THE CONTEXT: Kerala’s public debt management has come under scrutiny amidst the state’s fiscal challenges and a lawsuit against the central government’s borrowing restrictions. The issue requires broader discussion as debt-deficit dynamics significantly impact Centre-State financial relations. Kerala’s outstanding liabilities stand at 36.9% of GSDP for 2024-25 (BE), with a relatively low rollover risk compared to other states like Telangana.
ISSUES:
- Asymmetric Fiscal Rules: The call for “asymmetric fiscal rules” about deficits and debts underscores the need for tailored fiscal policies that consider the unique economic conditions and challenges of different states. This is particularly relevant in the aftermath of the COVID-19 pandemic, where fiscal strategies must be adaptive and responsive to the evolving economic landscape.
- Fiscal Deficit and Public Debt Targets: The specific targets for fiscal deficit and public debt, with states envisaged to maintain a fiscal deficit to GDP ratio of 3.5%, and a general government public debt to GDP ratio at 60%. Kerala’s outstanding liabilities are 36.9% of GSDP for 2024-25, indicating a focus on managing debt levels while addressing the need for economic recovery and growth.
- Revenue Stability and Fiscal Marksmanship: The stability of revenue streams and the accuracy of fiscal projections (fiscal marksmanship) are highlighted as essential for effective public expenditure design. Kerala’s reliance on its tax revenue and the challenges in achieving budget estimates for tax revenue underscore the importance of enhancing revenue collection and management.
- Volatility in Intergovernmental Fiscal Transfers: The volatility and decline in the share of Union Finance Commission tax transfers to certain states, including Kerala, raise concerns about the predictability and adequacy of fiscal transfers. This issue is critical for states’ budget planning and execution, affecting their ability to meet developmental and welfare objectives.
- Equity vs. Efficiency in Fiscal Transfers: The debate on equity versus efficiency in the design of intergovernmental fiscal transfers is brought to the fore, especially with the Fifteenth Finance Commission’s tax-transfer formula. The impact of this formula on growing states like Kerala, which may be disadvantaged by the weightage given to per capita income distance, calls for a reevaluation of criteria to ensure fair and equitable fiscal transfers.
- Investment in Sustainable Development: The need for investment in a green, resilient, and knowledge-based economy is emphasized as crucial for sustainable economic development. This includes the importance of state adaptation communications and budget allocations that support environmental sustainability and address climate change challenges.
- Gender Budgeting and Economic Growth: The significance of fiscal transfers and policies that advance gender budgeting and address gender inequalities is sin quo non. By promoting increased labor force participation of women and investing in gender-aware human capital formation, states can contribute to broader economic growth and social equity.
- Fiscal Austerity vs. Economic Recovery: The dilemma between implementing fiscal austerity measures and supporting sustained economic growth recovery is often visible. Austerity measures, which may compress expenditures, are not advisable, highlighting the importance of maintaining investment in human capital formation and social infrastructure to support recovery.
THE WAY FORWARD:
- Ensuring Financial Sustainability: Borrowers, including states, must plan fiscal spending and deficits carefully to keep public debt sustainable. Before taking on new debt, the potential returns on projects and the ability to repay through increased tax revenues should be considered. Lenders should assess the impact of new loans on the borrower’s debt position before extending credit. In 2018, the IMF introduced a new debt sustainability framework for low-income countries, which includes a more comprehensive assessment of debt vulnerabilities and a focus on the quality of public investment.
- Comprehensive and Transparent Reporting: Union and State governments should adhere to comprehensive and transparent reporting of public debts. Strengthening institutions responsible for recording, monitoring, and reporting debt is essential, especially in developing countries. Creditors should allow more extensive disclosure of borrowing terms and conditions to prevent the accumulation of large “hidden” liabilities. The World Bank’s Debt Reporting Heat Map shows that many developing countries have gaps in their debt reporting, particularly in contingent liabilities and debt of state-owned enterprises. In 2021, the G20 endorsed the Debt Service Suspension Initiative (DSSI) Disclosure Framework, which aims to improve the transparency of debt data and facilitate better coordination among creditors.
- Promoting Official Creditor Collaboration: Collaboration among official creditors is crucial, particularly in debt restructuring cases involving non-traditional lenders. Effective coordination among official creditors is critical for resolving debt crises.
- Investing in Sustainable Development: States should invest in green, resilient, knowledge-based economies to ensure sustainable development. A “State adaptation communication” with appropriate budget allocations is required to address state-specific issues such as demographic transition, inward and outward migration, and climate change crisis. According to the United Nations, achieving the Sustainable Development Goals (SDGs) will require an estimated $3.5 trillion per year in additional investment. In 2019, the State Bank of India issued a $650 million green bond to fund renewable energy and low-carbon transport projects.
- Gender Budgeting and Economic Growth: Fiscal transfers based on advancing gender budgeting in the state are critical to redressing gender inequalities. Increasing economic growth through increased labor force participation of women is significant, and states have a positive role in gender-aware human capital formation. A study by the McKinsey Global Institute found that advancing gender equality could add $12 trillion to global GDP by 2025.
- Balancing Austerity with Growth: India should not pursue austerity measures that impede growth but focus on strategic investments, inclusive development, and tax reforms to bolster government revenues. Optimizing spending through subsidy reforms and better targeting social programs could reduce wasteful expenditures. Strengthening economic growth through policy reforms and encouraging foreign investment could enhance GDP and tax revenues. Accelerating disinvestment and asset monetization could provide immediate fiscal relief and reduce the debt burden. India’s commitment to fiscal consolidation is evident from its adherence to the FRBM Act and the proposed LIC IPO. The disinvestment target for FY 2021-22 is INR 1.75 lakh crore, a significant step towards reducing the fiscal deficit.
THE CONCLUSION:
Moving forward, Kerala must focus on investing in a green, resilient, and knowledge-based economy for sustainable development. The state should negotiate with the Sixteenth Finance Commission for specific-purpose transfers to address state-specific issues like demographic transition, migration, and climate change. Furthermore, emphasizing gender budgeting and fiscal marksmanship is crucial to maintaining voters’ trust and promoting inclusive growth, as fiscal austerity measures may hinder human capital formation and economic recovery.
UPSC PAST YEAR QUESTION:
Q.1 How have the recommendations of the 14th Finance Commission of India enabled the States to improve their fiscal position? 2021
MAINS PRACTICE QUESTION:
Q.1 Asymmetric fiscal rules relating to deficits and debts are a significant issue in Centre-State financial relations in India. Critically analyze this statement in the context of public debt management and the fiscal challenges states face.
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