Can Kerala achieve financial stability as federalism weakens, experts weigh in

Kerala is facing a deep fiscal crisis because of the decline in grants in aid from the Union government, cuts in share of taxes and restrictions on borrowing. Can the state tide over the crisis to meet its development and welfare obligations?
Chief Minister Pinarayi Vijayan and Finance Minister KN Balagopal
Chief Minister Pinarayi Vijayan and Finance Minister KN BalagopalKN Balagopal Facebook page
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Kerala’s Minister for Finance KN Balagopal is contemplating presenting the annual state budget in January 2024, to ensure its passage before the general elections. However, the budget, being presented when the state is experiencing acute financial distress, is unlikely to see announcement of new projects.

This is because of the stance taken by the Union government that loans by Kerala Infrastructure Investment Fund Board (KIIFB), which drives infrastructure development, are the onus of the state and it cannot borrow anymore, according to reports. Off-budget borrowings by KIIFB and the Kerala Social Security Pension Ltd (KSSPL) have for long faced red flags by the Comptroller and Auditor General (CAG).

The state is in need of additional tax resources but the hike in taxes and duties last year was a cause of heartburn and it is unlikely that the state would burden citizens with a similar exercise in an election year. How the state would prioritise welfare spending amidst the crisis is another question.

The state government has squarely blamed the Union government, which allegedly defaulted on payments due to the state, for escalating its financial troubles. It also moved the Supreme Court in December 2023 arguing that the action violated fiscal federalism. 

Is the Union govt depriving Kerala of funds?

A 2023 study by Gulati Institute of Finance and Taxation (GIFT) said Kerala recorded one of the highest growth rates in state's own tax revenue. It also displayed strong evidence of fiscal consolidation in league with some other states. But the decline in grants in aid from the Union government, negligible growth in the share of Central taxes and unprecedented restrictions on borrowing to adhere to the Fiscal Responsibility and Budget Management (FRBM) Act, which the Union government too is guilty of violation,  severely impacted the state government's capital expenditure and fiscal freedom.

The study 'Turn around in own tax mobilisation yet the fiscal stress: Kerala in a comparative perspective' by KJ Joseph, Anitha Kumary L and Raj Krishna, said because of these restrictions the state could not even borrow even three percent of the Gross State Domestic Product (GSDP), which it is entitled to as per the FRBM Act.

The CPI(M)-led Left Democratic Front (LDF) government took a decisive step by approaching the Supreme Court on December 13 against the tactics of the Union government. The state government alleged that the Union government through various measures has been exacerbating the state's fiscal challenges, prompting Kerala to file a suit against the capping of its borrowing limit. The state contended that such restrictions, particularly the implementation of a Net Borrowing Ceiling (NBC), was an infringement on its constitutional powers, endangering its financial stability.

Under Article 131 of the Constitution, Kerala argued that state debt fell exclusively within its jurisdiction as per Article 246 under the 7th schedule. The suit contended that the imposed NBC, limiting borrowings from diverse sources, including international channels, undermines the state's fiscal planning under the Kerala Fiscal Responsibility Act, 2003. The state warned of catastrophic consequences, stating that "treasury operations will be halted or starkly curtailed" if the Union government's measures persisted.

Finance Minister KN Balagopal, in a letter to the Union Finance Minister on December 2, raised concerns about the deduction of Rs 332 crore from the settlement of Integrated Goods and Services Tax (IGST) for November 2023. Balagopal expressed frustration over the lack of clarity on the deduction and questioned the calculations behind it.

Balagopal had asserted in November 2023 that the state stood to lose Rs 57,400 crore in Union government transfers and loan approvals in the current fiscal year. Citing a decrease in Revenue Deficit Grant, a shortfall in GST compensation, and a significant drop in the state's share of taxes, he attributed the losses to the policies of the 15th Finance Commission. Chief Minister Pinarayi Vijayan echoed these concerns, accusing the Union government of 'suffocating the state' through its financial policies.

Congress Parliamentarian TN Prathapan added political weight to the issue by moving an urgent motion in the Lok Sabha on December 4, decrying the alleged discrimination of the Union government towards Kerala.

Union Finance Minister Nirmala Sitharaman, during her recent visit to Kerala, refuted claims of deprivation, asserting that the Union government had disbursed all funds to the state in a timely manner. She also alleged that the financial crunch faced by Kerala could be attributed to the state's extravagant spending. The Union Finance Minister however admitted that certain funds are pending but justified that by saying that they would only be allocated if the state adhered to specific guidelines and refrained from rebranding Union government policies. 

Union government ties fund allocation to branding

The Union government has made branding mandatory for the schemes like Swachh Bharat Mission (SBM), Ayushman Bharat, National Health Mission and Pradhan Mantri Awaz Yojana (PMAY), where central assistance is involved. But Kerala has taken a position that projects implemented with the participation of both Union and state governments cannot be branded only as central projects.

Nirmala Sitharaman during a state visit had stated that the disbursement would only occur when the Kerala government fulfilled specified requirements outlined by ministries and the directives of the 15th Finance Commission.

