[Answered] Examine how ring-fenced central loan programmes for capital expenditure facilitate the economic convergence of lower-income states. Critically analyze the role of such fiscal instruments in ‘crowding in’ state-level investments while balancing the imperatives of cooperative federalism and fiscal discipline.

Introduction

With inter-state income disparities persisting, evidence from FY19–FY25 shows lower-income states growing faster, driven by state capital expenditure, aided significantly by ring-fenced central capex loans supporting convergence-led growth.

Economic Convergence and the Role of State Capex

1. Concept of Convergence: As per neoclassical growth theory (Solow), poorer regions grow faster when capital accumulation rises.
2. India’s Federal Growth Reality: National GDP is an aggregation of State GSDPs; divergence weakens macro stability.
3. Recent Empirical Shift: Post-pandemic data shows UP, Bihar, Rajasthan, Assam outperforming richer peers in growth rates.

Ring-Fenced Central Capex Loan Programme: Design and Rationale

1. What the Programme Is: Interest-free/low-cost loans from Centre to states exclusively for capital expenditure.
2. Ring-Fencing Mechanism: Funds cannot be diverted to revenue expenditure or populist transfers.
3. Scale and Expansion: Outlays increased from ₹12,000 crore (FY21) to ₹1.5 trillion (FY26).
4. Alignment with Finance Commission Framework: Complements tax devolution (41% divisible pool) without distorting fiscal autonomy.

How Capex Loans Facilitate Convergence

1. Infrastructure-Led Growth: Physical capital creation; roads, urban transport, logistics, power, irrigation. Case Evidence; UP and Bihar ramped up road and urban infra capex, improving logistics efficiency. Multiplier effect, RBI studies estimate capex multiplier at 2.5–3.0, higher than revenue spending.
2. Crowding-In Private Investment: Signaling effect; higher state capex signals policy credibility and reform intent. Complementarity; center builds highways; states invest in urban links and industrial clusters. Outcome will be, increased private investment proposals in emerging states post-2020.
3. Fiscal Comfort for Laggard States: Revenue Smoothing: Capex loans offset GST compensation withdrawal. Counter-cyclical role, supported investment even during pandemic-induced slowdown.

Cooperative Federalism: Strengthened or Strained?

1. Positive Dimensions: Shared growth objective, aligns central macro goals with state development needs. Flexibility with accountability, states choose projects, Centre ensures purpose discipline. NITI Aayog’s competitive federalism, encourages reform-oriented states to leverage infrastructure-led growth.
2. Concerns of Centralisation: Conditionality risks; excessive central influence over state spending priorities. Asymmetric capacity, poorer administrative capacity may limit effective utilisation.

Fiscal Discipline: A Delicate Balance

1. Rising Fiscal Deficits: States widened deficits in FY25 to protect capex.
2. Pressure from Revenue Schemes: Election-linked cash transfers risk crowding out capex.
3. Debt Sustainability: FRBM targets demand careful calibration of loan expansion.

Critical Evaluation

1. Strengths: Targeted, growth-oriented, non-distortionary. Encourages long-term asset creation over consumption.
2. Limitations: Dependence on Centre’s fiscal health. Risk of capex slowdown if tax buoyancy weakens.
3. Way Forward: Multi-year capex loan visibility. Performance-linked flexibility. Stronger project appraisal and outcome monitoring.

Conclusion

As B.R. Ambedkar noted, federalism thrives on shared purpose. Well-designed capex loans can reconcile growth, discipline, and autonomy—provided infrastructure creation, not fiscal populism, remains the guiding compass.