The lack of financial governance in India

The scandalous squandering of taxpayer money over the Commonwealth Games highlights the sad lack of financial governance at the highest levels, writes Indira Rajaraman.

This particular episode showcases our inability to ensure prudence about expenditure which of its very nature can brook no delay.

There is an internal mechanism for financial approvals, which is perceived as rigid and dilatory, and therefore needing to be bypassed where speed is of the essence.

There is no fast-track protocol that will preserve time-bound expenditures from flagrant violation of benchmarked norms, to the point where equipment can apparently be leased for amounts far exceeding the purchase value.

But even on the slow track, audit of the Food Corporation of India (FCI), which has presided over large-scale grain losses several times in the past, has apparently had no impact. The FCI, after many audit reports, is still under tarpaulin sheets.

The need for improved financial governance is most acute at the level of local government. With urban bodies, the problem is not incapacity so much as political capture, but in rural India, there is plain lack of capacity.

The Ministry of Panchayati Raj estimates funds released directly to Panchayati Raj Institutions (PRIs) in 2009-10 under an assortment of schemes at Rs 95,000 crore , which works out to an average receipt per PRI of Rs 38 lakh. These are large sums to handle for the financially uninitiated.

In the rural local context, governance capacity is often equated to the most basic requirements of physical structures, staff, and honoraria and expenses for elected representatives.

The approach taken by the 10th Finance Commission (covering 1995-2000, the first after local government formally came into being), and endorsed by subsequent Commissions, is that these basics are the responsibility of state governments, since local bodies are brought into being by state legislation.

The 10th and 11th Commissions, therefore, explicitly directed that their funding provisions for local bodies should not go towards establishment costs on structures and salaries, so as to carry additionality.

These Commissions sought further protection from misuse by earmarking their local grants for specified functions, like water or sanitation or solid waste management.

The 11th Commission also dedicated a sum for account-keeping and building up a database, key capacity needs. But earmarking led to obstructions in fund flow.

The certification needed to ensure that utilisation matched the purposes intended led to procedural delays within the system, to the point where some fraction of the funds intended for local bodies never reached them at all.

The 12th Commission, therefore, earmarked only the funding for urban local government, at 50 per cent, for solid waste management. The result was that 10.6 per cent of urban funding never reached its destination, as against 7.4 per cent for panchayats where funding was functionally untied (but hedged by other requirements).

Finance Commission funds for local government must be routed through states, under the present constitutional provisions. The state thus becomes a pass-through agent, with no incentive whatever for monitoring usage.

The response to conditionalities is very different for grants where the state is the ultimate recipient. This has to be factored in when funding for local government is designed.

The 13th Commission, therefore, consciously eschewed earmarking of grants for local bodies, whether for capacity-building or specified functions, since delay and obstructions in fund flow achieve no purpose at all.

There remains the need to train local government functionaries and elected representatives in effective governance. The network of State Institutes of Rural Development, set up for this purpose, presently bears the full cost of training.

They are funded by state governments, supplemented by the Rashtriya Gram Swaraj Yojana, a centrally sponsored scheme, which carries a budget provison of Rs 34 crore (Rs 340 million) this year for training and capacity-building. Not much can be achieved with so small a sum.

This model, whereby training is funded at the supply end, is a recipe for ineffectiveness. Training works best when it is bought into by the organisations from where the trainees originate.

Organisations depute personnel and pay towards the cost of the programme. Funding from the demand end makes for a more rational match of trainee and training.

The large untied grant provision made by the 13th Finance Commission for 2010-15 now makes this possible. The prescribed flow to local bodies is set in two-track mode, with a basic grant, which amounts to roughly two-thirds of the total provision, completely untied in respect of usage.

For PRIs, this basic grant alone amounts to Rs 8,245 crore (Rs 82.45 billion) per year. Taking the total number of PRIs at all levels at 2.5 lakh, this is an average fund flow per PRI per year of Rs 3.3 lakh.

The sum disbursed could be even higher, since the grant has been configured to a stipulated share of central tax revenues, which could turn out to be more buoyant than projected. But even the minimum assured sum is a large provision, and it is completely untied.

Even if just one-third of this is used by PRIs to buy training for functionaries and elected representatives, it amounts to Rs 2,750 crore (Rs 27.50 billion) in annual potential demand for training.

While the purposes for which the funds are used remain entirely at the discretion of the recipient PRI, the need to ensure that reported expenditure actually goes towards the stated purpose remains.

The second track of the Commission's provision, therefore, supplementing the basic grant, is a performance grant conditional upon a number of institutional reforms, including financial audit under the supervision of the CAG.

There is the larger need to enhance the powers of the CAG itself. Financial governance can only be good as the agent that secures it. Part of the reason for the ineffectiveness of the CAG is the delay in release of audit reports.

A CAG Bill is on the anvil, which empowers the CAG to demand time-bound responses to its documentation requirements for scrutiny. CAG reports on local bodies must then be placed on websites accessible to the general public, to enable comparison and correction.

The author is honorary visiting professor, Indian Statistical Institute.