It took a great deal of cajoling by the Centre to get some states to embrace fiscal discipline as their profligacy was grossly undermining the reforms initiated by the Centre. The Fiscal Reform Facility was set up so that reform-minded states could access additional funds. To do so, the states were asked to draw up a medium-term fiscal reform programme to bring down their revenue deficit to zero and fiscal deficit to 2 per cent of gross state domestic product (GSDP) in a gradual manner over a period of five years.
The southern states embraced this facility to make up for the raw deal handed out by the Eleventh Finance Commission. But the severity of drought in the region is sure to take fiscal figures way off the target.
Sample these numbers: Rainfall in the eight meteorological sub-divisions in the southern region has been deficient, anywhere between 23 per cent to 49 per cent. Andhra Pradesh, suffering from the second consecutive year of poor monsoon, has received rains that are 33 per cent below normal. The shortfall in Karnataka is 37 per cent and 39 per cent in Kerala, while it is 38 per cent in the case of Tamil Nadu and Pondicherry.
The immediate impact of this is on revenue mobilisation. The fall in rural demand will directly impact indirect tax collections which are a significant component in the southern states revenue basket. Tamil Nadu, for example, has set an 8 per cent growth target in the 10th Plan, but this fiscal, which is the first year of the Plan, the state is expected to grow by only 5 to 6 per cent.
The drought will also entail unplanned expenditure that could send fiscal prudence down the drain. The progress of reforms itself will slow down. None of the southern states can meet their medium-term fiscal targets if they do not cut subsidies. Drought conditions make it difficult politically to raise user charges. Tamil Nadu will find it impossible to revoke free supply of power to farmers to cut its Rs 3,000 crore subsidy when the crops fail. Karnataka and Andhra Pradesh are also sitting on a Rs 2,500 crore to Rs 3,000 crore deficit in the power sector.
The lack of rains have hurt hydel power generation in Kerala and Karnataka. Deprived of low-cost power, Keralas power utility is all set to go deeper into red. The state is planning to go for another round of power tariff hike. Investors, who are beginning to look at Kerala as a potential investment destination, are not likely to view this favourably.
Declining revenues and unplanned expenditure will force the southern states to cut down on infrastructure spending. This, in the long run, can hurt their investment-attracting capacity. On the contrary, it will be wiser if these states go for fiscal expansion (higher deficits) and step up spending on infrastructure. The Chinese have realised that the best way to attack poverty is to build roads. The Food-for-Work programme can be used effectively for this. Otherwise, there is a distinct possibility that neither the fiscal targets will be met (due to lower tax revenues) nor will the infrastructure be developed. Achieving even one of these will be a victory of sorts.