growth effects of fiscal policy management in …
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Research Report No.1/2019-2020
Kengeri Post, Bangalore-Mysore Road, Bengaluru-560060
Phone: +91 80 26971000, Fax: +91 80 26971010,
e-Mail: director[at]fpibangalore[dot]gov[dot]in
Research Report
on
GROWTH EFFECTS OF FISCAL POLICY MANAGEMENT IN
KARNATAKA:
ROLE OF PUBLIC DEBT
Dr. Aneesha Chitgupi
Research Fellow
June 2020
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Abstract
The report presents an overview of the trends by various fiscal indicators in general and public
debt in particular. Deterioration in fiscal targets such as fiscal deficit, interest payments and public
debt is observed post-2015-16. The analysis finds that in the medium term (2024-25 to 2028-29),
nearly 69 per cent of the total existing market loans would become repayable. Also, more than 50
per cent of the total market loans have 8-8.99 per cent interest rate associated with them.
The inter-temporal budget constraint analysis highlights that Karnataka has maintained a strong
balance between government expenditure and revenue and short-run deviations due to external
factors such as global financial crisis have been corrected to maintain the long-run equilibrium
path between revenues and expenditures. This is further supported by the fiscal response function
analysis which stated that the business cycle fluctuations had limited significant impact on primary
deficits. The previous levels of primary deficit had a positive and significant impact on current
levels of deficits. This implies the persistence of primary deficit for Karnataka, but because the
primary deficit has been drastically reduced after the implementation of fiscal rules and is
maintained below the fiscal target, its impact is negligible. Also, using the Domar debt
sustainability condition, it was observed that a thrust towards higher economic growth and
increasing levels of GSDP ensures debt sustainability.
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Executive Summary
Karnataka Government was the first State Government which brought into effect the fiscal regulation
legislation known as the Karnataka Fiscal Responsibility Act (KFRA), 2002, with a view of providing
a roadmap to the State Government for fiscal consolidation. The Act along with the objective of
achieving fiscal correctness included the setting of fiscal targets with specific timelines, advocated
greater transparency and dissemination of budgetary information in a timely manner.
The KFRA, 2002 set numerical fiscal targets for the Karnataka Government to be achieved in a
stipulated time period, reduction in revenue deficit to zero and reduction of fiscal deficit to 3 per cent
of GSDP by 31st March, 2006 and outstanding liabilities to 25 per cent of GSDP by 2014-15. It also
mandated the government to release a Medium Tern Fiscal Plan (MTFP), a document mapping the
present fiscal condition of the State finances, along with a projection for the subsequent four years.
The MTFP is required to be tabled before the Legislature every year during the budget sessions. With
a roadmap to guide the State Government on fiscal policy, Karnataka has performed well in restricting
fiscal deficit, the achievement of revenue account balance and the gradual reduction in government
debt well before the set timelines.
Yet, there has been a gradual rise in fiscal deficits and public debt from 2015-16, which provided the
impetus to research and analyse whether this movement in fiscal indicators posed any threat to the
long-run fiscal stability and sustainability of the State Government. Also, the FRBM Review
Committee Report (2017) highlighted the role of public debt in fiscal policy management and
provided new numerical targets for the Centre and State to restrict it at 40 per cent of GDP and 20 per
cent of GSDP respectively. In the light of the fiscal target set by MTFP of the Karnataka Government
and a new outlook prescribed by FRBM Committee Report (2017) to provide focused attention to the
reduction of public debt, the present report analyses the trends, composition and sustainability of
public debt. The main objectives of the report are to assess the sustainability of the public debt of the
State Government through various techniques and analyse the impact of other macroeconomic
indicators such as GSDP growth rate, interest rate, level of fiscal and primary deficits on public debt.
