In the battle of poll promises in Karnataka, fiscal prudence should not be the casualty

The new government will have to be careful about implementing the pre-poll promises without heavily leaning on off-budget borrowing to finance these. (Image Source: AP/File photo)

Managing public finances has many similarities with managing household expenses. The broad guiding principle for spending management is to ensure that one should borrow a proportionately lower amount to finance expenses that are not asset-creating. Think of a family taking a loan to buy a home. Think of a state government borrowing funds to build roads and bridges. Both are examples of taking loans to create assets that have multiplier effects.

This is essential in public finances, particularly in poll-bound states, where pledges made to voters in the run-up to the elections can have important fiscal implications when put into practice. Karnataka is a case in point. Both the Bharatiya Janata Party (BJP) and the Congress are slugging it out in a high-octane campaign, vowing to implement a raft of schemes—ranging from unemployment allowance to free bus rides to subsidised cooking fuel.

Better Managed Economy

On a relative basis among states, Karnataka’s economy is better managed than many of its peers. According to the Reserve Bank of India’s (RBI’s) report State Finances: A Study of Budgets of 2022-23, Karnataka stands at fourth place among all the states contributing to nearly 5.8 percent of the total capital outlay by all the states put together. This is a good fiscal metric to showcase on a comparative canvas. For states, the essential marker of healthy public finance management would be not to slip onto the wrong side of the `committed expenditure’ components: scheme-based and non-scheme-based.

To be sure, the medium term fiscal policy (MTFP) statement of the Karnataka government presented along with the budget for 2023-34 is quite unambiguous on this front. “A larger proportion of the state budget allocated towards committed expenditure would result in lesser fiscal space towards developmental and welfare expenditure. Further, the flexibility available to the government to manage its expenditure would get greatly diminished… it is evident that the non-scheme based committed expenditure is witnessing a steeper year-on-year increase, particularly on account of salaries and pension payment and interest payment liabilities,” the MTFP statement said.

A Pioneer in Fiscal Responsibility

In terms of demonstrating its intent to walk the talk on fiscal discipline, Karnataka has been a pioneer. It introduced the Karnataka Fiscal Responsibility Act, a year before the Centre legislated the Fiscal Responsibility and Budget Management Act in 2003.

As a 2020 paper Fiscal Prudence for What? Analysing the State Finances of Karnataka by Jannet Farida Jacob and Lekha Chakraborty of the National Institute of Public Finance and Policy (NIPFP)  pointed out “Karnataka is consistently fiscally-prudent with its revenue deficit-to-GSDP ratio reducing to near-zero and the fiscal deficit-to-GSDP ratio below 3 percent.” The NIPFP analysis shows that the “state has compressed its capital expenditure and marginally decreased its spending on education and social welfare and nutrition. It is intriguing that the state, with comfortable levels of fiscal consolidation since 2005, has resorted to heavy off-budget borrowing to finance state programmes”.

The new government, regardless of whichever party comes to power, will have to be careful about implementing the pre-poll promises without heavily leaning on off-budget borrowing to finance these. In 2022-23, at the time of the presentation of the budget, Karnataka was estimated to spend Rs 94,699 crore on committed expenditure items, effectively setting aside half of its revenue receipts for expenses such as salaries (22 percent of revenue receipts), interest payments (15 percent), and pension (13 percent).

Committed Expenditure

There is, however, a deeper problem staring at the new government on the salaries bill. The Seventh Pay Commission payout, including arrears possibly, will likely happen during the next five years. The MTFP presented in February this year, just ahead of the announcement of the state elections, has flagged this in no uncertain terms. “Depending on the fitment factor, the additional financial implication of implementing the Seventh Pay Scale would range between Rs 12,000 crore and Rs 18,000 crore for the first year of implementation,” it said. One shouldn’t be surprised if “right-sizing” of the government, short-hand for reducing government employees’ headcount, becomes more talked about issue in the state secretariat in the coming months.

There is another red flag that is jutting in Karnataka’s otherwise seemingly healthy headline fiscal numbers. Interest payments have been pegged at Rs 34,023 crore for 2023-34. Over the last five years, interest payments as a percentage of revenue receipts have risen from 10.6 per cent in 2019- 20 to 15.1 per cent in budget estimates for 2023-24. The signal from this is pretty straightforward: raise revenue receipts urgently and have a defined roadmap to cut down on future borrowings.

Political parties would be well advised to keep an eye firmly fixated on the fiscal landscape before doling out promises. There are no free lunches. Electoral conquest cannot, and should not, come at the cost of fiscal prudence.

Gaurav Choudhury is consulting editor, Network18. Views are personal, and do not represent the stand of this publication.