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Fishing in Federal Waters

Since the mid-1990s, the World Bank moved the reform agenda steadily from the centre to the states. Deterioration in fiscal discipline forced the states to launch fiscal and administrative reforms under the World Bank's structural adjustment lending. A few states introduced a number of policy initiatives under the conditional lending of the Bank. The relationship between states and the Bank provides a new lens to observe the influence and domination of the multilateral institution on policy formulation and administration in the changed political-economic context.

Fishing in Federal Waters

Since the mid-1990s, the World Bank moved the reform agenda steadily from the centre to the states. Deterioration in fiscal discipline forced the states to launch fiscal and administrative reforms under the World Bank’s structural adjustment lending. A few states introduced a number of policy initiatives under the conditional lending of the Bank. The relationship between states and the Bank provides a new lens to observe the influence and domination of the multilateral institution on policy formulation and administration in the changed political-economic context.


he fiscal imbalance in many state governments in India has been a cause of concern. Over the years, their consolidated fiscal position has shown a marked decline in some of the major indicators. Structural imbalances in the form of large revenue deficits, rising interest burden, increasing distortions in the pattern of expenditure and slow growth of non-tax revenues are major areas of concern. The Reserve Bank of India’s report of 2004 on state finances however observes a reversal in the case of certain indicators, but the improvement is only marginal and confined only to a few states. On the whole, the fiscal situation is disconcerting in almost all the Indian states [RBI 2004]. Under these circumstances, the states have been driven to undertake fiscal and administrative reforms. The structural adjustment lending (SAL) by the World Bank came handy to correct some of these distortions but these were accompanied by the usual conditions.

Context for Reforms

There are good reasons for the shift of the focus of reform from the macro to the micro-level. First, the dependence of the states on the centre for financial aid declined on account of opening of the activities previously reserved for the public sector, elimination of licensing and weakening of central planning, which created an environment in which states assumed larger responsibilities to define their policies and attract private participation. Second, weakening of the national political parties has led to multi-party coalition governments at the centre and the states, enabling smaller regional parties to participate in these coalitions and have a strong influence on national and statelevel politics. Increased levels of state autonomy and weakening of the political authority of the centre over the 1990s provided more “political space” for states to “plough” their own course [Howes et al 2003: 5]. However, the major and immediate reason that forced many states to embark on reforms is the deterioration in their fiscal position. Several forms of subsidies, implementation of the Fifth Pay Commission’s recommendations, unlimited borrowings, and a steady decline in the quality of governance led to a decline in actual performance in many states in the 1990s. The centre, thus, adopted the strategy of forced restructuring as multilateral institutions provided only conditional lending and pushed the fiscal adjustment process.

World Bank Entry into State Finances

The Bank focused on the reform process at the national level in the first half of the 1990s, but shifted the reform agenda to the states in the second half of the decade. The Bank viewed that the states play a key role in devising and implementing policies to reduce poverty; promote human development and stimulate growth. One of the reasons for the shift of emphasis towards the states was that the Bank did not have much “leverage” with the centre to make an impact on state-level policy issues. Unlike the 1988 and 1993 Country Assistance Strategy1 (CAS), the 1995 CAS focused strongly on state finances and the statelevel reform process. The document observed that the areas under the responsibility of the states, such as infrastructure, health, primary education, and anti-poverty programmes, suffered from inadequate funding, and it was essential that the states’ finances be strengthened. A real break through emerged with the strategy put forth by CAS in 1997. The document noted that with the change in the political scene, the states could be pursuing more independent economic policies than the centre. Hence some states launched economic reforms, while other large but poorer ones “seemed to be standing still or going backward.” The strategy adopted in the CAS was to support the states commitment to reforms. In fact, the realisation that seems to have percolated down is about the federal-fiscal relationships between states and the centre. The coupled differential political ideologies directing sub-national level policies made it obviously essential to address the states directly.

The 2002 CAS argued that liberalisation policies at the state-level had not kept pace with the centre’s overall drive towards economic reforms. It says:

Unlike the reforms of the early 1990s, many of the reforms needed today, such as in the physical and social infrastructure sectors are in the domain of the states. The states also make up half of the consolidated fiscal deficit – fiscal reform at the state level is of increasing importance. In view of this, the Bank’s assistance strategy has been reoriented over the last two CAS periods. Now the Bank emphasis on states that: (i) have chosen to embark on a comprehensive programme of reforms, including fiscal and governance reforms, and reforms of key sectors such as power;

(ii) have expressed interest entering into a partnership with the Bank; and (iii) have relatively high levels of poverty. This approach of focusing on a relatively small number of states has enabled the Bank to take a holistic approach in these states using a mix of instruments (adjustment lending, project lending and analytical work) [World Bank 2002: 15].

