236 India Infrastructure Report 2003
9 RURAL INFRASTRUCTURE
9.1 IRRIGATION SUBSIDIES
Huge and soaring subsidies, mostly in the form of
unrecovered costs of goods and services provided by the
public sector, are among the main causes underlying the
fiscal crisis confronting the central and the state governments.
In 1994–5, according to a recent National Institute of
Public Finance and Policy (NIPFP) study, the total subsidies
(implicit and explicit) of the central and the state governments
amounted to Rs 1,27,400 crore (Srivatsava and Sen, 1998).
By comparison, the public sector plan outlay in that year
was Rs 98,200 crore and the gross fiscal deficit Rs 71,600
crore. The critical importance of reducing subsidies for
restoring the fiscal health of the public sector hardly needs
any emphasis.
Subsidies under the head ‘irrigation’ amounted, in
1994–5, to around Rs 14,000 crore or about one-eighths
of the total. Roughly half of this is on account of minor
irrigation works and flood control and drainage projects.
Major and medium projects, which are the focus of this
section, account for somewhat over half of this figure.
Up to the end of that year cumulative investments in this
sector—mostly by state governments—amounted to around
Rs 45,000 crore. Operating costs (including operation
and maintenance (O&M), depreciation, and interest on
capital) amounted to Rs 7600 crore, of which, only
Rs 440 crore were recovered from users, leaving a loss
of Rs 7200–7300 crore to be borne by their general
budgets.
This paper was discussed at a Conference on Fiscal Policies to
Accelerate Economic Growth organized by the National Institute of
Public Finance and Policy, May 2001. The author thanks the NIPFP
for their permission to publish it in this report.
A. Vaidyanathan
SUBSIDIES AND THEIR ORIGIN
Historically, under colonial rule, the government invested
in irrigation only if it could provide a reasonable rate of
financial return after covering operating costs. This policy
had undergone a gradual change. Initially this criterion was
relaxed for ‘protective’ works in areas liable to severe droughts
and recurrent famines. Subsequently social benefits of
irrigation by way of increased agricultural production and
their indirect beneficial impact on the rural economy and
government revenues came to be accepted as justifying
investment in irrigation. Under planning, social cost–benefit
analysis came to be officially accepted as the basis for public
investment decisions in this sector. The requirement regarding
a minimum financial return was dropped. At the same time
it was recognized that beneficiaries of public irrigation
projects should meet the costs incurred for providing water.
Besides water charges based on area and crops irrigated in
each season, most states had also passed legislation requiring
beneficiaries to pay a betterment levy to capture a part of
the increase in productivity and capital value of land due
to irrigation. The betterment levies did not yield much,
mainly because the law was not enforced.
Diluting Recovery
In the early 1970s, a National Irrigation Commission,
appointed by the Government of India (GOI, 1972), argued
that accepting social cost–benefit evaluation as the basis
for investment decisions does not minimize the ‘importance
of securing an adequate return from investment to irrigation
projects’ and recommended that ‘the financial return of a

project should also be examined at the time of approval
and, if found inadequate to cover working expenses and
indirect charges, water rates should be raised.’ In the
event, the state governments did not comply with these
guidelines and losses incurred on account of public irrigation
increased rapidly.
This trend was noted with concern by several official
committees and, in particular, successive Finance
Commissions. While emphasizing the necessity for improving
cost recovery, they also progressively diluted the standards
of cost recovery. Thus, the interest charges to be recovered
from beneficiaries was lowered from 2.5 per cent of
investment recommended by the Fifth Finance Commission
to 1 per cent by the subsequent two commissions. Faced
with failure to meet even this target, the Eighth Finance
Commission chose to dilute it further and exhorted the
states to ensure that at least the maintenance costs be
recovered. But few states were willing to comply even with
this.
Thus, in 1977–8, revenues from water charges under1
major, medium and multi-purpose works were around Rs
100 crore which fell short of working expenses (costs of
O and M) by nearly Rs 30 crore. Inclusive of interest on
accumulated investments in that category of works up to
that year (at the average interest rate on the outstanding
debt of state governments as a whole) and depreciation (at
1 per cent of the cumulated investment, the loss amounted
to Rs 420 crore). By 1994–5 the latest year for which data
on revenue and operating expenses are available—total
recurring costs (inclusive of depreciation and interest) had
increased fourteen-fold but revenue realizations increased
somewhat less than four-and-a-half times. Overall losses in
1994–5 were around Rs 7,000 crore compared to Rs 430
crore in 1977–8. Since then the situation has certainly has
deteriorated further2.
Cost Inflation
Both working expenses and capital charges have increased
at a rapid pace. Working expenses have increased from
around Rs 130 crore in 1977–8 to an estimated Rs 1700
crore in 1994–5 partly due to expansion in the number
of staff but mostly on account of the steep rise in salaries
1
It is not clear whether cesses on irrigated crops are fully covered
by this estimate. In some cases (for example, Tamil Nadu) areas
irrigated by old projects do not pay a separate water fee. Instead it
is integrated into the land revenue assessment which is not included
in the above figures. Revenue from sale of water from irrigation
projects for non-agricultural uses is also not covered. The degree of
underestimation on these accounts is, however, unlikely to be large
at the national level but could be significant in some states.
2 NIPFP is currently in the process of updating the estimation
up to 1988–9.
Rural Infrastructure 237
and allowances. In fact there is widespread complaint that
increased salaries have cut into the amounts available for
carrying out maintenance and repair works. Inadequacy
of funds for this purpose is invariably cited as the reason
for deterioration of the systems and the quality of service
they offer.
Capital costs rose because of three factors: general
inflation; new projects being in more difficult locations;
and higher costs of borrowing. According to Central Water
Commission (CWC) estimates (GOI, 1998), between
1976–7 and 1993–4, there was a four-fold increase in
construction costs due to increases in prices of material
and labour. Adjusting for inflation, the average investment
per hectare of addition to irrigation potential rose two-and-
a-half to three times.3 Since interest on investments outlays
during the construction of a project—and large irrigation
projects take several years to complete—are not included
in project costs, these figures understate the cost of
irrigation projects to a significant extent.
The average cost of government borrowing, which was
less than 4 per cent in the early 1970s, has also risen
sharply following change in the government’s interest-rate
policy in 1974. It averaged 5.6 per cent in 1977–8 and
was a shade more than 12 per cent in 1993–4.
Revenues have not kept pace with costs: collections
which were just under Rs 100 crore in 1977–8 rose to
Rs 140 crore in 1987–8 and an estimated Rs 490 crore
in 1994–5. In 1977–8 revenues covered three- fourths of
the ‘working expenses’ but only a sixth of the total cost
(including interest and depreciation). By 1987–8, revenue
covered barely a quarter of working expenses, and 6 per
cent of total cost. The position has vastly worsened since:
the recovery rates in 1993–4 fell to less than 15 per cent
of working expenses and 5 per cent of the total cost.
‘Populism’
The main reason of course is that water rates have become
a political hot potato and (along with electricity) a major
focus of competitive populism. Raising water rates is seen
as an invitation to electoral disaster and few governments,
irrespective of party affiliation, are willing to take the risk.
The Committee on Pricing of Irrigation Water (GOI,
1972) noted:
Revision of water rates has been infrequent, hesitant
and very much less than the increase in costs. For instance,
water rates in Tamil Nadu were last revised thirty years
back. In Punjab, Kerala, Haryana, Jammu and Kashmir,
3 At a rough estimate cumulated capital investment in major and
medium irrigation at current prices increased 7 ½ times between
1977–8 and 1994–5 and by about 3 ½ to 4 times in constant prices.
During that period irrigation potential of these projects increased
from 24.7 mha to 31.8 mha, that is, by about 30 per cent.
238 India Infrastructure Report 2003

Table 9.1.1
Estimated Losses on Account of Major and Medium Irrigation and Multi-purpose River Valley Projects, India

(Rs crore)
1977–8 1987–8 1994–5
1 Gross Revenuea 97 139 440
2 Working expenses a 127 493 1700
3 Depreciation b 60 223 450
4 Interest on Capital c 336 1787 5330
5 Total cost (2+3+4) 523 2500 7480
6 Deficit (5-1) 426 2361 7040
7 Cumulative investments in major and medium 6000 22300 44900
multipurpose river valley projects d
8 Total outstanding debt of states e 4700 60720 160000
9 Total interest payments f 822 4879 19410
10 Average interest rate period (9)/(8)*100 560 800 12010
Notes: aCWC estimates. Figures for 1977–8 and 1987–8 as cited in GOI, 1992 for 1994–5 as cited in Srivatsava and Sen, 1997
p. 7. Planning Commission estimates for working expenses in 1994–5 is Rs 2970 crore which seems primafacie high. We have used
a lower figure based on the assumption that working expenses of major and medium works grew at the same rate as total revenue
expenditure on all Irrigation and flood control projects.
b1 per cent of cumulative investments up to end of each year.
cComputed by applying an interest rate (row 10) to corresponding figures in row 7.
dCWC 1998, p. 267, investment in 1994–5 estimated at Rs 4500 crore.
e&f various issues of RBI’s annual reports on Currency and Finance.
The estimated losses in this table differ from those given in other sources notably GOI, 1992, Mundle and Rao, 1991 and Srivatsava
and Sen, 1998. The estimates of the Committee on Irrigation Pricing (GOI, 1992) for capital charges are based on cumulated
investments up to three years before the year indicated in each column while the figures in this table are based on cumulated
investments up to and including each year. There are also some differences in the estimated average interest rates. Estimates of
Srivatsava and Sen cover not only major, medium and river valley projects but also minor irrigation, flood control, drainage and
command area development. Estimates of capital charges by CWC (1998) and that of Planning Commission for 1994–5 (cited
in Srivatsava and Sen, 1998) do not include depreciation and use lower interests rates.

and Himachal Pradesh, there has been no change since
the mid-1970s. Several (including Andhra Pradesh, Bihar,
Gujarat, Karnataka, Madhya Pradesh, Orissa, Rajasthan,
Uttar Pradesh and West Bengal) announced revisions during
1981–6. But the implementation was held up in some (eg.
Gujarat, Karnataka) by the government. In the case of
Andhra Pradesh stay orders from courts prevented
implementation. The rate increases were themselves rather
modest and no state has accepted, much less implemented,
the Irrigation Commission recommendations by reviewing
and adjusting rates every five years. Only Maharashtra has,
within the past year broken from this pattern both in terms
of magnitude of increase in rates and announcing a
graduated increase every year for the next five years.
More recent information compiled by the Planning
Commission4 shows that the situation has not changed
materially. Uttar Pradesh and Bihar announced revisions
in 1995 and Andhra Pradesh in 1997. Maharashtra has
maintained its policy of graduated increase over several
4 Thanks are due to B.N. Navalwala, Adviser, Planning
Commission, for making this information available.
years. But at least one state, Punjab, has decided to give
water free. There is no authenticated data on their
implementation or impact on revenues. Whether even
these revisions in states like Maharashtra and Andhra
Pradesh will be large enough to meet soaring costs (narrowly
defined to cover working expenses with adequate provisions
for routine maintenance and repair works but excluding
capital charges) is in doubt.
Not only were rates not raised, but experience has also
shown that enforcement of the prescribed rates is far from
strict. There is ample scope in the existing arrangement for
collusion between officials and farmers leading to
understatement of area irrigated, especially of area under
crops carrying higher rates. Laxity in assessment is
compounded by laxity in collection. The committee on
Pricing of Irrigation Water found that actual revenue
collection fell short of demand (that is, assessments) in a
majority of states. During the late 1980s there was little or
no shortfalls in Haryana and Punjab. They were marginal
in Uttar Pradesh and substantial (ranging from 27 to 70 per
cent) in the others. Accumulated arrears—which do not
include remissions and waivers granted by governments

