RBI REPORT ON FINANCES OF PANCHAYATS

SYLLABUS :Functions and Responsibilities of the Union and the States, Issues and
Challenges Pertaining to the Federal Structure, Devolution of Powers and Finances up to
Local Levels and Challenges Therein.
REFERENCE: RBI report calls for steps to boost finances of panchayats; The Financial Express
Dt 26 Jan 2023
CONTEXT
With the finances of Panchayati Raj Institutions (PRIs) facing constraints due to their limited
own revenues, a Reserve Bank of India report on Thursday said the PRIs need to intensify
efforts to augment their own tax and non-tax revenue resources and improve governance.
LOCAL SELF GOVERNMENTS AND FINANCE
The 74th Constitution Amendment Act was passed in 1992 mandating the setting up and
devolution of powers to local bodies (LBs) as the lowest unit of governance.Three decades
since 74th amendment,for evolution of powers to local bodies (LBs), growing fiscal deficits,
constraints in tax base expansion, and weakening of institutional mechanisms that enable
resource mobilisation remain challenges to LBs.

Constitutional Provisions
● In the Constitution of India, no provision was made for the establishment of local
self-government, except the incorporation of Article 40 in the Directive Principles
of State Policy.
● These amendments added two new parts to the Constitution, namely, added Part
IX titled “The Panchayats” (added by 73rd Amendment) and Part IXA titled “The
Municipalities” (added by 74th Amendment).Panchayats to prepare plans for
economic development and social justice in respect of subjects as devolved by law
to the various levels of Panchayats including the subjects as illustrated in Eleventh
Schedule (Article 243G).
 ● Budgetary allocation from State Governments, share of revenue of certain taxes,
collection and retention of the revenue it raises, Central Government
programmes and grants, Union Finance Commission grants (Article 243H).
● Establish a Finance Commission in each State to determine the principles on the
basis of which adequate financial resources would be ensured for panchayats and
municipalities (Article 243I).
● The 74th Amendment Act, 1992 has inserted a new Part IX-A into the Constitution
which deals with the administration of Municipalities and Nagar Palikas.
● It consists of Article 243P to 243ZG. It also added a new twelfth schedule to the
Constitution. The 12th schedule consists of 18 items.

