overall recommended level of grants, may be increased to the extent necessary in consultation with the CAG; and 4. Measures to strengthen accounts and audit of local bodies have been accepted in principle. Details will be worked out in consultation with the CAG. Table 9.3.9 CFC Criteria for Distribution of Grants to PRIs and ULBs Indicator Population Index of decentralization Distance from higher per capita income Revenue effort Geographical area Weight age (%) 40 20 20 10 10 255 The Rs 8000 crore recommended for devolution to PRIs may still be inadequate! According to an NIRD study conducted for the Eleventh Finance Commission, it is estimated that PRIs will require more than Rs 142,000 crore for a period of five years for O&M of core services alone in the rural areas of the country. In addition, approximately Rs 84,000 crore will be needed to augment the basic infrastructure and services in rural India (CFC, 2000)11. Significantly, the term period of the Eleventh Finance Commission did not coincide in most cases with the tenure of the first SFCs. As a consequence, the recommendations of the CFC and the SFCs were not for the same period leading to problems in allocation of the grants. MAJOR SHORTCOMINGS When the first generation SFCs were constituted, it was expected that the state governments would follow a tradition of accepting the recommendations of the SFCs as in the case of the CFCs. But that did not happen. Action-taken reports of some of the states show that the state governments have not accepted all the recommendations made by the finance commissions. The Andhra Pradesh SFC, for example, made 84 recommendations on financial as well as non- financial matters. Of these, the government accepted only 60—that, too, in principle—and these are yet to be implemented. Even the recommendation concerning transfer of 39.24 per cent of tax and non-tax revenues of the state to the local bodies has not been accepted in its true sense. Although the concept of a fixed percentage of global sharing was accepted in principle no specific percentage has been fixed. In Tamil Nadu, of the total 413 recommendations made by the SFC, only 244 have been accepted by the state government. The report of the Maharashtra Finance Commission contains nearly 129 recommendations on various matters pertaining to PRI finances. Of the twenty-seven total recommendations made on devolution of grants and taxes to PRIs by the commission, the state government has accepted only twelve recommendations fully. Whereas eleven recommendations were accepted partially, four was rejected by the government. Share in profession tax was one of the recommendations which was rejected by the state government. 11 This works out to around Rs 400 per person as maintenance expenditure per year. The total expenditure of panchayats per person was just about Rs 286 per annum. In addition the estimated capital expenditure is itself about Rs 1200 per person. The gross capital formation (GCF) in the private sector in 2000–1 was about Rs 91,000 crore, and in the public sector about the same. Thus, these figures imply a 15 per cent to 20 per cent share of public sector GCF. Clearly, these estimates are highly unrealistic and are reflective of needs, rather than being demand based, or based on what is possible at this stage of development. (Editor). 256 India Infrastructure Report 2003 CONCLUSIONS 1. Although the Constitution Amendment Act provides full autonomy to the PRIs, the state level functionaries are hesitant to handing over the financial and functional powers to these local governments. The CAA are also silent on issues concerning financial devolution to PRIs in line with functional devolution as provided in the Eleventh Schedule. Had the CAA given direct financial powers to PRIs commensurate with the functions assigned to them, real autonomy at the local level, would also have been possible. It could have also made these local bodies more responsible and accountable to people’s needs. 2. House tax is one of the main sources of income for the PRIs. This should be simplified and rationalized. Exemptions from property tax should be minimized. Taxes which are local in nature, such as, entertainment tax, professional tax, stamp duty, land revenue, etc. should either be transferred to panchayats or a reasonable share of it be given to these local bodies. 3. PRIs should be given autonomy to fix tax rates and user charges as in the case of Punjab. 4. PRIs could privatize certain services. The state governments should prepare necessary guidelines and legislation in this regard. Frameworks for the active cooperation of the local population in the provision of basic services such as water supply, sanitation, education, health, need to be explored. Further, there could be a code of ethics for officials and non-officials of PRIs. 5. The major problem among the rural local bodies is the lack of expertise. Thus there is a need for capacity building and training of local officials, particularly with reference to taking up the challenge offered by the new functions assigned to them under the eleventh schedule. 6. National Infrastructure Development Fund (NIDF) could be established to extend loans and financial aid to both PRIs and ULBs for infrastructure development. 7. The central government, as a facilitator of change, has a special role. Through its administrative ministry, that is the Ministry of Rural Development, it should ensure the timely and effective action by the state governments on the recommendations of SFCs. The Ministry of Rural Development could also introduce schemes akin to the Ministry of Urban Development’s City Challenge Fund and Urban Reforms Incentive Fund for PRIs. APPENDIX 9.3.1 Key Recommendations of the First State Finance Commissions on Financial Devolution to PRIs in Selected States KERALA Tax Assignments Gram Panchayats (GPs): a. Tax on Buildings • Building tax to be exclusively assigned to Gram Panchayats in the range of 6–10% of annual rental value. • ARV should be replaced by tax, based on the plinth area. • Minimum tax payable may be fixed at Rs 15 and classification of buildings based on the basis of quality of construction, age, etc. • Charging interest @2% per month on arrears. • Other suggestions for rationalization of Property Tax. b. Advertisement Tax On Government may fix the minimum rate chargeable and leave it to panchayats