from time to time—were found to be nearly as large as
the annual demand in some cases, and three to four times
in several states. Little wonder that losses on account of
irrigation have recorded a phenomenal increase.5
IMPROVING COST RECOVERY
The situation is clearly untenable and unconscionable.
Untenable because of the huge and mounting fiscal deficits
of the state, which have severely constrained their capacity
even to maintain, let alone increase, investments in
expansion and improvement of social and economic
infrastructure. Unconscionable because a good part of the
unrecovered costs is in the nature of continuing subsidies
to farmers whose income increase substantially as a result
of irrigation. Moreover, a large proportion of benefits go
to relatively better-off farmers. The resulting squeeze on
public resources means less investments in extending and
improving irrigation, education and health facilities, and
other schemes for the benefit of other, less fortunate,
groups. Measures to reduce the un-recovered costs of
public irrigation are therefore imperative. Raising water
rates has to be an essential and important component of
these measures but not the only one. A number of other
related issues need to be clarified before deciding the
extent and pattern of increases in water charges.
Beyond O&M Recovery
The notion that it is enough to recover (O&M) costs is
ill founded. Amortization and interest on capital invested
in the projects are as much part of the cost of providing
irrigation as the working expenses. Governments can afford
to consider bearing part or all of it if they have substantial
revenue surpluses in their budgets. Even then, whether
beneficiaries of public irrigation systems are more deserving
of subsidies than others is questionable. The case for such
subsidies is totally untenable when indiscriminate
subsidization of public services, financed almost entirely
out of borrowings at high interest rates, are the major reason
for governments budgets being in the red. So long as the
revenue budget is in deficit and public investments cannot
be maintained at levels needed to sustain a reasonable rate
of overall growth, the principle of full cost recovery must
apply to irrigation and indeed to many other goods and
services provided by the public sector.
Exclusion of Waste from Cost Assessment
But fairness also requires that users be charged on the basis
of investments required, at reasonable levels of efficiency,
5 For details see chapter 6 in GOI, 1992.
Rural Infrastructure 239
to provide them with water. This means that investments
in ongoing works, which are yet to begin delivering water,
must be excluded while fixing rates. More important, users
must not be required to bear the costs of over- capitalization
due to over design, poor design and inefficiencies/leakages
in construction. There are innumerable instances where
the actual area irrigated turns out to be much less than
expected because of over-estimation of water availability,
failure to enforce crop patterns on the basis of which the
project was designed, and because transmission and
distribution losses are higher than assumed.
It is difficult to assess, even approximately, the magnitude
of the adjustments to allow for these factors. In the absence
of an independent and objective assessment of what a
reasonably well-designed and efficiently executed project
would cost, adjustments will necessarily be arbitrary. The
suggestion by the Committee on Irrigation Pricing whereby
the basis at tim (t) is taken as the cumulated investments
up to year (t – 3) is one way. Another will be to leave out
investments which have not yet resulted in additional
irrigation. Either way the base for estimating capital charges
to be recovered for users will be substantially smaller than
the total cumulated investments to date.
As for working expenses, establishment costs are high
because of over-staffing, and relatively high salaries. The
sharp increase in salary level in the last two decades has been
a major reason for the rapid increase in working expenses.
On the other hand there are complaints that the number
of staff for maintenance and water regulation at the ground
level as well as outlays on maintenance/repair works is
grossly inadequate and that the works done are costly and
of poor quality. What the optimum level of expenditure on
regular maintenance should be depends to a significant
extent on the manner in which the activity is organized and
managed. The present system depends entirely on the state
beauracracy which, besides being expensive, has little
incentive to manage costs. With appropriate autonomy and
financial responsibility, a significant difference in maintenance
and performance can be expected especially if users have
a stake and actively participate in management.
While users at present have little financial stake in the
systems which supply them water—and this situation is
unlikely to change significantly—experience (notably in
Andhra Pradesh) has shown that entrusting responsibility
for state-funded maintenace works to water-user associations
makes a significant improvement in terms of relevance and
appropriateness of works as well as their quality and cost.
Making users associations bear the responsibility for both
funding and execution of maintenance and repair below
the outlet level could be one way of improving cost recovery6.
6 For a case study of water users managing the distributories of
the irrigation system in Orissa see Chapter 9.2 by Binayak Rath in
this report.
240 India Infrastructure Report 2003
This is neither novel nor radical: local irrigation systems
in India have a long tradition of user management and
users meeting the cost of maintenance, repair and
beneficiary contributions in the form of labour, cash and
material besides involvement in the organizations.
Even after adjusting for all the above factors, current
levels of revenue realized are likely to fall well short of
required level. Full cost recovery in 1994–5 (with capital
charges based on cumulated investments up to the end of
1991–2) calls for a ten-fold rise in actual collections over
current levels.
It is clearly difficult to get politicians to even consider,
leave alone implement, a steep revision in one go. A graduated
approach is thus essential. The first step would be to
rationalize the existing area-based rates on the basis of the
relative irrigation requirements by season and crop in
different regions. It would approximate to a volumetric
charge without actually having to measure volumes delivered
to individual users. This could be followed by the strategy
adopted by Maharashtra whereby a progressive increase in
rates over a five-year period is announced in advance. This
way users can be given clear advance signals of the
government, long-term aims regarding the level of cost
recovery, as well as reasonable time for them to adjust their
use patterns accordingly.
Indexation of Tariffs
The aim should be to give a clear indication that full cost
recovery is to be achieved over a period. For this purpose,
governments should adopt a policy of automatic indexation
of water rates to O&M costs or product prices. If such
a policy had been followed from the 1970s, the increase
required to meet capital charges would have been more
manageable. Thus, the Wholesale Price Index (WPI) in
1993–4 was nearly four times the level in 1977–8. Assuming
no change in collection efficiency, indexing water rates to
the Wholesale Price Index would have raised revenues to
Rs 2100 crore by 1993–4, compared to the actual realization
of Rs 450 crore. The required realization for full cost
recovery would have been only 2½ times the collection on
the basis of indexed rate which is far less formidable
compared to the ten-fold rise needed on the basis of current
realizations. Graduated additions over the indexed rate
could then be made in such a way that capital charges can
also be recovered fully over a specified period of ten years.
The credibility of the government’s intention about its
goal and its seriousness about fairness to users will be
enhanced if a mechanism is created for an independent
review of reported investments in all projects to allow for
over-design and inefficiencies in determining the base for
determining capital charges. Such an approach has, however,
to contend with the argument that an increase in rates
should not be disproportionately large in relation to the
increase in productivity due to irrigation and that steep
increases will not be justified unless the quality of irrigation
service improves significantly. In this connection, it is worth
noting that on the average, during the early 1980s, a hectare
of irrigated land produced Rs 2400 more than a hectare of
rain-fed crops.7 Assuming that on the whole, average
productivity per hectare has been rising at the same rate on
both categories of land, the difference, at 1986–7 prices, in
the early 1990s would be around Rs 3200 per hectare.
Adjusting for price changes—WPI for agricultural
commodities roughly doubled between 1986–7 and 1994–
5—the differential in 1993–4 would be around Rs 6400
per hectare. The realization of irrigation charges from major
and medium works in that year averaged around Rs 200
per hectare which amounts to about 3 per cent of the
incremental productivity of irrigated land.
Full cost recovery, which calls for a ten-fold rise in revenue,
would mean that farmers will have to pay nearly 30 per cent
of the incremental productivity of irrigated land as water
charge. This would naturally be considered unreasonably
high. However, one must also bear in mind the following
factors which reduce effective incidence even at current low
rates: (1) The above estimates of the differential between
irrigated and rain-fed productivity is understated; (2) there
is considerable under recording of total area irrigated by
major and medium works, especially of area under crops
carrying higher rates; and (3) the assessed dues are not fully
collected. They underscore the importance of scrupulously
strict assessments of crop-wise areas irrigated and of ensuring
that dues are collected fully and promptly. In both respects
the quality of governance of irrigation systems leaves much
to be desired.
Convergence to Full Cost Recovery
The extent of rate increases will obviously depend on the
incidence of under-assessment and leakages. The extent of
the latter is not known; they are also likely to vary a great
deal between regions. It is, therefore, essential to commission
a systematic and objective assessment for each system of the
area actually receiving irrigation, the area under various
crops and their productivity. Even after these adjustments,
there is no doubt that full cost recovery will mean a substantial
increase in the incidence of water charges relative to output
at current levels of water use efficiency and productivity.
Phased raising of rates must, therefore, go along with
measures to make fuller, more effective use of available
7 This is based on a simple average of estimated productivity of
irrigated and rain-fed cropped areas. They relate to the period 1979–
83 and valuations are at 1986–7 prices. For details, see Vaidyanathan
et al., 1994.
 Rural Infrastructure 241

water and for managing its allocation and scheduling to Committee on Irrigation Pricing
achieve higher output per unit of water use. That there
It is on the basis of the above reasoning that the Committee
is much scope for both is widely recognized but seldom
on Irrigation Pricing stressed the necessity to view the strategy
quantified. Data on actual water deliveries and area irrigated
for reform of water pricing as part of a larger programme
for a number of projects (Table 9.1.2) suggest that the
of modernization of irrigation systems and the restructuring
amount of irrigation water used is in most cases far in excess
of their management. Large investments will of course be
of the deficit of rainfall relative to crop water requirement.
needed for physical improvements; and they should command
Rules and criteria for allocation/scheduling are fuzzy and
higher priority than construction of new systems. The planning
enforcement notoriously lax. Systems are not equipped with
of these works also needs considerable improvement based
engineering structures to permit effective regulation of water
on the experience of the National Watenr Management
distribution according to such rules as there are; water
Projects (NWMP) projects and using better data and more
delivery is amenable to change through influence and
sophisticated analytical tools. But far more challenging is the
pressure; and few systems can ensure that timing and
task of restructuring the management.
quantum of water supply is so managed as to achieve the
Experience has amply demonstrated that the present
maximum impact on productivity.
system, whereby the government assumes the responsibility
There is large scope and need for a major overhaul of
from conception through design, evaluation, financing and
the distribution network, repairing and installing devices
construction of irrigation systems as well as their continuing
for regulating water deliveries to different segments and
management, wholly through its bureaucracy, is incapable
redesign of the networks in the light of actual experience
of achieving the above objectives. The entire process at
in respect of water yield, losses in conveyance and
every stage is far too opaque, open to interference and mani-
application, crop patterns, and conjunctive use of water.
pulation, without any effective incentive or mechanism to
This needs to be accompanied by reformulation in clearer
ensure economical use of resources in construction and
and more precise terms of rules regarding crop pattern and
management or to ensure that costs are fully recovered.
delivery schedules as well as a restructuring of the
Besides introducing transparent criteria and procedures to
organization to achieve greater transparency and tighter
judge the soundness and viability of projects before they go
management. These measures, which together should make
on stream, the management of systems must be insulated
a substantial difference to the productivity of water, need
from external interferences from politicians, the bureaucracy,
to be accompanied by measures to ensure stricter assessment
and the local power centres.
and collection of dues. All this will reduce the effective
incidence of full cost recovery rates in relation to output
Users Involvement
and income of the beneficiaries of irrigation and help
make the case for rate enhancement stronger and more Beneficiaries of projects (new ones as well as modernized
persuasive. old ones) must be required to contribute a share of the

Table 9.1.2
Frequency Distribution of Irrigation Depth in Selected Projects/States

State Season PET minus

80% of No. of Projects by Depth of Irrigation in Metres 2
rainfall1
Nil or NA 0–0.2 0.2–0.4 0.4–0.6 0.6–0.8 1.0-1.5 <1.5
Andhra Kharif .135 – – 1 – 1 1 6
Pradesh Rabi .497 – – – – 4 2 3
Karnataka Kharif .164 2 – 1 2 5 6 3
Rabi .496 8 – 1 2 5 4 2
Madhya Kharif .138 9 2 2 – 3 – 2
Pradesh Rabi .369 2 1 2 3 8 3 2
Tamil Nadu Kharif .342 7 – – 1 3 4 1
Rabi .357 – – – 1 6 6 3
Notes: 1Maximum estimated values among different agro-climatic zones of each state computed from annexure 7 of GOI, 1992
2Computed from Annex 4.1 of GOI, 1992
3Kharif 15 June–15 October
4Rabi 15 October–15 March
242 India Infrastructure Report 2003
costs (which is necessary to give them a sense of stake and
ownership).8 This can take the form of direct contributions
in the form of labour, cash or materials for the project
as a whole; entrusting the responsibility for constructing
field channels and preparing lands below the outlet level
for irrigation; or compensating the displaced people by
giving a part of their land. The sense of stake will be
enhanced by ensuring that potential beneficiaries as well
as those adversely affected are consulted in deciding the
basic operational rules (governing the damarcation of areas
to be benefited, compensating project-affected people,
allocation between different uses, permissible crop patterns
and scheduling of water under different contingencies).
The continuing management should be entrusted to
autonomous organizations with powers to make, change
and enforce rules, levy and collect water rates on condition
that they become financially self-reliant.
Table 9.1.3
Illustrative Calculations of Increase in Collections for
Full Cost Recovery in 1994–5
Rs crore
Costs
Working expenses 1700
Depreciation1 340
Interest 4080
ALL 6120
Revenues
Actual realization 440
Potential revenues with index rate at 1850
current level of enforcement2
Potential revenues with index rate and 2310
strict enforcement 3
Notes: 1Based on cumulated investment up to end 1991–2
(Rs 33,700 crore).
2Wholesale price index in 1994–5 was 4.2 times the 1977–8 level
3Assuming 20% leakage due to under-assessment and laxity in
collection, this was the average shortfall as per cent of demand in
10 states during 1986–90 (GOI, 1992: chapter 5).
The internal structures of these organizations must be
such that user representatives participate in all levels and
functions of management. While contribution to capital
costs gives them a sense of ownership, involvement in
management provides them space and opportunities to evolve
generally acceptable allocation rules/criteria, monitor the
actual performance of the system and resolve conflicts through
a process of internal negotiation and compromise. It also
provides a better mechanism for adapting rules in the light
of changing conditions. The intention behind the suggestion
to have user associations at different tiers and the insistence
8 The subsequent suggestions are essentially a summary of the
detailed recommendations of the Committee on Irrigation Pricing.
on well-defined contracts between them and the system
management defining their respective entitlements and
obligations, is also aimed to create strong internal incentives
for efficient and accountable management.
PROSPECTS FOR REFORM
To outline a plausible, coherent package of reforms is one
thing and getting it implemented is quite another. Political
parties are still, for the most part, unwilling to confront the
issue of cost recovery in water (or, for that matter, in most
other sectors), much less to seriously discuss raising user
charges. They continue to see any attempt to do so as
suicidal. At the same time there are signs that the perilous
condition of state finances and the inability to find resources
for socio-economic infrastructure to support growth and
poverty alleviation is forcing at least a few of them to address
the issue. There are also signs—as yet limited and diffused—
of farmers taking active interest in improving the quality
of irrigation. The creation of water-user associations and the
declared commitment of the governments to ‘turn over’
management to users seems to have kindled both awareness
and interest in these matters among the farming community.
Properly mobilized through persistent and patient efforts on
the part of the media and the political leaders to explain
the necessity and rationale for reform—could build a strong
grassroots, pressure for reform.
Turning Point?
Fairly wide-ranging organizational reforms are already on
the agenda of several states: Andhra Pradesh, Orissa and
Tamil Nadu have enacted legislation envisaging major changes
in the organization for water development. Some—notably
Andhra Pradesh and Maharashtra—have taken significant
and, given the current political situation, bold steps to raise
water rates. Andhra Pradesh has perhaps gone the farthest
in implementing reforms: It has legislated water-user
participation at all levels of each major and medium irrigation
system; and legislation has been followed by elections. It also
shows that given strong backing from political leaders in
government, the attitude of the bureaucracy can be changed
from one of cynical indifference to a positive and active
interest in reforms and serious engagement in addressing
the problems they throw up. As already noted, entrusting
maintenance and repair to the local WUAs rather than
contractors has given a strong sense of involvement on the
part of users resulting in speedier completion of works at
lower cost and better quality than under the earlier
dispensation. However, as yet, much remains to be done.
The precise functions of the management committees at
the higher levels of each system, the relative roles of the
government officials and user representatives in decision-
making, the powers of the system-level boards in deciding

operational rules, procedures, rates, etc. and the relation
between the system-level organization and the government
remain ill-defined. There is still reluctance to committing the
9.2 PEOPLE’S PARTICIPATION FOR EFFICIENT AND ACCOUNTABLE
MANAGEMENT OF IRRIGATION SYSTEMS
While the Irrigation Department regulates the demand and
supply of water, the cropping patterns are suggested by the
Agriculture Department and the collection of water rates
and cess is vested with the revenue administration! This
fragmentation leads to none of the departments being fully
responsible for revenue collection.
Management of public irrigation systems has been
problematic, and only a fraction of the gains possible in
agriculture are realized. Improper pricing of water has been
recognized as one of the key problems in this
mismanagement. Recoveries today do not even cover
operations and maintenance (O&M) costs. Other aspects
of dysfunctionalities in the system are not widely recognized.
Recognition of the potential of the participation of farmers
and civil society in conceptualization and design as well as
O&M of the irrigation networks, which could have made
possible easy solutions in management, is only the beginning.
In spite of significant physical achievement of acreage covered
under irrigation, the country faces the paradox of drought-
flood-drought, syndrome that severely affects agricultural
production and yields. It is estimated that while one-third
of our land is subjected to drought one-eighth of cultivable
land is subjected to flood.
One can say that the state management of irrigation
projects has failed miserably in our country. It was even
noted by the Public Accounts Committee on Irrigation
(1983): ‘The entire planning process of irrigation project
is faulty. There have been serious slippages in major and
medium irrigation projects.’ There are instances when the
authorities find it difficult to operate and maintain projects
with the amount of grant received from the Government
budget (Rath, 1993; Mitra, 1998). There is no incentive for
efficiency or accountability in the system. In addition to
many planning and design-level problems, administrative
problems arise during execution and O&M of the projects.
In view of these problems, the National Water Policy, 1987,
had laid great emphasis on farmers’ participation in irrigation
management. In the post-liberalization period, the World
Bank, which had supported our irrigation development and
funded our Command Area Development Approach
(CADA) programmes, have urged the Government of
Rural Infrastructure 243
government to the principle of full cost recovery and a clear
time-frame for achieving the objective. The really difficult
task of restructuring irrigation management still lies ahead.
Binayak Rath
India to bring in a people-centric approach (World Bank,
1993). Since water is a state subject in our federal structure,
many state governments have announced their water policies
in tune with the National Policy with a focus on
participation of farmers through institutional arrangements
such as Water Users Association (WUA) Pani Panchayats
(PPs). We examine the scope of the PP scheme introduced
in 1996 and its impact on efficiency and accountability
through a case study of the developments in Orissa.
PANI PANCHAYATS
Despite Orissa’s endowment of vast water resources in its
river systems, almost every year it faces the problem of
drought or floods. Proper management of its irrigation and
flood control systems could have mitigated these problems.
Many of the older irrigation systems operate far below
capacity due to poor management. Shortage of funds and
poor maintenance have similarly made many irrigation
schemes defunct. The present practice of budgetary allocation
based on ayacut-certification by the revenue authorities, low
water rates, collections in which the department has no role
to play, poor incentives for people to use water optimally,
are the main causes of poor performance of the irrigation
projects. Poor functioning of CADA could not generate
enthusiasm among farmers to participate in irrigration
management. There was little space for the users, with a
natural interest in augmenting water resources, to be brought
in. Irrigation systems, including the lower canals and
distributories have aspects of common property resources.
So, there is prima facie meaning in involving users in
management, through appropriate frameworks and
institutions. Given the poor condition of much of the
irrigation systems, such involvement of users has vast
potential to improve incomes and reduce poverty. The
Government of Orissa realized the need to take further the
agenda laid out by the National Water Policy.
Accordingly, it enacted a new State Water Policy that
introduced some amendments in the Orissa Irrigation Act
(1959), Orissa Irrigation Rules (1961) as well as its Revised
Rules (1974). The new policy inter alia envisaged a
244 India Infrastructure Report 2003

