In today’s Finshots, we explain how the state ended up in a spot of bother and why it is unhappy with the central government.

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Now let's dive in.

The Story

Kerala took the Central government to the Supreme Court with a first-of-its-kind case. And things are getting ugly.


Well, Kerala is in the throes of a financial crisis. It defaulted on salary payments to more than half of the 5.15 lakh employees. It delayed payments of pensions to retired personnel. At one point, even police vehicles were shooed away from fuel pumps because the dues hadn’t been cleared.

Yup, things were that bad.

And the state is blaming its current predicament on the Central government.

But why, you ask?

Well, let’s take it from the top.

Now the first thing you need to know about Kerala is that it’s what some experts call a chronic revenue-deficit state.

See, Indian states get revenue from a few sources — they have excise duty on things like alcohol, they tax vehicles, there’s tax on property, tax on electricity, and there’s state GST (since 2017) as well as a share from the central pie. This is the revenue receipt.

And states use this revenue to first meet their committed expenses — things like salaries, pensions, welfare schemes, and interest payments. All of this is part of the revenue expenditure because it’s like maintenance spending and does not create any assets.

Ideally, states would love it if they can keep this kind of spending to a minimum. That way, they don’t need to borrow money to invest in building infrastructure like roads which have a long-term multiplier effect.

But the problem is that Kerala’s committed expenses have typically always been on the higher side — it is 71% of its revenue receipts when compared to other states which average below 60%. So it doesn’t have too much leeway to invest in infra projects that can generate more jobs and revenues.

Sure, that looks bad. But as per some reports, it’s simply because Kerala has invested heavily over the years in social sectors like education and healthcare. These sectors are personnel-heavy. And that has led to more cash pressure on the state.

Heck, it’s because of all this spending that a child born in Kerala has a better chance of surviving to age 5 than in the US. You can bet that other states in India can’t boast of such stats. So maybe you can excuse the spendthrift behaviour.

But not everyone agrees with that justification.

They say that if you want to spend money, you need to figure out a way to make more money as well.

And that’s where Kerala has struggled. While the state has a per capita GDP that’s 1.6 times higher than the Indian average, when it comes to the tax-to-GDP ratio, it’s at par with the rest of the country. It simply hasn’t been able to earn a higher share of revenue from taxes.

As one paper put it, “[Kerala] ‘competes’ with the Scandinavian countries as regards social protection with African level taxation.”

And the end result of this is that the state has been in financial trouble for years now.

So, why did Kerala blame the Centre and take the government to the Supreme Court all of a sudden?

Ah, that’s because Kerala alleges that the Central government’s new rules have compounded its woes even further.

The bone of contention is something called the Net Borrowing Ceiling (NBC) rule imposed by the Central government. Think of this as a diktat on how much money a state government is allowed to borrow to meet its needs. Mathematically, it’s 3% of a state’s GDP. And Kerala’s NBC was pegged at a little over ₹32,400 crores for FY24.

But here’s the deal now. Kerala has a state-owned enterprise called the Kerala Infrastructure Investment Fund Board (KIIFB). And this entity finances the infrastructure in the state. Until now, its debt was not considered under the State’s borrowing limit. So Kerala could freely fund its infra needs outside the ambit of the NBC. It was called an off-budget borrowing

Sidebar: Even the Central government has used the National Highways Authority of India (NHAI) in this manner.

But then, the Finance Commission closed this loophole in 2021 and Kerala’s problems multiplied. Suddenly, all of KIIFB’s debt was included in the state’s borrowing too. And Kerala found that its NBC was closer than it appeared. Its borrowing avenues were shut.

And when it asked the Central government for help, it was turned away.

Now Kerala says this violates Article 293 of the Constitution which says that public debt of a state is its own matter and not something the Parliament should have control over. So it took the matter to the Supreme Court.

And what did the Supreme Court say?

Well, we don’t have an answer yet. Since it’s the first case of its kind, we’re soon going to have a five-judge Constitution Bench set up by the Chief Justice of India to look into this matter. But that’s going to take some time.

And in the meantime, Kerala’s financial woes continue.

PS: Kerala has also complained that just because the state has a high per capita income, it is being penalised by getting a lower share of tax revenue from the Centre. This has reduced its revenues already. It’s something Karnataka has protested about too.

Until then…

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