RBI REPORTS ON FINANCING LOCAL BODIES

With the finances of Panchayati Raj Institutions (PRIs) facing constraints due to their limited
own revenues, a Reserve Bank of India report said the PRIs need to intensify efforts to
augment their own tax and non-tax revenue resources and improve governance.
● Dependence : The report noted that around 95% of the PRI revenues are in the form
of grants from the Centre and states, restricting their spending ability that is already
hampered by delays in the constitution of State Finance Commissions (SFCs).
● Role of SFC : Nevertheless, the prompt establishment of SFCs, eschewing the
sizeable delays that occur currently, assumes importance. SFCs, with roles identical to
those of the Central Finance Commission (CFC), and with the obligation of tabling
their action-taken reports in State legislatures, can fortify the financial position of
PRIs and help them in better delivery of their responsibilities for upliftment of the
rural economy,”.
● Data on Revenue: Drawing upon data on 2,58,000 Panchayats, the RBI report found
that the average revenue per Panchayat from all sources – taxes, non-taxes and
grants – was Rs 2.12 million in 2020-21, Rs 2.32 million in 2021- 22 and Rs 2.12 million in
2022-23. The decline in 2022-23 was owing to lesser devolution of grants.
 ● Own Revenue Generation: The own revenues of the Panchayats – generated by
imposing local taxes, fees, and charges on various activities, including land revenue,
professional and trade taxes, and miscellaneous fees – were only 1.1% of their total
revenue during the study period.
CHALLENGES WITH EXISTING FINANCE MECHANISMS
● Share of own revenue : The Local bodies own sources of revenue were very less in
their total revenue, with large untapped potential.The key revenue sources are
taxes, fees, fines and charges, and transfers from Central and State governments,
which are known as inter-governmental transfers (IGTs).The share of own revenue
to total revenue is an important indicator of its fiscal health and autonomy.This ratio
reflects the its ability to use the sources they are entitled to tap, and their
dependency on IGTs.Local bodies with a higher share of own revenue are more
financially self-sustaining.
● Dependent on IGTs : Many local bodies were highly dependent on IGTs.Mostly they
were highly dependent on external grants accounted for about 40% of the its total
revenue.Stable and predictable IGTs are particularly important since its own revenue
collection is inadequate.Tax revenue depends on the size Tax revenue is the largest
revenue source for larger cities, while smaller cities are more dependent on
grants.There are considerable differences in the composition of revenue sources
across cities of different sizes.
● Operations and maintenance (O&M) : O&M expenses are on the increase but still
inadequate.O&M expenses are crucial for the upkeep of infrastructure and for
maintaining quality of service delivery.The share of O&M expenses in local bodies
total revenue expenditure increased from about 30% in 2012-13 to about 35% in
2016-17.While the expenses were on the rise studies indicate that they remained
inadequate.Thus the scale of local bodies finances in India is undoubtedly inadequate.
CONCERNS WITH THE FUNCTIONS OF LOCAL BODIES
● Poor working of Institutions: There have been several lacunae in the working of MCs
and no appreciable improvement in their functioning despite institutionalisation of
 the structure of local governance in India.The availability and quality of essential
services for urban populations in India has consequently remained poor.
● Lack of Financial Autonomy:
○ Most local bodies only prepare budgets and review actuals against budget
plans but do not use their audited financial statements for balance sheet and
cash flow management, resulting in significant inefficiencies.
○ While the size of the local bodies budgets in India are much smaller than
peers in other countries, revenues are dominated by property tax collections
and devolution of taxes and grants from upper tiers of government, resulting
in lack of financial autonomy.
● Minimal Capital Expenditure: Local bodies committed expenditure in the form of
establishment expenses, administrative costs and interest and finance charges is
rising, but capital expenditure is minimal.It mostly rely on borrowings from banks
and financial institutions and loans from centre/ state governments to finance their
resource gaps in the absence of a well-developed market for municipal bonds.
● Stagnant financial Status : Municipal revenues/expenditures in India have stagnated
at around 1 % of GDP (Gross Domestic Product) for over a decade.In contrast,
municipal revenues/ expenditures account for 7.4 % of GDP in Brazil and 6 % of GDP in
South Africa.
● Ineffective State Financial Commissions:Governments have not set up State
Financial Commissions (SFCs) in a regular and timely manner even though they are
required to be set up every five years. Accordingly, in most of the States, SFCs have
not been effective in ensuring rule-based devolution of funds to Local governments.
15TH FINANCE COMMISSION RECOMMENDATIONS
● Increase in the outlay for municipalities : It has set aside Rs 29,000 crore for FY
2020-21 and indicated the intent to raise the share of municipalities in the total grants’
of local bodies including panchayats gradually over the medium term, from the
existing 30 per cent to 40 per cent.
● Ensuring financial accountability through conditions : There are two entry conditions
lay strong foundations to receive Finance Commission grants for financial
accountability of municipalities and own revenue enhancement respectively.
○ 1) Publication of audited annual accounts.
○ 2) Notification of floor rates for property tax.
○ There is also a thrust on municipal bonds and municipal finance reform
conditions under AMRUT.
● Distinguishing between million-plus urban agglomerations, and other cities : The XV
FC has adopted an approach of distinguishing between million-plus urban
agglomerations, and other cities.This is well-founded, based on the pattern of
urbanisation in India, where 53 million-plus urban agglomerations comprising 44 per
cent of the total urban population.For the first time, there is also an
acknowledgement of the metropolitan area as a unified theatre of action to solve
complex challenges of air quality, water and sanitation, with implicit emphasis on
inter-agency coordination.
● Common digital platform for accounts : The report recommends a common digital
platform for municipal accounts, a consolidated view of municipal finances and
sectoral outlays at the state level, and digital footprint of individual transactions at
source, the FC has broken new ground and demonstrated farsightedness.
● Role of the state governments : The ultimate responsibility for municipal finance
reforms remains with state governments.Constitutional bodies such as the finance
commission can, at best, prepare the ground and provide incentives and
disincentives.We need municipal legislation to reflect progressive and enabling
financial governance of our cities through five reform agendas:
○ 1) Fiscal decentralisation including strengthening state finance commissions.
○ 2) Revenue optimisation to enhance own revenues.
○ 3) Fiscal responsibility and budget management to accelerate municipal
borrowings.
○ 4) Institutional capacities towards an adequately skilled workforce.
 ○ 5) Transparency and citizen participation (for democratic accountability at
the neighbourhood level).
● Better Governing Practices: The first step needs to be predictable fiscal transfers
from state governments to municipalities and other civic agencies on a
formula-based approach as against the present practice of ad hoc, discretionary
grants.
○ State finance commissions would need to emulate the XV FC and its
predecessors, and emerge as credible institutions.
○ State governments need to ensure that state finance commissions are
constituted on time, resourced right, and their recommendations taken
seriously.
WAY FORWARD
● Revenue Generation: Tapping into property taxes, other land-based resources and
user charges are all ways to improve the revenue of Local bodies.
● Stable Government Transfers : IGTs assume significance in the fiscal composition of
Local bodies, and a stable support from Central and State governments are crucial to
improve their own revenues.Measures need to be made to also cover O&M expenses
of local bodies for better infrastructure and service.
● Infusing Transparency : Institutions such as Zonal Panchayat and Municipal council
need to adopt sound and transparent accounting practices with proper monitoring
and documentation of various receipt and expenditure items, and explore different
innovative bond and land-based financing mechanisms to augment their resources.
● Need Based Approach: The rapid rise in population density, calls for better
infrastructure, and hence, requires greater flow of financial resources to Local
governments.
● Innovative Practices : With the revenue generation capacity of municipal
corporations declining over time, dependence on the devolution of taxes and grants
from the upper tiers has risen. This calls for innovative financing mechanisms.
 ● State Government Budgets : Local bodies in India need to balance their budgets by
law, and any borrowing needs to be approved by the State government.
● Sharing of GST : In order to improve the buoyancy of Local bodies revenue, the
Centre and the States may share one-sixth of their GST (Goods and Services Tax).

The state government must act on these reform agenda and ensure the transformation of
financial governance of their Local bodies.The financial health of local bodies is a critical
element of its effective governance which will determine whether India realises its economic
and developmental promise.

DO PRACTICE: EASE AND ACE MAINS ANSWER WRITING

Recent RBI report highlighted for steps to boost finances of panchayats.In this context
discuss the key financial constraints of local self governments that hinder the efficient
functioning and suggest the corresponding measures .(250 Words)