Kerala finance minister Dr Thomas Issac recently tabled a White Paper on the state government’s finances in the Assembly. First of all I compliment the finance minister for releasing this document as it provides many interesting insights and establishes a context for the upcoming budget proposals. It is without any doubt that the state’s finances are in a precarious situation with negative effective treasury balance after accounting for committed liabilities.
Even though the fiscal deficit declined in 2015-16 (to Rs 15,888 crore from Rs 15,999 crore in the previous year) it has been at the cost of capital and developmental spending. Of course neither is this situation unprecedented (LDF handed over a similar financial position to its successor in West Bengal in 2011 and the newly elected BJP government is staring at a similar fiscal crisis in Assam) nor is it unique (states across India are undergoing fiscal stress although it has to be said that Kerala is worse performing than its peers). But the LDF government should not repeat the mistake of the TMC in West Bengal and waste the honeymoon period that a newly elected government enjoys.
There are immense pressures from the newly elected representatives to reward the voters with populist measures, but it causes long-term damage. The LDF government should bite the bullet now than later. The White Paper offers hope that the government is planning to launch some corrective actions. Before going any further a little bit of context is in order. One must understand that governments should run their finances like households do. Families meet their current expenses out of current income and use debt only for long-term purposes such as housing or higher education.
Similarly governments need to keep their revenue deficit low (preferably at zero) and borrow only for financing productive expenditure like social and physical infrastructure (this is what leads to fiscal deficit). There are enough theories and evidence to support this strategy. Research has shown that debt and deficits beyond a certain level hurt economic growth. But capital spending and social sector expenditure help growth. In other words the deficit itself is not a problem, but the quality of deficit is more important than its size. RBI’s report on state finances 2015-16 shows that Kerala spends above the average for non-special category states when it comes to the social sector, but below average for physical infrastructure. This is going to hurt long-term growth.
Some types of expenditure such as salaries, interest and pensions are unavoidable, but it is still remarkable that, according to the figures in the RBI report, Kerala has the second highest revenue deficit among all states of India (second only to Haryana while West Bengal’s figures are not reported). But that does not stop Kerala from being the second highest spending state (second only to Punjab) when it comes to non-developmental expenditure (as a share of total disbursement). Moving to income, growth in the state’s own tax revenues has been sluggish in the past few years. This may be defended citing general economic slowdown, but is surprising when one witnesses the growing fields of prosperity manifested in the booming retail, real estate and jewellery businesses in Kerala.
What are the options before the state government? To begin with, it has to implement major steps to improve the efficiency of tax collection and significantly improve recoveries. The government has to increase automation not only in tax administration, but wherever possible in its overall functioning so that the high growth in salaries and pensions can be checked. The White Paper is silent on the large number of state PSEs that are destroying public wealth. The largest loss making PSEs are not just public utilities (such as KSRTC and KWA), but also companies that sell textiles, automobiles and steel.
The government should do an audit of the role played by these companies in the state’s economy. If they are neither delivering public goods nor returning dividends, then they should be closed down or sold off. Since these are not options available to a Left government, it should at least bring in professional managers to improve their performance. The government could also think of introducing Employee Stock Ownership Plan (ESOP) in these companies to improve financial performance by boosting employee morale and productivity.
High dependence of the state economy on private remittances is a risk. The government must think of ways to channelize remittances into select industries that require less land but utilize the state’s high levels of human capital. The government should come up with a new industrial policy and also a new tourism policy to rejuvenate the sector that is the state’s mainstay. According to RBI data, Kerala spends above the average for non-special category states on education, sports, art and culture. The government should try to channelise remittances into these areas especially the last three. It should work closely with large companies to deploy their CSR spending in development activities. The ease of doing business has to significantly improve and the government has to work with private enterprises in a spirit of cooperation with transparency and strict regulatory oversight.
Finally, on the tax front, the government would probably go for higher tax rates on luxury goods and services to shore up revenues. A liquor policy that focuses on awareness generation rather than prohibition will also help the exchequer. The GST bill is set to be introduced in the Monsoon Session of Parliament. If passed, it will hugely benefit Kerala as GST is a destination tax and Kerala is a destination state for most goods. In fact the LDF should prevail upon its Central leaders to back the GST bill in the interest of the state. Increase in revenues from the GST will help the state to fill its fiscal hole and spend more on development. After all good economics needs good politics.
