Whither Karnataka’s fiscal discipline?

The prevailing fiscal profligacy is a threat to the state's progress.

In a broad sense, fiscal discipline can be understood as the practice of controlling deficits and debt to prevent their adverse effects on the economy. Karnataka took a pioneering step in promoting fiscal discipline by enacting the Karnataka Fiscal Responsibility Act (KFRA) in 2002, preceding the Centre’s Fiscal Responsibility and Budget Management Act, 2003. The KFRA stipulated that the state achieve a revenue surplus and keep the fiscal deficit within 3% of GSDP. Additionally, a limit of 25% of GSDP for outstanding liabilities was introduced in 2005. Karnataka strictly adhered to the provisions of KFRA, except during the Covid-19 pandemic.

Revenue Deficit

Karnataka attained a zero revenue deficit in 2004–05, ahead of the target year of 2006–2007, and subsequently achieved a small revenue surplus. Although this surplus was small and began to decline, achieving a zero revenue deficit was an achievement in itself. The revenue deficit reappeared, amounting to Rs 6,931 crore in 2020–21. Thereafter, it started declining, with a revenue surplus also achieved in 2022–23. Nonetheless, the revenue deficit reappeared in 2023–24, surpassing the budget estimate of Rs 12,522 crore to Rs 13,951 crore in the revised estimate. The budget estimate for 2024–25 has placed it at a whopping Rs 27,353 crore, an increase of Rs 13,402 crore over 2023–24. A revenue deficit of this order is unprecedented in Karnataka. This surge in revenue deficit is primarily due to the expenditure incurred on fulfilling the five pre-election guarantees. If revenue falls short of the budget estimate and expenditure increases due to the implementation of the 7th Pay Commission recommendations, the revenue deficit may increase further. A rise in the revenue deficit implies an increase in the diversion of borrowed funds to meet expenditures that do not contribute to asset creation. It is also noteworthy that while revenue expenditure has seen growth, there has been no corresponding increase in capital expenditure. In fact, the estimated capital expenditure for 2024–25 is lower by Rs 4,446 crore than the actual capital expenditure for 2022–23. The percentage share of capital expenditure in total expenditure has declined from 19.5% in 2020–21 to 16.6% in 2023–24 and further to 15% as per the budget estimate for 2024–25.

Fiscal Deficit

KFRA stipulates that the fiscal deficit should not exceed 3% of GSDP. The state achieved this target in 2004–05 and maintained it until 2020–21. In 2021–22, the fiscal deficit increased to 3.5% of GSDP due to the pandemic. Despite the 15th Finance Commission allowing the state to raise its fiscal deficit to 4% of GSDP in 2021–22, Karnataka limited it to only 2.84% of GSDP. Similarly, for 2022–23, the state was allowed to increase the fiscal deficit to 3.5% of GSDP, but it managed to restrict it to 2.62%. Thus, the state’s record in maintaining fiscal discipline was commendable.

The budget estimate for 2023–24 placed the fiscal deficit at 2.60%, but it increased to 2.67% of GSDP according to the revised estimate for the year. The budget estimate for 2024–25 has placed it at 2.95%. But this is no reason to become complacent, as the estimated fiscal deficit for 2024–25 is very close to the mandated limit, and it may be exceeded if there is any shortfall in revenue realisation and an increase in expenditure. In absolute terms, the fiscal deficit increased from Rs 46,622 crore in 2022–23 to Rs 68,505 crore in 2023–24 as against the budget estimate of Rs 66,646 crore, and for 2024–25, it is estimated at Rs 82,980 crore, a big jump over the fiscal deficit in the previous two years. Gross borrowing is estimated to increase from Rs 85,818 in 2023–24 to Rs 1,05,458 crore, an increase of Rs 19,640 crore over the current year, which again is an unprecedented rise.

Outstanding Liabilities

As the government continues to borrow year after year, net borrowing adds to the debt stock, leading to a continuous increase in total liabilities. Karnataka’s outstanding liabilities rose from Rs 5,22,847 crore in 2022–23 to Rs 5,81,28 crore in 2023–24, with a projected increase to Rs 6,65,095 crore in 2024–25. As a percentage of GSDP, outstanding liabilities will increase from 22.64 in 2023–24 to 23.68 in 2024–25. While this is below the mandated limit of 25% of GSDP, there is uncertainty about whether this trend will persist given the current borrowing practices.

In conclusion, with an unprecedented revenue deficit of Rs 27,353 crore, a fiscal deficit of Rs 82,980 crore, gross borrowing of Rs 1,05,458 crore, and a declining share of capital expenditure estimated for 2024–25, fiscal discipline has suffered a setback in Karnataka. The prevailing fiscal profligacy is inimical to the state’s progress.

(The writer is a former professor of economics at the University of Mysore and a former member of the Karnataka Tax Reforms Commission)