reorganization in the structure of administration. The
Department of Water Resources (DOWR) was reorganized
and a Water Resource Board was created in 1993 to plan,
execute and coordinate the utilization of the water resources
of the state. The Government of Orissa also approached,
in 1994, international funding agencies like the World
Bank and the Department For International Development
(DFID) for funds to renovate the projects. Through their
post- evaluation studies these organizations identified the
weaknesses in the system and then advised the government
on how to bring about people’s participation in irrigation
management. They also advised gradual disinvestment in
the irrigation sector. The new policy of the state creates
and gives responsibility to the institution of the PP for all
aspects of water planning and management. The idea is
to hand over the O&M of irrigation systems to the users
in due course. PPs were introduced on a pilot basis in 1996
and the scheme’s success led the government to legalize
people’s involvement in management through Orissa
Irrigation (Amendment) Rules, 1999.
For better and sustainable O&M it recognizes the need
to involve farmers especially at the lowest level of the
distribution system. As a first step to this process of change,
it was decided to hand over a part of the network of the canal
system for its O&M to appropriately formed PPs WUAs.
In the first phase, the government identified four pilot projects,
viz., Ghodahada and Rushikulya Distributary No.11 of Ganjam
District, Aunli and Derjang Projects of Angul District, and
the initiatives for forming PPs started in 1996. Consultancy
assignments were given to different non-government
organizations (NGOs) to undertake the preliminary spade-
work as well as to communicate and motivate the farmers
to participate in PPs. The selected NGOs and the Water and
Land Management Institute (WALMI) of the Government
of Orissa demonstrated the benefits of PPs. Minor maintenance
activities by farmers eased flow of water up to the tail reaches.
They were also helped to organize water distribution, resolve
disputes, if any, and adopt their own crop planning, etc in
consultation with agronomists. With the help of the NGOs,
50 PPs were registered as legal bodies in the four command
areas. Under the new arrangement responsibility for O&M
of the reservoir/diversion weir (as the case may be) of dam,
spillways, sluices, primary, and secondary distribution
networks, etc. rests with the DOWR. But the responsibility
for O&M of the tertiary system, that is, below minor/sub-
minor, is vested with the PPs.

Box 9.2.1
The 1987 N ational Water P
National olicy
Policy

In 1987, the Government of India announced its ‘National Water Policy’, that recognized water as a prime natural resource and
a basic need. It was further envisaged that the planning and development of water and related land resources should be directed
to improve the quality of life as well as the environment. The policy laid emphasis on:
• Integrated and multi-disciplinary approach to the planning, formulation, clearance, and implementation of projects, including
catchment treatment and management, environmental and ecological aspects, the rehabilitation of affected people and command
area development. Focus on environmental impact assessment (EIA) during project planning;
• Promotion of appropriate organizational structure for management of water resources;
• Well-developed information systems;
• Maximizing availability of water to the users;
• Multi-purpose use of water resources as well as integrated and coordinated development of surface water and groundwater
and their conjunctive use;
• Proper maintenance and modernization of projects;
• Water allocation priorities in rank order: drinking, irrigation, hydro-power, navigation, industrial and other uses;
• Water allocation in terms of equity and social justice. Disparities in the availability of water between head-reach and tail-end
farms and between large and small farms to be alleviated by adoption of a rotational water distribution system and supply of water
on a volumetric basis;
• Participation of farmers and voluntary agencies in various aspects of management of irrigation systems (that is, participatory
irrigation management (PIM);
• Command Area Development Approach to ensure overall optimality;
• Fixation of water rates so as to convey the scarcity value of the resource to the users and to foster the motivation for economy
in water-use. The rates should be adequate to cover the annual O&M charges and a part of the fixed costs;
• Awareness about water conservation should be promoted through education, regulation, incentives and disincentives;
• Flood control and drought management as integral to water management;
• Training of both officials and users;
• Need to equip local government to cope with burdens imposed directly or indirectly by development projects;
• Need to move towards decentralized decision-making and eliminate interference that have restricted the authority of regional
and local officials in water management.

The formal handing over of the system to the people
took place in April 2001 for 40 PPs out of the 50 registered
till date. All these PPs are enthusiastic in taking up their
respective canal systems. For handing over of the remaining
systems to the PPs, work is on in full swing. Thereafter,
the government plans to extend the PP programme to other
areas. It has identified another 29 irrigation projects
covering an area of over 3 lakh hectares for its second
phase where PP schemes are to be introduced. It is
estimated that 688 PPs are to be formed to look after the
irrigation system in these projects. The success of the first
phase has given much confidence to go ahead and introduce
PIM among the farming community more generally.
WALMI takes an active part in the training of both officers
and farmers. Inaugurating the ‘Awareness Campaign’ of
‘PPs Programme’, the Chief Minister of Orissa, Naveen
Pattanaik, has recently reiterated that PPs will open the
door to development by ensuring the direct participation
of farmers in the management of irrigation. Emphasizing
the need to transform the PPs into a ‘mass movement’ he
has indicated that very soon the ‘Biju Farmers Project’ will
be implemented in the state. The estimated budget of the
new project is Rs 1000 crore and 80 per cent of the funds
will be utilized through PPs. He has further assured that
tube-well irrigation would be enhanced and strengthened
through the scheme of ‘Operation Trushna’, where, again,
PPs would be introduced. Additionally, he has also proposed
disinvestment of the state-run ‘Tube-Well Corporation’.
IMPACT
Our post-evaluation study was undertaken in two project
sites, namely, Derajang and Aunli Medium Irrigation
Projects of Angul district. Field-work was carried out in
June–July, 2001, and again in June 2002. In addition to
the secondary data gathered from the Irrigation Department,
at Angul, a specially designed questionnaire was canvassed
among the members of the PP in a few villages, that is,
Gramashree Water Users Association and Swarnprasu Water
User Association in the command area of Derjang project.
In addition we had extensive discussions with the field-
level officials on different aspects of the PP. We fond that
the institution of the PP scheme resulted in major economic
gains. Some of these are listed below:
• Water available at the outlets has gone up. An
examination of the water supply data at the outlets and the
rainfall for 1995–6 to 1999–2000 for the Derajang project
indicate that in spite of 82 per cent less rainfall during the
rabi season of 1998–9, water supply in the corresponding
period had increased by 47 per cent of the same period
in the earlier years. Similarly, though there was a small
Rural Infrastructure 245
increase in rainfall during the kharif season of 2000–1
(1.34 per cent) only the water supply at the outlets had
increased by 17 per cent.
• Higher productivity is noticed in the Derajang
command areas. Our field data show that per hectare
productivity of paddy in the kharif season had increased
by 50 per cent in 1998–9 over that in 1997–8. Moreover,
the per hectare productivity of pulses had gone up by 62
per cent, groundnut by 25 per cent, sesame by 5 per cent,
and vegetables by 22 per cent. This increase has been
maintained since then.
• The cropping patterns too have changed. Earlier no
sunflower was grown in the command area owing to lack
of water, and no information or advice from the Agriculture
Department. Now sunflower cultivation has picked up and
its yields have risen from 1350 kg per hectare in 1997–
8 to 1620 kg in 1998–9.
• In Aunli too, data indicate a rising trend in the per
hectare productivity of all the crops after introduction of
PPs. The per hectare productivity of paddy has gone up
by 35 per cent, pulses by 56 per cent, groundnut by 33
per cent, seasame by 25 per cent, vegetables by 18 per
cent and suga rcane has gone up by 20 per cent.
• Improved yields have raised benefits from land. The
per hectare average annual benefits accruing to farmers
increased from Rs 2873 in 1995–6 to Rs 13,258 in 1999–
2000, (that is, a four-fold increase!). This, of course,
implies that the water rate paying capacity of the farmers
has gone up.
• The stipends paid to member beneficiaries who
attended training programmes was retained by the WUAs/
PPs to purchase the much needed instruments for use in
measurement of water!
• The assurance of water has encouraged the farmers
to use new high-yielding varieties of seeds.
• The wastage of water from the canal/sub-canal head
has reduced a great deal, by about 90 per cent.
There are other intangible economic and social benefits
that have followed the introduction of PPs.
• Significant awareness among the farmers regarding
the benefits of PP has come about since their participation
in the training programmes and meetings organized by the
NGO and WALMI from time to time.
• PPs have resulted in greater cooperation and
coordination among the concerned officials and the member
farmers. One of the beneficiaries reported that prior to
the formation of PPs, officials did not bother to hear them,
when they went with any water-related problems. Then
their access to the officials of the Irrigation as well as the
Agriculture Department was very limited. But now, since
all those officials come to their ‘doorsteps,’ they get ample
246 India Infrastructure Report 2003

opportunity to interact with them and to bring out their
grievances and views on better distribution of water. These
and similar interactions have enhanced the awareness among
the farmers as well as among the officials. Farmers are
optimistic and there is a distinct change in the attitude
of officials. These would, in the longer term, result in gains
that are not evident at present.
• Thus, already the accountability of the officials to
farmers (in terms of water availability) during the crop
seasons as improved.
PPs are accountable to their members. Earlier, conflicts
between neighbours regarding use of water, were common,
and the department officials did not bother to resolve
them. Now farmers are able to resolve their disputes
themselves. It has generated a sense of ownership among
the farmers for the facilities created. A sense of unity and
fellowship among the farmers has emerged.
• Farmers see the value of training and of workshops
to improve their knowledge for their economic gains.
• There is much less damage of the minors and the
sub-minors.
• Political interference in the job contracts for the
minors and the sub-minors has also reduced considerably
as now the officials of the Irrigation Department ask the
respective panchayats to provide the required number of
people for the job.
• To a large extent the distribution of water is equitable
and there is no bias against the tail-end farmers. The ‘quota
of water’ is proportionate to the Culturable Command
Area (CCA) of the WUA.
• Farmers have the right to bring through the Apex
Committee their suggestions for improvements in the
management of the main canal system, water delivery
schedule, etc. at the project level.
• Farmers enjoy the freedom of choice with regard to
the crops they grow, since the amount of water they receive
is proportional to their land.
• The officials of the Agriculture Department in their
extension activities show much improved working.
• The middle and higher level officials of the Irrigation
Department are enthused to push forward the idea of PPs
because many of them feel that this will result in less
political interference in their day-to-day managerial
functions, especially with regard to awarding contracts to
maintain the tertiary irrigation networks.
EMERGING CHALLENGES
The PPs have crossed only the first step of PIM, that is,
partial participation in O&M of the tertiary system. The
next two stages, namely, taking over of minors and sub-
minors for direct O&M, and collections of water rates are
yet to be implemented. We have identified a few contentious
issues, which ought to be resolved to improve the
performances of the PPs and take the institution further.
Insufficient Maintenance Fund: As per the agreement
between the PPs and the Irrigation Department, in the
second phase the PPs will be paid an amount of Rs 35
per hectare per year as maintenance grant out of the
existing water rate of Rs 100 per hactare. But this rate
sharing is not acceptable to the PPs on the ground that
the amount is insufficient to maintain the minors and sub-
minors, since such work also involves the maintenance of
inspection roads alongside the minors and sub-minors.
The work also involves continual repair of the dykes
through the year, and also cleaning of the canal bed at least
twice a year to ensure smooth flow of water.

Box 9.2.2
Str uctur
ucturee of the ‘P
tructur ani P
‘Pani anchayat
anchayat’’
Panchayat

• The PPs are formed on a three-tier system with two informal associations and one formal association on minor/sub-minor
basis comprising an ayacut ranging between 300–600 hectares.
• Chak Committees per outlet are formed taking farmers, one each from the high land, middle land, and low land areas of the
ayacut. A representative from the Chak Committee will be a member of the executive body of the PP. Each PP will have a president,
secretary, and treasurer.
• Each beneficiary landowner within the ayacut of the concerned minor/sub-minor qualifies to be a member of the concerned
PP.
• For registering a PP, a minimum of 51 per cent of the beneficiaries, possessing 60 per cent of command area, are required
to be members. To be eligible as a member in a PP, a token membership fee of Rs 10, or as is decided by the PP, is charged.
• A fund is created in the form of share capital with the contributions made by the members of the PPs proportionate to their
land holding plus a part of the water rates (Rs 35 per acre) in order to take up maintenance work of canals or to attend any work
of emergent nature. The authorized office bearers of the PP have powers to spend out of these funds.
• An ‘Apex Committee’ in each command area, comprising of all the presidents of the WUAs and with invited official members
would prepare the canal operation schedules, O&M plans of the system, suggest cropping patterns and undertake the overall
co-ordination among the PPs.