Her statement was in reference to housing projects like Kerala's Life Mission, executed in coordination with the Pradhan Mantri Awas Yojana (PMAY) and rebranding of Public Health Centres. Sitharaman highlighted the Union government's desire for PMAY's logo and name to be displayed on houses, emphasising adherence to established guidelines. Kerala, however, argued that beneficiaries under this scheme receive an additional state share. According to the state, each beneficiary under this scheme receives an additional state share of 62.5% (in urban regions) and 82% (in rural areas). Under PMAY housing schemes, the Union government provides Rs 1.50 lakh for each beneficiary and the state government additionally provides Rs 2.50 lakh each, so that one can build a house for Rs 4 lakh.

In a letter to Union Minister for Housing Hardeep Singh Puri, Kerala's Local Self-Government Minister MB Rajesh defended the decision not to brand the state scheme, expressing concern that branding might imply charity and compromise the dignity of beneficiaries. 

The letter said “We've chosen not to brand our state scheme, as branding may imply charity, potentially affecting the dignity and self-respect of beneficiaries. We are steadfast in our commitment to upholding democratic values and ensuring people's right to a dignified life, without any implication of charity.”

“We express our concern that affixing branding logos on houses may inadvertently compromise the dignity and self-respect of beneficiaries. We believe that a safe living space is a basic right, and the state's duty is to ensure it, not present it as a gift,” the minister said in the letter.

The state also argued that it pays security pensions to 60 lakh people, and Union government beneficiaries are only around 6 lakh among that.

Most Public Health Centres (PHCs) in the state have been rebranded as Ayushman Atrogya Mandirs, as per a directive of the Union Health Ministry. But the Union government is yet to release the funds.

Further complexities emerged as the Union Minister alleged that the GST compensation cess was withheld due to the state requesting a reevaluation of numbers by the Accountant General before release. 

Kerala’s financial crisis goes deeper

While there is apprehension about the Union government bending the rules, creating challenges for the state, experts argue that Kerala's financial crisis extends beyond these concerns.

In an address on the "Fiscal Crisis in Kerala" at a Kerala University event on December 14, Midhun VP, Assistant Professor at Government College, Kasaragod, underscored that Kerala's financial woes are not a recent phenomenon but have persisted over many years.

"When we compare our outstanding debt—comprising the total principal and interest amount of debt yet to be paid—with neighbouring states, Karnataka and Tamil Nadu, spanning the period from 2005 to 2023, it surpasses theirs. So, the financial crisis in Kerala is not a novel issue; it has been a longstanding concern," he emphasised.

Midhun pointed out that Kerala has been grappling with a financial crisis since 2015 but managed to overcome these challenges through three key factors: GST Compensation, off-budget borrowing, and Revenue Deficit Grants. However, he cautioned that these measures are sustainable only in the short run, raising doubts about the long-term financial stability of the state.

Experts pointed out that the impact of financial allocations from the 15th Financial Commission has triggered a notable shift in the fiscal landscape, especially concerning Kerala's share of the Revenue Deficit Grant. Traditionally designated to assist states in navigating financial crises, the grant also serves to enhance fiscal services. In contrast to the 14th Financial Commission, which extended the revenue deficit grant to approximately 11 states, the 15th Commission expanded this provision to include a broader spectrum, benefitting around 17 to 19 states. Consequently, Kerala witnessed a decline in its share.

Speaking to TNM, Nagaraja Naidu, former Associate Professor for Economics at Kerala University said that the state government hasn’t yet published enough details regarding its pending payments and financial situation.

According to guidelines set by the Union Government, every state is permitted to raise up to three percent of its Gross State Domestic Product (GSDP) annually. In Kerala's case, the state government typically extends guarantees to various public sector enterprises, facilitating their borrowing from the open market. However, the Union government contends that these guarantees should also be considered a future liability of the state.

“The budget provision for borrowing is capped at three percent of the GSDP, adhering to Union Government regulations. Additionally, some states engage in off-budget borrowing, a practice of borrowing outside the official budget. Kerala, notably, employs off-budget borrowing through entities like Kerala Infrastructure Investment Fund Board (KIIFB) and pension funds. In response to these financial strategies, the Union Government has taken a significant step by reducing the borrowing limit for the state government, introducing a new layer of complexity to the financial relationship between Kerala and the central administration,” Naidu said.

Another setback for the state government was stopping GST compensation. Initially, in 2017, a compensation policy was in place, wherein if a state failed to meet a specific GST revenue threshold, the central government would provide compensation. This compensation mechanism operated seamlessly for the first five years but came to a halt thereafter.

“In the face of halted funding, we had ample time to implement measures to compensate. While more resourceful states managed to withstand the challenge, the reality is that as a consumer state with limited resources, Kerala found itself in a vulnerable position,” Naidu said.

Economists suggest that Kerala should increase its GSDP to increase its borrowing limits.

“In the current scenario, we need to temporarily trim down unproductive expenditure, especially on populist policies. Effective expenditure management is a viable solution. Exploring collaboration with private agencies and leveraging the resources of the private sector is imperative. To enhance the purchasing power of the people, a crucial avenue lies in increasing revenue, primarily through strategic tax measures, which can boost demand and stimulate consumption,” Naidu added.

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