to fix it above those rates (New). c. Tax on Land • Land tax may be doubled (from 50 paise to Re 1) • 60% of the collection may go to block panchayats and the balance to district panchayats. • Irrespective of the size of the holding minimum land tax may be fixed at Rs 5 per year in panchayat areas. • Portion of income from the sale of court fee stamps may be earmarked to local bodies (LBs). d. Tax on Entertainment • Entertainment tax and additional entertainment tax should be merged into a single item. • The difference between show tax and surcharge on show tax may be abolished and merged into one. e. Tax on Professions • Profession tax in the case of persons other than salary and wage earners may be levied at the rates recommended. • The rates of profession tax may be uniform in urban and rural LBs and that the number of slabs be reduced to ten from earlier sixteen in case of PRIs and fourteen in municipalities, and the rates should be rationalized. f. Land Cess • Collection of a tax on the sale of land from owners at the time of sale. Rural Infrastructure 257 Panchayat Samitis (PSs): Not assigned any taxes as per the Conformity Act. Zila Parishads (ZPs): Not assigned any taxes as per the Conformity Act. Revenue Sharing Land Tax 60% of additional income from Land Tax may go to block Panchayat and the balance to District Panchayat. Building Exemption Fee 50% of the building exemption fee. Stamp Duty 25% of surcharge. Grants Devolution of Plan Grants Devolution of plan grants of state to LBs. The SFC has endorsed the existing pattern as followed by the State Planning Board. • Population in 1991 census—70% • Population of SC/ST in 1991 census —10% • Total workers excluding workers in manufacturing processing, servicing & repairs outside household industry—10% • Proportion of agriculture workers —10%. Total—100% Distribution of Rural Pool • Population in 1991 census—75% • Population of SC/ST in 1991 census—5% • Financial needs of LBs—15% Financial needs of the LBs is assessed on the basis of income classification ranging from lowest income (getting less than Rs 5 lakh p.a.) to highest income category (getting more than Rs 20 lakh p.a.) Kerala SFC has classified such four groups of panchayats. Income for this purpose includes income from all sources including motor vehicle tax and loans. Tax efforts of LBs–5% Tax efforts are judged by two indicators: • The percentage of collection to demand • The rate at which property tax is being levied. Intra-District Allocation Following is the State Planning Board’s formula, which has been followed for intra-district allocation: • GPs—55.80% • PSs—14.33% • ZPs—14.93% Types • • • of Grants New plan grants for development projects Old plan grants prior to 1994—untied plan funds given to LBs. General purpose grants—Non- Statutory Non-Plan Grants: 1% of the state revenue is assigned for general-purpose grant. This 1% has to be distributed between ULBs and PRIs on the basis of population • Maintenance grants for building of schools and hospitals, should be related to the current cost of construction. PUNJAB Tax Assignments Gram Panchayats • Total land revenue should be assigned to the GPs. • Mandatory tax on professions, individuals, traders, commission agents and shopkeepers based on income slabs to be levied by GPs (new). • GPs to levy tax on advertisement and hoardings (new). • GPs to tax brick kilns, rice sellers, stone crushers, petrol pumps, poultry farms, dairy units, stud farms, fish farms, and small and large scale industries in the rural areas (new). • GPs to charge fee @ 2% of the value of goods sold from sellers where markets are held (new). • GPs to charge parchi fee from buses @Rs 5 to Rs 10 where they provide certain facilities (new). 258 India Infrastructure Report 2003 House tax • No tax on kutcha houses. Below 10 marla houses and houses of yellowcard holders. • House tax on pucca houses at the rate not below Rs 100 p.a. (new) Panchayat Samitis • 10% Auction money on Punjab medium liquor vends and 20% excise duty on Indian made foreign liquor should be the share of PSs and GPs. The share in 50:50. GPs should get their individual share on population basis. Zila Parishad • Land revenue cess, levied should be assigned to the PRIs. If ZPs pass a resolution for levying the cess on land revenue the state should levy, collect and then transfer to PRIs at the rate of GPs—50%, PSs—30%, ZPs—20%. • ZPs can levy a tax on the sale of immovable properties within the district at the rate of 1% of the sale price. • Registration fee in cattle fairs raised from Rs 2 to Rs 5 per cattle. The management of cattle fairs be transferred to ZPs along with assets. (new) Revenue Sharing Transfer of revenues of five taxes now collected by state government to local bodies (Stamp duty, motor vehicles tax, electricity duty, entertainment tax and entertainment tax on cinematograph) 20% of the net proceeds of these five taxes. General principles: • Buoyant and elastic taxes. • Proportion of sharing on the basis of fiscal needs. • To enhance autonomy, unconditional transfer with in-built provision for incentives. Sharing between ULBs and PRIs On the basis of % of collection from PRIs and ULBs • Stamp-duty: on the basis of derivative principle • Punjab motor vehicle tax: On the basis of proportionate length of roads maintained by the ULBs/ PRIs. • Electricity duty: On the basis of collection • Entertainment tax: 20% share Inter-tier Distribution • GPs—50% • PSs—30% • ZPs—20% Distribution amongst GPs, PSs and ZPs • On the basis of population Grants Per Capita Grant • to be given to weak GPs having a per capita income of less than Rs 100 to bring their income up to Rs 100 Rs 18 crore. For the five years from 1995–2000. No part of it should be utilized on salaries and wages. Payment of 50% electricity charges for street lighting to weak GPs Varies between 25% and 50% of the total electricity bill to be divided by the department on merit. Incentive grants For good performing PRIs. • GPs—Rs 0.50 lakh • PSs—Rs 1.00 lakh for 1995–2000 No incentive grant is suggested for ZPs. Remark: The commission recommends only two types of grants viz. general-purpose grant and specific-purpose grant. WEST BENGAL Tax Assignments Gram Panchayats Water rate, lighting rate, conservancy rate. Panchayat Samitis • Water rate and lighting rate Zila Parishad Water rate and lighting rate: Rural Infrastructure 259 