Difficulty in Collecting Water Fees: As per the policy and
agreement, in the third phase the PPs will be responsible
for the collection of ‘water fees’ from their members along
with the distribution of water and maintenance of the
minors and the sub-minors. But, in this respect, the
members have expressed their concerns, with regard to the
task of collection of ‘water fees’ from all the members. They
feel that it will be an uphill task for them and this will lead
to conflicts among the office bearers and the irrigators.
Their argument is that when the District Magistrate (DM)
and his army of officials, who are armed with all the official
powers including a police force, have failed to collect the
water rates properly under the present system, how can
they discharge the same function smoothly under similar
circumstances? Many raise questions like: Are PPs more
powerful than the DM?
Lack of Commitment of the Government: According to the
PPs the government has not made any serious effort to fulfil
its promises made at the time of the agreement. According
to the president of the Apex Committee, though machinery
worth Rs 6 lakh had been promised at the initial stage for
common use by the farmers, they have not received the same.
Constraint of Field Channel: We noted that there are no
field channels in the ayacut area. In their absence some
farmers have made temporary earthen channels, which
break often. The flooding method that this results in leads
to wastage of water and reduces the amount that is available
to tail-end farmers.
Technical Problems: The topography and climate of the
command area results in quick growth of weeds inside the
main canals that results in the reduced velocity of water and
raises the Full Storage Level (FSL) which further obstructs
the free flow of water to the minors and sub-minors. Hence,
the PPs are apprehensive of the availability of sufficient
9.3 PANCHAYATI RAJ INSTITUTIONS AND THE STATE FINANCE
COMMISSIONS—A REPORT
Self-governing village communities existed in India from
600 B.C. or even earlier. These village units were the points
of contact with higher authorities on matters affecting the
village communities (Mathew, 2000). In the post-
independence period, the Balwantray Mehta Committee in
1959, first laid down the foundation of local self-government
in the rural areas of the country. Based on Gandhian
philosophy, this committee emphasized the strong need for
Rural Infrastructure 247
water to them and they insist that the main canal should
be cleaned every month during its operation period.
No Effort to Collect Reveneue: The present practice of
collection of water rates from the farmers is replete with
many loopholes which need to be urgently reviewed. The
present practice wherein the revenue officials certify the
irrigation ayacut after a joint verification by the staff of both
Revenue and Irrigation Departments provides no challenge
for the officials of Irrigation Department. They do not even
know how much area is certified by the Revenue Department
and how many farmers are charged, and at what rates. The
lack of involvement of the irrigation officials in water rate
and cess collection is one of the major reasons for the poor
health of many irrigation projects in the state.
As the DM/Collector is assigned all revenue collection
on behalf of the government, he does not bother to know
or keep track of the revenue coming from particular heads
of account. As soon as his earmarked quota (which is
assigned to each DM) is fulfilled, his effort in collecting
the rest of the dues wanes. Thus, the present practice of
revenue collection is hardly geared towards efficient
collection. There are no incentives for improved collections.
The rise in crop productivity and the subsequent increase
in net income of the farmers indicate that the water rate
paying capacity of the farmers has gone up. The government
should exploit this opportunity to collect the arrears in
water charges from the farmers as their ability to pay has
gone up substantially.The water rate collection could be
assigned to the irrigation authorities on an incentive system
(both individual and collective) where part of any additional
collection over the targeted one could be shared by the field
officials who are responsible for collection.
PIM with the improvements as suggested, especially with
regard to collection of water rates, is crucial to the efficient
and accountable working of irrigation systems. PIM ought
to be extended to irrigation projects over much of the country.
Mukesh P. Mathur
an institution such as the Gram Panchayat to look after the
interests of the rural population at the grassroot level. The
Gram Panchayat was visualized as an implementing agency
of the government-sponsored schemes and programmes for
orderly development of the rural areas of the country.
Rajasthan was the first state of the country to pass legislation
on Panchayati Raj Institutions (PRIs), and by 1959, all the
states passed Panchayat Acts (Mathew, 2000).
248 India Infrastructure Report 2003
Over the years, however, the local-level governments,
especially at the village level, weakened considerably due
to the withdrawal of traditional legitimate local functions
and a mismatch between the sources of revenue and even
the residual local functions. Large numbers of local bodies
were superseded, sometimes for periods in excess of a
decade. These village bodies failed to function as vibrant
units of local self-government. Much of the explanation for
their failure lies in the policy and defining framework
which did not allow adequate space for their existence. The
weakening of local bodies in terms of function, finances
and institutional capabilities would have contributed to the
poor quality and inadequate levels of services in rural
habitats9.
But that situation changed in 1992 with the path-breaking
73th Constitutional Amendment Act (CAA) on panchayats.
Similarly, the passage of the 74th CAA on municipalities
the same year changed the constitutional position of urban
local bodies (ULBs). These path-breaking Acts have provided
a new dimension to fiscal federalism and decentralized public
finance in the country’s federal system. In addition to ensuring
constitutional validity to local bodies, these legislations have
also broadened the range of powers and functions of local
governments. The provisions that concern the constitution
of State Finance Commissions (SFCs) aim to rationalize
state–local fiscal relations.
The new fiscal arrangement has also affected a major
change in the scope of the tasks of the Central Finance
Commission (CFC), which, until the insertion of item (3–
C) to the Article 280, was confined to the distribution of
divisible taxes between the union and the states and grants-
in-aid to states under Article 275 of the Constitution. The
CFC now has also to suggest measures needed to augment
the consolidated fund of a state to supplement the resources
of the local bodies on the basis of recommendations made
by the SFC. Thus there is a positive departure in the state–
local fiscal relations from the earlier practices when the
system had been ad hoc. It is expected that recommendations
of SFCs as well as of the Eleventh Central Finance
Commission (EFC) would set norms, conventions and
practices relating to fiscal federalism and efficient local
governance in the country.
All the states of the Indian Union have amended their
legislations both for panchayats and municipalities to confer
to the provisions of the 73rd and 74th CAAs.
PANCHAYATI RAJ INSTITUTIONS TODAY
The 73rd CAA provides a three-tier structure to these
institutions across the country viz; (1) Gram/Village
9 The situation with regard to urban bodies was no different.
Panchayat at the village level; (2) Panchayat Samiti at the
intermediate (block/tehsil/mandal/taluk) level; and (3) Zila
Parishad or District Panchayat at the district level.
All the states have passed legislations in conformity with
the 73rd CAA with a view to establishing a three-tier system
of panchayats. All the three levels of panchayats have directly
elected members with reservation for SCs, STs, backward
classes, and women both at the membership level and the
executive level. The executive heads of panchayats are
designated as presidents elected indirectly by the members
of the respective panchayats. The local MLAs/MLCs/MPs
are also given membership with voting rights in the Zila
Parishad and the Panchayat Samiti. According to the
amended Karnataka Panchayati Raj Act of 1993, one-fifth
of the village panchayat presidents are to be made ex
officio members of the Panchyat Samitis. The chief executive
officer, executive officer and secretary, at these three levels
of local governance, provide the administrative support to
the panchayats. The panchayats have the responsibility of
preparing local development plans at their respective levels
and implementing them, for which they have to mobilize
their own resources in addition to the resources devolved
to them from the state governments and the central
government.
The first round of elections for PRIs and ULBs has been
held in most states. A sizeable number of elected
representatives (approximately 2,60,000 to PRIs and over
60,000 to ULBs) including women and scheduled castes/
scheduled tribes, have been elected and bear responsibility
for taking decisions and giving voice to the needs of the
people.
As on May 1998, there are 2,34,078 PRIs in the
country, classified into three categories of Gram Panchayats
(2,27,698), Panchayat Samitis (5906), and Zila Parishads
(474). In some of the states rural local bodies are designated
as the ‘traditional councils’. These are Meghalaya, Mizoram
and Nagaland (Table 9.3.1).
FINANCES OF PRIS
The finances of the panchayats consist of: (i) Own sources,
that is, taxes assigned by the state panchayat acts to the local
bodies concerned and levied and collected by them. Own
sources also include non-tax revenues such as fee and fines,
user charges for services rendered, rent from the properties,
etc.; (ii) Shared taxes, that is, are collected by the states with
a share of the proceeds being disbursed among the local
bodies of the state; and (iii) grants from the state/central
government which may be either tied or untied. In some
states, certain taxes are statutorily assigned to the local
bodies but collected by their respective state governments
and made over to local bodies. For example, the surcharge
 Rural Infrastructure 249

Table 9.3.1 to the first and second tiers of panchayats that is, zila
Panchayati Raj Institutions in India: As on May 1998 parishads (ZP) and taluk panchayats/panchayat samitis (TP/
PS). In cases where powers to levy taxes, fee and user
State/UT Grams Panchayat Zila All
Panchayats Samitis Parishads charges have also been given to ZP or PS, these are being
collected by the village panchayats and then transferred to
Andhra Pradesh 21943 1098 22 23063 the concerned local bodies. Usually, the taxes and charges
Arunachal Pradesh 2112 79 12 2103
levied by the ZP and PS are in the form of surcharge on
Assam 2489 202 21 2712
Bihar 12181 725 55 12961
the taxes and user charges levied by the village panchayats.
Goa 183 – 2 185 The finances of PRIs are presented in Tables 9.3.3 to
Gujarat 13316 184 19 13519 9.3.7. Panchayats are heavily dependent on the state
Haryana 5958 110 16 6084 government to finance their local activities. Income from
Himachal Pradesh 2922 72 12 3006 ‘other sources’ that primarily consist of transfers from the
Jammu and 2683 – 14 2697 state government that is, grants-in-aid and shared taxes,
Kashmir form an important part of the total revenue receipts of all
Karnataka 5675 175 20 5870 the three tiers of PRIs in most states. The dependence of
Kerala 991 152 14 1157
Panchayat Samitis (Taluka Panchayats) and District
Madhya Pradesh 30992 459 45 31426
Maharashtra 27619 319 29 27967 Panchayats on transfers is almost total.
Manipur 166 – 3 169 Whereas ULBs are generating, on an average, more
Mizoram – Traditional – – than 80 per cent of their revenue incomes from their own
Councils sources, this proportion is less than even five per cent in
Meghalaya – Traditional – – PRIs. The dependency ratio of PRIs on state governments
Councils varies significantly across states. PRIs of Bihar and Manipur
Nagaland – Traditional – – ‘function’ entirely on government grants. The local bodies
Councils of Haryana generate a substantial amount of revenue from
Orissa 5261 314 30 5605
their own sources, especially by tapping the non-tax
Punjab 11591 138 17 11746
Rajasthan 9185 237 31 9453 resources of their income (62.20 per cent).
Sikkim 148 – 4 152 Tables 9.3.5 and 9.3.6 show that fiscal transfer from
Tamil Nadu 12584 384 28 12996 the states to panchayats have gone up substantially during
Tripura 525 16 3 544 the last eight years for which the data is available. In per
Uttar Pradesh 58605 901 68 59574 capita terms, the transfers have gone up from less than Rs
West Bengal 3314 341 17 3672 100 in 1990–1 to more than Rs 250 in 1997–8. It is
A & N Islands 67 – 1 68 striking that although the share of tax income to total
Chandigarh – – – – income declined significantly over the years, non-tax
Dadra & Nagar 11 – 1 12
revenues have maintained their status in the finances of
Haveli
Daman & Diu 10 - 2 12 local bodies. In fact they have recorded a sharp increase
NCT Delhi – – – – of over 12.5 per cent per annum during the reference
Lakshadweep 10 – 1 11 years. User charges and land based non-property taxes,
Pondicherry 10 – 1 11 such as revenue from commercial properties and
All 227698 5906 474 234078 development of rural housing and entertainment schemes,
Source: Mathur, O.P. (2000); Decentralization in India–A Report, are some of the promising areas for resource generation
UMP–Asia Occasional Paper No. 47, Asian Institute of Technology, from the non-tax sector. Transfers from the state have
Klong Luang, Thailand. increased at the highest rate. The revenue at 16.6 per cent
has more than kept pace with inflation and population
on duty of transfer of property is collected by the growth, so that PRIs are in a better position than what
Government of Kerala, and after deducting the cost of they were in the 1980s. The tax revenues, though, have
collection is transferred to the local bodies of the state. grown slower than they could have.
Panchayats also raise loans from the state governments and Abdul Aziz, presenting the case of Karnataka, concludes
other financial institutions primarily to finance their that the panchayats have survived primarily on the
developmental works. The resource structure of panchayats development grants provided by the state. There was hardly
is given in Table 9.3.2. any attempt to generate own resources (Aziz, 1998). John,
It is interesting that the state legislations, which empower Oommen in the case of Kerala, notices more or less similar
the three levels of PRIs, do not give any source of revenue trends. He, however, observed that the financial position
250 India Infrastructure Report 2003

Table 9.3.2
Major Sources of Income for Panchayats in India

Sources Major Components

Internal/Own sources
a. Tax revenue Building/house tax; taxes on profession, trade, callings and employment; pilgrim tax; tax on fair and
other entertainments; tax on advertisements; octroi on animals or goods or both brought for sale (was
prevalent in Gujarat and Rajasthan which was abolished recently); vehicle tax (bullock cart/ tractor etc.);
land tax (for non-agricultural use); special tax for special works such as construction and public works
b. Non–tax revenue Fee and user charges levied by the respective panchayats for the provision of services. Water rate, street
lighting fee, conservancy fee, street cleaning fee, drainage fee, sanitary fee for public latrines and urinals,
pilgrimage fee, fee on sale of cattle, cess on conversion of land use, fee/rent and charges for use of common
resources such as panchayats shelter, hospital/ dispensary, schools, gazing land, market and weekly
bazaars, etc.
External sources
a. Shared taxes Stamp duty (duty on transfer of property), land revenue, motor vehicle tax, entertainment tax, seignior
government age royalties, forest revenue, etc.
b. Grants from General purpose, specific purpose, untied funds for developmental purposes and grants in lieu of taxes
such as in lieu of octroi in Gujarat and Rajasthan.

of Gram Panchayats is stronger than the other two tiers of
PRIs since the taxation powers lie only in the hands of the
Gram Panchayats (Oommen, J., 1998). One possible danger
of the liberal provisions of grants-in-aid is that the efforts
of PRIs to mobilize their own resources could slacken.
Many State Finance Commissions have recommended a
performance-based grants-in-aid system to local bodies. The
Himachal Pradesh State Finance Commission, for example,
has recommended release of transfers contingent on local
bodies collecting statutory levies (Mathur, M.P., 1999).

Table 9.3.3
Sources of Revenues of PRIs, 1997–8

State Total revenue Own sources (%) of total Transfers (%) of

(Rs in lakh) Tax Non-tax Both total revenue
Andhra Pradesh 100060 3.18 2.30 5.48 94.52
Assam 1550 22.13 0.20 22.33 77.67
Bihar 36596 Nil Nil Nil 100.00
Goa 1057 27.53 9.93 37.46 62.54
Gujarat 223254 1.39 0.42 1.81 98.19
Haryana 8522 5.28 56.92 62.20 37.80
Himachal Pradesh 2525 2.69 Nil 2.69 97.31
Karnataka 376807 0.69 0.11 0.80 99.20
Kerala 98277 8.91 1.17 10.08 89.92
Madhya Pradesh 177901 0.66 1.14 1.80 98.20
Maharashtra 330747 2.26 1.14 3.40 96.60
Manipur 35 Nil Nil Nil 100.00
Meghalaya 1752 0.27 17.76 18.03 81.97
Orissa 64002 0.72 0.37 1.09 98.91
Punjab 13541 0.51 39.27 39.78 60.22
Rajasthan 152021 N.A. N.A. 2.02 97.98
TamilNadu 42216 7.80 0.26 8.06 91.94
Uttar Pradesh 88324 0.98 4.30 5.28 94.72
West Bengal 48775 1.61 2.41 4.02 95.98
All India 1935554 1.94 1.55 3.49 96.51
Notes: N.A.: Not Available
Source: CFC (2000), Report of the Eleventh Finance Commission (2000–5), Govt. of India, Ministry of Finance, Department of
Economic Affairs, New Delhi.
 Rural Infrastructure 251

Table 9.3.4
Dependency of PRIs on Higher Levels of Governments

Level of PRIs 1990–1 1994–5 1997–8

Total Revenue % Transfers Total Revenue % Transfers Total Revenue % Transfers CAGR 1997–8
Receipts from state Receipts from state Receipts from state over 1990–1
(Rs crore) and centre (Rs crore) and centre (Rs crore) and centre (% per annum)
Village Panchayats 1941 83.74 3797 89.69 5452 89.56 15.9
(Village level)
Panchayati Samitis 1680 98.98 2968 90.04 4305 99.20 14.4
(Intermediate level)
District Panchayats 2992 98.74 5388 98.86 9599 99..22 18.1
(District level) (220.81)
All Tiers 6613 94.41 11882 95.98 193556 96.51 16.6
Figures in brackets refer to per cent increase in transfers from the state, in absolute terms (base year: 1990–1).
Source: CFC (2000).

