Why in the News?
Kerala and Tamil Nadu recently released White Papers describing their outstanding government debt as alarming. This has revived the debate on whether State debt reflects fiscal mismanagement or a structural mismatch between States’ welfare responsibilities and their limited fiscal capacity.
Why do State governments face a persistent fiscal squeeze despite bearing the bulk of welfare spending?
- Vertical fiscal imbalance: The Union government holds the larger share of taxation powers. State governments bear a larger share of overall government spending. Vertical fiscal imbalance: mismatch between a government tier’s revenue powers and its expenditure responsibilities.
- Welfare-heavy State budgets: State spending is concentrated in health, education, agriculture, and irrigation. These sectors directly affect livelihoods.
- Kerala and Tamil Nadu’s social spending record: Per capita State social expenditure was 30% higher in Kerala and 20% higher in Tamil Nadu than the all-India average (2020-23). It was 35% lower in Bihar and 40% lower in Uttar Pradesh.
- Kerala’s own tax effort: Kerala’s per capita own-tax revenue was 1.5 times the national average, driven mainly by SGST and sales tax.
- Skewed devolution: Kerala received 1.92% of Union tax devolution in 2023-24. Its population share was 2.6%.
- Composition of Kerala’s expenditure: Salaries took up about a fifth of the budget, pensions 15.3%, and interest payments 16.5%. Only 10% of expenditure went to capital expenditure. Capital expenditure: spending that creates productive assets, as against revenue expenditure on salaries, pensions and subsidies.
Does Kerala’s fiscal stress reflect mismanagement, or an unresolved conflict between protecting welfare gains and financing future growth?
- The retrenchment trap: Cutting pensions or retrenching employees would create fiscal space. It would also erode Kerala’s social sector strengths.
- The investment deficit: Kerala needs large-scale, State-directed investment in infrastructure, higher education, research, and public transport. This investment is necessary to compete in knowledge-intensive sectors.
- Outmigration of talent: Educated youth are leaving Kerala in large numbers. The State cannot create matching educational and employment opportunities.
- The affluence paradox: Kerala’s weak public fiscal capacity coexists with visible private affluence, large houses, expensive cars, and a high density of gold shops. This gap threatens to widen inequality.
Is Kerala’s fiscal constraint a resource problem or an allocation problem?
- Low credit-deposit ratio: Kerala’s credit-deposit ratio was around 66% in 2023. The national average was 76%, and Maharashtra and Tamil Nadu exceeded 100%. Credit-deposit ratio: share of a bank’s deposits that it lends out as credit in the same region.
- Unutilised savings: Deposits in excess of credit disbursed in Kerala rose from ā¹1,388 billion in 2016 to ā¹1,906 billion in 2020 and ā¹2,792 billion in 2026.
- Foregone investment: Kerala’s actual public investment stood at ā¹1,134 billion. Potential additional investment financeable from this surplus stood at ā¹1,404 billion.
- Doubling potential: Kerala’s capital expenditure could have at least doubled between 2016 and 2026 had surplus savings been channelled into investment.
What does China’s local government financing model reveal about the limits of India’s system?
- China-local government bonds (LGBs): Chinese provinces and lower-level governments finance the bulk of investment-led growth through local government bonds. These draw on large domestic bank savings.
- China-local government financing vehicles (LGFVs): Off-budget borrowing through LGFVs supplements fiscal transfers. LGFV: an entity set up by a local government to raise off-budget debt for infrastructure projects.
- China-centrally coordinated planning: Local borrowing and investment are coordinated through central government planning, keeping decentralised borrowing aligned with national goals.
- China-low cost of local borrowing: Chinese local governments borrow from their banking system at around 2%.
- India-costlier State Development Loans (SDLs): Indian States pay 6.5% to 7.5% interest on SDLs. SDL: a market security issued by State governments to raise loans. This rate is 0.25 to 0.75 percentage points higher than the Union government’s borrowing rate.
Should State debt be treated as a liability or as an investment in citizens?
- Domestic ownership of debt: State and Union bonds are largely held by domestic commercial banks and insurance companies.
- Debt as debt to own people: These institutions channel citizens’ savings into government bonds. The government’s debt is effectively owed to its own people, not external creditors.
- Welfare-expanding borrowing: A government that borrows to expand welfare and opportunity serves a larger public purpose than a tight-fisted government.
- The reform gap: No fiscal structure currently allows State governments to access domestic savings easily and cheaply for planned development projects.
Conclusion
State government debt is not primarily a symptom of profligacy. It reflects a structural mismatch between the Union’s concentration of taxation powers and States’ disproportionate share of welfare and development spending. India worsens this mismatch, unlike China, by failing to channel abundant domestic savings into cheaper, State-directed investment. Fiscal reform must lower the cost and ease the terms of State borrowing, not merely discipline State expenditure.
PYQ Relevance
[UPSC 2015] Though the federal principle is dominant in our Constitution and that principle is one of its basic features, it is equally true that federalism under the Indian Constitution leans in favour of a strong Centre. Discuss.
Linkage: It examines the constitutional design of Indian federalism, including financial powers and Centre-State fiscal relations. The article argues that States bear major expenditure responsibilities but have limited revenue and borrowing autonomy, highlighting the fiscal imbalance within India’s federal structure.
