God’s own country inching towards a fiscal precipice. Blaming the Centre alone won’t help

Kerala’s debt burden as a proportion of gross state domestic product (GSDP) has remained above a worrisome 37 percent since 2020.

“Our neighbouring countries like Sri Lanka and Pakistan have fallen into severe economic crises. Pakistan is facing such a crisis that they are even unable to buy diesel fuel for power generation. This peculiar situation can be survived only by taking every single step forward carefully”.

This is how Finance Minister of Kerala KN Balagopal, in his Budget speech (2023-24) on February 3, 2023, underlined the need for fiscal righteousness in macro-economic policy making amid a shaky world economic environment.

The ruling Communist Party of India (Marxist) in Kerala has alleged that the Union Government fiscal policies have put the state “under an economic siege”.

Kerala’s recent record, however, demonstrates that the state’s own macroeconomic managers have not really walked the talk on fiscal discipline.

Sample this: In 2023-24, the state has projected revenue receipts of Rs 1,35,418.67 crore. Of this, Rs 94,649 crore or about 70 percent of revenue receipts, will be spent on committed expenditure. This comprises spending on salaries (30 percent of revenue receipts), pension (21 percent), and interest payments (19 percent).

Committed expenditure of a state typically includes expenditure on payment of salaries, pensions, and interest. A larger proportion of budget allocated for committed expenditure items limits the state’s flexibility to decide on other expenditure priorities such as capital outlay.  Committed expenditure is expected to increase by 5 percent over the revised estimate of 2022-23.

In public finance, as it is for households, borrowing in itself is not a bad idea, if the bulk of the loans are spent on asset creation. The expenditure pattern of Kerala, however, shows some red flags.

Kerala’s debt burden as a proportion of gross state domestic product (GSDP) has remained above a worrisome 37 percent since 2020.

For 2023-24, revenue expenditure in the state constitutes more than 70 percent of total expenditure. The share of capital outlay, which can help in improving growth prospects through building requisite infrastructure by the state, is projected to be less than 7 percent of the total expenditure.

There are other signals of fiscal stress too. The Reserve Bank of India (RBI) has identified Kerala among the “highly stressed states” along with Bihar, Punjab, Rajasthan and West Bengal.

In the case of Kerala, the five year average of the share of revenue expenditure in total expenditure accounted during 2017-18 to 2021-22 was more than 90 percent.

By all accounts, this doesn’t make for a healthy public finance management glide path. “Although welfare-enhancing, the impact of revenue spending on economic activity lasts for just about a year. In contrast, the impact of capital outlay is stronger and lasts longer, with the peak effect materialising after two-three years. In the medium to long term, states with high revenue spending and low capital investment may experience slower revenue growth and higher interest outgo,” the RBI said in a paper State Finances: A Risk Analysis.

New sources of risks have emerged – rising expenditure on non-merit freebies; expanding contingent liabilities; warranting strategic corrective measures. Kerala, along with Odisha, Telangana and Uttar Pradesh are the top five states with the largest rise in subsidies over the past three years.

Kerala, along with Rajasthan and West Bengal are projected to exceed the debt-GSDP ratio of 35 per cent by 2026-27. These states will need to undertake significant corrective steps to stabilise their debt levels.

Amid all of these, state finance minister KN Balagopal, in last year’s budget 2022-23 announced to have “global peace conference’ on nuclear disarmament and world peace, and an amount of Rs 2 crore was earmarked for this. While the amount may be insignificant in a more than Rs 2 lakh crore budgeted total expenditure, the announcement has raised eyebrows about the state government’s fiscal priorities in an uncertain economic environment.

Chief Minister Pinarayi Vijayan and team’s tour to America and Cuba earlier this year, which reportedly cost Rs 2.5 crore, have also drawn flak, given the financial crunch that the state finds itself in.

A recent book, Kerala’s Economic Development: COVID-19 Pandemic, Economic Crisis and Public Policy, a collection of essays edited by B. A. Prakash, former chairman of the Kerala Public Expenditure Review Committee and the State Finance Commission, and Jerry Alwin, Associate Professor of Economics, SN College, Varkala, has emphasised that regaining ‘‘lost fiscal capacity’‘ is perhaps the most important challenge that Kerala faces today.

Kerala’s finances require a long hard look. Blaming the Centre for the state’s fiscal stress may not yield much amid the tantalising prospect of dangerously hurtling down a debt hole.