Among the various taxes, building/house tax is the most
common and stable source of income for the majority of
village panchayats in the country. In Kerala, house/building
tax constituted more than 50 per cent of the total receipts
from the taxes in 1993–4. The other important taxes are
profession tax and entertainment tax (SFC, Kerala, 1996).
There is much scope for improvement in the collection
of house taxes. Many state finance commissions have, in
their reports, given suggestions for improvement in property
tax assessment and its administration. Design and
construction of houses in the rural areas in states like Tamil
Nadu, Andhra Pradesh, Kerala, Karnataka, Maharasthra,
Haryana, Punjab, etc., are in no way less impressive and
fashionable than in urban areas. In most states, the
assessment cycle has not been followed and tax rates have
not been revised since long. Wherever properties are
taxed, the arrears of taxes are allowed to accumulate due
to sheer inefficiency of local authorities, which has a direct
impact on the finance of the local bodies concerned.
Spending Structure
Expenditure on maintenance of the core services such as
water supply, street lighting, sanitation, and roads accounted
for only 7.43 per cent of the total expenditure of the PRIs
in 1997–8. In absolute terms this amounted to Rs 1555
crore for 1997–8, which was a bare Rs 21 per person! This
is suggestive of inadequate maintenance.
STATE FINANCE COMMISSIONS AND THEIR
RECOMMENDATIONS
The State Finance Commissions (SFCs), constituted as
per the provisions of the 73rd and 74th Amendments in
the Constitution of India bore responsibility for examining
not only the revenue-sharing arrangements between the
state governments and local bodies, but the entire gamut
of issues concerning the assignment of taxes, transfers and
such other issues for improving the financial health of local

Table 9.3.5
Revenue Structure of Panchayati Raj Institutions (All tiers) in India, 1990–1 and 1997–8

Sources of Revenue 1990–1 1997–8

Amount % to total Amount % to total CAGR 1997–8
(Rs in lakh) (Rs in lakh) over 1990-1
(% per annum)
A. Own Sources
Tax 23850 3.60 37691 1.94 6.8
Non-tax 13186 1.99 30017 1.55 12.5
Sub-total (A) 37036 5.59 67708 3.49 9.0
B. Other Revenues
(Transfers from 624347 94.41 1867846 96.51 16.9
the state)
Total Revenue (A + B) 661383 100.00 1935554 100.00 16.6
252 India Infrastructure Report 2003

Table 9.3.6
Trends in PRI Finances (in Rs)

Year Per capita Revenue Receipts Per capita Revenue

Own sources Others (Transfers) All Expenditure
1990–1 5.89 99.30 105.19 113.68
1991–2 5.47 110.09 115.56 128.98
1992–3 5.60 132.74 138.34 147.32
1993–4 6.35 152.74 159.09 173.90
1994–5 6.98 166.52 173.50 189.88
1995–6 7.74 186.33 194.07 207.84
1996–7 8.45 217.89 226.34 241.39
1997–8 9.27 255.76 265.03 286.61
Source: CFC (2000).

bodies. They were to cover the basis and method for both
distribution of grants and taxes, and also the quantum.
They were also to cover the measures to improve the
financial position of PRIs and ULBs.
The wide-ranging task entrusted to the SFCs as
incorporated in Article 243 I and Y and the addition of
Article 243 G and W (11th and 12th Schedules) of the
Constitution is a landmark development. It opened up a
new opportunity to review and streamline the existing
state–local fiscal relations.
Appendix 9.3.1 provides a brief summary of the
recommendations of the selected SFCs with reference to
tax assignments, tax sharing and grants to PRIs. Finance
Commissions of many states also suggested some changes
in the legislative and administrative spheres to strengthen
the local government institutions. These are:
• A Finance Commission Cell should function in the
Finance Department of the state government after the
expiry of the SFC’s term to review the implementation of
its recommendations (Karnataka, Tamil Nadu and (Kerala).

Table 9.3.7
Revenue and Expenditure of Panchayati Raj Institutions (All Tiers) in India (Rs in lakh)

Selected States 1990–1 1994–5 1997–8 CAGR of 1997–8

over 1990–1 (% p.a)
Total Total Total Total Total Total Total Total
Receipts Expenditure Receipts Expenditure Receipts Expenditure Receipts Expenditure
Andhra Pradesh 100060 100034 158151 160403 251159 250359 14.1 14.0
Assam 301 213 371 3991 1550 4057 26.4 52.3
Bihar 359 13630 59164 92656 36596 66040 93.6 25.3
Goa 367 207 776 405 1057 763 16.3 20.5
Gujarat 101816 108097 149445 150919 223254 226881 11.9 11.2
Haryana 4629 6787 6156 10825 8522 14643 9.1 11.6
Himachal Pradesh 404 404 578 578 2525 2525 29.9 29.9
Karnataka 131443 125092 245746 199249 376807 369641 16.2 16.7
Kerala 9662 9874 19353 19453 98277 73056 39.3 33.1
Madhya Pradesh 23368 22643 30234 30266 177901 178530 33.6 34.3
Maharashtra 104520 144425 204688 319695 330747 458538 17.9 17.9
Manipur 34 93 73 165 35 209 0.4 12.3
Meghalaya 914 1179 989 1478 1752 2356 9.7 10.4
Orissa 17813 17813 39773 39773 64002 64002 20.0 20.0
Punjab 9746 9999 16616 15829 13541 15953 4.8 6.9
Rajasthan 75450 74292 108474 108886 152021 153738 10.5 10.9
Tamil Nadu 27950 21967 32605 26134 42216 49062 6.1 12.2
Uttar Pradesh 42931 43376 61371 61161 88324 90714 10.9 11.1
West Bengal 7220 12101 48771 53587 48775 55488 31.4 24.3
All India 661383 714690 1188298 1300495 1935554 2093116 16.6 16.6
Source: CFC (2000).

• Periodic service training for the local government
employees to increase their efficiency (Karnataka, Punjab,
Maharashtra, Tamil Nadu and Kerala).
• Establishment of a local development fund for
subsidizing interest rates for non-remunerative but desirable
service schemes (Kerala).
• A Tax Valuation Committee to listen to the objections
of the taxpayer regarding PT assessment (Punjab).
• One common legislation for all local bodies to avoid
confusion regarding the regulations and bye-laws (Karnataka,
Kerala, Punjab and Uttar Pradesh).
• Privatization for activities like maintenance of street
lights and roads and other core services (Kerala, Uttar
Pradesh, Punjab and Tamil Nadu).
• Privatization of the maintenance of commercial assets
(Tamil Nadu).
• Public participation for the maintenance of services
(Maharashtra).
A close examination of some of the SFC reports show
that these Finance Commissions have tried to rationalize
the local tax structure by suggesting reforms in assessment
and administration of taxes besides giving powers to local
bodies. Finance Commissions of Kerala, Karnataka, Tamil
Nadu and Uttar Pradesh, for example, have recommended
reform in property taxes and have suggested the ‘area based’
or ‘site valuation’ system for assessment of property tax. A
majority of SFCs also recommended autonomy to local
bodies, particularly village panchayats (VPs) for fixing tax
rates and user charges. The West Bengal SFC has
recommended a new regime of tax collection in which tax
administration works in close cooperation with panchayats
and gives a proportion of tax collection as entitlement to
these bodies.
The Kerala State Finance Commission (KSFC) emphasized
the need to develop new sources of revenues besides suggesting
principles to rationalize the local tax structure. The Punjab
State Finance Commission (PSFC) has recommended
autonomy to all the three tiers of PRIs to levy taxes and
fees, and also to fix the rates thereof, without the state
control that had been imposed following the Punjab
Panchayati Raj Act of 1994 (Oommen, M.A., 1998).
Some of the new taxes suggested by the KSFC are: a tax
on sale of properties, central government properties, entry
of transport vehicles10 carrying goods for local sale and
consumption, cable TV operators, stamp duty on documents
to be submitted to local bodies and library cess. In case
10 Entry taxes fragment markets and the distortions they create
are very large, much larger than what their first order effects alone
would indicate. The process of growth and transformation in the UK
(the first industrial revolution) had the integration of the home
market brought about by the abolition of local tolls and taxes as
a necessary condition (Editor).
Rural Infrastructure 253
of tax on sale of properties, the commission has suggested
that Zila Parishads may be empowered to levy a tax on the
sale price of all immovable properties within the district,
where the price is Rs 25,000 or more at the rate of 1 per
cent. The Registration Department has to collect this tax.
Three per cent of the total collection should go to the state
government as collection charges. Revenue from rural areas
of the district is shared in equal proportion between the
Zila Parishads and Panchayat Samitis. The distribution of
shared revenue among the panchayat samitis will be made
on the basis of their population as per the 1991 Census.
The Rajasthan SFC also suggested interesting taxes, which
could be levied by the village panchayats of the state. These
are: tax on dhabas, hotels, motels, automobile servicing and
repair shops, petrol/diesel pumps, etc. situated on the
national/state highways in their respective jurisdictions.
Transfers from the state to local bodies in the form of
revenue sharing and grants-in-aid play an important role
in the financial structure of local governments. This is
more so in the case of rural local bodies. It is significant
that prior to the enactment of CAA, grants-in-aid have
been the major component of fiscal transfers from the state
to local bodies, and the share of state taxes and levies were
extremely low. SFCs constituted as per the provisions of
CAA have recommended sharing of state-level resources
in addition to grants-in-aid to local bodies. Variations,
however, have been noticed among different states in terms
of scope of resources to be pooled and its sharing principles
among the PRIs and ULBs. Whereas the Rajasthan, Tamil
Nadu, Uttar Pradesh and West Bengal Finance Commissions
recommended the devolution of a set percentage of the net
proceeds of only the tax revenues of the states, Andhra
Pradesh has suggested for sharing of both from taxes and
non-taxes. The Karnataka SFC has adopted a different
mechanism by replacing the present system of sharing a
portion of the specific taxes levied by the state government
by a share in the ‘total non-tax gross own revenue receipts’.
Table 9.3.8 brings out the relevant details of only those
states where SFCs have recommended the concept of
‘global sharing’ for transfer of state revenues. SFCs of other
states have recommended sharing of only specific taxes or
awarded a fixed amount for PRIs and ULBs.
The SFCs of some states like Punjab and Kerala have
suggested the sharing of only specific taxes with the local
bodies of the states. The Punjab SFC, for instance,
recommended transferring 20 per cent of the net proceeds
of the five major taxes to the local bodies. These are: stamp
duty, electricity duty, entertainment tax, entertainment tax
on cinematography and motor vehicle tax. Distribution
among the PRIs and ULBs will be made on the basis of
the following criteria: (1) Stamp duty—on the basis of
directive principle; (2) Motor-vehicle tax—on the basis of
254 India Infrastructure Report 2003

Table 9.3.8
Recommended Share in State Resource Pool: SFC Award

State Per cent Ratio of PRIs and ULBs Basis of distribution

Net proceeds of state taxes:
Rajasthan 2.18 1.8 % and 1% Rural–urban population
Tamil Nadu 8.0 55% and 45% Not available
Uttar Pradesh 11.0 4% and 7% Population (80%); area (20%)
West Bengal 16.0 Break-up not available Population and % of SC/ST/non-literates
Tax and non–tax revenues:
Andhra Pradesh 39.24 70% and 30% Development criteria such as length of roads, etc.
Madhya Pradesh 2.91 85% and 15% Population, area, tax efforts
Tax revenues:
Assam 2.0 Not available Population
Non-tax revenue:
Karnataka 36.0 85% and 15% For panchayats—population, area literacy, no. of
beds, road length
Source: NIRD (2000), Background papers prepared for the National Workshop on Follow-up Measures by State Governments on
SFC Recommendations, organized by the State Finance Commission Cell, National Institute of Rural Development, Hyderabad,
3–4 October 2002.

proportionate length of roads maintained by the PRIs and
ULBs; (3) Electricity duty–on the basis of collections in
PRIs and ULBs; (4) Entertainment tax—20 per cent share
of collections to PRIs and ULBs; (5) Entertainment tax on
cinematography—20 per cent share of collections to PRIs
and ULBs.
The mechanism of revenue sharing is marked by
significant interstate variations. First, with pooling ad
hocism would reduce and PRIs and ULBs could look
forward to more stable flows. Second, this system provides
some incentives for PRIs/ ULBs to use their own sources
of revenues by using various tools of resource mobilization
and generation. Third, the buoyancy of state taxes and
levies will benefit the local bodies. State taxes grow as per
the growth in the state economy, and the benefits of
economic growth in the state will automatically be transferred
to the local bodies.
In case of grants-in-aid, usually there are three types of
grants: (i) general purpose, (ii) in lieu of taxes and (iii)
specific or conditional grants. The general-purpose grants
provide local bodies with additional resources the autonomy
to use them. The specific purpose or conditional grants,
however, are to be used for specific service/programmes or
may have some conditions for its use. Grants in lieu of taxes
are given as compensatory grants on account of the abolition
or withdrawal of certain taxes, such as octroi, in Madhya
Pradesh, Uttar Pradesh, Karnataka, etc.
Grants sometimes provide for matching provisions and,
like other transfers, can help local bodies to address the
mis-match between the local resources and their
responsibilities. Rationalization of the grants-in-aid system
was one of the primary objectives of the first State Finance
Commissions. However, this issue has remained unsolved,
and grants are still largely ad hoc and have varying basis.
Although some of the SFCs have recommended tied,
untied as well as performance-based incentive grants, the
devolution mechanism between various levels of local
governments, both urban as well as rural, has not been
addressed properly. Only the Kerala State Finance
Commission has recommended grants, both for plan and
non-plan activities, with a mechanism for their devolution
among different layers of local governments. In a sense,
the Kerala Finance Commission has tried to bring in some
kind of rationality in the structure of grant-in-aid as also
its mechanism for devolution. Appendix 9.3.1 gives a brief
overview of the key recommendations of the selected SFCs
regarding grants-in-aid.
THE ELEVENTH FINANCE COMMISSION
As stated earlier, the Article 280 of the Constitution of
India stands amended by the Constitution 73rd and 74th
Amendment Act of 1992, and a new clause has been inserted
in it making it mandatory for the CFC to suggest measures
needed to augment the consolidated fund of the state so as
to supplement the resources of the local bodies in the state
on the basis of recommendations made by the SFC.
The CFC has recommended grants amounting to Rs
10,000 crore for local bodies of the states during 2000–
5. Of this, Rs 1600 crore are for the panchayats and Rs
400 crore are for the municipalities for each of the five
years, starting from the financial year 2000–1. In per capita
terms, the amount recommended for the PRIs is higher
than that for the ULBs. This amount will be over and above

