With the new governments assuming office in Kerala, Tamil Nadu and West Bengal, the focus has shifted to the management of finances in these states. The winning coalitions in these states would naturally want to implement the promises made in their manifestos and that would require exploring additional fiscal space. The precarious state of West Bengal?s finances was discussed in these columns on May 17. It would be instructive to make an objective analysis of the finances of Kerala.
Kerala, along with Punjab and West Bengal was considered to be a highly fiscally-stressed state according to the 13th Finance Commission. Even with significant improvements in the finances of state governments since 2003-04, these were the only states among the general category to continue to have a revenue deficit in 2007-08 and fiscal deficits of more than 3% of GSDP. The Commission set out a different scheme for fiscal consolidation for these states so that each of them phases out their revenue deficit and reduces the fiscal deficit to below 3% of GSDP by 2014-15. In the case of Kerala, in particular, the Commission recommended that as a ratio of GSDP, the revenue deficit should be brought down from 2.3% in 2007-08 to 1.4% in 2011-12 and thereafter by 0.5 percentage points every year to finally be eliminated in 2014-15. Similarly, the fiscal deficit was mandated to be brought down from 3.6% in 2007-08 to 3% in 2013-14.
Kerala?s fiscal health has shown considerable improvement, particularly since 2002-03. The revenue deficit, 4.5% of GSDP, was brought down to 1.4% in 2010-11 (revised estimates), which was actually the target set for 2011-12 by the Finance Commission. In the case of compressing fiscal deficit, the performance of the state has been even better. It has actually achieved the target set by the Finance Commission for 2013-14 in 2010-11 itself. The fiscal deficit-GSDP ratio was brought down from 5.5% in 2002-03 to 2.9% in 2010-11. Notably, the ratio of capital expenditure to GSDP increased from 0.7% in 2003-04 to 1.2% in 2010-11. All this was possible because the state was able to increase tax revenue from its own sources from 7.1% in 2005-06 to 8.3% in 2010-11 which is an impressive achievement.
How has this improvement been brought about? As a ratio of GSDP, the revenue deficit was reduced by 2.7 percentage points from 4.2% in 2000-01 to 1.4% in 2010-11 and the improvement in the post FRBM era since 2003-04 was 2.3 points. In fact, the last government was able to bring down the revenue deficit to 1.4% of GSDP even though the target set by the Finance Commission was 2.3%. In the post FRBM era, the reduction in revenue deficit was brought about both by an increase in revenue and a compression of revenue expenditures. While the reduction in revenue expenditures as a ratio of GSDP from 2003-04 to 2010-11 amounted to 1.2 points, the increase in revenue amounted to over one point. Among the revenue sources, it was the state?s own revenues and not the central transfers that contributed to higher revenue collections. In fact, central transfers in 2010-11 as a ratio of GSDP declined marginally by 0.1 point whereas the state?s own revenues registered an increase of over 1.1 points. An overwhelming proportion of revenue expenditure compression was on account of interest payments. Of course, the general category states on average have shown a significant improvement since 2003-04, with the revenue deficit declining by 3.2 percentage points backed mainly by strong revenue performances from own sources (2 points) and higher transfers (0.9 point). Nevertheless, the fiscal adjustment achieved by the state is impressive and, in particular, the compression of revenue expenditures in spite of the rigidities arising from the predominant social sector expenditures in the states is impressive.
Despite the improvements in the finances of the state government noted above, the state?s fiscal indicators do not compare favourably with those of other general category states. The state had a revenue deficit of 1.4% of GSDP in 2010-11, compared to the average revenue surplus of over 1.6% in general category states. As the state has tried to compress the fiscal deficit to 3% of GSDP even with a revenue deficit of 2.4%, it has much lower level of capital expenditures. The general category states on average were able to incur capital expenditures of more than 3.4% of GSDP in 2010-11 financed substantially by a strong revenue account surplus. Although the state has managed to substantially bring down the ratio of interest payments to its own revenues from 35.5% in 2005-06 to 24% in 2010-11, the expenditure is much higher than the average of 18% for general category states. Similarly, even as the outstanding liabilities of the states have shown a declining trend from 36% of GSDP in 2005-0-6 to 31% in 2010-11, it is well above 25%, which is the average for general category states.
The new government faces formidable challenges in taking the fiscal consolidation process forward in the coming years and in achieving the fiscal consolidation targets set by the 13th Finance Commission. Added to this are the new commitments made by the UDF in its election manifesto. Although much less populist than the manifestos of competing Dravidian parties in Tamil Nadu, the UDF election manifesto promises 25 kilogrammes of rice at R1/kg to all BPL families and 25 kg every month at R2/kg for APL families. The coalition has promised employment to 25 lakh persons during its five year term and universal health insurance to the people of the state. It also proposes major infrastructure projects like the Kochi Metro Rail. Other promises include depositing a fixed amount of money in the name of the newborn girl child that can be withdrawn when the girl attains the age of 15. Although the funding for some of these projects will largely have to come from outside the budget, the state will have to provide for viability gap funding.
Even more important is the requirement to meet the targets set by the 13th Finance Commission. Predominance of wages and salaries and interest payments in the state?s spending makes expenditure compression difficult. The slender majority in the assembly rules out the feasibility of bold measures to achieve consolidation. The previous finance minister, even as he complained about the centre?s treatment, went about mobilising revenues through a variety of measures including micromanaging the tax administration and achieved substantial consolidation. The new government in the state, like West Bengal, will seek a bail-out from the centre. Such periodic bail-outs for selected states will only erode the federal values and undermine the existing institutions that have been set up in the Constitution to make federal transfers in an objective manner.
The author is director, National Institute of Public Finance and Policy. Views are personal