Race to the bottom

Elections are a fascinating part of the dance of democracy, and in a country like ours they are the rare occasions when the ordinary citizen matters to the politician. Elections also serve to give voice to the hopes and aspirations of the common people. In recent times, however, electoral politics has seen the growing spectre of reckless populist schemes in the hope of influencing the voter, with political parties jostling to give away goods and services free. Such freebies make no distinction between those who can afford to pay for the goods and services given and those who cannot, betraying poor judgement on who should benefit. Such populism has significant fiscal consequences because they distort prices and misallocate resources. The negative fiscal impact of such politically expedient allurements is deep and enduring and can seriously jeopardise the long-term prospects for real progress for the poor. Worse still is the domino effect, resulting in political parties, in state after state, resorting to similar populism. In the longer term, this undermines the process of democratic deliberation and legislating public policy. Sadly, no political party is an exception to such deception, and are all engaged in a race to the bottom.

Introducing a subsidy or offering public goods for free is intrinsically inefficient and welfare-diminishing. Besides having negligible effect on improving the human condition, these freebies only exacerbate the role of intermediaries and create the double jeopardy of moral hazard and adverse selection. The politics of largesse never considers the costs associated with financing and distributing a subsidy or giving a freebie. Politicians assume that programme delivery is without costs, which is never the case.

Identifying legitimate recipients of subsidies and implementing subsidy programmes without widespread leakages bleeding the budget is often impossible. Consider the spate of so-called welfare measures that have come into play in the backdrop of the recently concluded Karnataka elections: the 17% salary hike for government servants announced by the BJP government, even before the duly constituted Pay Commission gave its recommendations; and the five guarantees announced by the Congress party that they believe brought them back to power. Together, they will weigh down the state finances by about Rs 70,000 crore per year, or approximately 30% of the state’s annual revenues. Karnataka will be hard pressed to maintain fiscal sustainability over the short to medium term.

A recent RBI report on the fragility of state finances points out that new sources of risks have emerged in the form of rising expenditure on non-merit freebies, expanding contingent liabilities, and the ballooning overdue of the electricity distribution companies across the country. The slowdown in own tax revenue, a high share of committed expenditure, and rising subsidy burdens have stretched state government finances already exacerbated by Covid-19. With a series of state elections -- Rajasthan, Madhya Pradesh, Chhattisgarh -- due later in the year, followed by Lok Sabha elections next year, the surge of politically motivated freebies will push states down the slippery slope of fiscal crisis.

It is imperative, therefore, to turn the spotlight on the fiscal risks confronting state governments in India, especially the debt burdened states. When analysed across a panel of fiscal vulnerability indicators: Debt-GSDP ratio indicating unsustainable debt burden; GFD-GSDP ratios more than 3%, besides a rising revenue deficit; the interest payments to revenue receipt ratios more than 10% in as many as 10 states that have emerged as highly fiscally stressed states. The other states are not much better off. 90% of the expenditure in these states is on the revenue account, severely compromising the quality of expenditure, with poor capital or asset creating outlays. Committed expenditure on debt servicing, salaries and pensions, and administrative expenditure preempts over 35% of total revenue expenditure, leaving little fiscal room to undertake development expenditure.

The unsustainability of public debt at sub-national levels is a clear and present danger. The politics of handing out cash subsidies, provision of free utility services, proposals for reintroducing the old pension scheme, and extension of implicit and explicit guarantees by various state governments in India, simply means that precarious fiscal vulnerability hangs over many states like the sword of Damocles.

In this backdrop, it is important to distinguish a freebie from a genuine welfare-enhancing scheme. For instance, expenditure on public/merit goods result in economic benefits for the poor and the disadvantaged. Good examples are expenditure on education and health, employment guarantee, skill development, and food security. On the other hand, provision of free electricity, free water, free public transportation, unemployment dole, loan waivers, and waiver of pending utility bills undermine incentives for development, distort prices, weaken the credit culture, erode incentives for private investment, and disincentivise work at the current wage rate, leading to a drop in labour force participation.

State governments must re-prioritise their expenditure to achieve optimum long-term welfare advantages. Urgent corrective measures are necessary. State governments must restrict expenditure on non-merit goods in the near term. In the medium term, efforts must aim to stabilise debt levels. Reforming the electricity distribution sector to reduce losses and make it financially sustainable and operationally efficient should be a priority. In the long term, increasing the share of capital outlays in the total expenditure will help create long-term assets, generate revenue, and give impetus for economic growth. A third of the states in India show warning signs of building unsustainable fiscal stress. It is therefore important that risk mitigation strategies to manage fiscal risks efficiently receive the policy attention that it deserves.

In any crisis, especially a fiscal crisis, it is the poor and the disadvantaged populations that endure the worst deprivation. Political expediency should not mean that you sow the wind of freebies and reap the whirlwind of fiscal crisis. The recent economic crisis in Sri Lanka serves as a grim reminder of the critical importance of public debt sustainability. Chief Ministers of states must show sagacity and leadership to steer state finances toward sustainability and demonstrate that good economics is, in fact, good politics.

(The writer is Director, School of Social Sciences, Ramaiah University of Applied Sciences)