Content
- India’s Fiscal Federalism Under Strain
- India’s “White Space” Diplomacy
India’s Fiscal Federalism Under Strain
Core Argument
- The article argues that India’s fiscal architecture has gradually shifted towards greater centralisation, where the Union government’s revenue buoyancy contrasts sharply with persistent fiscal stress faced by States.
- Despite constitutional guarantees of fiscal federalism, States’ effective spending autonomy has reduced, owing to constrained revenue mobilisation and rising dependence on conditional transfers from the Centre.
Relevance
- GS II – Cooperative federalism, Finance Commission, Article 270, cesses and surcharges, GST Council, Centre–State trust deficit, centrally sponsored schemes
- GS III – Public finance, taxation system, GST reforms, FRBM constraints, fiscal deficits, public expenditure composition, capital vs revenue expenditure
Practice Question
- “India’s fiscal federalism is constitutionally designed but operationally centralised.” Examine this statement in light of the growing role of cesses, surcharges and centrally sponsored schemes. (250 words)
Constitutional Design vs Fiscal Reality
- Constitutionally, India follows a quasi-federal fiscal structure, where expenditure responsibilities of States exceed their independent revenue-raising powers, making them structurally dependent on central transfers.
- The intended balance through Finance Commission devolution and grants is increasingly undermined by the growing role of cesses and surcharges, which lie outside the divisible pool.
Rising Central Revenues and Asymmetry
- Over the past decade, gross tax revenues of the Union have expanded steadily, driven by income tax, GST stabilisation, and improved compliance through digitalisation.
- However, the share of States in gross tax revenue has not risen proportionately, creating an asymmetry where revenue growth is increasingly concentrated at the Centre.
Cesses and Surcharges: Key Source of Centralisation
- The editorial highlights that cesses and surcharges now form a significant portion of Union tax revenues, yet are not shared with States under Article 270.
- This practice allows the Centre to bypass Finance Commission devolution, effectively reducing the States’ share even when headline devolution percentages appear unchanged.
Finance Commission Devolution in Practice
- Although the 15th Finance Commission recommended 41% devolution of divisible pool taxes, the actual fiscal benefit to States is diluted by the shrinking divisible base.
- Consequently, States experience a gap between constitutionally promised transfers and realised fiscal resources, weakening trust in institutional mechanisms.
GST and the Erosion of State Autonomy
- GST subsumed major State taxes, including VAT, excise, and entry taxes, significantly curtailing States’ independent taxation powers.
- The expiry of GST compensation in June 2022 exposed States to revenue volatility, while decision-making within the GST Council remains heavily Centre-driven.
Declining Fiscal Space of States
- The article notes that States’ fiscal deficits remain constrained, even as expenditure demands increase due to welfare obligations, infrastructure needs, and disaster management responsibilities.
- Limited borrowing space under FRBM norms further restricts States’ ability to undertake counter-cyclical fiscal policies during economic slowdowns.
Revenue Expenditure Dominance
- A large share of State budgets is absorbed by committed expenditures such as salaries, pensions, interest payments, and subsidies, leaving little room for capital investment.
- This reduces States’ capacity to spend on growth-enhancing sectors like health, education, irrigation, and infrastructure, impacting long-term development outcomes.
Centrally Sponsored Schemes (CSS) and Conditionality
- The growing reliance on centrally sponsored schemes shifts spending priorities away from State-specific needs towards centrally determined objectives.
- Conditional funding under CSS weakens State-level policy innovation and accountability, as expenditure choices are increasingly dictated by the Union government.
Case Study: Employment Guarantee and Welfare Schemes
- Programmes like MGNREGA illustrate fiscal stress, where delays in central releases force States to front-load expenditures, straining their cash balances.
- Inadequate or delayed reimbursements disrupt scheme implementation and erode the credibility of welfare delivery at the grassroots level.
Political Economy of Fiscal Centralisation
- The article implicitly highlights a political economy where centralised fiscal control enhances political leverage, especially over opposition-ruled States.
- Fiscal dependence reduces States’ bargaining power, potentially distorting cooperative federalism into asymmetric federal dominance.
Impact on Competitive Federalism
- Shrinking fiscal autonomy undermines competitive federalism, as States lack sufficient resources to differentiate policies, attract investment, or innovate service delivery.
- Instead of healthy competition, States face uniform constraints, reducing incentives for reform and efficiency.
Macroeconomic Risks of Over-Centralisation
- Concentration of fiscal power at the Centre risks sub-optimal public spending, as local preferences and regional disparities are inadequately addressed.