The descriptive analysis highlights that there has been a consistent increase in the levels of public
debt of the State Government, of which there has been a higher share of market loans at considerably
higher rates of interest. It was also found that nearly 69 per cent of these market loans are due to
repayment in the medium term (2024-25 to 2028-29), with half of them with a high-interest rate of 8-
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8.99 per cent. Further, the rolling out of crop loan waiver schemes has an adverse impact on fiscal
deficits and must be undertaken with caution. A large part of this loan waiver announced for farmers’
debt up till 2017 was paid off in 2018-2019 and 2019-20. The change in fiscal deficit on account of
loan waiver was an increase by 38 and 37 per cent when compared to the fiscal deficit without the
waiver for 2018-2019 and 2019-20 respectively.
The Domar condition of debt sustainability highlighted the importance of growth rate remaining
greater than interest rates in achieving long-run debt sustainability. The declining growth rate of
GSDP since 2016-17 poses a challenge for the government to ensure debt sustainability in the wake
of rising fiscal deficits and public debt. With the onset of a pandemic crisis across the world, the fiscal
situation may deteriorate further, due to a decline in economic activity and output.
The inter-temporal budget analysis as well as the fiscal response function highlight that Karnataka’s
revenues and expenditure are cointegrated in the long run, implying that the revenue receipts and total
expenditure do not deviate from one another in the long run which reduces the dependence of
borrowings to pay for increased expenditures. The short-run deviations in these variables are
corrected to achieve the long-run equilibrium path, ensuring debt sustainability in the long run. This
is further corroborated by the fiscal response function analysis which highlights that business cycle
fluctuations which may affect the government expenditure pattern during boom and low growth
periods had limited impact on primary deficits for Karnataka. The estimations underscored that
previous period primary deficits of the government had a strong and significant impact on the present
deficit. Thus, it is essential that the government continues to follow the path of fiscal correctness to
ensure long-run sustainability of public debt and fiscal deficit.
The extension of the Domar debt sustainability condition further highlighted the importance of
maintaining high economic growth of the State for debt sustainability. The analysis states that even
if there is a rise in primary deficits and debt, a high rate of GSDP growth can help achieve public debt
sustainability. In the case of low economic growth, a marginal increase in the interest rate and other
deficits could push the debt into unsustainability.
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List of Chapters
Chapter 1 ....................................................................................................................................... 10
Introduction ................................................................................................................................... 10
Review of Deficits and Debt Management at Centre and State level ....................................... 11
Central Government .............................................................................................................. 11
Role of Finance Commissions .................................................................................................. 13
Fiscal Responsibility Legislation: Karnataka ........................................................................ 15
Chapter 2 ....................................................................................................................................... 17
Review of Literature ..................................................................................................................... 17
Theoretical Literature ................................................................................................................ 17
Empirical Literature .................................................................................................................. 18
International Studies on Debt-Growth Relationship ............................................................. 18
Indian Studies on Debt-Growth Relationship ........................................................................ 18
State Level Studies on Debt Sustainability ............................................................................ 19
Chapter 3 ....................................................................................................................................... 21
Trends in Fiscal Indicators in Karnataka ...................................................................................... 21
Deficits and Debt ....................................................................................................................... 21
Financing Fiscal Deficit ............................................................................................................ 28
Debt Servicing and Interest Payments ...................................................................................... 30
Impact of Loan Waiver Scheme ................................................................................................ 33
Chapter 4 ....................................................................................................................................... 36
Debt Sustainability for Karnataka ................................................................................................. 36
Solvency, Sustainability and Stability ....................................................................................... 36
Domar Model of Debt Sustainability ........................................................................................ 37
Debt Sustainability: Indicator Based Analysis .......................................................................... 40
Inter-temporal Budget Constraint Approach ............................................................................. 41
Fiscal Policy Response Function............................................................................................... 46
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Chapter 5 ....................................................................................................................................... 50
