Managing State Finances: States Under ‘Severe Stress’, Says Kerala FM Thomas Isaac

The economic slump that India finds itself in the midst of has led to ‘severe’ pressure on state finances and the government’s decision to cut corporate tax rates hasn’t helped, said Thomas Isaac, finance minister of Kerala.

According to Isaac, poor implementation of the goods and services tax along with a series of GST rate cuts and now the corporate tax cut has led to a dwindling of revenues. The delays in transferring GST compensation due to states has only added to the pain.

The situation is worse for states for two reasons, Isaac told BloombergQuint in a recent interview. “One, the share in the central taxes; that is drastically going down because of all these tax breaks and corporate tax cuts as 42 percent belongs to states. So, the central transfers are declining. Add to that, the GST is not growing, not only for the centre but also the states,” said Isaac.

For Kerala, this has meant that revenue growth has fallen to less than 10 percent, while expenditure is growing at 15-16 percent, Isaac said. “This is a big gap.”

The shortfall in revenue will likely mean an uptick in the state’s fiscal deficit for 2019-20. As per its budget projections, Kerala was targeting a fiscal deficit of 3 percent and a revenue deficit of 1 percent. These projections will likely go awry unless the state cuts spending significantly.

Spending Off-Budget

One way in which Kerala hopes to keep spending to support the state’s economy is a route that has generated considerable controversy.

The state-backed Kerala Infrastructure Investment Fund Board, which was set up by as a body corporate, is raising funds for infrastructure investment. Apart from raising money through the domestic bond markets, KIIFB has also raised funds internationally using masala bonds. The move raised eyebrows as state governments aren’t allowed to raise funds outside the Indian borders. However, since KIIFP is a body corporate, the state believes the route is open to it.

The nearly Rs 45,000 crore investment plan approved to be routed via KIIFB is rousing ‘animal spirits’ in the state at a time of recessionary conditions, Isaac said.

While the spending will help the state’s economy, it will add to its liabilities via increased guarantees. According to the RBI’s latest report on state finances, outstanding guarantees for Kerala have risen over the last few years and stood at Rs 17,365 crore in 2017-18. Data beyond that was not available.

High Debt Burden

Kerala is also saddled with a relatively high debt burden

The state’s outstanding liabilities as a percentage of gross state domestic product are pegged at 30.8 percent for FY21, shows the RBI’s state finances report. Historically, too, the state’s debt-GSDP ratio has remained above 30 percent, even though it declined below that for a few years between 2012 and 2015.

At current levels, the state’s debt is above the 20 percent level that an FRBM review committee had earmarked for total state debt. The committee, headed by NK Singh, had suggested that total government debt be brought down to 60 percent by FY23, with central government debt restricted to 40 percent and state debt to 20 percent.

Will Kerala need to bring down its own debt levels to meet those benchmarks? Isaac disagrees.

Centre-State Fiscal Relations

Isaac, who has been among the fiercest critics of the central government’s management of centre-state fiscal relations over the last few months, also cautioned the Fifteen Finance Commission against over-stepping its mandate.

His comments come at a time when the Commission’s recommendations are awaited. The terms of reference provided to the Commission, including a recent addition asking the panel to look into the feasibility of a separate financing pool for national security, has caused concern across states.

Isaac hopes the Finance Commission will keep the states’ concerns in mind and not reduce the 42 percent devolution of taxes to states provided for by the Fourteenth Finance Commission.

“My biggest worry is that they should not reduce the 42 percent (devolution to states).... It cannot be reduced, it is politically damaging. So therefore, they are trying it the other way around. Reduce the divisible pool itself.... That is the centre’s problem. The centre should provide for defence,” Isaac argued.

Watch the full interview with Kerala FM Thomas Isaac:

This is the second part in a BloombergQuint series on ‘Managing State Finances’.