- Weak State finances can also impair overall public investment, given States account for nearly two-thirds of capital expenditure in India.
Fiscal Transparency and Accountability Concerns
- Extensive use of off-budget borrowings, special purpose vehicles, and extra-budgetary resources reduces fiscal transparency at both Union and State levels.
- This complicates assessment of true fiscal deficits and undermines Parliamentary and legislative oversight.
Comparative Federal Perspective
- In mature federations like Canada and Germany, sub-national governments retain robust taxation powers, ensuring alignment between revenue authority and expenditure responsibility.
- India’s growing centralisation diverges from these models, risking long-term federal imbalance.
Way Forward: Restoring Fiscal Federal Balance
- Rationalising cesses and surcharges and bringing them under the divisible pool would restore credibility of Finance Commission transfers.
- Strengthening GST Council federalism through greater consensus-based decision-making can enhance trust and revenue predictability for States.
Enhancing State Fiscal Capacity
- States must be supported to improve own-tax revenue mobilisation, including property taxes, user charges, and better compliance mechanisms.
- Relaxation of borrowing limits linked to reform performance and capital expenditure can provide States with growth-oriented fiscal flexibility.
Conclusion
- The article underscores that fiscal federalism is not merely an accounting arrangement, but a democratic necessity for responsive governance and balanced development.
- Without restoring States’ fiscal space, India risks weakening cooperative federalism, undermining development outcomes, and centralising accountability away from citizens.
India’s “White Space” Diplomacy
Core Thesis
- The editorial argues that in a fragmented global order marked by rivalry and institutional paralysis, India’s diplomatic advantage lies in small, functional coalitions rather than overstretched universal forums.
Relevance
- GS II – India’s foreign policy, India–EU relations, BRICS, Quad, multilateral vs minilateral diplomacy, global governance reforms
- GS III – Strategic partnerships, technology diplomacy, trade standards, supply-chain resilience, global public goods
Practice Question
- “In an era of institutional paralysis, influence flows through small coalitions rather than large multilateral forums.” Analyse India’s ‘white space’ diplomacy with reference to the EU, BRICS and the Quad. (250 words)
Symbolism of Republic Day 2026 and Strategic Signalling
- Inviting the European Union’s institutional leadership, rather than a single national leader, signals India’s recognition that power and rule-making increasingly reside in supranational and regulatory blocs.
- This choice reflects India’s understanding that future diplomacy will be shaped less by ceremonial bilateralism and more by collective entities controlling trade, technology, climate, and standards.
Limits of Traditional Bilateral Diplomacy
- The editorial notes that India’s bilateral relationships will remain demanding due to neighbourhood instability, and persistent frictions with both Washington and Beijing across trade and security domains.
- Such pressures constrain diplomatic bandwidth, making it harder for India to rely solely on traditional bilateral engagement to advance long-term strategic interests.
Concept of “Diplomatic White Spaces”
- “White spaces” are defined as gaps in global leadership, where problems demand coordination but no major power can credibly lead due to rivalry, legitimacy deficits, or domestic constraints.
- These spaces present opportunities for India to act as a convener, bridge-builder, and rule-shaper, provided it selects priorities that match its material and diplomatic capacity.
Europe as India’s First White Space Test
- Engagement with Europe is framed as a technocratic test, where India must deal primarily with the EU’s collective authority over trade, competition, climate, and data governance.
- The long-pending India–EU Free Trade Agreement is less about tariffs and more about market access rules, regulatory alignment, sustainability standards, and digital governance norms.
Strategic Payoffs of the India–EU Compact
- If treated as a de-risking partnership, the India–EU agreement can strengthen India’s access to European markets, embed it in restructured value chains, and hedge against U.S. trade pressure.
- However, the deal will raise compliance and adjustment costs for Indian firms, requiring domestic regulatory capacity and industrial upgrading to avoid exclusion.
Narrow Window of Opportunity with Europe
- The editorial emphasises urgency, noting that Europe’s interest in India is driven by its desire to reduce dependence on China and hedge against U.S. unpredictability.
- Such strategic windows are temporary, and delayed Indian decision-making risks losing leverage as European priorities shift or alternative partners emerge.
BRICS as the Political Test of White Space Diplomacy
- BRICS in 2026 is portrayed as an expanded but internally fragmented grouping, with divergent member interests diluting coherence and slowing collective action.
- The central question is no longer expansion, but purpose — what BRICS is meant to deliver, and whether it can move beyond rhetoric into practical outcomes.