the normal flow of funds to the local bodies from the states
and the amount that would flow from the implementation
of SFC recommendations (CFC, 2000).
These grants are to be utilized exclusively for the
maintenance of civic services in the rural and urban areas
and will be distributed among the local bodies of the state
on the basis of the principles recommended by the SFC.
The grants are to be untied on condition that they are not
used for payment of salaries and wages. The CFC has also
suggested the levy of a profession tax, rationalization of
property/house tax, the levy of a substitute for octori and
an efficient system of user charges. The CFC has also
recommended the levy of surcharge/cess on state taxes and
the delegation of power to PRIs to levy land tax. They also
emphasized a need for improvements in budgetary and
accounting systems besides capacity building of local
governments in various fields of local administration and
management.
The CFC has recommended a special grant of Rs. 200
crore for development of database on the finances of the
PRIs and ULBs and Rs 98.61 crore for maintenance of
accounts. The criteria recommended by the CFC for
distribution of grants to the PRIs and ULBs have been
shown in Table 9.3.9.
The Government of India has accepted the
recommendations of the Eleventh Finance Commission
subject to the following conditions (CFC, 2000):
1. The local bodies should be required to raise suitable
matching resources;
2. In case where elected local bodies are not in place,
the central government shall hold the share of such bodies
in trust on a non-lapsable basis during 2000–5. The central
government may also similarly hold back a part of the
recommended share in case of such bodies to whom functions
and responsibilities have not been devolved;
3. Earmarking of funds for maintenance of accounts,
within the overall recommended level of grants, may be
increased to the extent necessary in consultation with the
CAG; and
4. Measures to strengthen accounts and audit of local
bodies have been accepted in principle. Details will be
worked out in consultation with the CAG.
Table 9.3.9
CFC Criteria for Distribution of Grants to PRIs and ULBs
Indicator Weight age
(%)
Population 40
Index of decentralization 20
Distance from higher per capita income 20
Revenue effort 10
Geographical area 10
Rural Infrastructure 255
The Rs 8000 crore recommended for devolution to
PRIs may still be inadequate! According to an NIRD study
conducted for the Eleventh Finance Commission, it is
estimated that PRIs will require more than Rs 142,000
crore for a period of five years for O&M of core services
alone in the rural areas of the country. In addition,
approximately Rs 84,000 crore will be needed to augment
the basic infrastructure and services in rural India (CFC,
2000)11.
Significantly, the term period of the Eleventh Finance
Commission did not coincide in most cases with the tenure
of the first SFCs. As a consequence, the recommendations
of the CFC and the SFCs were not for the same period
leading to problems in allocation of the grants.
MAJOR SHORTCOMINGS
When the first generation SFCs were constituted, it was
expected that the state governments would follow a tradition
of accepting the recommendations of the SFCs as in the case
of the CFCs. But that did not happen. Action-taken reports
of some of the states show that the state governments have
not accepted all the recommendations made by the finance
commissions. The Andhra Pradesh SFC, for example, made
84 recommendations on financial as well as non- financial
matters. Of these, the government accepted only 60—that,
too, in principle—and these are yet to be implemented.
Even the recommendation concerning transfer of 39.24 per
cent of tax and non-tax revenues of the state to the local
bodies has not been accepted in its true sense. Although the
concept of a fixed percentage of global sharing was accepted
in principle no specific percentage has been fixed. In Tamil
Nadu, of the total 413 recommendations made by the SFC,
only 244 have been accepted by the state government. The
report of the Maharashtra Finance Commission contains
nearly 129 recommendations on various matters pertaining
to PRI finances. Of the twenty-seven total recommendations
made on devolution of grants and taxes to PRIs by the
commission, the state government has accepted only twelve
recommendations fully. Whereas eleven recommendations
were accepted partially, four was rejected by the government.
Share in profession tax was one of the recommendations
which was rejected by the state government.
11 This works out to around Rs 400 per person as maintenance
expenditure per year. The total expenditure of panchayats per person
was just about Rs 286 per annum. In addition the estimated capital
expenditure is itself about Rs 1200 per person. The gross capital
formation (GCF) in the private sector in 2000–1 was about Rs
91,000 crore, and in the public sector about the same. Thus, these
figures imply a 15 per cent to 20 per cent share of public sector GCF.
Clearly, these estimates are highly unrealistic and are reflective of
needs, rather than being demand based, or based on what is possible
at this stage of development. (Editor).
256 India Infrastructure Report 2003

CONCLUSIONS 4. PRIs could privatize certain services. The state

1. Although the Constitution Amendment Act provides
full autonomy to the PRIs, the state level functionaries
are hesitant to handing over the financial and functional
powers to these local governments. The CAA are also
silent on issues concerning financial devolution to PRIs
in line with functional devolution as provided in the
Eleventh Schedule. Had the CAA given direct financial
powers to PRIs commensurate with the functions
assigned to them, real autonomy at the local level, would
also have been possible. It could have also made these
local bodies more responsible and accountable to people’s
needs.
2. House tax is one of the main sources of income for
the PRIs. This should be simplified and rationalized.
Exemptions from property tax should be minimized. Taxes
which are local in nature, such as, entertainment tax,
professional tax, stamp duty, land revenue, etc. should
either be transferred to panchayats or a reasonable share
of it be given to these local bodies.
3. PRIs should be given autonomy to fix tax rates and
user charges as in the case of Punjab.
governments should prepare necessary guidelines and
legislation in this regard. Frameworks for the active
cooperation of the local population in the provision of
basic services such as water supply, sanitation, education,
health, need to be explored. Further, there could be a code
of ethics for officials and non-officials of PRIs.
5. The major problem among the rural local bodies
is the lack of expertise. Thus there is a need for capacity
building and training of local officials, particularly with
reference to taking up the challenge offered by the new
functions assigned to them under the eleventh schedule.
6. National Infrastructure Development Fund (NIDF)
could be established to extend loans and financial aid to
both PRIs and ULBs for infrastructure development.
7. The central government, as a facilitator of change,
has a special role. Through its administrative ministry, that
is the Ministry of Rural Development, it should ensure the
timely and effective action by the state governments on the
recommendations of SFCs. The Ministry of Rural
Development could also introduce schemes akin to the
Ministry of Urban Development’s City Challenge Fund
and Urban Reforms Incentive Fund for PRIs.

APPENDIX 9.3.1
Key Recommendations of the First State Finance Commissions on Financial Devolution to PRIs in Selected States
KERALA
Tax Assignments
Gram Panchayats (GPs):
a. Tax on Buildings
• Building tax to be exclusively assigned to Gram Panchayats in the range of 6–10% of annual rental value.
• ARV should be replaced by tax, based on the plinth area.
• Minimum tax payable may be fixed at Rs 15 and classification of buildings based on the basis of quality of construction,
age, etc.
• Charging interest @2% per month on arrears.
• Other suggestions for rationalization of Property Tax.
b. Advertisement Tax On
Government may fix the minimum rate chargeable and leave it to panchayats to fix it above those rates (New).
c. Tax on Land
• Land tax may be doubled (from 50 paise to Re 1)
• 60% of the collection may go to block panchayats and the balance to district panchayats.
• Irrespective of the size of the holding minimum land tax may be fixed at Rs 5 per year in panchayat areas.
• Portion of income from the sale of court fee stamps may be earmarked to local bodies (LBs).
d. Tax on Entertainment
• Entertainment tax and additional entertainment tax should be merged into a single item.
• The difference between show tax and surcharge on show tax may be abolished and merged into one.
e. Tax on Professions
• Profession tax in the case of persons other than salary and wage earners may be levied at the rates recommended.
• The rates of profession tax may be uniform in urban and rural LBs and that the number of slabs be reduced to ten from
earlier sixteen in case of PRIs and fourteen in municipalities, and the rates should be rationalized.
f. Land Cess
• Collection of a tax on the sale of land from owners at the time of sale.
 Rural Infrastructure 257

Panchayat Samitis (PSs):

Not assigned any taxes as per the Conformity Act.
Zila Parishads (ZPs):
Not assigned any taxes as per the Conformity Act.
Revenue Sharing
Land Tax
60% of additional income from Land Tax may go to block Panchayat and the balance to District Panchayat.
Building Exemption Fee
50% of the building exemption fee.
Stamp Duty
25% of surcharge.
Grants
Devolution of Plan Grants
Devolution of plan grants of state to LBs. The SFC has endorsed the existing pattern as followed by the State Planning Board.
• Population in 1991 census—70%
• Population of SC/ST in 1991 census —10%
• Total workers excluding workers in manufacturing processing, servicing & repairs outside household industry—10%
• Proportion of agriculture workers —10%.
Total—100%
Distribution of Rural Pool
• Population in 1991 census—75%
• Population of SC/ST in 1991 census—5%
• Financial needs of LBs—15%
Financial needs of the LBs is assessed on the basis of income classification ranging from lowest income (getting less than Rs 5
lakh p.a.) to highest income category (getting more than Rs 20 lakh p.a.) Kerala SFC has classified such four groups of panchayats.
Income for this purpose includes income from all sources including motor vehicle tax and loans.
Tax efforts of LBs–5% Tax efforts are judged by two indicators:
• The percentage of collection to demand
• The rate at which property tax is being levied.
Intra-District Allocation
Following is the State Planning Board’s formula, which has been followed for intra-district allocation:
• GPs—55.80%
• PSs—14.33%
• ZPs—14.93%
Types of Grants
• New plan grants for development projects
• Old plan grants prior to 1994—untied plan funds given to LBs.
• General purpose grants—Non- Statutory Non-Plan Grants:
1% of the state revenue is assigned for general-purpose grant. This 1% has to be distributed between ULBs and PRIs on
the basis of population
• Maintenance grants for building of schools and hospitals, should be related to the current cost of construction.

PUNJAB
Tax Assignments
Gram Panchayats
• Total land revenue should be assigned to the GPs.
• Mandatory tax on professions, individuals, traders, commission agents and shopkeepers based on income slabs to be levied by
GPs (new).
• GPs to levy tax on advertisement and hoardings (new).
• GPs to tax brick kilns, rice sellers, stone crushers, petrol pumps, poultry farms, dairy units, stud farms, fish farms, and small
and large scale industries in the rural areas (new).
• GPs to charge fee @ 2% of the value of goods sold from sellers where markets are held (new).
• GPs to charge parchi fee from buses @Rs 5 to Rs 10 where they provide certain facilities (new).
258 India Infrastructure Report 2003

House tax
• No tax on kutcha houses. Below 10 marla houses and houses of yellowcard holders.
• House tax on pucca houses at the rate not below Rs 100 p.a. (new)
Panchayat Samitis
• 10% Auction money on Punjab medium liquor vends and 20% excise duty on Indian made foreign liquor should be the
share of PSs and GPs. The share in 50:50. GPs should get their individual share on population basis.
Zila Parishad
• Land revenue cess, levied should be assigned to the PRIs. If ZPs pass a resolution for levying the cess on land revenue the state
should levy, collect and then transfer to PRIs at the rate of GPs—50%, PSs—30%, ZPs—20%.
• ZPs can levy a tax on the sale of immovable properties within the district at the rate of 1% of the sale price.
• Registration fee in cattle fairs raised from Rs 2 to Rs 5 per cattle. The management of cattle fairs be transferred to ZPs along
with assets. (new)
Revenue Sharing
Transfer of revenues of five taxes now collected by state government to local bodies (Stamp duty, motor vehicles tax, electricity duty,
entertainment tax and entertainment tax on cinematograph) 20% of the net proceeds of these five taxes.
General principles:
• Buoyant and elastic taxes.
• Proportion of sharing on the basis of fiscal needs.
• To enhance autonomy, unconditional transfer with in-built provision for incentives.
Sharing between ULBs and PRIs
On the basis of % of collection from PRIs and ULBs
• Stamp-duty: on the basis of derivative principle
• Punjab motor vehicle tax: On the basis of proportionate length of roads maintained by the ULBs/ PRIs.
• Electricity duty: On the basis of collection
• Entertainment tax: 20% share
Inter-tier Distribution
• GPs—50%
• PSs—30%
• ZPs—20%
Distribution amongst GPs, PSs and ZPs
• On the basis of population
Grants
Per Capita Grant
• to be given to weak GPs having a per capita income of less than Rs 100 to bring their income up to Rs 100
Rs 18 crore. For the five years from 1995–2000. No part of it should be utilized on salaries and wages.
Payment of 50% electricity charges for street lighting to weak GPs
Varies between 25% and 50% of the total electricity bill to be divided by the department on merit.
Incentive grants
For good performing PRIs.
• GPs—Rs 0.50 lakh
• PSs—Rs 1.00 lakh for 1995–2000
No incentive grant is suggested for ZPs.
Remark: The commission recommends only two types of grants viz. general-purpose grant and specific-purpose grant.

WEST BENGAL
Tax Assignments
Gram Panchayats
Water rate, lighting rate, conservancy rate.
Panchayat Samitis
• Water rate and lighting rate
Zila Parishad
Water rate and lighting rate:
 Rural Infrastructure 259

Collection of irrigation rates and the related responsibility of supplying water and routine maintenance should be handed over
to ZPs, having jurisdiction over such projects. The raised resources may be distributed proportionally to the collection efforts of
individual LBs within a district.
• Taxes on entertainment now collected by the state should be handed over to local bodies.
• Resources generated in the regulated markets should be brought within the purview of DPCs & the net proceeds ploughed
back in the market hinterlands.
• All taxes collected from all districts will go to the state kitty and distribution will start from there following the entitlement
ratios as provided in the revenue sharing.
Tax Sharing
• Tax sharing is considered an entitlement to be used for plan and non-plan purposes.
• Funds to be spent according to priorities set by each local body in its development plan.
16% of the net proceeds to all tax collected by the state in a year should be transferred to LBs.
Li – 0.5, Dli + 0.1
(D2i + D3i + D4i + D5i + D6i)
Where li – total percentage allocation for district ‘i’.
• Dli – Proportion of population of the district i to the total population of the district (weight 50%). The rest of the 50%
weight is assigned to degree of backwardness viz.
• Illiteracy level of the district (10%)
• SC/ST and Muslim population (10%)
• Area of the district (10%)
• Rural population of the district (10%)
• Inverse ratio of per capita Bank Deposits (10%)
Intra-District Allocation:
• District Panchayat Fund = D.P./100. Where P=% of Panchayat population to total population. D=98% of the total
entitlements. 2% is kept for funding incentive schemes.
PRIs allocation
ZPs—30%
PSs—20%
GPs—50%
Entitlement for GPs
Population—50%
Percentage d of SC/ST—25%
Percentage of illiterates—25%
Entitlement for PSs
Population – 50%
Percentage SC/ST—25%
Percentage of illiterates—25%
Entitlement for ZPs
30% of the district panchyat fund i.e. DP/100
Grants
The commission has not discussed much about grants in its report
The total district plan fund is divided into following:
• Grants
• Entitlements going to districts
Plan grants may follow the distribution pattern of entitlements explained. A large number of centrally-sponsored schemes such
as JRY, IRDP, etc. are now in operation in which the central releases have to be matched by proportionate state resources. Such state
and central releases would continue to be grants and will not be part of the untied entitlement of the LBs concerned.
Source: Compiled from the Reports of First State Finance Commissions, Kerala, Punjab and West Bengal.
260 India Infrastructure Report 2003
9.4 THE RURAL INFRASTRUCTURE DEVELOPMENT FUND: A REVIEW
THE RURAL INFRASTRUCTURE DEVELOPMENT
FUND
The Government of India announced in the 1995–6 Budget
the setting up of the Rural Infrastructure Development
Fund (RIDF) to be operated through the National Bank
for Agriculture and Rural Development (NABARD) for
financing ongoing rural infrastructure projects. The fund
was to be made up of contributions from Indian scheduled
commercial banks against their shortfall in agricultural
lending up to an extent of 1.5 per cent of net bank credit.
The initial corpus for RIDF-I was Rs 2000 crore. This
was utilized for extending loans to state governments
mainly for incomplete irrigation projects.) The successive
union budgets have enhanced the corpus. In 2001–2 the
corpus was Rs 5000 crore. The total corpus allocated for
RIDF aggregated to Rs 23,000 crore. The outlay for
RIDF–VIII in the budget presented for 2002–3 is Rs
5500 crore. Apart from financing incomplete projects the
NABARD, since 1996–7, has been providing, under the
RIDF funding, for new infrastructure initiatives. The
loans are guaranteed by the state government, except in
the case of certain projects, where NGOs, ‘self -help
groups’, and Panchayati Raj Institutions (PRIs) have taken
the initiative.
Ongoing and new projects with a gestation period of 2–
3 years are given priority .The rate of interest was 13 per
cent in 1995–6. It was lowered to 12 per cent in RIDF–
II and V. It was further reduced to 11.5 per cent in RIDF-
VI and 10.5 per cent in RIDF-VII. The Budget for 2002–3
has announced that the interest rate for RIDF-VIII will be
linked to the bank rate. The interest currently stands at 8.5
per cent. The ceiling on loan amount was 50 per cent of
updated/revised cost of the project in 1995–6 but has been
increased to 90 per cent in the subsequent years. The maturity
period for deposits/ advances was 5 years till 1998–9 (RIDF-
IV). This has been liberalized to 7 years since RIDF-V in
1999–2000.
Initially the fund was available for implementing medium/
minor irrigation projects, soil conservation, rural roads,
bridges, energization of state-owned tube wells and rural
market yards. Later inland waterways, integrated rural market
yards, integrated rural cold chains with support facilities,
construction of fish jetties, rural godowns were added. In
RIDF-VI mini hydro and system improvement projects
under the power sector and citizen’s information centres and
projects within the IT sector were also covered.
Alice Albin Morris • Sebastian Morris
PRIs/SHGs/NGOs
In 1995–6 state governments/state-owned corporations
were the institutions eligible to avail of the fund. In 1999–
2000 there was a major policy change. Rural infrastructure
projects through Panchayati Raj Institutions/Self-Help
Groups /Non Government Organizations (PRIs/SHGs/
NGOs) from RIDF were allowed12. To facilitate village
level infrastructure implemented by PRIs/SHGs/NGOs
the list of the eligible purposes was extended to cover
activities like rural links/culverts/small bridges, community
irrigation including indigenous systems like bandhara,
primary school building, primary health service, village
haat, cold storage, godowns, and seed farms. To date,
though only Rs 1737.77 crore out of a total of Rs 16,835.57
crore, that is 10.32 per cent (RIDF-V to VII) had been
lent to projects spearheaded by PRIs /SHGs /NGOs.
NABARD’s Appraisal
All loans sanctioned from the fund are project-based. The
project proposals received from the state governments are
appraised for technical feasibility, financial viability, and
economic and social benefits. A Project Sanctioning
Committee (PAC) sanctions the projects, which is a sub-
committee of the Board of Directors of NABARD. In terms
of numbers medium and minor irrigation project accounts
for majority of the projects sanctioned. In terms of amount,
rural roads and bridges have the highest share. Over the
years there has been an increase in number and amount
sanctioned for projects other than irrigation, rural bridges
and roads.
12 In projects to be implemented by PRI/SHG/NGO if the state
government borrows for PRIs/SHGs/NGOs then the bank takes
additional guarantees. Where the state government desires that the
PRI/SHG/NGO apart from implementing the project should also be
the borrowers the loan is released on execution of a default guarantee
by the state government in favour of the bank along with the usual
mandate. In case NABARD is satisfied that (i) the project to be
financed are likely to generate adequate income to enable the PRI/
SHG/NGO to repay the interest and the principle on time without
default, (ii) PRI/SHG/NGO are financially, managerially and
organizationally capable of managing the project and (iii) PRI/SHG/
NGO has power to create assets and charge on its assets/ income in
favour of the lender the national bank will waive the requirement of
security and may favour making alternative arrangement.
The NABARD has constituted State/ District Level Sanctioning
Committees depending on the flow of proposals from PRIs/ SHGs/
NGOs to expedite the sanctioning process of SHG/PRI/NGO initiated
projects.
 Rural Infrastructure 261