Collection of irrigation rates and the related responsibility of supplying water and routine maintenance should be handed over to ZPs, having jurisdiction over such projects. The raised resources may be distributed proportionally to the collection efforts of individual LBs within a district. • Taxes on entertainment now collected by the state should be handed over to local bodies. • Resources generated in the regulated markets should be brought within the purview of DPCs & the net proceeds ploughed back in the market hinterlands. • All taxes collected from all districts will go to the state kitty and distribution will start from there following the entitlement ratios as provided in the revenue sharing. Tax Sharing • Tax sharing is considered an entitlement to be used for plan and non-plan purposes. • Funds to be spent according to priorities set by each local body in its development plan. 16% of the net proceeds to all tax collected by the state in a year should be transferred to LBs. Li – 0.5, Dli + 0.1 (D2i + D3i + D4i + D5i + D6i) Where li – total percentage allocation for district ‘i’. • Dli – Proportion of population of the district i to the total population of the district (weight 50%). The rest of the 50% weight is assigned to degree of backwardness viz. • Illiteracy level of the district (10%) • SC/ST and Muslim population (10%) • Area of the district (10%) • Rural population of the district (10%) • Inverse ratio of per capita Bank Deposits (10%) Intra-District Allocation: • District Panchayat Fund = D.P./100. Where P=% of Panchayat population to total population. D=98% of the total entitlements. 2% is kept for funding incentive schemes. PRIs allocation ZPs—30% PSs—20% GPs—50% Entitlement for GPs Population—50% Percentage d of SC/ST—25% Percentage of illiterates—25% Entitlement for PSs Population – 50% Percentage SC/ST—25% Percentage of illiterates—25% Entitlement for ZPs 30% of the district panchyat fund i.e. DP/100 Grants The commission has not discussed much about grants in its report The total district plan fund is divided into following: • Grants • Entitlements going to districts Plan grants may follow the distribution pattern of entitlements explained. A large number of centrally-sponsored schemes such as JRY, IRDP, etc. are now in operation in which the central releases have to be matched by proportionate state resources. Such state and central releases would continue to be grants and will not be part of the untied entitlement of the LBs concerned. Source: Compiled from the Reports of First State Finance Commissions, Kerala, Punjab and West Bengal. 260 India Infrastructure Report 2003 9.4 THE RURAL INFRASTRUCTURE DEVELOPMENT FUND: A REVIEW Alice Albin Morris • Sebastian Morris THE RURAL INFRASTRUCTURE DEVELOPMENT FUND The Government of India announced in the 1995–6 Budget the setting up of the Rural Infrastructure Development Fund (RIDF) to be operated through the National Bank for Agriculture and Rural Development (NABARD) for financing ongoing rural infrastructure projects. The fund was to be made up of contributions from Indian scheduled commercial banks against their shortfall in agricultural lending up to an extent of 1.5 per cent of net bank credit. The initial corpus for RIDF-I was Rs 2000 crore. This was utilized for extending loans to state governments mainly for incomplete irrigation projects.) The successive union budgets have enhanced the corpus. In 2001–2 the corpus was Rs 5000 crore. The total corpus allocated for RIDF aggregated to Rs 23,000 crore. The outlay for RIDF–VIII in the budget presented for 2002–3 is Rs 5500 crore. Apart from financing incomplete projects the NABARD, since 1996–7, has been providing, under the RIDF funding, for new infrastructure initiatives. The loans are guaranteed by the state government, except in the case of certain projects, where NGOs, ‘self -help groups’, and Panchayati Raj Institutions (PRIs) have taken the initiative. Ongoing and new projects with a gestation period of 2– 3 years are given priority .The rate of interest was 13 per cent in 1995–6. It was lowered to 12 per cent in RIDF– II and V. It was further reduced to 11.5 per cent in RIDFVI and 10.5 per cent in RIDF-VII. The Budget for 2002–3 has announced that the interest rate for RIDF-VIII will be linked to the bank rate. The interest currently stands at 8.5 per cent. The ceiling on loan amount was 50 per cent of updated/revised cost of the project in 1995–6 but has been increased to 90 per cent in the subsequent years. The maturity period for deposits/ advances was 5 years till 1998–9 (RIDFIV). This has been liberalized to 7 years since RIDF-V in 1999–2000. Initially the fund was available for implementing medium/ minor irrigation projects, soil conservation, rural roads, bridges, energization of state-owned tube wells and rural market yards. Later inland waterways, integrated rural market yards, integrated rural cold chains with support facilities, construction of fish jetties, rural godowns were added. In RIDF-VI mini hydro and system improvement projects under the power sector and citizen’s information centres and projects within the IT sector were also covered. PRIs/SHGs/NGOs In 1995–6 state governments/state-owned corporations were the institutions eligible to avail of the fund. In 1999– 2000 there was a major policy change. Rural infrastructure projects through Panchayati Raj Institutions/Self-Help Groups /Non Government Organizations (PRIs/SHGs/ NGOs) from RIDF were allowed12. To facilitate village level infrastructure implemented by PRIs/SHGs/NGOs the list of the eligible purposes was extended to cover activities like rural links/culverts/small bridges, community irrigation including indigenous systems like bandhara, primary school building, primary health service, village haat, cold storage, godowns, and seed farms. To date, though only Rs 1737.77 crore out of a total of Rs 16,835.57 crore, that is 10.32 per cent (RIDF-V to VII) had been lent to projects spearheaded by PRIs /SHGs /NGOs. NABARD’s Appraisal All loans sanctioned from the fund are project-based. The project proposals received from the state governments are appraised for technical feasibility, financial viability, and economic and social benefits. A Project Sanctioning Committee (PAC) sanctions the projects, which is a subcommittee of the Board of Directors of NABARD. In terms of numbers medium and minor irrigation project accounts for majority of the projects sanctioned. In terms of amount, rural roads and bridges have the highest share. Over the years there has been an increase in number and amount sanctioned for projects other than irrigation, rural bridges and roads. 