Since the new economic policies in India depended critically on sustained efforts in key areas under the states’ purview, the Bank strongly argued that reform needs to address (a) lowering subsidies and curtailing the budgetary burden of public sector units (PSUs); (b) raising the resource allocation for social services;

(c) enhancing resource mobilisation through wide-based tax collection and greater cost recovery; and (d) the creation of a conducive climate for privatisation of public services. Following this line of argument, the specific conditions provided were: (1) provision of a legal framework to institutionalise the reforms;

Economic and Political Weekly August 12, 2006

  • (2) reduction in government employment through natural attrition, abolition of posts;
  • (3) closure of sick public sector undertakings (PSUs) through introduction of a Voluntary Retirement Scheme (VRS); and
  • (4) capping of the fiscal deficit and rationalising expenditure.
  • Since benefits associated with the Bank loans are higher,2 many states are competing to seek loans from it. While active in a variety of states, the bulk of the Bank’s work to support core governance reforms has been in three ‘focus’ states – Andhra Pradesh (AP),3 UP4 and Karnataka.5 The “focus” states received 34 per cent financial assistance from the Bank during 1998-2002 and they collectively represented 28 per cent of the country’s population and 30 per cent of the poor. In the Bank’s current portfolio, about 60 per cent of lending is concentrated in seven states. The largest state portfolios are in UP (17 per cent of total commitments), AP (11 per cent), Maharashtra (9 per cent), Gujarat (8 per cent), Tamil Nadu and Rajasthan and Karnataka (7 per cent). Centrally implemented projects now account for 38 per cent of total commitments and state implementing agencies account for the balance [World Bank 2004].

    The Bank has significant lending roles in Orissa, Rajasthan and Maharashtra, which had shown an interest in comprehensive reforms. The Bank loans are designed primarily to contribute in improving government effectiveness and promoting private sector-led growth. A central principle built into the loan’s conceptualisation is flexibility, such that the Bank can intensify support when reforms build momentum, and disengage when reforms go off the track. The states that received the Bank’s SALs have adopted a twopronged strategy: First, reorient the role of the state to focus on the most critical public goods and services, which the private market could not effectively supply; and second, enhance the state’s capability to perform this reoriented role efficiently and effectively through increased competition among service providers, increased citizens’ voice, and reforms to make the public service function more efficiently.

    The state-level SALs had the usual components such as fiscal discipline to rein in the fiscal deficit, business deregulation, public enterprise reform, administrative reforms and poverty eradication by focused spending in the social sectors. These are re-emphasised, but not new, policy initiatives. One of the new elements is that the Bank’s future aid will be contingent on the state’s ability to accelerate Bank approved policies. Second, Bank aid will now be available for supporting the VRS to facilitate closure of loss-making PSUs. Arguably the scene is now set for a more energetic state government drive towards marketisation that has not been seen in earlier years.6 However, the Bank continued to invest in specific sectors in non-reforming states that have an acceptable sectoral reform programme and implementation record. The CAS of 1997 and 2002 called for stopping of all new lending, if the policies in a given state ran “counter to trends in the country.”

    Outcomes and Externalities

    In terms of the outcomes achieved with Bank support, the performance of the “focus” states, in terms of economic indicators, was encouraging. There has been evidence of progress, both in fiscal and governance aspects. This included reduction in the fiscal deficit and improvement in revenue generation in the three states. The reform states provided a legislative framework for reform by passing various laws and levied of user charges in the health and irrigation sectors. Water users associations were set up in AP and Karnataka, though the actual cost recovery is negligible owing to drought during 2001-04. Karnataka has institutionalised medium-term fiscal plan (MTFP). In Karnataka nine sick public enterprises were closed. The focus states, particularly AP and Karnataka, encouraged public-private partnerships in the road and power sectors.

