Kerala Fiscal Crisis Reforms Explained

A report recently unveiled by new Kerala Chief Minister V D Satheesan presents a grim picture of his government’s financial health, showing that the state trails the national average across most crucial parameters.

This is a state that once boasted the most sought-after growth model in India. The decline, however, did not happen overnight.

Satheeshan, a Congress leader who is also the state’s Finance Minister, wrote in the report’s preface: “The purpose of this report is not to revisit the past in a spirit of criticism, but to understand the challenges before us with clarity and objectivity.”

Long before Arvind Kejriwal’s “Delhi model”, Nitish Kumar’s “sushashan” (good governance) in Bihar and Narendra Modi’s “Gujarat model”, there was the Kerala model of economic development.

In the 1950s, it had the country’s highest population growth rate. By the 1970s, it became one with the lowest.

This was not all. Over the next two decades, Kerala achieved levels of social and economic development — better health, education and quality of life — that not only surpassed other states but rivalled influential countries.

What’s more, Kerala achieved all this with much lower levels of income. In 1996, its per capita income was one-hundredth of the US’s. Despite this, it had a Human Development Index (HDI) score of 0.775, close to the US’s 0.925 and well above India’s 0.45 — and without the kind of coercion that countries such as China employed.

However, over the past several years, Kerala’s model has lost its sheen. The telltale sign has been the worsening state of the state government’s finances.

Simply put, with each passing year, the state has had to borrow more just to meet the gap between its expenses and its revenues. What’s worse is that the bulk of this money goes towards paying salaries and pensions.

This means very little is left to spend on developmental areas (such as health and education) or building the state’s productive capacity (also called capital expenditure).

As a result, despite having one of the most educated populations, Kerala has some of the highest levels of unemployment, especially for women.

The table below shows how far Kerala’s fiscal position has slid relative to the national average on some of the most important metrics.

Outstanding liabilities refers to all the debt that the state government has to pay back. Kerala’s outstanding liabilities as a percentage of its total economic output (gross state domestic product, or GSDP) is at 35%. The national average is around 29%.

Not surprisingly, Kerala also has a very high interest burden thanks to its past loans.

The next three metrics show that despite having high levels of borrowings, the state is stuck in a cycle of using the bulk of its money just to pay salaries and pensions, etc. This is what is called committed expenditure.

This leaves it with a much lower amount of money to spend on development — say providing better health, education and welfare.

Finally, the state is also unable to spend enough on creating new productive assets. Capital expenditure lags far behind the national average.

The state government’s report sums this up. “Kerala has been violating the basic tenet of ‘borrow to invest, growth will repay’ in a big way, weakening the growth generating capacity.”

What has the new UDF government’s proposed?

Part of the solution is to address the wastage in expenditure and to make the administration more efficient. Some of the solutions discussed in the report include raising the retirement age to the same level as the Union government. This move is expected to cut down on the pension bill.

Similarly, it is proposed to have pay commissions only once in ten years, just like the Union government does.

Public-sector enterprises (PSE) will also come under stringent review. The report finds that Kerala has the largest number of PSEs among the Indian states and “the majority of them are making losses”. This is draining state finances that could otherwise be put to more productive use.

The report suggests two changes with regard to PSEs.

One, to shift from production subsidies to consumption subsidies. In other words, instead of subsidising PSEs, let them compete in the market, and let the government directly provide subsidies to those who are too economically weak to consume goods at market prices.

The second idea is to privatise the non-strategic PSEs. This is also in line with the thinking of the 1991 economic reforms.

Yet another body that has been draining state government finances is the Kerala Infrastructure Investment Fund Board (KIIFB). It was established in 2016 to raise financial resources from the market through innovative methods.

In reality, it is raising funds at a rate much higher than the state government. Additionally, there are serious question marks over KIIFB’s financing priorities. The report finds that just three districts — Kannur, Thiruvananthapuram and Ernakulam — account for 50% of all money released. “Neither human development indices nor economic need indices provide an obvious justification for this concentration,” notes the report.

The report also recognises that “there is a limit to how much we can address the problem by tightening our belts” and states that the “best way forward is to put in place measures to promote growth, investment and employment”.

This, in turn, “would entail significant reform in laws relating to agriculture, land reforms, building of skills and start-ups in industry, creation of reasonably priced industrial infrastructure, expansion of tourism, services (particularly IT and AI) in collaboration with industry and strongly developing our coastal network”.

The state government will also look to boost its revenues especially from GST.