12 In projects to be implemented by PRI/SHG/NGO if the state government borrows for PRIs/SHGs/NGOs then the bank takes additional guarantees. Where the state government desires that the PRI/SHG/NGO apart from implementing the project should also be the borrowers the loan is released on execution of a default guarantee by the state government in favour of the bank along with the usual mandate. In case NABARD is satisfied that (i) the project to be financed are likely to generate adequate income to enable the PRI/ SHG/NGO to repay the interest and the principle on time without default, (ii) PRI/SHG/NGO are financially, managerially and organizationally capable of managing the project and (iii) PRI/SHG/ NGO has power to create assets and charge on its assets/ income in favour of the lender the national bank will waive the requirement of security and may favour making alternative arrangement. The NABARD has constituted State/ District Level Sanctioning Committees depending on the flow of proposals from PRIs/ SHGs/ NGOs to expedite the sanctioning process of SHG/PRI/NGO initiated projects. Rural Infrastructure 261 Table 9.4.1 Loan Disbursements Under the RIDF Tranches, and Deposits Received from Commercial Banks Year RIDF-I 1995–6 387.3 1996–7 795.5 1997–8 250.1 1998–9 109.2 1999–2000 149.3 2000–01 51.0 2001–02 18.3 Total 1760.7 RIDF-II RIDF-III – 291.6 542.2 602.6 440.5 215.5 157.5 2249.9 – – 216.7 469.1 726.8 472.7 297.9 2183.1 RIDF-IV – – – 132.3 543.3 706.7 480.8 1863.0 RIDF-V RIDF-VI – – – – 418.0 771.4 779.9 1969.3 The aggregate amount disbursements under RIDF -I to VII till 31 March 2002 stood at Rs 13,041.66 crore. Details of disbursement are given in the Table 9.4.1. The deposit outstanding received from banks at the end of March 2002 was Rs 9725.02 crore. Repayments were being received regularly from the state governments by the NABARD. Large Time Overruns Projects showed considerable time overruns the reasons for which according to the NABARD, were: (1) Mismatch between physical and financial disbursements; (2) The implementing departments (of governments) were not adequately funded by the state governments; (3) The projects also faced problems of land acquisition, forest and environmental clearance; (4) Inadequate monitoring and inability to take corrective action by government officers also delayed the project, (5) Lack of transparency among the key functionaries also led to delays in the completion of the projects. Based on the Project Completion Reports (PCRs) received from the state governments, the NABARD observed that much irrigation, potential, employment growth, and value added had taken place. Some of the salient features along with memo items are presented in Table 9.4.2. Furthermore, the irrigation potential created by the projects was 16.67 lakh hectares. Utilization of irrigation on an average was 68 per cent. Incremental incomes from the project ranged from Rs 7000 to 9000 per hectare. The projects were financially viable with a financial rate of return (FRR) ranging from 13 to 50 per cent. The social returns in these are known to be very high, and as such the focus on these activities of physical infrastructure is most laudable. – – – – – 959.6 939.5 1899.1 RIDF-VII Disbur- Growth Deposits Growth sement rate of received rate in during disbursefrom deposits the year ments banks (per on all (per cent cent per RIDFs per annum) annum) – – – – – – 1116.6 1116.6 387.3 1087.1 1009.0 1313.1 2277.9 3176.9 3790.4 13041.7 – 350.0 180.7 1042.3 -7.2 1007.0 30.1 1338.0 73.5 2306.6 39.5 2653.6 19.3 3590.7 – 12288.3 – 197.8 n 32.9 72.4 15.0 35.3 – Completion Still Awaited The completion status of projects from RIDF-I to IV (which should have been completed by end-2002, as per the project plans, is shown in Table 9.4.3. Only about 71 per cent of the projects had been completed. Larger projects especially in irrigation show poorer completion. Thus, it is certain that the size-weighted completion status is much worse than what Table 9.4.3 would indicate. Irrigation and rural roads and bridges dominate. Table 9.4.4 brings out the average size of projects, which could lend support our claim that the size-weighted delays have been large. Unfortunately, for irrigation projects there is no break up into minor, major and medium. Table 9.4.5 brings out the purpose-wise loans under all RIDFs. A COMMENTARY Macroeconomic Compulsion Public investments in agriculture had been slowing down in the 1980s and there was much concern that the pace of agricultural output would not be maintained. In the early 1990s the economy underwent stabilization and then structural adjustment. Public investments bore the brunt of the expenditure reduction policies that were put in place to bring the fiscal deficit in line. In the first flush the centre did most of the adjustment. Soon enough part of the burden of adjustment fell on the states as the grants and loans from the centre that supported capital expenditures slowed down. More importantly, the simultaneous pursuit of financial sector reform along with the real sector reform that raised interest rates, meant that state governments were suddenly stressed/extended on their debt service. Their borrowings 262 India Infrastructure Report 2003 Table 9.4.2 A Summary of ‘Benefits’ and Effects of Irrigation, and Roads and Bridges Projects under RIDF RIDF-I 1995–6 Estimated GDP generated in irrigation projects / Outlay on RIDF Average output to net fixed capital in agriculture (NAS) GFCF in agriculture (Rs cr) GFCF in electricity gas and water (Rs cr) GFCF in construction (Rs cr) RIDF outlay on irrigation as per cent of GFCF in agriculture RIDF outlay on roads and bridges as per cent of GFCF in construction GCF by the Public Sector in Agriculture (NAS) RIDF outlay on irrigation as per cent of GCF in agriculture in public sector NNP per capita (NAS) (Rs) Surplus share in NNP per capita (NAS) Imputed wage and mixed Income (Rs) RIDF created employment due to irrigation projects (recurring) (lakh) RIDF created employment* due to irrigation projects (non-recurring) (lakh) RIDF created total employment due to irrigation