Growth Effects and Fiscal Policy Management ............................................................................ 50
Chapter 6 ....................................................................................................................................... 53
Conclusion and Way Forward ...................................................................................................... 53
Policy Recommendations .......................................................................................................... 54
Possible Extensions and Way Forward ..................................................................................... 55
Appendix ....................................................................................................................................... 56
References ..................................................................................................................................... 57
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List of Tables
Table 1: Policy Targets and Timelines prescribed and enacted under FRBM Act. .................................... 12
Table 2: Components of Capital Receipts, 1980-81 to 2019-20, Karnataka. .............................................. 28
Table 3: Details on Crop Loan Waivers, December 2018 to May 2020, Karnataka. ................................. 34
Table 4: Fiscal Impact of Loan Waiver, 2017-18 to 2019-20, Karnataka. ................................................. 34
Table 5: Domar Condition for Debt Sustainability for period 1981-82 to 2019-20 (BE), Karnataka. ....... 39
Table 6: Indicator based analysis of debt sustainability, 1981-82 to 2019-20 (BE), Karnataka. ................ 40
Table 7: Unit Root Tests ............................................................................................................................. 42
Table 8: Zivot-Andrews Unit Root Test for Presence of Structural Break. ................................................ 43
Table 9: Unit Root Test with Structural Break ........................................................................................... 43
Table 10: Johansen Cointegration Test ....................................................................................................... 44
Table 11: Gregory-Hansen Cointegration Test with Structural Break ........................................................ 44
Table 12: Long-run Coefficient and Error Correction Model. .................................................................... 45
Table 13: Unit Root Test ............................................................................................................................. 47
Table 14: ARDL Estimations: Long Run and Error Correction Coefficients ............................................. 48
Table 15: Debt Sustainability Analysis under Different Scenarios, Karnataka. ......................................... 51
List of Figures
Figure 1: Key Fiscal Indicators, 1990-91 to 2019-20, Karnataka. .............................................................. 21
Figure 2: Contribution to Change in Fiscal Deficit, 2008-09 to 2019-20, Karnataka. ................................ 23
Figure 3: Contribution to Change in Revenue Surplus, 2008-09 to 2019-20, Karnataka. .......................... 24
Figure 4: Total Outstanding Liabilities, 1990-91 to 2019-20, Karnataka. .................................................. 25
Figure 5: Outstanding Public Debt and Public Account Liabilities, 1980-81 to 2019-20, Karnataka. ....... 26
Figure 6: Off Budget Borrowings, 1999-00 to 2019-20, Karnataka. .......................................................... 27
Figure 7: Components of Public Debt, 1990-91 to 2019-20, Karnataka. .................................................... 29
Figure 8: Share of Market Loans in Total Capital Receipts, 1990-91 to 2019-20, Karnataka.................... 30
Figure 9: Interest payments, 1980-81 to 2019-20 (BE). ............................................................................. 31
Figure 10: Components of Interest payments, 1990-91 to 2019-20, Karnataka. ........................................ 32
Figure 11: Maturity Profile of Market loans, as on 31st March 2019, Karnataka. ...................................... 33
Figure 12: Interest Rate Profile of Market Loans, as on 31st March 2019, Karnataka. ............................... 33
Figure 13: Debt Sustainability Analysis under Different Scenarios, Karnataka. ........................................ 52
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List of Abbreviations
BE Budget Estimate
DCRF Debt Consolidation and Relief Facility
DSS Debt Swap Scheme
FC Finance Commission
FRBM Fiscal Responsibility and Budget
Management
FRF Fiscal Reform Facility
FRL Fiscal Responsibility Legislature
GDP Gross Domestic Product
GFC Global Financial Crisis
GoI Government of Karnataka
GoK Government of Karnataka
GSDP Gross State Domestic Product
KFRA Karnataka Fiscal Responsibility Act
MTFP Medium Term Fiscal Policy
MTFRP Medium Term Fiscal Reforms Programme
NSSF National Small Savings Fund
RBI Reserve Bank of India
RE Revised Estimate
TOR Terms of Reference
UDAY Ujwal DISCOM Assurance Yojna
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Chapter 1
Introduction
It is well established that the developing economies pursuing economic growth and development
objectives need to upgrade infrastructure, provide quality education, healthcare and ensure smooth
functioning of the State machinery. Achieving these objectives requires the government to
undertake concomitant expenditures. While government consumption and investment are
essential, the same beyond a threshold can lead to macroeconomic instability and deter economic
growth (Reinhart & Rogoff, 2010). The increased attention towards fiscal indicators in India was
due to the deterioration in fiscal performance during the 1980s and 1990s. The combined fiscal
deficit of the Centre and States (together termed as General Government) reached a peak of 9.3
per cent of GDP during 1990-91 and remained at 9 per cent until 2002-03. The persistent fiscal
deficits called upon drastic measures to instil macroeconomic stability which led to the enactment
of the Fiscal Responsibility and the Budget Management (FRBM) Act of 2003. Many State
Governments followed suit and enacted the Fiscal Responsibility Legislation (FRL) in their
respective States to overcome fiscal slippage and ensure transparency in maintaining State
finances.
