'Competitive federalism' will trigger Centre-states’ investment ‘war’

From 'cooperative federalism', it is going to be largely 'competitive federalism' in India with the central and state governments competing for investments, according to the latest S&P Global Ratings report.

"While competitive federalism will dominate, prospects for cooperative federalism still exist and will be pursued intermittently. International governments and businesses engaging with India will need political astuteness to navigate different layers of bureaucracy and stakeholder interests," the report notes.

India's realised -- and unrealised -- potential over the next decade will be a story about the successes and opportunities of its diverse states, says the report. The country’s political and economic integrity has historically been based on "cooperative federalism", an approach that espouses mutually beneficial coordination between the Centre and state governments in solving problems and unlocking capabilities.

Centre-state relations in the coming years are more likely to be characterised by "competitive federalism", where Central and state governments jostle for investment opportunities and the chance to create jobs, the report said.

"These tensions are heightened when some states benefit from close ties with the central government or from inherent advantages such as size, geography or population," S&P Global Ratings said.

Further competitive elections in India are also driving competitive federalism, particularly because voters increasingly distinguish between state and parliamentary polls.

This trend encourages national and subnational governments to pursue policies that go beyond their traditional mandates. The Constitution broadly gives strategic authority to the central government and functional authority to the states.

According to the report, the biggest impediment for the central government in the case of the Goods and Services Tax (GST) -- an example of cooperative federalism -- is working out how to divide tax revenue between the various states.

"Calls from both more and less developed states to change how GST funds are redistributed -- along with the Central government's response -- will test the system's spirit of cooperative federalism. States’ increasing responsibility for policy execution, including politically sensitive social welfare schemes, will further intensify this argument," S&P Global Ratings said.

According to the report, Indian states will likely adopt differing policies for land acquisitions, tax incentives and especially labour reform, reflecting local conditions.

They will also want to deliver reforms in ways that give them an advantage over other states in the competition for foreign direct investment.

Looking forward, the report said successive Central governments will need to find ways of equitably sharing revenue with states-adequately compensating states that deliver higher growth while addressing the needs of states that are found lagging behind.

"The implementation of GST shows that this can be a point of contention. The Finance Commission will be pivotal in tackling this challenge and in setting a precedent," the report notes.