projects (lakh) RIDF outlay per unit employment created by irrigation projects (Rs) RIDF-II 1996–7 RIDF-III 1997–8 RIDF-IV RIDF-V RIDF-VI RIDF-VII 1998–9 1999–2000 2000–1 2001–2 1.45 0.74 0.78 0.81 1.14 0.76 0.83 0.79 0.84 0.83 20739 23826 23086 27971 24608 29423 23785 33160 31717 37835 0.69 28425.5 35200 0.60 29720.3 39700 5665 8.66 3189 5.43 6855 3.88 6029 3.59 6455 3.32 6400 4.31 6200 4.02 0.50 39.40 23.30 32.75 35.88 40.91 39.52 6762 7296 26.56 10160 0.17 8463 6.62 6921 17.20 7549 13.78 11601 12772 0.17 0.16 9664 10716 2.21 1.59 11.30 14712 16047 16487 17789 0.16 0.16 0.16 0.16 12358 13479 13849 14943 2.35 14.30 7.88 1.92 1.12 0.52 0.20 0.34 0.30 0.40 0.33 7.74 2.73 1.79 2.69 14.60 8.28 2.25 23196 45873 53169 31696 7211 14809 53175 Note: For comparison and ratios the NAS (National Accounts Statistics) figures for the start of RIDF year is used. GCF—gross capital formation; GFCF—gross fixed capital formation. went up sharply so did the debt service burdens13. The RIDF was announced by the centre as a way to support the states in the rural, especially agricultural, capital forming investments, without the centre having to fund the same. The loans from the NABARD at concessional rates are given on the basis of state guarantees, to state governments, and now local bodies and others. The centre announces the NABARD’s corpus for this lending. The actual fund flow is from banks that were allowed to park funds with NABARD in lieu of their lending to the agriculture. Bank Liberalization Simultaneously, the policy of priority sector lending to agriculture (and also to other sectors such as small-scale industries) became problematic. The policy of directed credit was not in tune with the liberalization of the banking sector, but lacking good ideas on methods of ensuring 13 See chapter 6.1 by Tapas K. Sen in this report for a synoptic view of the fiscal situation with regard to the states. credit flows to these ‘priority’ sectors, the government continued with the policy. But it allowed banks not meeting Table 9.4.3 Completion Status of Projects (RIDF-I to IV), as on 31 March 2002 Area No. of projects sanctioned Irrigation 85 Medium Irrigation 149 Minor Irrigation 17035 Rural Roads 12660 Rural Bridges 2546 Watershed 192 Management Flood Protection 120 Market Yard 18 Drainage 132 Others 17 Total 32954 No. of projects completed Per cent of projects completed 40 81 10996 9969 2127 102 47.1 54.4 64.5 78.7 83.5 53.1 103 0 101 13 23532 85.8 0.0 76.5 76.5 71.4 Rural Infrastructure 263 Table 9.4.4 Average Project size (Rs lakhs per project) Irrigation Rural roads Rural bridges Others RIDF-I RIDF-II 44.1 146.0 17.8 157.2 32.2 96.2 22.9 301.7 RIDF-III 10.8 28.7 29.9 132.6 their targets to park funds with financial institutions like the Small Industries Development Bank of India (SIDBI), Housing and Urban Development Corporation (HUDCO) and NABARD which were deeply involved in their respective priority areas. It would have been better to allow banks to trade their priority sector portfolio so that the sector as a whole met the target14. This would have had the good effect of converting a hard constraint to a soft one for banks that had little motivation or competence to lend to agriculture and other priority sectors. Whereas those with specialized competencies (including wider reach) in this direction could have built on their strengths by lending even more than the stipulated limits15. But parking funds with NABARD at least reduced the entry barriers for new banks, to usher in competition in the sector16. Nevertheless, given the macro-economic situation17, RIDF would have been a godsend to public sector capital formation in agriculture. Projects of high return, essentially those that awaited funds for completion, (since they had been delayed inter alia due to capital scarcity post reform) were to be selected. The idea was not entirely motivated by the need to shift borrowings off the balance sheet. Guarantees of state governments have, of course, gone up. Guarantees of State Government The fiscal and transparency implications of the RIDF, though, are quirky. The state governments were quite willing to 14 For a discussion of how priority sector lending targets could be incentivised, so that optimality in banks’ portfolios can emerge, along with enhanced lending to the sectors, see Morris, (2001). 15 Interest rate freedom does not exist for small loans. The regulated low interest rates, could severely restrict fund flow to the sector. 16 Even that measure would not have arrested the relative decline of access to savings of the priority sectors. Being largely dependent on the banking sector, rather than on capital markets, as the disinvestment process gathered momentum in the first half of the nineties, the flows on account of credit to the real sector fell quite rapidly. 17 Credit was also affected by the sterilisation of capital inflows given money targeting. So agriculture even with RIDF and the continuance of priority sector lending could hope at best to hold to a share of a cake whose size was rapidly shrinking. As gilt rates rose with tight monetary targeting banks were comfortable parking funds in SLR securities. That would have aggravated the problem further for firms (small), and agriculture with comparative advantage for accessing bank funds, and a disadvantage in going to capital markets. RIDF-IV RIDF-V 195.6 72.3 29.9 57.3 1.0 72.1 15.1 5.1 RIDF-VI RIDF-VII 4.7 71.4 33.6 12.9 5.9 18.8 32.5 9.9 borrow from the RIDF since the rates were lower than what they would have to pay in the market. NABARD took little or no risks, and probably did not even really worry about the project and its performance since the money was guaranteed by the state government by means of ‘irrevocable letters of authority (mandate) executed by the state governments and registered with the Reserve Bank of India (RBI) and Time Promissory Notes (TPNs) of the state governments’ (Annual Report, 2001–2, NABARD). But lending to state governments did involve payments risk since many state governments have defaulted on salaries and even on pensions. That possibility was side-stepped at least on the books of NABARD through the above mentioned guarantee, and by ensuring that lending growth (that is, of outstanding) rates stayed higher than the rate of debt service. ‘Ponzi Finance’? In such a situation state governments could look forward to cash