A large part of the responsibility of providing for public goods and services and investing in
physical and social infrastructure is borne by the State Governments. Increased dependence on
borrowed resources for developmental expenditure highlights that State Governments find it hard
to match available receipts with the required expenditure. While borrowing for productive
purposes is beneficial in the long-term, the uncontrolled dependence on debt finances can
adversely affect macroeconomic and financial stability (Kaur, Mukherjee, & Ekka, 2018). Since
the adoption of FRBM at Centre and FRL at State level, the overall General Government witnessed
a remarkable improvement.
A deviation from targeted fiscal indicators was observed during the period 2008-2011, with a view
to overcome the negative economic spillovers experienced by the Indian economy due to the onset
of Global Financial Crisis (GFC) both at Centre and State levels. Yet, the divergence between
States’ financial resources and associated expenditure has become serious since 2015-16, due to
issuance of Ujwal DISCOM Assurance Yojna (UDAY) bonds, farm loan waivers and the Seventh
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Pay Commission awards. The fiscal performance of many States indicate greater dependence on
market borrowings with rising interest payments and increasing public debt, thus jeopardizing the
debt sustainability of State Governments in the medium term (RBI, 2019).
Review of Deficits and Debt Management at the Centre and State levels
Central Government
At the central level, since independence, successive Estimate and Public Accounts Committees of
the Parliament have urged the government to fix a ceiling for government borrowings, whereas the
RBI post-1990s has repeatedly advised the Central Government to limit its fiscal deficit and
outstanding debt (Roy & Kothia, 2017). The further deterioration of Central finances during 1999-
2000 led the government to set up a committee to recommend a roadmap for fiscal correction with
Dr. E. A. S. Sarma as its Chairman, who was also the then Finance Secretary. The
recommendations of the committee were submitted to the Central Government in 2000 in the form
of Fiscal Responsibility Legislature Draft (FRL). Its recommendations on deficits (fiscal and
revenue) and debt/total liabilities1 were accompanied by policy targets to be achieved under set
timeframes. The Committee focused on the reduction of fiscal deficit to 3 per cent of GDP by 31st
March, 2006 through 0.33 per cent reduction every year, whereas revenue deficit was to be reduced
to zero for the same period, through a reduction of 0.5 per cent of GDP annually. To curtail the
increasing debt, the committee recommended a debt-to-GDP ratio of 50 per cent of GDP in a
period of 10 years commencing on April 1, 2001.
The FRBM Act (2003) enacted by the Parliament diluted the draft submitted by the Sarma
Committee considerably. (i) Numerical targets laid down were made less stringent and alterable
through a notification in the Gazette of India and (ii) The Escape clauses which restricted the
government from side-stepping the targets was extended to any situation the government felt was
an exceptional circumstance.
1 Debt was defined as the total liabilities of the Central Government on the security of the Consolidated Fund of India,
including external debt (valued at current exchange rates), total outstanding liabilities in the public account of India,
financial liabilities of any body corporate or other entity owned or controlled by the Central Government, reduced by
the cash balance available at the end of that financial year.
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In the year 2017, the FRBM Review Committee (N. K. Singh as Chairman) reviewed the Act over
the past 12 years and proposed a fiscal path in the context of global uncertainty and volatility. The
major recommendations were to repeal the present Act and pass a new Debt and Fiscal
Responsibility Act, highlighting the role of debt in fiscal policy management. The fiscal targets
set by the Committee required the General Government to reduce its debt to 60 per cent of GDP
by 2022- 23 with a ratio of 40 to 20 for Centre and States respectively. The N. K. Singh committee
also proposed to adopt fiscal deficit, a key operational target and restrict it to 2.5 per cent of GDP
by 2022-23 and reduce revenue deficit to 0.80 per cent of GDP in the same period.
