To say that Kerala is going Sri Lanka's way would be far-fetched.
The debt-GDP ratio that saw Sri Lanka collapse into civil unrest was a stupendous 120 per cent; meaning the debt was higher than even the GDP of the country.
Kerala's debt-GSDP (Gross State Domestic Product) for 2021-22, on the other hand, was 36.98 per cent.
Nonetheless, this can be considered reassuring only in comparison to Sri Lanka.
Fact is, Kerala's debt situation is the worst in the country after Punjab's.
Based on data for the year 2020-21, an RBI-supervised study 'State Finances: A Risk Analysis' has ranked Kerala among the top five most indebted states in India; the others being Punjab, Rajasthan, Bihar, and West Bengal.
There is no immediate risk of a 'Sri Lanka'-like fiscal paralysis in Kerala, yet the study supervised by RBI deputy governor Michael Debabrata Patra has identified symptoms that hint that Kerala will find the mounting debt impossibly stressful if corrective measures are not put in place.
The situation seems more dire than even the study suggests. The RBI-supervised study projects Kerala's debt stock to surge by seven per cent in seven years; from 31.3 per cent in 2019-20, the pre-COVID fiscal, to 38.2 per cent of the GSDP in 2026-27.
As it turned out, this dangerous fattening happened in just a year. In 2020-21, the first COVID year, Kerala's debt soared to 37.18 per cent. And it has not shown any signs of climbing down from this high perch.
The only saving grace for Kerala is the virtual absence of expenditure on what has been called "non-merit freebies" like blanket loans and electricity bill waivers. Otherwise, all other fiscal indicators of Kerala that measure fiscal vulnerability have crossed the danger mark.
India's worst fiscal deficit
Take, for instance, the most obvious indicator, the fiscal deficit. The average for Indian states is 2.5 per cent, which is lower than the Fiscal Responsibility legislation (FRL) ceiling of 3 per cent. In 2021-22, Kerala's fiscal deficit was 4.17 per cent, the worst even among the five most indebted states in the country.
Kerala's interest payments are the other major source of fiscal stress. The RBI-supervised study found that the interest payment to revenue receipts (IP-RR) ratio (a measure of debt servicing burden on states’ revenues) in eight of the most highly-stressed states in India was more than 10 per cent.
Kerala's IP-RR ratio, in 2020-21, was 18.8 per cent, the fifth-worst in the country after Punjab (21.3%), Tamil Nadu (21%), Haryana (20.9%), and West Bengal (20.8%).
Burgeoning committed expenditure is the other big bane of Kerala. Committed expenditure, which includes interest payments, salaries, pensions and administrative expenses, accounts for a significant portion of the total revenue expenditure of states. For Kerala, it is 38.8 per cent, the worst in the country after Punjab (47.1%).
At 3 per cent of the GSDP, Kerala's pension commitment is the highest in the country.
Forever depleting coffers
An unbridled increase in expenditure is not even remotely offset by revenue.
Kerala and Haryana are the only states that depend on own tax revenue (OTR) for more than half of their total revenues. Kerala's own tax revenue forms 53.5 per cent of its total revenues. As for Haryana, it is 65.4 per cent.
However, the study says that Kerala's OTR, in contrast to even a poor performer like Haryana, was showing a decline over the years, which according to experts is a sign of administrative inefficiency.
The decline in OTR, the study says, increases the state's dependence on market borrowing. Though GST revenues have touched record levels nationally, this buoyancy is not reflected in Kerala's tax collection.
Burden called KIIFB
According to the study, Kerala's contingent liabilities too have been piling on the debt. Contingent liabilities are the contractual obligations of the government to pay in the event of a default by the borrower, like the Kerala Infrastructure Investment Fund Board (KIIFB) or KSRTC or KSEB.
What was 2.5 per cent in 2017-18 has incrementally risen to 3.9 per cent in 2020-21. With KIIFB all set to step up investments in this COVID restoration phase, contingent liabilities are all set to balloon.
Calling Thomas Isaac's bluff
Given the situation, it is no surprise that Kerala's debt has long gone out of control.
The study says that Kerala had exceeded the debt target fixed by the 15th Finance Commission in 2020-21 itself. The 15th FC had said that the states should bring down their debt from 33.1 per cent of GDP in 2020-21 to 32.5 per cent by 2025-26. In 2020-21, Kerala's debt was 37.13 per cent of the GSDP.
Fiscally adventurous economists like T M Thomas Isaac, Kerala's former finance minister, have justified high borrowing on the basis of the Domar Gap condition, which essentially says that debt is sustainable as long as the real interest rate is below the real GSDP growth of the state.
If Domar Gap is used as the measure, Kerala debt has generally been sustainable. Except for the COVID fiscal of 2020-21, when the GSDP growth turned negative for the first time ever (-3.1%), Kerala's GSDP growth rate has consistently stood far above the average interest rate.
However, the RBI-supervised study introduces a formula evolved by the IMF called the Fiscal Reaction Function (FRF) to assess debt sustainability and as per this formula, Kerala's debt is unsustainable.
At a very basic level, the FRF is about the relationship between the primary balance (the difference between the government's revenue and its non-interest expenditure) and debt. If the primary balance increases along with the debt, it indicates debt sustainability because it means the debt creates a primary surplus that can be used for repayment.
In the case of the five most indebted states, including Kerala, the study found an inverse relationship between primary balance and debt. Meaning, that when debts expand in Kerala, its primary balance shrinks.
Further, it was found that especially for Kerala, the rate of growth of public debt was higher than the GSDP growth. In the last five fiscals, when average GSDP growth was below 10 per cent, Kerala's debt grew by an average of 14 per cent.
Parting shot
By way of conclusion, the study says: “In the long term, increasing the share of capital outlays in the total expenditure will help create long-term assets, generate revenue and boost operational efficiency.”