Global South Expectations from BRICS
- Many BRICS members seek greater voice for the Global South, fairer representation in global institutions, and credible alternatives in development finance and economic governance.
- These demands are legitimate but contested, making BRICS a forum where leadership must reconcile ambition with feasibility.
India’s Chairmanship Opportunity in BRICS 2026
- As chair and host in 2026, India has the opportunity to steer BRICS toward delivery-oriented outcomes, rather than ideological posturing or maximalist declarations.
- The article suggests leveraging New Development Bank guarantees and practical toolkits to translate political intent into tangible development support.
Managing External Risks Around BRICS
- The article cautions against careless signalling, especially amid U.S. tariff threats targeting countries perceived as aligning too closely with anti-Western blocs.
- India gains little from BRICS drifting into anti-West rhetoric or aggressive de-dollarisation, which could undermine capital inflows and technology partnerships.
India’s Balancing Act in BRICS
- India’s strategic task is to separate reform from rejection, advocating fairer global governance without positioning itself as hostile to existing economic and financial systems.
- This balancing reinforces India’s image as a moderating power, capable of engaging both the Global South and advanced economies.
The Quad as the Third Diplomatic White Space
- The Quad is presented as a functional coalition rather than a formal alliance, with potential to deliver concrete public goods in the Indo-Pacific.
- Hosting a Quad leaders’ summit in 2026, potentially including U.S. President Donald Trump, would elevate expectations for tangible outcomes.
Quad’s Value for the Indian Ocean Region
- The Quad’s focus on maritime domain awareness, resilient ports, and capacity-building addresses the needs of Indian Ocean littoral states seeking security without entanglement.
- This approach aligns with India’s preference for inclusive regionalism rather than bloc confrontation.
Operation Sagar Bandhu as Proof of Concept
- India’s Operation Sagar Bandhu during Cyclone Ditwah in Sri Lanka demonstrated the strategic value of rapidly deployable capabilities that deliver assistance without diplomatic friction.
- Such examples strengthen India’s credibility as a first responder and net security provider in the region.
Constraints on Quad Effectiveness
- The success of Quad cooperation will depend partly on Washington’s ability to manage trade disputes with partners without allowing them to derail broader strategic collaboration.
- Persistent trade frictions risk undermining trust and narrowing the scope of cooperation.
Limits of Large Multilateral Forums
- The editorial underscores that while the United Nations remains essential for legitimacy and norm-setting, it is increasingly ineffective for delivery amid great-power rivalry.
- Decision-making and outcomes are therefore shifting toward smaller coalitions that can function even when universal consensus is absent.
G-20 Fatigue and Fragmentation
- The G-20, theoretically the premier forum for economic coordination, is increasingly constrained by domestic politics, agenda disputes, and geopolitical tensions.
- The U.S. boycott of the Johannesburg G-20 in 2025 highlights the forum’s vulnerability and declining inclusiveness.
Implications for Global South Priorities
- Efforts to narrow the G-20 agenda risk sidelining Global South concerns, weakening the forum’s legitimacy as a representative platform for global economic governance.
- This creates further incentive for issue-specific coalitions outside traditional multilateral settings.
India’s Strategic Menu for 2026
- The article maps India’s 2026 priorities clearly: Europe for standards, BRICS for functionality, and the Quad for public goods, each serving a distinct strategic purpose.
- Success depends on matching ambition with institutional capacity and diplomatic follow-through.
AI and Emerging “Small Tables”
- The AI Impact Summit in Delhi (February 2026) is highlighted as an opportunity for India to convene governments, firms, and researchers where interests partially overlap.
- Such forums allow India to bridge regulatory and technological divides without being trapped in zero-sum geopolitics.
Proliferation of New Minilateral Forums
- Proposals such as a U.S.-led ‘Board of Peace’ and India’s potential inclusion in Pax Silica illustrate how rapidly new, issue-specific coalitions are emerging.
- This proliferation requires India to be selective, avoiding overstretch while maximising strategic returns.
Strategic Message for India
- In a divided world, influence increasingly accrues not from hosting the largest forums, but from making smaller, focused tables deliver results.
- India’s comparative advantage lies in convening, balancing, and operationalising coalitions rather than dominating them.
Conclusion
- The editorial concludes that India’s success in 2026 will depend on its ability to convert diplomatic white spaces into working arrangements, aligning national interests with global public goods.
- By prioritising functionality over form, India can enhance its global influence despite systemic uncertainty and great-power rivalry.