inflows from new loans which would more than cover the debt service. The day the rate of growth rate of lending falls such that they do not deliver net resources to the states, the incentive to default or delay payments can be high. Notice from the Table 9.4.1 that the disbursement in the year 2000–1 was as much as Rs 3176 crore while the repayments was Rs 866.15 crore. The current interest rate is 10.5 per cent, and the repayment period is seven years with some rescheduling possible. This implies a service Table 9.4.5 Purpose-Wise Sanction of Loans under All RIDF (31 March 2002) Purpose Irrigation Rural Bridges Rural Roads Others* Total No. of projects (% to total) Amount (Rs crore) (% to total) 165165 7593 35954 24523 233235 70.8 3.3 15.4 10.5 100.0 8332.66 3090.2 9150.99 2858.64 23432.49 35.6 13.2 39.1 12.2 100.0 Note: * Others include watershed development, flood protection, market yard/godown, drainage, cold storage, fisheries, forest development, inland waterway, primary schools, public health, etc. 264 India Infrastructure Report 2003 rate of 21per cent of principal per annum. In other words, if the nominal growth of disbursements is larger than this rate then the payments risk can be ‘side stepped’. From Table 9.4.1 we see that the annual growth rate in disbursements has been higher. The Compound Annual Growth Rates (CAGR) (1995–6 to 2001–2) is 39 per cent. Overall, credit expansion has been at a slower growth than this at about 13.8 per cent (CAGR between 31 March 1996 and 31 March 2001), so banks may well be viewing NABARD as parking for a return a shade better than on gilt. NABARD’s Weak Incentive Does the fact that the funds are being routed through a financial intermediary with specialized skills in evaluation and monitoring and viability assessments make any significant difference? On some key aspects of government failure there is not much improvement. The studies (even the rather formal and possibly ritualized) variety carried out by NABARD and its ‘consultants’ reveal that time overruns were common. Project completion as per schedule was rare, and delays of up to three years were common. The NABARD has little incentive to improve the situation. First, independent of whether the projects were delayed or completed, or even if they were quite uneconomical, NABARD could look forward to debt and interest service. All payments due were fully realized as is mentioned in the annual reports. State governments showed a tendency to treat the disbursements under the RIDF as treasury transaction rather than being project related (though on paper they were). Therefore, little learning in lending to small infrastructure projects, and irrigation would have taken place. As such the perceived risk would continue to remain high forever, condemning the set of activities to be risky in the eyes of financial intermediaries. We will soon consider this aspect while discussing one CAG Report on Irrigation, which inter alia covered the RIDF. High Social Returns The Annual Reports of NABARD indicate very high financial rate of return on the irrigation projects. There was no question of the rate of return in any commercial sense being as high as the 30 per cent or more that many projects seem to have. Irrigation benefits, though very large, have hardly been appropriable in India, given the virtual give away of public irrigation services. Typically, not even operational and maintenance costs tend to be recovered. That aspect has not changed at all. While part of the very high social rate of return on RIDF irrigation projects may not be borne by a more rigorous ex-post consideration of the cost and benefits, the internal social rate of return are likely to be far above the cost of capital. This is because of two reasons. Irrigation has large social benefits in waterconstrained and water-uncertain situations18. Since the projects, especially those taken up in the first three rounds of the RIDF, were those that had got delayed for inter alia want of funds, the IRRs that are based on ignoring the sunk cost would naturally show very high returns. This is as it should be since the RIDF was intended to be focused, to realize maximum social gain, by completing the projects. Since the RIDF funds came on a route parallel to Plan Funds, and with possibly less stringent ex-ante procedures in spending, it was effective in completing long incomplete projects. Despite that, there were further delays of about nearly three years in many cases. Better Management? Table 9.4.6 gives a sample of projects for which some information to work back to the overall time overrun was available in the Annual Reports. Overall time overruns of the projects were very high and the RIDF was probably the key to their completion. Even if such projects represent those falling just around the one sigma value in terms of time overruns, the time overruns in irrigation projects in general is likely to very high. This is in minor and medium irrigation projects that involve the state. One can well imagine the situation with major irrigation projects. The RIDF outlay as a proportion of total cost (including sunk cost) is small in the range of 15–18 per cent (see Table 9.4.6). Thus, if RIDF could have ensured ‘that from now on irrigation projects are going to be better managed’ then things could have really improved from the point of view of the public exchequer. But there is no indication at all that in any significant way, project management would have improved. ‘Off Budget’ Borrowing We could get just one independent reference to the RIDF. That was by the CAG and pertained to the state of Rajasthan and the RIDF was only a part of a comprehensive study of the working of the Irrigation Department. Rajasthan could be considered as an average state on the aspect of governance. Thus according to the Audit Report (Civil) for the year ended 31 March 2001 of the Irrigation Department: 18 The high returns to irrigation may be inferred from the high marginal productivity of water, and the finding that irrigation supplies best explain agricultural growth. Also in water-constrained areas, the water market rates are high—far above the cost of public supply with all its inefficiencies. The best indicator of the value of rural bridges and road is the large price difference between farm gate and mandis, in many parts of rural India that are poorly connected. Also the