Kerala prepares to fight Centre’s economic policy legally, politically

The ruling CPI(M) in Kerala is all set to hit the streets against the Union government alleging that New Delhi’s fiscal policies are effectively subjecting the state to an “economic blockade”.

In the upcoming weeks, the CPI(M) plans to commence a week-long demonstration spanning all 140 Assembly constituencies. The main objective of this protest is to voice its disapproval of the Central government’s economic strategy vis-à-vis the state.

The LDF government is concerned about the fiscal limitations of the state and predicts a graver scenario in fiscal year 2023-24. It anticipates a deficit of approximately Rs 8,400 crore as compared to last year in revenue deficit grants which are allocated by the Union government to aid the state in bridging the gap in revenue shortfall.

An additional revenue decline, ranging from approximately Rs 10,000 to 12,000 crore annually, is expected due to the discontinuation of Goods and Services Tax (GST) compensation starting from June 2022. Following the implementation of GST in 2017, the Central government had committed to providing compensation to states for up to five years to offset the shortfall in their revenue collection resulting from the amalgamation of various taxes under GST.

Another substantial fall of Rs 8,000 crore is anticipated due to limitations imposed on the state’s borrowing capacity.

Financial mess

“Kerala’s efforts to improve its finances through the fiscal consolidation path have been hindered by a series of setbacks which are beyond the control of the state government,” read a letter written by the state finance minister to his Union counterpart on July 12, 2023.

The net borrowing ceiling (NBC), which is the maximum amount a state can borrow in a given financial year, based on the estimated Gross State Domestic Product (GSDP) of the state, set by the Financial Commission is another area where Kerala is raising the red flag.

According to an answer given in the Kerala assembly by the finance minister, the 15th Finance Commission (which provided recommendations for the period from 2021 to 2026) has set the standard NBC for all states during the fiscal year 2023-24 at 3 per cent of the projected GSDP.

For Kerala, the NBC calculated at 3 per cent of the estimated GSDP stands at Rs 32,442 crore.

In a letter dated March 27, 2023, the department of expenditure of the Union finance ministry states that “Off-budget borrowings like borrowings by state public sector companies, special purpose vehicles (SPVs) and other equivalent instruments, where principal and/or interest are to be serviced out of the state budgets, have the effect of bypassing the net borrowing ceiling (NBC) of the state by routing loans outside state budget through government-owned companies/statutory bodies despite being responsible for repayment of such loans.

“Such borrowings have impact on the revenue deficit and fiscal deficit and thus have the effect of surpassing the targets set for fiscal indicators… Therefore, borrowings by state public sector companies/corporations, SPVs and other equivalent instruments where principal and/or interest are to be serviced out of the state budget and/or by assignment of taxes/cess or any other state’s revenue shall be considered as borrowings made by the state itself for the purpose of issuing the consent under Article 293(3) of the Constitution of India.”

Why deficit?

From 2017 onwards, Kerala has engaged in off-budget borrowing mainly through the Kerala Infrastructure Investment Fund Board (KIIFB) and the Kerala Social Security Pension Ltd (KSSPL). KIIFB was established in 2016 with the aim of raising finances for the state’s infrastructure initiatives, while KSSPL, introduced in 2018, had a similar purpose of generating funds for social security welfare pensions.

According to the above letter, the off-budget borrowings undertaken by KIIFB and KSSPL, while not being accounted for in the state budget, contribute to reducing the state’s maximum borrowing limit.

Kerala Finance Minister KN Balagopal told the Assembly: “This situation would have negative repercussions on the state’s already strained financial situation, limiting its ability to borrow funds. The state government has demanded the exclusion of off-budget borrowings by public entities from the state’s annual borrowing cap. Kerala has persistently urged the Union government to raise its borrowing limit by an additional 1 per cent beyond the prescribed ceiling for the fiscal year 2023-24.”

He added: “Over time, Kerala’s portion of the divisible pool -- the overall tax revenue that is divided between the Central government and the individual states -- among the states has experienced a decline. In the era covered by the 10th Finance Commission, spanning from 1980 to 1985, Kerala’s tax allocation from the divisible pool stood at 3.875 per cent. This proportion diminished to 3.057 per cent during 2000 to 2005. Presently, under the 15th Finance Commission’s tenure, the state’s share has further decreased to 1.92 per cent.

“We strongly disagree with this approach. It is unfair to penalize us for achieving a high index. This is resulting in a substantial loss of revenue for the state, totaling tens of thousands of crores. Kerala boasts the highest human development index when compared to other states. Ironically, states that allocate significant resources for citizen development are facing punitive consequences,” said Balagopal.

Kerala’s appeal

The state government has appealed to the Central government to permit a “special borrowing expansion” of 1 per cent of the Gross State Domestic Product (GSDP) beyond the established ceiling for fiscal 2023-24 in light of the state’s resource deficit.

Centrally sponsored schemes are presently categorized into two groups: core of the core schemes and core schemes.

Under the first category, the Union government provides 90 per cent of the funding; however, the quantity of projects within this classification has decreased. In the projects classified as core schemes, the states are required to bear 40 per cent of the financial responsibility.

According to the Kerala finance minister, this requirement exacerbates its fiscal limitations. “The state has been advocating for a change in the ratio of funding for centrally sponsored schemes in the core category, proposing an increase to 75 per cent from the current 60 per cent. Nonetheless, the Union government has not yet shown support for this request,” said Balagopal.

The limit set by the Union government on the open market borrowings which is approximately Rs 7,000 crore less than the state’s anticipation is another area of concern for the Left government. This development deals a significant blow to a government that relies on borrowing to cover even day-to-day expenditures.

Kerala fumes

‘‘It has been decided by the competent authority in the Government of India to accord consent to the government of Kerala under Article 293 (3) of the Constitution to raise open market borrowing of Rs 13,390 crore under proposed borrowing programme of the state for 2023-24.” (A borrowing of Rs 2,000 crore permitted at the start of 2023-24 fiscal would be added to this amount, taking the total to Rs 15,390 crore,” reads the union finance ministry’s communique.

The Kerala finance minister said: “All together Kerala is literally facing financial sanctions from the Centre. We are paying around 70 per cent of the revenue to the Union government and less than 30 per cent of the revenue is coming from their side. There is a sharp disparity and it is discrimination.”

On the other hand, acknowledging that the state of Kerala’s public finances as critical, VD Satheesan, the Leader of Opposition, attributed the current situation to the policies pursued during the first term of Chief Minister Pinarayi Vijayan’s government. Specifically, he pointed fingers at the off-budget borrowing carried out by the Kerala Infrastructure Investment Fund Board (KIIFB) as the cause of the state’s financial challenges.

Not only the fiscal autonomy of the state has become a significant political concern, but also the state government is mulling over the possibility of challenging the Union government’s attitude in the Supreme Court, raising the crucial question of whether the New Delhi possesses the authority to decrease the borrowing cap of the states.