The fiscal consolidation framework mandates all state governments in India to keep their fiscal deficit-GDP ratio at 3.5 percent. The extra-borrowing powers (0.5 percent) of the states are linked to power sector restructuring. Kerala is not an exception to this rule. The fiscal deficit for 2023-24 is pegged dot on 3.5 percent of GDP in Kerala Budget 2023 which was presented by Finance Minister KN Balagopal on February 3, 2023.
The fiscal deficit-GDP figure was 3.6 percent in 2022-23 revised estimates (RE), which was lower than what was pegged in 2022-23 budget estimates (BE) at 3.91 percent. During the pandemic years of 2020-21 and 2021-22, Accounts showed fiscal deficit-GDP ratios of 4.6 percent and 4.1 percent, respectively. This formidable fiscal roadmap says that there are no impending fiscal risks in the state as generally perceived. The question is how the state manages to be on the path of fiscal consolidation amidst high volatility in the intergovernmental fiscal transfers from the Union to the states. Kerala finance minister pointed out that the decline in revenue deficit grants and the discontinuation of GST compensation had further affected the fiscal space of the state.
If the fiscal deficit-GDP ratio is maintained at 3.5 percent, as envisaged within the fiscal rules framework, (with 0.5 percent extra borrowing powers of the state linked to power sector reforms) through expenditure compression, the economic growth recovery will be affected. If it is maintained through increased revenue mobilisation, the fiscal consolidation will be less painful. The aggressive announcements in the Budget 2023 to increase the tax rates including that of petrol and diesel points to the finance minister’s intention towards a less painful fiscal consolidation through a revenue buoyancy path. This intention is well taken given the shrunken fiscal space available before him. However, citizens are puzzled due to the timing of tax hikes amidst mounting inflation.
People vote back a government to power analysing their policies in retrospect. Will these aggressive tax hike announcements instead of freebies in a budget be a powerful strategy to make people feel authentic about the party in power? People love to pay taxes when they are convinced about the role of government in supporting economic welfare. The tax you pay and the benefits you derive from the government should be linked. If this link breaks, people do not show any willingness to pay taxes.
Revenues And Expenditure
Where is the money coming from? Analysing Kerala Budget 2023 from the total receipts side, it is deciphered that 46 percent of the money comes from the state’s own tax revenue, 10 percent from its own non-tax revenue (including lotteries, user charges and mining), 28 percent from central government transfers and 23 percent from capital receipts in 2023-24 (BE). In Kerala Budget 2023, the finance minister announced aggressive tax rate hikes, and in addition, has also focused on non-tax revenue mobilisation including raising revenue from revising the royalty rates of minor minerals and increasing the user charges.
A quick analysis of public expenditure from his 2023-24 BE figures revealed that 18 percent of the government exchequer goes for economic services, 34 percent for social services and 48 percent for general services in Kerala. People would be delighted to know how their money is spent by the government. Within the economic services budget, transport, agriculture and allied services, rural development, irrigation and flood control are the major components. Within the social sector budget, education, health and family welfare, social welfare and nutrition, the welfare of SC/ST/OBC/minorities and water supply and sanitation are the main components. Within general services, interest payments, police, pension and other retirement benefits constitute major components. The demographic transition towards a more dependent population in the state of Kerala has public finance implications in terms of pensions and social security benefits.
Budget credibility is crucial, as citizens love to ensure that there is no deviation between the budget announcements by the government and the actual spending and also, there is no deviation between tax projections and taxes realised. The fiscal marksmanship analysis (on fiscal forecasting errors) for Kerala Budget 2022-23 showed that there is a deviation or fiscal forecasting error relative to revenue projections. The revenue receipts in 2022-23 BE were Rs 1.34 lakh crore. This is higher than the revised estimates (RE) of 2022-23 at Rs 1.29 lakh crore. The fiscal forecasting error was of the magnitude of Rs 4,829.65 crore, which is a forgone fiscal space equivalent to 0.48 percent of gross state domestic product (GSDP). Such forecasting errors have repercussions on public expenditure design. Against these fiscal forecasting errors of 2022-23, Kerala has engaged in conservative projections of the revenue receipts at Rs 1.35 lakh crore (BE) for FY23, which is lower than the Revised estimates of 2022-23.
The fiscal forecasting errors of the revenue side spill over to decisions related to the size of the government. Has the size of the government declined over the years in Kerala, amidst shrinking fiscal space from the fiscal transfers? The answer is in the affirmative. The size of the government (public expenditure GDP ratio) is 15.6 percent, with total expenditure estimated at Rs 1.76 lakh crore in 2023-24 BE, and GSDP is Rs 11.32 lakh crore. In 2020-21 (Accounts), the size of the government was 18.01 percent and this contacted 16.4 percent in 2022-23 (RE).