mortality avoidable by being able to quickly access central medical facilities is indicative. Rural Infrastructure 265 Table 9.4.6 Benefits Derived from Select Irrigation Projects Financed Under RIDF Project Time overrun** (%) Tons Pump Canal 400 (Allahabad, Uttar Pradesh) Amipur Medium 375 Irrigation Project (Porbunder and Junagadh, Gujarat) Tilar Medium Irrigation 400 Project (Sahajpur, Madhya Pradesh) Tank and Barrage Schemes N.A. (Vizag, Nalgonda and Kurnool Andhra Pradesh) Tank and Barrage Schemes 200 (Chitradurga and Dharwad, Karnataka) Capital cost (Rs cr) RIDF Loan (Rs cr) Net RIDF Increme- Outlay/ ntal income Total (Rs per capital hectare) cost (%) FRR* (%) 27.43 6.29 4061 18.7 29 10.93 1.45 9635 11.7 50+ 39.30 6.56 2932 14.3 0.73 0.24 8896 0.45 0.14 4720 Original Reference starting year post date of the RIDF project 1969 1998–9 1978–9 1997–8 46 1978 1998–9 24.7 48 N.A. 1997–8 23.7 42 1990 1998–9 Note: FRR—presumably ‘financial’ rate of return; N.A.—Not available Source: From Table 4.6 of NABARD, Annual Report, 2000–1, and information in text. ‘Time overrun’ has been estimated using a normal time of completion of four years for medium and three years for minor irrigation projects. ‘NABARD sanctioned 179 schemes under trench (sic.) I to VI of the RIDF of which 76 were completed (40 within the targeted time and the rest after a delay of 1–3 years). Of the remaining 103 incomplete schemes, 50 were scheduled to be completed by March 2001 and an expenditure of Rs 103.32 crore were incurred on these schemes. A test check of the completed projects revealed that canal work in respect of Boodpada (RIDF-I), Anandpur, Hamipur, Danpur, Bahadurpur, Bidloi (RIDF-II) and the head works in respect of Bhanpura (RIDF-II) were not complete but the schemes were declared complete’. (Emphasis Added.) ‘...An advance of Rs 9.45 crore for fifty-five schemes was received from NABARD during 1998–2000. The loan amount was credited to Internal Debt of the state government from NABARD. None of these, except one, was started as no budget was allotted by the FD [Finance Department] for these works and no advance was made available to the Irrigation Department. Instead Rs 9.10 crore (Rs 9.45– 0.35 crore) were not spent for the purpose it was sanctioned but was used to boost ways and means position of the State. Further, interest liability of Rs 1.62 crore (up to March 2001) was created.’ (Emphasis Added.) check of 44 schemes sanctioned under RIDF-III revealed that as against a loan of Rs 23.21 crore, Rs 40.96 crore and Rs 28.38 crore sanctioned for 1997–8,1998–9 and 1999–2000 respectively, the budget provision for these projects/schemes were Rs 11.53 crore (50 per cent) Rs 24.54 crore (60 per cent) and 17.79 crore (63 per cent). Eight schemes were completed within the stipulated time. Inadequate provision caused delay in completions of 36 schemes.’ ‘...The amount of loan Rs 1.16 crore drawn in excess of expenditure on six completed and one dropped scheme by the department was not utilized for the purpose for which it was sanctioned.’ NABARD points to two aspects of the RIDF to make out a case for success—the high social return and employment generation and the near perfect repayment experience. We have argued that these cannot be used as measures that are indicative of the correctness of the design: the former is a matter of both the high returns in irrigation per se and the fact that RIDF funds were instrumental in bringing about completion. The second is no measure either, given the guarantees and the fact that governments have an incentive to repay when the disbursement growth rates are higher than service rates. Tardy Implementation Monitoring by NABARD ‘...The state government was required to make adequate budget provision for sanctioned schemes/projects. A test The next question is, has NABARD’s involvement in any way improved the implementation of the projects? The 266 India Infrastructure Report 2003 Annual Report (2001–2) mentions ‘monitoring’ through ‘...desk reviews of periodic returns as also field visits... Services of consultants [Agricultural Finance Corporation] have also been commissioned for monitoring implementation... Findings have been promptly communicated to the [government]’. These efforts would have at best resulted in evaluatory assessments and not information for corrections since they ignore time lag in the information, and the lead times for the government to act. These analyses, mistakenly called monitoring, would have little use in managerial actions to correct slippage and such problems at the project level. At best they could inform the next round of implementation, or influence the strategy of the next round, if there is learning taking place somewhere in government. But this is doubtful because there are hardly any organizational processes or structure, that allow embedding of learning in government. Chief Secretary to Monitor? More importantly ‘.. the progress in the implementation of projects continued to be reviewed in quarterly meetings of the High Power Committee (HPC) constituted for the purpose in each of the states under the chairmanship of the Chief Secretary/Finance Secretary of the state’ (Annual Report, NABARD, 2000–1). It is a moot point if the roughly 10,000 projects per state can in any way be meaningfully reviewed except on macro (economic) aggregative and overall financial dimensions, by chief secretaries who have many other pressing matters. Thus, if land acquisition is found to be a major cause for delay what can the HPC do? There is no way the specifics of a project could be brought out at so high a level, but the specifics are necessary for corrective action. It falls into the same trap, rife in government systems and thinking in India, that information alone can lead to correct action, even if incentives are unaligned or perversely aligned against the performance of the primary task. Only common general problems could at best emerge (assuming that the reporting systems correctly gather the information and tabulate the same). But the general problems are known and their resolution involves deeper changes in the politics, macroeconomics, the law and the working of the bureaucracy19. So we cannot but conclude that the RIDF too fits in with the ritualization of evaluation and monitoring that is widespread in government today. The only thing positive here is that since funding is from an external body, the form of reporting, monitoring and assessment would be adhered to better. 