HSS India Insights
Leveraging the Federalism-Economy Nexus for Viksit Bharat 2047

Federalism, a system that distributes power between central and subnational governments, is not only a political arrangement, but can also be a key driver of economic growth. Federal systems are marked by their abilities to tailor policies and governance to local needs that can lead to significant economic outcomes.

As the Prime Minister of India, Shri Narendra Modi, envisions a Viksit Bharat by 2047, understanding how federalism enhances economic growth can help shape a long-term strategy essential for achieving balanced growth and prosperity. Federalism allows states to adopt unique approaches towards their economic development. The decentralization of power under federalism enables a state government to address the state’s local and specific needs, leading to faster and more efficient economic outcomes. The principles of federalism warrant more coordination between the Union and States of India for better alignment of their economic policies, strategies, and resource allocation to achieve the goal of Viksit Bharat.

For federalism to truly serve as a catalyst for economic growth, following conditions must be met:

1. Clear Distribution of Powers: A well-defined separation of responsibilities between the Union and State governments is critical to avoiding overlaps and conflicts.
2. Sufficient Financial Independence for States: States need fiscal autonomy, alongside a strong central framework, to effectively implement tailored policies and initiatives.
3. Minimal Political Conflicts: Cooperative federalism thrives when political disputes between the Centre and States do not hinder governance and economic decision-making.
4. Strong Institutional Framework: Institutions that promote dialogue and coordination between the Centre and States are essential for fostering sustainable, long-term economic growth.

Cooperative and Competitive Federalism in India

The Constitution of India clearly defines the roles and responsibilities of the centre and the states, creating an interdependent federal ecosystem. Facilitating coordination and managing relations between the centre and the states and among the states is done by the centre.  PM Modi has been stressing on the need to leverage cooperative and competitive federalism for an all-round growth. In the 9th Governing Council Meeting of NITI Aayog, PM Modi emphasized the importance of collaboration between the Centre and the States to achieve the vision of Viksit Bharat 2047. Through the power of cooperative and competitive federalism, he envisions the fulfilment of this ambitious vision. The formation of National Institution for Transforming India (NITI) Aayog in January 2015 was to act as an institution to foster cooperative federalism and promote competitive federalism. Cooperative federalism is a concept where the central and state governments work collaboratively to achieve common goals, particularly in areas where their responsibilities overlap. In India, schemes like the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) and Pradhan Mantri Awas Yojna involve a coordinated effort between the central and the state governments to reduce poverty and improve housing.

Political differences between central and state governments, particularly when they are governed by opposing parties, can impede effective cooperation. On the competitive front, inequalities exist among states – some states like Gujarat, Maharashtra, and Tamil Nadu have better infrastructure, resources and expertise to attract investment while others, such as Bihar, Jharkhand, and Odisha, struggle due to meagre resources. This disparity often leads to widening regional gaps and uneven development. To address these challenges and pursue the vision of ‘Viksit Bharat’ by 2024, specific priorities have been outlined in the Union Budget 2024-25. These priorities, and how they can be translated into action at the sub-national level, are as follows:

