A way out of Kerala’s fiscal vulnerability

Increasing incremental borrowing along with a growing level of outstanding liabilities, off-budget borrowings, and mounting guarantees foretell a poor situation, but there could be solutions

Increasing incremental borrowing along with a growing level of outstanding liabilities, off-budget borrowings, and mounting guarantees foretell a poor situation, but there could be solutions

Kerala’s fiscal problems have been in the news for several years now. The parlous impacts of the two floods (2018 and 2019) and the COVID-19 pandemic have worsened the situation. In this context, the obfuscating assertions and counter postures on the political chess board of Kerala about the fiscal management of the State demand objective scrutiny. A recent Reserve Bank of India study (RBI Bulletin, June 2022) on the fiscal vulnerability of Indian States undertaken in the backdrop of the Sri Lankan debt-default crisis of May 2022 has identified Kerala among the five most-indebted states of India, the others being Punjab, Rajasthan, Bihar and West Bengal. This article attempts to shed light on Kerala’s fiscal vulnerability and offer some suggestions for improvement.

Understanding the fiscal stress

In an expanding economy, debt is not a sin and becomes a problem only when it turns unsustainable. A government is vulnerable when it finds it difficult to meet its fiscal obligations efficiently. As per the 2022-23 Budget, the public debt/GSDP ratio of Kerala is 37.2% which is clearly high particularly when compared to the average of 14.6% for the 1981-91 decade. That the Fourteenth Finance Commission fixed the upper limit at 25% underscores the vulnerability. Only Kerala, Jharkhand and West Bengal crossed the debt target stipulated by the Fifteenth Finance Commission (FC-15). That the yield rate to be paid for the special development loans issued by the State auctioned by the RBI is pegged high (8.3% in 2018-19. and around that now) keeps Kerala in a bad light. The increasing incremental borrowing along with the growing level of outstanding liabilities, off-budget borrowings, and mounting guarantees foretell a poor situation.

Kerala has already breached several fiscal norms. During the last five years, the famous Domar stability rule — namely that interest rate adjusted for inflation should be lower than the GSDP growth rate — has been broken except for 2019-20 and 2020-2021. The condition that the increase in nominal GSDP growth rate should be higher than the debt growth rate is also violated. During the last 10 years from 2013-14 through 2022-23, except for two years the rate of debt growth exceeded GSDP growth. The growth dynamics of the State needs to be closely investigated given its admittedly high per capita consumption, high savings (bank deposits in March 2021 were above ₹6.05 trillion, with an non-resident Indian component of ₹2.29 trillion) along with its weak investment trajectory.

The increase in the interest payments/revenue receipts (IP/RR) ratio from 16.86% in 2014-15 to 21.49% in 2020-21 and the estimated 19.36% for 2022-23 does not portend a healthy situation. If we accept the FC-14 IP/RR ceiling of 10%, Kerala is surely on a sticky wicket. The own tax revenue mobilization needs drastic improvement to save the situation. In 2010-11, Kerala’s per capita own tax revenue was a remarkable ₹6,521, while the all-State average was ₹3,278, nearly 100% below. However, for 2020-21, Kerala’s per capita tax is ₹12,929, with an all-State average of ₹9,162, the difference falling to 41%. Evidently, the tax effort of Kerala has not improved compared to that of other States. The own tax revenue for 2020-21 of Kerala, at ₹47,661 crore was lower by a huge margin of ₹2,662 crore compared to 2019-20. The 2021-22 (RE) shows a shortfall of ₹13,465 crore vis-à-vis the Budget estimate. The budgeted tax revenue for 2022-23 of ₹74,098 crore is unlikely to be achieved. The tax performance of the State leaves many things to be desired.