    The AP state treasury was richer by Rs 20.99 billion in 2002 by increasing the power tariff, water rates, bus fare revision, rationalisation of sales tax and reduction in the rice subsidy. The AP economic restructuring project helped the state to promote a number of e-governance initiatives, introduce reforms to promote human resource development and quality of governance.7 The business community too reacted positively to these initiatives. However, the reform package, namely, that of cutting public expenditure and the hike in power and irrigation charges, appears to have hit the low-income groups in both the rural and the urban sectors, with the poor bearing the brunt of the burden of reform.

    In Karnataka, achievements are visible on the revenue front. The tax-GSDP ratio increased from 8.1 per cent in 1999-2000 to 9.6 per cent in 2003-04. On account of reforms, annual savings increased from

    1.5 per cent of GSDP in 2000-01 to 3.3 per cent of GSDP in 2002-03. The fiscal deficit has been brought below the target of 3 per cent of GSDP in 2004-05. The value added tax (VAT) has been introduced in 2004 and reforms in tax administration resulted in buoyancy in tax collection. The commercial tax collection reached Rs 10,000 crore, registering 26 per cent growth in 2004-05. The government encouraged public-private partnerships in the road, health, education, and power sectors and provided a legislative approach to reform.


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    Economic and Political Weekly August 12, 2006

    The UP government made an initial attempt to revitalise the state’s economic performance through a wide-ranging reform programme in the backdrop of high fiscal deficit (Rs 11,632 crore) and revenue deficit (Rs 8,689 crore) in 1998-99. With the Banks’ assistance, a MTFF was developed and 90 treasury offices were computerised. In 1999, the UP government designed a strategy aimed at restoring the efficiency and integrity of the civil service.8 However, the Bank has slowed its lending to UP from 2001 onwards as the state is unable to sustain reforms in the power sector [World Bank 2002: 21]. Change of chief ministers and the absence of a commitment to reform have further slowed down the process.

    In terms of externalities, borrowings resulted in increased interest payments and debt servicing costs of the states. Interest payment consumed 23.5 per cent, 17.5 per cent and 21.4 per cent of revenue receipts of AP, Karnataka and UP, respectively, in 2002-03. The debt-GSDP ratio in Karnataka increased from 20.3 per cent to 32.4 per cent; from 22.4 per cent to 34.1 per cent in AP; and from 34.2 per cent to 53.1 per cent during 1992-97 -2002-03, respectively [Rajaraman et al 2005].

    Due to the slower-than-expected pace of reform implementation in the states, the Bank’s lending commitments fell short of the base case of CAS (2002-04). The total planned base case lending during 2002-04 was $ 9 billion ($ 6.4 billion IBRD and $ 2.6 billion IDA) and actual lending was $ 5.2 billion ($ 2.2 billion IBRD and $ 2.9 billion IDA). Adjustment operations were postponed in Karnataka, TN, UP and AP. Power and urban sector reform was slow in many others. Two observations become very clear. On the one hand, the Bank’s presence was increasing in the states whereas, on the other hand, fissures were quite visible in the relationship with the states. One area where the Bank showed considerable disapproval towards the states was the latter’s emphasis on “commanding heights for the state in the power sector”. In its 2005-08 CAS, the Bank decided to give a big push to private sector participation in the power sector to bring in efficiency in bill collection and metering.

    With the introduction of reforms, particularly in Karnataka and AP, there is a paradigm shift in the role of state governments in implementing their developmental agendas. This shift is visible in various dimensions such as economic management, employment generation, financial management, policy formulation, and service delivery [Howes et al 2003]. Now the government role is more of a facilitator and a regulator of the market economy. Moves to improve delivery of social services and crackdown on corruption have been welcomed by the public. Now more states are embracing reforms, and taking “good governance” as their campaign theme in the assembly elections. But, at the same time there are a good number of politicians who consider reforms as irrelevant to the political success.

    Have the People Approved of the Reforms?