During the fiscal period of 2018-19, the FRBM Act was amended through the introduction of new
FRBM frameworks and changes to the FRBM rules. (i) Revenue deficit was no longer a parameter
for measuring fiscal outcomes in the FRBM Act, but shown as a reference indicator in (MTFP)
Statement. The fiscal parameter - total liabilities at the end of the year was replaced with Central
Government debt as a percentage of GDP. The policy targets recommended by the two committees
discussed earlier and the subsequent FRBM Acts are presented in Table 1.
Table 1: Policy Targets and Timelines prescribed and enacted under the FRBM Act.
Report/ Act Fiscal deficit Revenue deficit Debt/liabilities to GDP
EAS Sarma
Committee Report
(2000)
3 per cent zero Total outstanding debt: 50 per
cent
Timeline 31st March, 2006 31st March, 2006 31st March, 2011
FRBM Act (2003) 3 per cent zero Additional annual debt: 9 per
cent
Timeline By 31st March, 2008 By 31st March, 2008
By 31st March, 2005 and
subsequently reduced by one
percentage point thereafter
annually.
FRBM Review
Committee Report
(2017)
2.5 per cent 0.8 per cent Total outstanding debt: 40 per
cent
Timeline By 31st March, 2023 By 31st March, 2023 By 31st March, 2023
FRBM Act (2018) 3 per cent NA Total outstanding debt: 40 per
cent
Timeline By 31st March, 2021 By 31st March, 2025
Source: Author’s compilation.
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Role of Finance Commissions
The Finance Commissions (FCs) have routinely engaged in assessing and monitoring the fiscal
performance of Centre and States, apart from their primary task of recommending resource
transfers aimed at correcting the vertical and horizontal fiscal imbalances equitably and efficiently
(RBI, 2011). The 2nd FC was the first which included recommendations to correct the size of debt
and deficits of the State Governments by reviewing interest rates and repayment of loans to the
Centre by the States. The explicit mention of reviewing the States’ debt was made in the terms of
reference (TOR) of the 6th FC, which was to assess the debt positions of the States with respect to
the Central loans outstanding and its repayment. While the TOR for the subsequent FCs was
focused on the Central loans, the 9th and 10th FCs had broadened the TOR, which included the
review of the overall debt position of the States. Following which, the 11th FC recommended a
scheme known as the States’ Fiscal Reform Facility (FRF) for 2000-01 to 2004-05, with the
creation of FRF Incentive Fund constituted by Government of India to correct the revenue deficits
of the States. This scheme also required the preparation of Medium Term Fiscal Reforms
Programme (MTFRP), which would instruct the States to plan for revenue deficit reduction, public
sector reform, power and irrigation sector reform and fiscal transparency (Gopinath, 2009). The
12th FC noted that the FRF scheme failed to produce the desired reduction in the revenue deficits,
but it was successful in triggering the enactment of the State FRBM Acts to facilitate them in
achieving fiscal consolidation and reform.
The 12th FC recommended for the Centre to reduce its lending activities to the States as the loans
advanced reflected the Centre’s cost of borrowings and thus pushing the States to approach the
market directly. This recommendation was to restrict the role of the Central Government as an
intermediary for future lending and allowing the States to take advantage of the low-interest rates
by borrowing from the markets. In addition, it also recommended a fiscal restructuring plan with
debt relief for the States with the Fiscal Responsibility Legislature (FRL) in place with fiscal
targets as (i) elimination of revenue deficit by 2008-09 and (ii) reducing the gross fiscal deficit to
3 per cent of GSDP in the given period. Based on the recommendations of the 12th FC, the Central
Government brought in (i) Debt Swap Scheme (DSS) (operational from 2002-03 to 2004-05) and
(ii) Debt Consolidation and Relief Facility (DCRF) (effective fiscal 2005-06). The DSS assisted
the State governments to reduce their enlarged burden of interest payments and augment their
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efforts towards fiscal correction. The DSS capitalised on the prevailing low interest and enabled
the State governments to repay the expensive Central Government loans through low coupon-
bearing small savings and open market loans (GoK, 2017). The DCRF allowed the States to
reschedule the Central loans at a reduced interest rate of 7.5 per cent and a complete debt waiver
based on an absolute reduction of the revenue deficit upon the enactment of the FRL. Apart from
debt restructuring and waiver, upon the recommendations of the 12th FC, interest rates on securities
issued to NSSF during 1999-2000 to 2001-02 were reduced to 10.5 per cent from 11.0-13.5 per
cent, further reducing the interest burden of the State Governments.