1. Productivity and Resilience in Agriculture: Different states can focus on their dominant crops or sectors utilizing central support to enhance agricultural productivity and developing climate resilient varieties. The Central government, in partnership with the states, will facilitate the implementation of the Digital Public Infrastructure (DPI) in agriculture for coverage of farmers and their lands in 3 years.
2. Employment & Skilling: The states can prioritize skill development of the youth in order to boost the employment. The Government of Andhra Pradesh has announced conducting the Skill Census 2024 which is a first of its kind comprehensive assessment and data collection of the skills and competencies of individuals and the skillset required by the industry. 
3. Inclusive Human Resource Development and Social Justice: The states can focus on the issues as per their demographic and socio-economic challenges. The plan is developed for the states of the eastern region, including Bihar, Jharkhand, West Bengal, Odisha, and Andhra Pradesh for generation of economic opportunities. As part of a special package, the central government will provide financial support of Rs. 15,000 crore (US$ 1.80 billion) in 2024-25 to Andhra Pradesh to meet the requirement under the Andhra Pradesh Reorganization Act, 2014.
4. Manufacturing & Services: As of March 2024, Maharashtra has 17.74% of the total Micro, Small and Medium Enterprises (MSME) in India, followed by Tamil Nadu 10.2%. To support the lagging states, the 2024-25 union budget places a strong emphasis on MSMEs in the manufacturing sector with the introduction of credit guarantee scheme which enables the MSME to get term loans without collateral or third-party guarantees.
5. Urban Development: To address the skewed urbanisation in India, the budget calls for working in partnership with the states in the seven different areas – cities as growth hubs; creative redevelopment of cities; transit-oriented development; urban and rental housing; water supply, sewerage and sanitation; street markets; and stamp duty.
6. Energy Security: A significant amount has been allocated for the Ministry of New and Renewable Energy (MNRE), enabling further development of renewable energy sources and to encourage energy efficiency improvements in industries across states. States with greater renewable energy potential could benefit more from these initiatives, highlighting the need for targeted support to ensure equitable energy access across India. The state electricity boards will need to work on their existing grid capacity for the installation of rooftop solar plants.
7. Infrastructure: In addition to the total allocation, a provision has been made for long-term interest-free loans to states to assist them in their resource allocation and support infrastructure projects aligning with their development priorities.
8. Innovation, Research & Development: The Anusandhan National Research Fund (ANRF) shall be set up for basic research and prototype development. The states with designated “Growth Hubs” can expect increased investment in research facilities, and innovation-oriented projects.
9. Next-generation Reforms: The collaboration between the Centre and the States shall be required for the effective implementation of several reforms for improving productivity of factors of production (land, labour, capital and entrepreneurship, and technology as an enabler of improving total factor productivity and bridging inequality facilitating markets and sectors to become more efficient. 

Competitive federalism refers to a system where different states or regions compete with each other to attract investment, improve governance, and achieve better socio-economic outcomes. States strive to outperform each other in areas like ease of doing business, infrastructure development, and social indicators. NITI Aayog ‘endeavours to promote competitive federalism’ by facilitating improved performance of States/UTs and encouraging ‘healthy competition among states through transparent rankings, in various sectors, along with a hand-holding approach’. To promote competition among the states, the ranking of states is done by the NITI Aayog, on a number of indices like the Health Index, Education Index etc.

Fiscal Federalism and Finance Commissions

Fiscal federalism, the financial relationship between different levels of government, is fundamental to the functioning of a federal system. Fiscal federalism, a term coined by the German-born American economist Richard Musgrave in 1959, and deals with the division of governmental functions and financial relations among levels of government. In India, the Finance Commissions play a crucial role in ensuring equitable distribution of financial resources, enabling states to meet their developmental goals. The task of the Union Finance Commission is to rectify the vertical and horizontal imbalances between the Union, the States and the Local Bodies.

The FC recommendations ensure that states have the financial resources needed to meet their developmental needs while maintaining fiscal discipline. The 15^th FC 2021-26, for instance, emphasized the need for states to enhance their revenue generation capacities while also receiving adequate central support. This balanced approach helps maintain economic stability and fosters sustainable development across the country. The recommendations made by the finance commissions are usually for five years but are, legally speaking, non-binding on the union government. However, the 15^th FC is an exception as it covers a period of 6 years.

The 15th FC increased grants to local bodies by 51.81 per cent, providing critical support for regional development. Alongside the Union Finance Commissions, State Finance Commissions (SFCs), focus on the equitable distribution of resources between state governments and local bodies. They ensure local governments have the necessary financial autonomy to address regional priorities.

Conclusion

Federalism is a cornerstone of economic governance in any functional democracy. It enhances the value of decentralized decision-making, fosters competition, and ensures balanced development. In the Indian federalism system, the challenge lies not only in policy formulation but in the effective execution and adaptability of these policies across diverse states. As India progresses, fostering a balanced, inclusive, and innovation-driven economy will be key to unlocking its true potential. By 2047, if this synergy between central and state governments continues to grow, India can indeed become a global economic powerhouse, realising the aspirations of a Viksit Bharat.