With the shrinking government, how has the state tried to achieve fiscal consolidation – through expenditure compression in revenue and capital budgets? A quick analysis of the 2023 Kerala Budget reveals that the state has not phased out revenue deficits. Phasing out the revenue deficit means the revenue expenditure will be entirely covered by the receipts earned, translating the entire borrowings will go for capital expenditure. In Kerala, the revenue deficit is not zero. The revenue deficit to GSDP ratio was 2.6 percent (2020-21 Accounts), and has reduced gradually to 2.1 percent (2023-24 BE). It is alarming if the reduction in revenue deficits is through a reduction in revenue spending. In the post-pandemic fiscal strategy, revenue expenditure has a prominent role, especially in education to cope with “learning loss” due to the digital divide and also in the health sector for strengthening infrastructure in primary, secondary and tertiary sectors. The off-budget borrowings (OBB) through a corporate entity called KIFFB have been used for strengthening physical and social infrastructure in the state. Kerala's finance minister raised his concerns to the central government for curtailing the borrowing powers of states by including the borrowings by public sector entities, including Special Purpose Vehicles like KIFFB in their public debt account.
Discretionary expenditure is arrived at by deducting the interest payments liabilities. From that perspective, primary deficits are crucial to understanding the current fiscal stance devoid of past debt servicing liabilities. The primary deficit (fiscal deficit minus interest payments) which shows the current fiscal stance is pegged at 1.2 percent of GDP in 2023-24.
So far, the narrative in Kerala was that high debt and deficit can be substantiated if it is used to strengthen the capex infrastructure and to reduce the productivity gaps across sectors. However, the capex to GSDP ratio remained constant over the years to approximately around 1-2 percent of GSDP. The capital expenditure-GSDP in Kerala in 2020-21 was 1.7 percent, with capex at Rs 12,889.65 crore and GSDP at Rs 7.71 lakh crore. In 2021-22 (Accounts) and 2022-23 (RE), the capex was 1.6 percent and 1.5 percent of GSDP, respectively. In 2023-24 BE, the capital outlay to GSDP ratio is 1.3 percent with capex at Rs 14,605.53 crore and GSDP at RS 11.32 lakh crore.
With this budget, has the narrative shifted from debt financing to tax financing? Ricardian Equivalence Theory of public finance argues that whether it is debt financing or tax financing, the impact on the economy is going to be the same – as today’s deficit is tomorrow’s taxes. However, the neoclassical school always believed that a deficit is detrimental to the economy as it “crowds out” private investment while Keynesians believed that a timely deficit is good for the economy as it can strengthen the aggregate demand and in turn economic growth recovery.
The narrative so far in the context of Kerala has been the high debt burden of the state and its “intergenerational inequity” in the sense that today’s deficit is tomorrow’s taxes – leaving future generations in debt. With this budget, the tax burden is shifted to the present generation.
In the low-interest rate regime, high public debt has been substantiated globally. However, with mounting global inflation, interest rates have started shooting up globally and this has made public debt management difficult. The cost of borrowing has started rising in the high-interest rate regime and therefore debt servicing has become costlier. In Kerala, public debt as a percentage of GSDP has been 37-38 percent since 2020-21 and it is pegged at 36.05 percent in 2023-24BE.
The debt servicing burden – the ratio of interest payments to GSDP is 2.6 percent in 2023-24 BE. This ratio has been around 2-3 percent since 2010-11. The interest payment as a proportion of the state’s total own revenue receipts is as high as 26.7 percent in 2023-24 (BE). Salaries and pensions as a percent of the state’s own revenue are as high as 69.6 percent in 2023-24(BE), which is lower than 84.87 percent in 2020-21 (Accounts).
High-interest rate regime will make it tough for fiscal policy to remain “accommodative” for long. Given these constraints in fiscal space, resorting to revenue mobilisation is a no-brainer.
However, one should not undermine the intergeneration “equity” and “fairness” of debt financing the state has been substantiating so far by creating physical and social infrastructure right now that future generations can enjoy.
This article was published in 'Money Control' on February 6, 2023.
Lekha Chakraborty is Professor, NIPFP and Research Associate of Levy Economics Institute of Bard College, New York and Member, Governing Board of International Institute of Public Finance (IIPF) Munich.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.