The 13th FC which was mandated to review and examine the DCRF for the period 2005-10 and
highlight the shortcoming of the same to ensure sustainable fiscal environment consistent with
equitable growth. It recommended a reduction in debt-GSDP ratio to 25 per cent and upheld the
views of the previous 12th FC that the debt relief and interest rate reduction must be extended to
the States that have not yet availed it, subject to the condition that the States that have enacted FRL
and made concerted efforts towards fiscal consolidation. The same was applicable for receiving
interest relief on NSSF. It was the 11th FC that recommended restructuring States’ finances by
having in-built incentives for fiscal discipline and allocating a weight of 12.5 per cent for tax effort
and index of fiscal discipline which was increased to 15 per cent during the 12th FC and
subsequently to 17.5 per cent by the 13th FC (RBI, 2011). This was revoked by the 14th FC which
eliminated fiscal discipline as one of the criteria for devolution of central resources citing better
aggregate performance by the States in adhering to fiscal discipline. It also increased the maximum
fiscal deficit to 3.5 per cent in a given year from 3 per cent inscribed in the13th FC, provided the
debt to GSDP is less than or equal to 25 per cent and the interest payments are less than 10 per
cent of the revenue receipts in the preceding year. The other recommendation was to exclude the
States from the operations of the NSSF scheme in the future, effective from 1st April, 2015. The
involvement of the States in the NSSF should be restricted to the discharge of the debt obligations
incurred till that date only.
The TOR of the 15th FC also include the review of debt, deficit and financial discipline of the
Centre and the State Governments and to recommend fiscal consolidation roadmap towards higher
inclusive growth. In addition, the Commission needs to examine the provisioning of revenue
deficits grants to the States.
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Thus, FCs have had an important role in pushing the State Governments towards better fiscal
performance and ensured fiscal discipline through various recommendations on debt restructuring
and interest reductions as well as assigning weights to fiscal performance for a greater share of the
central resources. The 11th and 12th FC were instrumental in initiating fiscal prudence, deficit and
debt fiscal management, whereas the recommendations of the 14th FC do not highlight fiscal
management, citing that there has been considerable work performed by the States in its adoption
and implementation.
Fiscal Responsibility Legislation: Karnataka
Among the States, Karnataka was first to adopt and enact the Karnataka Fiscal Responsibility Act
(KFRA) in 2002, even before its adoption by the Centre Government. The KFRA was formulated
on similar lines as that of FRBM Bill (2000) and specified a reduction in revenue deficit to zero
and reduction of fiscal deficit to 3 per cent of GSDP by 31st March, 2006. It also mandated the
submission of a Medium Term Fiscal Plan on similar lines as stipulated in the FRBM Bill (2000)
with projections of fiscal performance for the following five years. Apart from revenue and fiscal
deficit targets, it also mentioned the gradual reduction in total liabilities (inclusive of public debt
and public account liabilities) to 25 per cent of GSDP by 2014-15. It also restricted the government
guarantees to 80 per cent of the revenue receipts. Among the fiscal management principles laid in
the KFRA, management of debt at a prudent level finds itself as the first guiding principle followed
by maintaining the level and quality of government guarantees and contingent liabilities.
Thus, Karnataka’s fiscal management principles included prudent management of debt and
liabilities, along with transparency and routine publication of fiscal indicator for analysis and
monitoring.