19 Refer to Chapter 5.1, by Sebastian Morris in this report for the general factors causing time overruns in public sector peojects, at the central level. The next paragraph brings out the general factors in time overrun of RIDF irrigation projects. Table 9.4.7 Results of a Regression: Log (Sanctions) Independent variable Coefficient t-value Constant ( ) Log(Agri.Value added) ( ) R-SQ. (ADJ.) –3.36608 0.736696 –3.5840 10.1907 0.8108 No. of Obs Sig.level 0.0016 0.0000 25 Note: See text for explanations. Time Overruns Based on the PCRs sent by the state governments, NABARD consolidated the PCRs for the projects of the first tranche to report: ‘The time lag between allocation of funds, actual sanction and the first disbursement ranged from six months to more than a year. Time overrun has been very common in the irrigation projects. All the projects sanctioned under RIDF-I were to be completed by March 1997. However, by that date only 543 projects (13 per cent of total) would be completed. .......The delayed completion/implementation of projects was due to faulty formulation of projects, inadequacies in appraisal and sanction and poor monitoring of progress of implementation. The cost overrun as compared to original estimates was on an average 7.79 per cent over the period...’ If this assessment is to be relied upon (recall the comments of the CAG on the situation with regard to the RIDF in Rajasthan earlier), then clearly the time delays are significant. A rough assessment of the time delays in relation to the completion times stipulated at approval that this 13 per cent completion would mean is about 60 per cent! This is of course for the ‘to be completed’ part of the project. Thus, when there are delays of this magnitude for the work taken up specifically for speedy completion then for irrigation projects as such in all probability there would have been little or no change for the better. Reported cost overruns are small. Here the data could be relied upon. The delayed decisions affect the physical start of project implementation and the completion time once the work has started. Much of the delays are in the pre-physical implementation stage, and the costs incurred (or benefits lost) during this period would not have been taken into account, since the usage of the fund as such starts ticking only with the first disbursements. So delays pre-disbursement would not add to cost for the NABARD outlay, though delays post disbursement would. So the cost overrun figures have limited meaning since they do not take into account the benefits lost on delayed completion. Even then there is a certain improvement in that the money being routed through a financial institution (independent of the state government) would mean that at least all the known ex ante difficulties would have influenced the disbursal of funds. Rural Infrastructure 267 Table 9.4.8 Ratio of Observed ‘Sanctions to Predicted Sanction’, and Observed to ‘Predicted Disbursals’ State Sanctions under all RIDF cumulative (Rs cr) Manipur Bihara Assam Haryana Punjab Sikkim Goa Rajasthan Tripura Kerala Uttar Pradesh West Bengal Karnataka Gujarat Maharashtra Meghalaya Madhya Pradesh Mizoram Tamil Nadu Nagaland Orissa Andhra Pradesh Jammu & Kashmir Arunachal Pradesh Himachal Pradesh 10.08 432.71 389.79 613.44 907.49 40.04 50.66 1352.13 108.9 843.63 2741.21 1757.26 1531.86 1431.36 2293.94 103.67 1948.18 67.64 1507.55 81.06 1020.33 2741.41 645.22 183.01 630.91 Agricultural value added at current prices, c. 1997–8 46989 1334617 658691 1216376 1759870 23104 26965 2064891 61151 950326 4386323 2274283 1720204 1530338 2901190 42529 2148754 19989 1262639 22400 638032 2417704 211107 32733 146838 Ratio of observed to ‘Predicted’ sanctions 0.11 0.39 0.58 0.58 0.66 0.71 0.80 0.87 0.94 0.96 1.02 1.06 1.13 1.15 1.15 1.17 1.22 1.33 1.40 1.47 1.56 1.57 2.23 2.50 2.85 Disbursals (Rs cr) 0.96 42.04 225.02 300.68 578.50 31.45 27.13 842.35 20.21 432.26 1613.46 886.57 802.65 878.90 1397.04 47.15 985.59 36.81 941.57 28.02 608.78 1591.89 291.17 68.55 362.37 Ratio of disbursals to ‘predicted disbursals’ 1.03 0.22 1.31 1.03 1.26 2.60 1.70 1.15 0.52 1.02 0.97 0.89 0.95 1.13 0.88 0.40 1.65 1.29 1.14 1.02 1.16 0.96 0.94 0.96 1.21 Notes: a The ‘sanctions’ predicted are from a model that estimates the sanctions as a function of agricultural GDP c. 1997–8 of the states; and ‘predicted’ disbursements from a model that estimates disbursements as a linear function of sanctions. See text for details. Including Jharkhand, Uttaranchal and Chattisgarh, respectively. Better Allocative Efficiency That takes us to the state-wise distribution of RIDF. Interestingly, it is here where we see some difference in outcomes over routing the same funds through the usual ministerial and planning commission channels. Annexure 4.1 of the NABARD Annual Report 2001–2 gives the state-wise sanctions and disbursals of the various tranches. The aggregate over the tranches of sanctions and disbursals have been taken and a simple model fitted to ‘explain’ sanctions as a function of the agricultural value added of the state (taking 1996–7 figures). The Model: log(Sanctions)= a + b*log(Agricultural value added); was estimated with a high degree of fit (see Table 9.4.7 for the results), and the ratio of the observed sanctions to the ‘predicted’ sanction is reported in Table 9.4.8. Observe that there is significant variation. If the special category states are left out, then Bihar with little or no discipline to even submit project proposals, and others under severe fiscal stress, for example, Assam, Kerala, Punjab and Haryana (and also because they have much infrastructure already in place) and, possibly, Uttar Pradesh show poorer sanctions. Similarly, in the next stage estimating disbursals conditional on sanctions we find that disbursals have been poor for Bihar and Tripura and not particularly different for the others. Thus, except for Bihar, the NABARD sanctions, more than disbursals (conditional on sanctions), bring out the evidence that NABARD does recognize and use state failure and the fiscal situation in its sanctions and disbursals, but perhaps very weakly. But even this is a significant improvement over direct allocations by the central government. 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