Table 9.4.1
Loan Disbursements Under the RIDF Tranches, and Deposits Received from Commercial Banks

Year RIDF-I RIDF-II RIDF-III RIDF-IV RIDF-V RIDF-VI RIDF-VII Disbur- Growth Deposits Growth
sement rate of received rate in
during disburse- from deposits
the year ments banks (per
on all (per cent cent per
RIDFs per annum) annum)
1995–6 387.3 – – – – – – 387.3 – 350.0 –
1996–7 795.5 291.6 – – – – – 1087.1 180.7 1042.3 197.8
1997–8 250.1 542.2 216.7 – – – – 1009.0 -7.2 1007.0 n
1998–9 109.2 602.6 469.1 132.3 – – – 1313.1 30.1 1338.0 32.9
1999–2000 149.3 440.5 726.8 543.3 418.0 – – 2277.9 73.5 2306.6 72.4
2000–01 51.0 215.5 472.7 706.7 771.4 959.6 – 3176.9 39.5 2653.6 15.0
2001–02 18.3 157.5 297.9 480.8 779.9 939.5 1116.6 3790.4 19.3 3590.7 35.3
Total 1760.7 2249.9 2183.1 1863.0 1969.3 1899.1 1116.6 13041.7 – 12288.3 –

The aggregate amount disbursements under RIDF -I to Completion Still Awaited

VII till 31 March 2002 stood at Rs 13,041.66 crore. Details
of disbursement are given in the Table 9.4.1. The deposit
outstanding received from banks at the end of March 2002
was Rs 9725.02 crore. Repayments were being received
regularly from the state governments by the NABARD.
Large Time Overruns
Projects showed considerable time overruns the reasons
for which according to the NABARD, were: (1) Mismatch
between physical and financial disbursements; (2) The
implementing departments (of governments) were not
adequately funded by the state governments; (3) The projects
also faced problems of land acquisition, forest and
environmental clearance; (4) Inadequate monitoring and
inability to take corrective action by government officers
also delayed the project, (5) Lack of transparency among
the key functionaries also led to delays in the completion
of the projects.
Based on the Project Completion Reports (PCRs)
received from the state governments, the NABARD
observed that much irrigation, potential, employment
growth, and value added had taken place. Some of the
salient features along with memo items are presented in
Table 9.4.2. Furthermore, the irrigation potential created
by the projects was 16.67 lakh hectares. Utilization of
irrigation on an average was 68 per cent. Incremental
incomes from the project ranged from Rs 7000 to 9000
per hectare. The projects were financially viable with a
financial rate of return (FRR) ranging from 13 to 50 per
cent. The social returns in these are known to be very high,
and as such the focus on these activities of physical
infrastructure is most laudable.
The completion status of projects from RIDF-I to IV
(which should have been completed by end-2002, as per
the project plans, is shown in Table 9.4.3. Only about 71
per cent of the projects had been completed. Larger projects
especially in irrigation show poorer completion. Thus, it
is certain that the size-weighted completion status is much
worse than what Table 9.4.3 would indicate. Irrigation and
rural roads and bridges dominate. Table 9.4.4 brings out
the average size of projects, which could lend support our
claim that the size-weighted delays have been large.
Unfortunately, for irrigation projects there is no break up
into minor, major and medium. Table 9.4.5 brings out the
purpose-wise loans under all RIDFs.
A COMMENTARY
Macroeconomic Compulsion
Public investments in agriculture had been slowing down
in the 1980s and there was much concern that the pace
of agricultural output would not be maintained. In the early
1990s the economy underwent stabilization and then
structural adjustment. Public investments bore the brunt of
the expenditure reduction policies that were put in place
to bring the fiscal deficit in line. In the first flush the centre
did most of the adjustment. Soon enough part of the burden
of adjustment fell on the states as the grants and loans from
the centre that supported capital expenditures slowed down.
More importantly, the simultaneous pursuit of financial
sector reform along with the real sector reform that raised
interest rates, meant that state governments were suddenly
stressed/extended on their debt service. Their borrowings
262 India Infrastructure Report 2003

Table 9.4.2
A Summary of ‘Benefits’ and Effects of Irrigation, and Roads and Bridges Projects under RIDF
RIDF-I RIDF-II RIDF-III RIDF-IV RIDF-V RIDF-VI RIDF-VII
1995–6 1996–7 1997–8 1998–9 1999–2000 2000–1 2001–2
Estimated GDP generated in irrigation 1.45 0.74 0.78 0.81 1.14 0.69 0.60
projects / Outlay on RIDF
Average output to net fixed capital in 0.76 0.83 0.79 0.84 0.83
agriculture (NAS)
GFCF in agriculture (Rs cr) 20739 23086 24608 23785 31717 28425.5 29720.3
GFCF in electricity gas and 23826 27971 29423 33160 37835 35200 39700
water (Rs cr)
GFCF in construction (Rs cr) 5665 3189 6855 6029 6455 6400 6200
RIDF outlay on irrigation as per cent 8.66 5.43 3.88 3.59 3.32 4.31 4.02
of GFCF in agriculture
RIDF outlay on roads and bridges 0.50 39.40 23.30 32.75 35.88 40.91 39.52
as per cent of GFCF in construction
GCF by the Public Sector in 6762 7296 6921 7549
Agriculture (NAS)
RIDF outlay on irrigation as per cent 26.56 17.20 13.78 11.30
of GCF in agriculture in public sector
NNP per capita (NAS) (Rs) 10160 11601 12772 14712 16047 16487 17789
Surplus share in NNP per capita (NAS) 0.17 0.17 0.16 0.16 0.16 0.16 0.16
Imputed wage and mixed Income (Rs) 8463 9664 10716 12358 13479 13849 14943
RIDF created employment due to 6.62 2.21 1.59 2.35 14.30 7.88 1.92
irrigation projects (recurring) (lakh)
RIDF created employment* due to 1.12 0.52 0.20 0.34 0.30 0.40 0.33
irrigation projects (non-recurring) (lakh)
RIDF created total employment due to 7.74 2.73 1.79 2.69 14.60 8.28 2.25
irrigation projects (lakh)
RIDF outlay per unit employment 23196 45873 53169 31696 7211 14809 53175
created by irrigation projects (Rs)
Note: For comparison and ratios the NAS (National Accounts Statistics) figures for the start of RIDF year is used. GCF—gross capital
formation; GFCF—gross fixed capital formation.

went up sharply so did the debt service burdens13. The credit flows to these ‘priority’ sectors, the government
RIDF was announced by the centre as a way to support continued with the policy. But it allowed banks not meeting
the states in the rural, especially agricultural, capital forming
investments, without the centre having to fund the same. Table 9.4.3
Completion Status of Projects
The loans from the NABARD at concessional rates are
(RIDF-I to IV), as on 31 March 2002
given on the basis of state guarantees, to state governments,
and now local bodies and others. The centre announces the Area No. of No. of Per cent
NABARD’s corpus for this lending. The actual fund flow projects projects of projects
is from banks that were allowed to park funds with NABARD sanctioned completed completed
in lieu of their lending to the agriculture. Irrigation 85 40 47.1
Medium Irrigation 149 81 54.4
Bank Liberalization Minor Irrigation 17035 10996 64.5
Rural Roads 12660 9969 78.7
Simultaneously, the policy of priority sector lending to Rural Bridges 2546 2127 83.5
agriculture (and also to other sectors such as small-scale Watershed 192 102 53.1
industries) became problematic. The policy of directed Management
credit was not in tune with the liberalization of the banking Flood Protection 120 103 85.8
sector, but lacking good ideas on methods of ensuring Market Yard 18 0 0.0
Drainage 132 101 76.5
13 See chapter 6.1 by Tapas K. Sen in this report for a synoptic Others 17 13 76.5
view of the fiscal situation with regard to the states. Total 32954 23532 71.4
 Rural Infrastructure 263

Table 9.4.4
Average Project size (Rs lakhs per project)

RIDF-I RIDF-II RIDF-III RIDF-IV RIDF-V RIDF-VI RIDF-VII

Irrigation 44.1 32.2 10.8 195.6 1.0 4.7 5.9
Rural roads 146.0 96.2 28.7 72.3 72.1 71.4 18.8
Rural bridges 17.8 22.9 29.9 29.9 15.1 33.6 32.5
Others 157.2 301.7 132.6 57.3 5.1 12.9 9.9

their targets to park funds with financial institutions like borrow from the RIDF since the rates were lower than what
the Small Industries Development Bank of India (SIDBI), they would have to pay in the market. NABARD took little
Housing and Urban Development Corporation (HUDCO) or no risks, and probably did not even really worry about
and NABARD which were deeply involved in their respective the project and its performance since the money was
priority areas. It would have been better to allow banks guaranteed by the state government by means of ‘irrevocable
to trade their priority sector portfolio so that the sector letters of authority (mandate) executed by the state
as a whole met the target14. This would have had the good governments and registered with the Reserve Bank of India
effect of converting a hard constraint to a soft one for (RBI) and Time Promissory Notes (TPNs) of the state
banks that had little motivation or competence to lend to governments’ (Annual Report, 2001–2, NABARD). But
agriculture and other priority sectors. Whereas those with lending to state governments did involve payments risk since
specialized competencies (including wider reach) in this many state governments have defaulted on salaries and even
direction could have built on their strengths by lending on pensions. That possibility was side-stepped at least on
even more than the stipulated limits15. But parking funds the books of NABARD through the above mentioned
with NABARD at least reduced the entry barriers for new guarantee, and by ensuring that lending growth (that is, of
banks, to usher in competition in the sector16. Nevertheless, outstanding) rates stayed higher than the rate of debt service.
given the macro-economic situation17, RIDF would have
been a godsend to public sector capital formation in ‘Ponzi Finance’?
agriculture. Projects of high return, essentially those that
In such a situation state governments could look forward
awaited funds for completion, (since they had been delayed
to cash inflows from new loans which would more than
inter alia due to capital scarcity post reform) were to be
cover the debt service. The day the rate of growth rate of
selected. The idea was not entirely motivated by the need
lending falls such that they do not deliver net resources to
to shift borrowings off the balance sheet. Guarantees of
the states, the incentive to default or delay payments can
state governments have, of course, gone up.
be high. Notice from the Table 9.4.1 that the disbursement
in the year 2000–1 was as much as Rs 3176 crore while
Guarantees of State Government
the repayments was Rs 866.15 crore. The current interest
The fiscal and transparency implications of the RIDF, though, rate is 10.5 per cent, and the repayment period is seven
are quirky. The state governments were quite willing to years with some rescheduling possible. This implies a service
14 For a discussion of how priority sector lending targets could
be incentivised, so that optimality in banks’ portfolios can emerge, Table 9.4.5
along with enhanced lending to the sectors, see Morris, (2001). Purpose-Wise Sanction of Loans under
15 Interest rate freedom does not exist for small loans. The regulated
All RIDF (31 March 2002)
low interest rates, could severely restrict fund flow to the sector.
16 Even that measure would not have arrested the relative decline
Purpose No. of (% to Amount (% to
of access to savings of the priority sectors. Being largely dependent on projects total) (Rs crore) total)
the banking sector, rather than on capital markets, as the disinvestment
process gathered momentum in the first half of the nineties, the flows Irrigation 165165 70.8 8332.66 35.6
on account of credit to the real sector fell quite rapidly. Rural Bridges 7593 3.3 3090.2 13.2
17 Credit was also affected by the sterilisation of capital inflows
Rural Roads 35954 15.4 9150.99 39.1
given money targeting. So agriculture even with RIDF and the Others* 24523 10.5 2858.64 12.2
continuance of priority sector lending could hope at best to hold to Total 233235 100.0 23432.49 100.0
a share of a cake whose size was rapidly shrinking. As gilt rates rose
with tight monetary targeting banks were comfortable parking funds Note: * Others include watershed development, flood protection,
in SLR securities. That would have aggravated the problem further market yard/godown, drainage, cold storage, fisheries, forest
for firms (small), and agriculture with comparative advantage for development, inland waterway, primary schools, public health,
accessing bank funds, and a disadvantage in going to capital markets. etc.
264 India Infrastructure Report 2003
rate of 21per cent of principal per annum. In other words,
if the nominal growth of disbursements is larger than this
rate then the payments risk can be ‘side stepped’. From
Table 9.4.1 we see that the annual growth rate in
disbursements has been higher. The Compound Annual
Growth Rates (CAGR) (1995–6 to 2001–2) is 39 per cent.
Overall, credit expansion has been at a slower growth than
this at about 13.8 per cent (CAGR between 31 March 1996
and 31 March 2001), so banks may well be viewing NABARD
as parking for a return a shade better than on gilt.
NABARD’s Weak Incentive
Does the fact that the funds are being routed through a
financial intermediary with specialized skills in evaluation
and monitoring and viability assessments make any
significant difference? On some key aspects of government
failure there is not much improvement. The studies (even
the rather formal and possibly ritualized) variety carried
out by NABARD and its ‘consultants’ reveal that time
overruns were common. Project completion as per schedule
was rare, and delays of up to three years were common.
The NABARD has little incentive to improve the situation.
First, independent of whether the projects were delayed
or completed, or even if they were quite uneconomical,
NABARD could look forward to debt and interest service.
All payments due were fully realized as is mentioned in
the annual reports. State governments showed a tendency
to treat the disbursements under the RIDF as treasury
transaction rather than being project related (though on
paper they were). Therefore, little learning in lending to
small infrastructure projects, and irrigation would have
taken place. As such the perceived risk would continue to
remain high forever, condemning the set of activities to
be risky in the eyes of financial intermediaries. We will
soon consider this aspect while discussing one CAG Report
on Irrigation, which inter alia covered the RIDF.
High Social Returns
The Annual Reports of NABARD indicate very high
financial rate of return on the irrigation projects. There
was no question of the rate of return in any commercial
sense being as high as the 30 per cent or more that many
projects seem to have. Irrigation benefits, though very
large, have hardly been appropriable in India, given the
virtual give away of public irrigation services. Typically, not
even operational and maintenance costs tend to be recovered.
That aspect has not changed at all. While part of the very
high social rate of return on RIDF irrigation projects may
not be borne by a more rigorous ex-post consideration of
the cost and benefits, the internal social rate of return are
likely to be far above the cost of capital. This is because
of two reasons. Irrigation has large social benefits in water-
constrained and water-uncertain situations18. Since the
projects, especially those taken up in the first three rounds
of the RIDF, were those that had got delayed for inter alia
want of funds, the IRRs that are based on ignoring the
sunk cost would naturally show very high returns. This is
as it should be since the RIDF was intended to be focused,
to realize maximum social gain, by completing the projects.
Since the RIDF funds came on a route parallel to Plan
Funds, and with possibly less stringent ex-ante procedures
in spending, it was effective in completing long incomplete
projects. Despite that, there were further delays of about
nearly three years in many cases.
Better Management?
Table 9.4.6 gives a sample of projects for which some
information to work back to the overall time overrun was
available in the Annual Reports. Overall time overruns of
the projects were very high and the RIDF was probably the
key to their completion. Even if such projects represent
those falling just around the one sigma value in terms of
time overruns, the time overruns in irrigation projects in
general is likely to very high. This is in minor and medium
irrigation projects that involve the state. One can well imagine
the situation with major irrigation projects.
The RIDF outlay as a proportion of total cost (including
sunk cost) is small in the range of 15–18 per cent (see Table
9.4.6). Thus, if RIDF could have ensured ‘that from now
on irrigation projects are going to be better managed’ then
things could have really improved from the point of view
of the public exchequer. But there is no indication at all that
in any significant way, project management would have
improved.
‘Off Budget’ Borrowing
We could get just one independent reference to the RIDF.
That was by the CAG and pertained to the state of Rajasthan
and the RIDF was only a part of a comprehensive study
of the working of the Irrigation Department. Rajasthan
could be considered as an average state on the aspect of
governance. Thus according to the Audit Report (Civil) for
the year ended 31 March 2001 of the Irrigation Department:
18 The high returns to irrigation may be inferred from the high
marginal productivity of water, and the finding that irrigation supplies
best explain agricultural growth. Also in water-constrained areas,
the water market rates are high—far above the cost of public supply
with all its inefficiencies. The best indicator of the value of rural
bridges and road is the large price difference between farm gate and
mandis, in many parts of rural India that are poorly connected. Also
the mortality avoidable by being able to quickly access central
medical facilities is indicative.
 Rural Infrastructure 265

