When I stepped down as the finance minister of Kerala, there was one issue that I found very embarrassing. On the last day of my final financial year as finance minister, the Kerala treasury had a cash balance of Rs 3,880 crore. A part of it was spent on the pending bills in the course of April. Still the treasury at the end of April had a cash surplus of around Rs 2,500 crore.
Normally, a finance minister should feel happy about this. I was embarrassed, because in my first budget in 2006, I had devoted a couple of pages to analyse the phenomenon of the cash surplus of the states that totalled around Rs 48,000 crore. Kerala was an outlier with a negative cash balance, i.e. dependent on ways and means advance and occasionally slipping into overdraft. I tried to make a virtue of the Kerala situation. Overdraft should be avoided, but it made no sense to have a cash surplus. My declared goal was to spend. So that Kerala should always remain a non-cash surplus state.
When there is a surplus balance in the treasury, the Reserve Bank of India invests the surplus in the intermediate treasury bills of the Union government on behalf of the state. The investments of the states in these 14-day intermediate treasury bills earn a return of 5% per annum. However, the average cost of mobilization of funds by the states is much higher. It ranges between 9.5% for small savings to 7.5% in open market borrowings. This has enabled the Union government to make profit through positive spreads from the state’s cash surpluses. This situation implies that cash surplus results in a reverse transfer of resources from the states to the Union government. It also eases the ways and means problem of the latter.
The cash surplus of the states sharply declined during recession. Now it has once again crossed the Rs 1 trillion mark. It makes no sense to have such a large amount of money lying unutilized in state treasuries. There is so much that needs to be done to ensure decent human existence to our citizens in schooling, healthcare, drinking water, housing, connectivity and so on. Why are the states not spending? The then Union finance minister speaking in the Lok Sabha made it out be a governance issue. The states were incapable of spending.
This taunt prompted me to publish a paper in the Economic and Political Weekly (2 December, 2006) titled “Why do the States not Spend?” along with R. Ramkumar from the Tata Institute of Social Sciences. We argued that the constraint on revenue expenditure imposed by the Fiscal Responsibility and Budget Management Acts is responsible for this perverse phenomenon. State governments, even if they have cash surpluses in their treasuries, are unable to spend on welfare or social infrastructure because they have to meet certain fiscal targets. They cannot by law have a revenue deficit. Thus, we have the curious phenomenon of some of the most backward states—where majority of the people lived a sub-human existence—using cash surpluses to reduce their debt stock.
Take the predicament faced by Kerala. It is one of the few states that fail to adhere to the fiscal consolidation part. During the last five years, it always had revenue deficit of 1.5-2%. Fiscal experts, particularly of the neo-liberal persuasion, have made much of this. They forget that the revenue deficit is partly an accounting phenomenon. Government of Kerala gives more than Rs 2,000 crore as plan grant to local governments. This amount cannot be used for any salary payment, routine maintenance or non-development expenditure; 50-60% of the funds are clearly capital expenditure. But given the accounting practices, the entire amount is treated asrevenue expenditure.
Further, there are certain conceptual issues. Investment in physical infrastructure such as roads, bridges and buildings are considered capital expenditure. Why should investment in social infrastructure be treated as revenue expenditure? Kerala, it may be remembered, has historically chosen a path of heavy investment in social infrastructure. Rule-based fiscal governance disregarding the aspects such as above has very little theoretical basis.
Nevertheless, Kerala will have to reach the fiscal target of zero revenue deficit within the next two years. Otherwise, it will be penalized by the denial of special grants recommended by the 13th Finance Commission. What does this imply? Two years from now, the entire borrowing of state governments will have to be year-marked for capital expenditure. It means that sanctions must be given for such capital works today so that the bills would mature for payments two years from now. However, as per the state government budget rules, sanction can be given for works only up to 150% of actual provision made in the state budget. What is relevant is not money at hand, but what would be available in the future.
T.M. Thomas Isaac is a former finance minister of Kerala
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