That the budgeted non-tax revenue of ₹11,770 crore for 2022-23 is ₹495 crore lower than the actual of 2019-20 is disquieting. The insinuating assertion by some that the State government relies heavily on lotteries is untenable. In the pre-COVID-19 2019-20, the revenue from lotteries was ₹9,973.67 crore, but the gross expenditure on it was ₹8,475.3 crore with a net income of only ₹1,498.3 crore; the corresponding figure in the present Budget works out only to a measly ₹77 crore. That the 133 public sector undertakings with an investment of ₹20,025 crore (as on March 31, 2018) could contribute only a sum of ₹110 crore in 2019-20, and even in 2022-23 (BE) only ₹257 crore to the own source revenue kitty, tells a dismal story.

Decline in capital formation

The quality of spending is a critical variable because it shows prudent fiscal management and good governance. The fiscal norm of generating revenue surplus is almost impossible for Kerala with a huge committed expenditure comprising salary, pension and interest payments, which in 2017-18 reached 80.5% of total revenue expenditure and currently running at 70.7%. A five-yearly salary and pension revision along with an escalator clause to protect the real income of the civil servants go with practices such as providing pension to the staff of Ministers for a minimum service of two years (which arguably has to be extended to all civil servants) etc. and can exist comfortably only in Alice’s wonderland. It is no wonder then that the fiscal space for development expenditure for Kerala with 51% (five-year average, 2017-22), is way below that of Madhya Pradesh (73.4%), Rajasthan (71.4%) and Bihar (71.3%) ) — the details are in the RBI Bulletin, June 2022, p.119.

Also read CAG pulls up Kerala again for off-budget borrowings

There has been a visible decline in capital formation in crucial sectors such as education, health, infrastructure, agriculture and the like. To be forewarned is to be forearmed. Although the analysis given is suggestive of solutions, the outcomes of continuing social failures and policy miscarriages have to be addressed for any rational rebuilding. Rent-seeking politics, endemic corruption, ecological overkill, a pathological disregard of the rule of law, a visible decline in the public action and public reasoning tradition, a decline in the quality of public services such as health, sanitation, solid waste management, higher education and roads (ubiquitous pot-holes are scandalous), pervasive drug and liquor addiction, an increase in avoidable deaths and so on cannot be solved by public relations managers, but only through informed social choices.

Course correction for the State

To augment its own source revenue, the State has to streamline its tax administration to reduce arrears and evasion and tap its tremendous non-tax revenue potential. Property tax could have been easily doubled. Non-tax revenue can be stepped up by enhancing fees and user charges along with visible quality improvements. Without noticeable quid-pro-quo in services, users will naturally resist hikes. The dividend from the public sector undertakings can be increased if there is efficient rationalization of management. Unbundling of land values ​​can yield good income. The Kerala State Road Transport Corporation (KSRTC) is a millstone around the fiscal neck of Kerala. Monetisation of the land and asset values ​​of the KSRTC along with restructuring of management can be a solution. Permitting private universities of world class standards can arrest the exodus of brilliant students. Why Kerala with a fabulous remittance inflow since the mid-1970s has failed to be a happy place for the enterprising private sector to create wealth for the State is a moot question for which honest answers elude us. A meaningful pension reform including raising retirement and recruitment ages can make big changes. If the Kerala government wants to put its fiscal house in order, it has to experiment with zero-base budgeting or at least with performance budgeting with determination. Departments have to improve their accountability significantly.

Also read Indiscriminate borrowing, non-merit expenditure by states will harm fiscal health: Nirmala Sitharaman

In the fiscal federal polity of India, with yawning mismatches between resources and responsibilities, all inter-governmental transfers must be normative and formula-based. Central transfers are entitlements and certainly not largesses. That 35% of the transfers are still outside the Finance Commission is against the canons of cooperative federalism.

In sum, Nava Kerala cannot be built on a fragile fisc, and rhetoric is not a resounding solution.

MA Oommen is Honorary Fellow, Center for Development Studies, Thiruvananthapuram and Distinguished Fellow, Gulati Institute of Finance and Taxation, Thiruvananthapuram

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