Table 9.4.6
Benefits Derived from Select Irrigation Projects Financed Under RIDF

Project Time Capital RIDF Net RIDF FRR* Original Reference

overrun** cost Loan Increme- Outlay/ (%) starting year post
(%) (Rs cr) (Rs cr) ntal income Total date of the RIDF
(Rs per capital project
hectare) cost (%)
Tons Pump Canal 400 27.43 6.29 4061 18.7 29 1969 1998–9
(Allahabad, Uttar Pradesh)
Amipur Medium 375 10.93 1.45 9635 11.7 50+ 1978–9 1997–8
Irrigation Project
(Porbunder and
Junagadh, Gujarat)
Tilar Medium Irrigation 400 39.30 6.56 2932 14.3 46 1978 1998–9
Project (Sahajpur,
Madhya Pradesh)
Tank and Barrage Schemes N.A. 0.73 0.24 8896 24.7 48 N.A. 1997–8
(Vizag, Nalgonda and
Kurnool Andhra Pradesh)
Tank and Barrage Schemes 200 0.45 0.14 4720 23.7 42 1990 1998–9
(Chitradurga and Dharwad,
Karnataka)
Note: FRR—presumably ‘financial’ rate of return; N.A.—Not available
Source: From Table 4.6 of NABARD, Annual Report, 2000–1, and information in text. ‘Time overrun’ has been estimated using
a normal time of completion of four years for medium and three years for minor irrigation projects.

‘NABARD sanctioned 179 schemes under trench (sic.)
I to VI of the RIDF of which 76 were completed (40 within
the targeted time and the rest after a delay of 1–3 years).
Of the remaining 103 incomplete schemes, 50 were
scheduled to be completed by March 2001 and an
expenditure of Rs 103.32 crore were incurred on these
schemes. A test check of the completed projects revealed
that canal work in respect of Boodpada (RIDF-I), Anandpur,
Hamipur, Danpur, Bahadurpur, Bidloi (RIDF-II) and the
head works in respect of Bhanpura (RIDF-II) were not
complete but the schemes were declared complete’.
(Emphasis Added.)
‘...An advance of Rs 9.45 crore for fifty-five schemes
was received from NABARD during 1998–2000. The loan
amount was credited to Internal Debt of the state government
from NABARD. None of these, except one, was started as
no budget was allotted by the FD [Finance Department]
for these works and no advance was made available to the
Irrigation Department. Instead Rs 9.10 crore (Rs 9.45–
0.35 crore) were not spent for the purpose it was sanctioned
but was used to boost ways and means position of the State.
Further, interest liability of Rs 1.62 crore (up to March
2001) was created.’ (Emphasis Added.)
check of 44 schemes sanctioned under RIDF-III revealed
that as against a loan of Rs 23.21 crore, Rs 40.96 crore
and Rs 28.38 crore sanctioned for 1997–8,1998–9 and
1999–2000 respectively, the budget provision for these
projects/schemes were Rs 11.53 crore (50 per cent) Rs
24.54 crore (60 per cent) and 17.79 crore (63 per cent).
Eight schemes were completed within the stipulated time.
Inadequate provision caused delay in completions of 36
schemes.’
‘...The amount of loan Rs 1.16 crore drawn in excess of
expenditure on six completed and one dropped scheme by
the department was not utilized for the purpose for which
it was sanctioned.’
NABARD points to two aspects of the RIDF to make out
a case for success—the high social return and employment
generation and the near perfect repayment experience. We have
argued that these cannot be used as measures that are indicative
of the correctness of the design: the former is a matter of both
the high returns in irrigation per se and the fact that RIDF
funds were instrumental in bringing about completion. The
second is no measure either, given the guarantees and the fact
that governments have an incentive to repay when the
disbursement growth rates are higher than service rates.

Tardy Implementation Monitoring by NABARD

‘...The state government was required to make adequate The next question is, has NABARD’s involvement in any
budget provision for sanctioned schemes/projects. A test way improved the implementation of the projects? The
266 India Infrastructure Report 2003
Annual Report (2001–2) mentions ‘monitoring’ through
‘...desk reviews of periodic returns as also field visits...
Services of consultants [Agricultural Finance Corporation]
have also been commissioned for monitoring imple-
mentation... Findings have been promptly communicated
to the [government]’. These efforts would have at best
resulted in evaluatory assessments and not information for
corrections since they ignore time lag in the information,
and the lead times for the government to act. These
analyses, mistakenly called monitoring, would have little
use in managerial actions to correct slippage and such
problems at the project level. At best they could inform
the next round of implementation, or influence the strategy
of the next round, if there is learning taking place somewhere
in government. But this is doubtful because there are
hardly any organizational processes or structure, that allow
embedding of learning in government.
Chief Secretary to Monitor?
More importantly ‘.. the progress in the implementation
of projects continued to be reviewed in quarterly meetings
of the High Power Committee (HPC) constituted for the
purpose in each of the states under the chairmanship of
the Chief Secretary/Finance Secretary of the state’ (Annual
Report, NABARD, 2000–1). It is a moot point if the
roughly 10,000 projects per state can in any way be
meaningfully reviewed except on macro (economic)
aggregative and overall financial dimensions, by chief
secretaries who have many other pressing matters. Thus,
if land acquisition is found to be a major cause for delay
what can the HPC do? There is no way the specifics of
a project could be brought out at so high a level, but the
specifics are necessary for corrective action. It falls into
the same trap, rife in government systems and thinking
in India, that information alone can lead to correct action,
even if incentives are unaligned or perversely aligned against
the performance of the primary task. Only common general
problems could at best emerge (assuming that the reporting
systems correctly gather the information and tabulate the
same). But the general problems are known and their
resolution involves deeper changes in the politics,
macroeconomics, the law and the working of the
bureaucracy19. So we cannot but conclude that the RIDF
too fits in with the ritualization of evaluation and monitoring
that is widespread in government today. The only thing
positive here is that since funding is from an external body,
the form of reporting, monitoring and assessment would
be adhered to better.
19 Refer to Chapter 5.1, by Sebastian Morris in this report for
the general factors causing time overruns in public sector peojects,
at the central level. The next paragraph brings out the general factors
in time overrun of RIDF irrigation projects.
Table 9.4.7
Results of a Regression: Log (Sanctions)
Independent Coefficient t-value Sig.level
variable
Constant ( ) –3.36608 –3.5840 0.0016
Log(Agri.Value 0.736696 10.1907 0.0000
added) ( )
R-SQ. (ADJ.) 0.8108 No. of Obs 25
Note: See text for explanations.
Time Overruns
Based on the PCRs sent by the state governments, NABARD
consolidated the PCRs for the projects of the first tranche
to report: ‘The time lag between allocation of funds, actual
sanction and the first disbursement ranged from six months
to more than a year. Time overrun has been very common
in the irrigation projects. All the projects sanctioned under
RIDF-I were to be completed by March 1997. However,
by that date only 543 projects (13 per cent of total) would
be completed. .......The delayed completion/implementation
of projects was due to faulty formulation of projects,
inadequacies in appraisal and sanction and poor monitoring
of progress of implementation. The cost overrun as compared
to original estimates was on an average 7.79 per cent over
the period...’ If this assessment is to be relied upon (recall
the comments of the CAG on the situation with regard to
the RIDF in Rajasthan earlier), then clearly the time delays
are significant. A rough assessment of the time delays in
relation to the completion times stipulated at approval that
this 13 per cent completion would mean is about 60 per
cent! This is of course for the ‘to be completed’ part of the
project. Thus, when there are delays of this magnitude for
the work taken up specifically for speedy completion then
for irrigation projects as such in all probability there would
have been little or no change for the better. Reported cost
overruns are small. Here the data could be relied upon. The
delayed decisions affect the physical start of project
implementation and the completion time once the work has
started. Much of the delays are in the pre-physical
implementation stage, and the costs incurred (or benefits
lost) during this period would not have been taken into
account, since the usage of the fund as such starts ticking
only with the first disbursements. So delays pre-disbursement
would not add to cost for the NABARD outlay, though
delays post disbursement would. So the cost overrun figures
have limited meaning since they do not take into account
the benefits lost on delayed completion. Even then there
is a certain improvement in that the money being routed
through a financial institution (independent of the state
government) would mean that at least all the known ex ante
difficulties would have influenced the disbursal of funds.
 Rural Infrastructure 267

Table 9.4.8
Ratio of Observed ‘Sanctions to Predicted Sanction’, and Observed to ‘Predicted Disbursals’

State Sanctions under Agricultural Ratio of observed Disbursals Ratio of disbur-

all RIDF cumulative value added at to ‘Predicted’ (Rs cr) sals to ‘predicted
(Rs cr) current prices, sanctions disbursals’
c. 1997–8
Manipur 10.08 46989 0.11 0.96 1.03
Bihara 432.71 1334617 0.39 42.04 0.22
Assam 389.79 658691 0.58 225.02 1.31
Haryana 613.44 1216376 0.58 300.68 1.03
Punjab 907.49 1759870 0.66 578.50 1.26
Sikkim 40.04 23104 0.71 31.45 2.60
Goa 50.66 26965 0.80 27.13 1.70
Rajasthan 1352.13 2064891 0.87 842.35 1.15
Tripura 108.9 61151 0.94 20.21 0.52
Kerala 843.63 950326 0.96 432.26 1.02
Uttar Pradesh 2741.21 4386323 1.02 1613.46 0.97
West Bengal 1757.26 2274283 1.06 886.57 0.89
Karnataka 1531.86 1720204 1.13 802.65 0.95
Gujarat 1431.36 1530338 1.15 878.90 1.13
Maharashtra 2293.94 2901190 1.15 1397.04 0.88
Meghalaya 103.67 42529 1.17 47.15 0.40
Madhya Pradesh 1948.18 2148754 1.22 985.59 1.65
Mizoram 67.64 19989 1.33 36.81 1.29
Tamil Nadu 1507.55 1262639 1.40 941.57 1.14
Nagaland 81.06 22400 1.47 28.02 1.02
Orissa 1020.33 638032 1.56 608.78 1.16
Andhra Pradesh 2741.41 2417704 1.57 1591.89 0.96
Jammu & Kashmir 645.22 211107 2.23 291.17 0.94
Arunachal Pradesh 183.01 32733 2.50 68.55 0.96
Himachal Pradesh 630.91 146838 2.85 362.37 1.21
Notes: a The ‘sanctions’ predicted are from a model that estimates the sanctions as a function of agricultural GDP c. 1997–8 of the
states; and ‘predicted’ disbursements from a model that estimates disbursements as a linear function of sanctions. See text for details.
Including Jharkhand, Uttaranchal and Chattisgarh, respectively.

Better Allocative Efficiency
That takes us to the state-wise distribution of RIDF.
Interestingly, it is here where we see some difference in
outcomes over routing the same funds through the usual
ministerial and planning commission channels. Annexure
4.1 of the NABARD Annual Report 2001–2 gives the
state-wise sanctions and disbursals of the various tranches.
The aggregate over the tranches of sanctions and disbursals
have been taken and a simple model fitted to ‘explain’
sanctions as a function of the agricultural value added of
the state (taking 1996–7 figures).
The Model: log(Sanctions)= a + b*log(Agricultural value
added); was estimated with a high degree of fit (see Table
9.4.7 for the results), and the ratio of the observed sanctions
to the ‘predicted’ sanction is reported in Table 9.4.8.
Observe that there is significant variation. If the special
category states are left out, then Bihar with little or no
discipline to even submit project proposals, and others
under severe fiscal stress, for example, Assam, Kerala,
Punjab and Haryana (and also because they have much
infrastructure already in place) and, possibly, Uttar Pradesh
show poorer sanctions. Similarly, in the next stage estimating
disbursals conditional on sanctions we find that disbursals
have been poor for Bihar and Tripura and not particularly
different for the others. Thus, except for Bihar, the NABARD
sanctions, more than disbursals (conditional on sanctions),
bring out the evidence that NABARD does recognize and
use state failure and the fiscal situation in its sanctions and
disbursals, but perhaps very weakly. But even this is a
significant improvement over direct allocations by the
central government. This perhaps is the major gain in the
RIDF mechanism.
268 India Infrastructure Report 2003
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