Grants-in-Aid and State Domestic Product: An Empirical Analysis in India

The smooth transfer of the finances keeping in view the objectives and the requirements of the different levels of the government is an indicator of the healthy federal system. Further, it demarcates the degree of decentralization that exists within a federation. This study examines the relationship between Grants-in-Aid taken as a measure of fiscal decentralization and state domestic product in case of India using panel data for 14 non-specialized states for the period 1981–2014. The results showed that long-run equilibrium relationship exists between the two. The estimates from FMOLS, and dynamic OLS (DOLS) framework revealed that Grants-in-Aid have a positive and significant impact on the state domestic product. So from this angle, it is centralization that is growth enhancing, not decentralization. However, the study failed to detect the true nature of the causation between these two.