    Interestingly, the pro-reform Karnataka and AP governments were voted out in the legislative assembly elections in 2004. It is felt that both the state governments had given importance to urban areas and neglected the problems of rural areas. Corruption in the administration, drinking water problem, erratic power supply and bad management of drought, accentuation of poverty, growing income inequalities, unemployment, and unabated farmers’ suicides were the major causes for the defeat of the ruling parties in Karnataka and AP. The question in the minds of the observers is whether the policies pursued by the earlier governments in the two states would undergo any substantial change. The governments that came to power after 2004 polls in AP and Karnataka declared that they are not against reforms. Then, it is interesting to see how these governments implement alternative policies and fulfil the assurance made to the electorate? The country’s intelligentsia has expressed doubts about the significance of reforms tailored under the Bank’s adjustment lending. It is argued that the Bank prescribes the same medicine, probably with some variations in dosage, for the states.9

    Summary and Conclusions

    Since the mid-1990s, a wave of reforms has been sweeping at the state-level in India. The number of new reform initiatives is growing rapidly. A few lessons can be drawn from this analysis. First, the introduction of the state-level reforms led to a paradigm shift in the role of state governments in implementing the developmental agenda. This shift is visible in various dimensions. Many states are embracing reforms, and taking measures to provide “good governance”. Second, by implementing a set of reforms that generally address the Bank’s conditions, governments created an environment for successful loan negotiation and reduce the domestic opposition to Bank loans. Andhra Pradesh and Karnataka had adopted this strategy by setting up of task forces for recommending reforms in various areas and hiking the prices for public services before obtaining the SALs. Third, while creating a healthy rivalry among states in attracting investment, both domestic and foreign, the reforms have widened regional disparities among the states. In states that lacked infrastructure and institutions, the Bank continued to invest in specific sectors that had an acceptable sectoral reform programme and a good implementation record. The 2005-08 CAS tries to build a productive development relationship with four states where poverty is increasingly concentrated and where public institutions are considered to be at their weakest – Bihar, Jharkhand, Orissa and UP. The state-level adjustment lending operations in poor and reform-oriented states is aimed at supporting the achievement of the millennium development goals.

    In the future, Bank lending need to focus on issues such as fiscal policy (in particular, VAT) and in building up institutions in poor states where governance is ineffective in delivering public services. The Bank’s lending to select states should generate a public debate on issues such as the need of good governance, elimination of corruption, requirement of political stability and good leadership to reduce poverty.




    1 The 1988 and 1993 CAS also made a reference

    to state-level issues and support for policy

    based investment operations. 2 Benefits of Bank loans include favourable

    borrowings terms (low interest rates, long

    maturities) and technical assistance. Available

    information suggests that IBRD lending terms

    are the most favourable among all multilateral

    development banks and obviously cheaper than

    private flows. 3 The AP economic restructuring project was

    approved in 1997, providing $ 543 million

    financial support for the state’s comprehensive

    reform programme. 4 The UP economic restructuring project was

    approved in 1998, providing $ 251.3 million.

    The UP project focuses mainly on fiscal reform

    and public sector restructuring.

    Economic and Political Weekly August 12, 2006

    5 Karnataka is the leading state in the country to receive aid from the Bank in 2000. The state has received aid for six projects during the year and many more projects are on the pipeline. The state has been implementing the Karnataka economic restructuring programme with the assistance of the Bank.

    6 The Hindu, Bangalore, November 18, 2001.

    7 The Institute of Administration has been redesignated as the Human Resource Development Institute of AP and entrusted with the task of formulating total HRD action plans for the state government. A plan is under implementation to provide HRD inputs annually for about 50,000 public functionaries of the state.

    8 In 1999, Business Today ranked the state as the second worst state to invest in for reasons of policy instability and poor governance. From 1992 to 1998, each chief minister in UP transferred an average of 420 IAS officers per year out of the total cadre strength of just under

    500. See, Howes et al (2003).

    9 See, C T Kurien, ‘Winds of Change’? The Hindu, December 21, 1999.


    Howes, Stephen, Ashok K Lahiri and Nicholas Stern (2003): State Level Reforms in India: Towards More Effective Government, Macmillan, New Delhi.

    Rajaraman, Indira, Shashank Bhide and R K Patnaik (2005): ‘A Study of Debt Sustainability at State-level in India’, RBI, Mumbai.

    RBI (2004): State Finances: A Study of Budget of 2002-03, Reserve Bank of India, Mumbai.

    World Bank (1995): India: Recent Economic Development and Prospects, World Bank, Washington DC.

  • (2002): India: Country Assistance Strategy: Progress Report, Report No 25057-IN, World Bank, Washington DC.
  • (2004): Country Strategy for India, Report No, 29374-IN, South Asia Region.
  • Economic and Political Weekly August 12, 2006

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