In the post pandemic fiscal strategy, the Indian States are instructed to maintain a fiscal deficit GDP ratio to 3.5 per cent of GSDP, with 0.5 percent extra borrowing powers tied to mandatory power sector reforms. To meet the challenges related to maintaining a robust growth path through capital spending and to maintain a threshold level of human capital formation, States have started innovating fiscal space outside the purview of fiscal rules and legislations. The borrowing through public sector entities was treated as an off-budget borrowing outside the purview of calculating fiscal deficit till recently . However due to data constraints , India has not yet calculated Public Sector Borrowing Requirement ( PSBR) which covers the "general government deficit" and of public sector entities. 

 

Kerala State Finance Minister recently highlighted that the changed approach by the Centre government in calculating  the Net borrowing ceiling (NBC) incorporating the off budget borrowing will affect the fiscal space of the State in planning the economic growth path and economic development of the state.

 

It is said that in this fiscal year, in Kerala, the limit of availing loans was fixed at Rs 32,440 crore. But permission so far has been given to avail loans of only Rs 15,390 crore. In the previous fiscal, the limit was Rs 23,000 crore, he highlighted. The Kerala Finance Minister reported that KIIFB and the KSSPL were formed to tide over the state’s fiscal space  and to avoid financial crisis . 

 

On March 31, 2022, centre government instructed about the changed approach in estimating the borrowing space , and centre informed that the borrowings by special purpose vehicles like KIIFB and KSSPL will be adjusted in the Net Borrowing Ceiling( NBC).This has affected significantly the fiscal space at Kerala State level in designing social policy measures, especially when the tax  transfers from centre has remained highly volatile. 

 

Fiscal Rules and Off-budget Borrowings 

 

The central government had informed that loans taken by KIFBI, and the companies formed to distribute welfare pensions and public sector entities  will be considered as Kerala’s loans. 

 

Over the years, the off-budget borrowings (OBB) through  KIFFB have been used for strengthening social and physical infrastructure investment in Kerala.The fiscal innovation of KIFFB has its roots in fiscal rules. The fiscal rules and legislations - the FRBM Act - has stipulated fiscal deficit to GSDP at 3 per cent of GDP. Maintaining fiscal deficit GSDP ratio at 3 per cent through increased tax buoyancy would be a relatively a better fiscal consolidation than expenditure compression.  However when there is no sufficient revenue buoyancy, adequate debt financing need to be resorted to. 

 

Though substantial tax rate revisions have been announced in the State Budget 2023-24, tax financing alone cannot cover the entire revenue expenditure of the State.  If revenue receipts can finance the entire revenue expenditure , the revenue deficit remain zero and whatever State borrows can go for capital expenditure. However in Kerala, the revenue deficit is not zero. The revenue deficit to GSDP ratio however has declined from 2.6 percent in 2020-21 (Accounts) to 2.1 percent (2023-24 BE). Further reduction in revenue deficits  might be plausible only through revenue expenditure compression. In the post-pandemic fiscal strategy, revenue expenditure compression has detrimental effects in economic growth and human development.

 

The Size of Government 

 

In order to prevent the reduction in the size of government ( measured as public expenditure to GSDP ratio) further, Kerala needs support  through tax transfers and grants from Centre. The size of the government (public expenditure GDP ratio) has reduced from 18.01 % in 2020-21 ( accounts) to 15.6 percent in 2023-24 BE. The total expenditure estimated at Rs 1.76 lakh crore in 2023-24 BE and GSDP is Rs 11.32 lakh crore. With the shrinking size of the government over the years, this revised treatment of net ceiling for loans by Centre has further reduced the fiscal space . This will make the situation further tight for Finance Minister to plan his committed bills and capex infrastructure plans. 

 

The Discretionary Fiscal Space 

 

The committed bills need sufficient "discretionary fiscal space" . Discretionary fiscal space  is calculated by subtracting the interest payments liabilities from total public spending. The ratio of interest payments to GSDP is 2.6 percent in 2023-24 BE in Kerala. This ratio has been around 2-3 percent since 2010-11. This reflects the debt servicing burden of the State. 26.7 percent of State's own revenue goes for interest payment obligations ( debt servicing). 

 

If the fiscal space is further reduced due to changed approach by the Centre,it will affect the flexibility of finances of the State to budget for committed liabilities and capital spending . In Kerala,  69.6 percent of own revenue is estimated for salaries and pensions in this financial year- in 2023-24(BE). This is however lower than 84.87 percent in 2020-21 (Accounts).

 

Public Debt Management and Capital Spending 

 

With the interest rate shooting upwards, the public debt management becomes tough as debt servicing becomes costlier. In the cooperative federalism models, adhering to top down approach of calculating the borrowing powers can affect the fiscal space of the States, especially the discretionary fiscal space.  

 

The capital spending  to GSDP ratio in Kerala remained constant over the years to approximately around 1-2 percent of GSDP. The alarming narrative about high public debt burden so is about “intergenerational inequity” in the sense that today’s deficit is tomorrow’s taxes – leaving future generations in perpetual debt. In Kerala, public debt as a percentage of GSDP is estimated to be 36.05 %  in 2023-24BE. 

 

The Off budget borrowings ( OBB) of the State are loans availed of by Kerala Infrastructure Investment Fund Board (KIIFB) and the Kerala Social Security Pension Ltd (KSSPL). Kerala Finance Minister said that a shortfall of Rs 23,000 crore is estimated for this FY. The Minister informed that it will affect the sub national public finances  in meeting expenditure for social infrastructure investment and social security schemes for the poor.

 

The earlier version of this article was first published in The Fourth News, May 29th 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.