The amendments to the KFRA (2009 and 2011) extended the fiscal space to 4 per cent for 2009-
10 and 3.44 per cent during 2010-11 respectively, to accommodate for the counter recession
measures. Since then, Karnataka has not breached its fiscal or revenue deficit targets. Also, the
State was a pioneer in including the off-budget borrowings in the budget. The 2014 amendment to
the KFRA mandated the inclusion of off-budgetary borrowings paid from the State’s Budget in
the ‘Total Liabilities’, which is yet to be adopted by the Centre to provide an accurate picture of
overall debt of the government, thus providing greater transparency.
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Given the brief overview of the evolution of the fiscal responsibility legislatures at the Centre and
Karnataka State, this report examines the recent trends in various fiscal indicators for Karnataka
State Government. The mention of rising levels of debt for the State Governments is a cause of
concern (RBI, 2019) yet without a thorough analysis for Karnataka, one cannot comment on the
unsustainability of the government debt and higher deficits. With the main purpose of government
expenditure to ensure greater economic growth and public welfare, it would be interesting to know
the growth effects of following fiscal prudence, especially by restricting debt for Karnataka. As
the State has maintained total liabilities which inclusive of public debt, Public Account liabilities
and others well below the policy target of 25 per cent of GSDP since 2011-12, it is academically
interesting as well as policy-relevant to understand its contribution to the overall economic growth
of the State. Apart from the growth effects of fiscal policy management focused on restricting debt
levels, it is also interesting to know the threshold level of debt that is detrimental for future growth.
Thus, two research questions emerge (i) What impact does government debt have on the growth
rates of GSDP for Karnataka? and (ii) At what level does the government debt become
unsustainable to economic growth? Apart from the debt sustainability analysis accompanied by
the estimation of growth effects of fiscal policy management, the analysis is further extended to
include the impact of loan waiver schemes and the taker over of debt liabilities of the state power
utilities under the UDAY scheme implemented by the Central Government.
The rest of the report is organised as follows: Chapter 1 discusses the background and history of
FRBM and KFRA. Chapter 2 provides a brief review of literature encapsulating the role of fiscal
policy and public debt on economic growth. Chapter 3 presents the trends in various fiscal
indicators with respect to GSDP and analyses the impact on them, post-implementation of KFRA.
Chapter 4 provides the methodological framework for the estimation of growth effects along with
the analysis of the sustainability of public debt. Chapter 5 discusses the results, followed by the
concluding chapter which highlights key policy recommendations.
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Chapter 2
Review of Literature
Theoretical Literature
In standard macroeconomic literature, there are three theoretical perspectives on fiscal policy,
public debt and economic growth. The neoclassical view highlights the negative effects of debt
and deficits on the overall growth and objectives of macroeconomic stabilisation. It suggests that
fiscal deficits have an adverse impact on growth if the revenue deficit is not offset by a rise in
private savings. This could lead to a rise in interest rates in the absence of increased savings in the
economy, leading to crowding out of private investments. Given such a scenario, the neoclassical
theory indicates that fiscal deficits would shift the taxes to future generations and increase the
present generation’s consumption, thus leading to intergenerational inequity and an adverse impact
on economic growth.
The Keynesian view argues in favour of public debt and greater public borrowings. It propounds
that an increase in autonomous expenditure by the government through increased consumption of
expenditure would lead to increased output through the functioning of the Keynesian multiplier.
This approach suffers from certain limitations. First, it does not make any distinction between
government investment or consumption which have a varied impact on economic growth. Second,
it fails to distinguish between the sources of borrowings (monetisation, internal or external
borrowings). This approach is said to be relevant only during the lower phases of the business
cycle and may crowd out private investments through increased interest rates, if implemented
during an economic upswing.
The Ricardian Equivalence theory states that increased borrowings and public debt fail to have an
impact on economic growth significantly. It argues that the increased demand due to government
expenditure is off-set by rising savings. This happens as people tend to increase their savings to
pay for higher taxes in the future. Thus, increased savings in the present to pay-off the debt in the
future through the levy of higher taxes nullifies the effect of increased government expenditure on
economic growth.
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Empirical Literature
International Studies on Debt-Growth Relationship
Most empirical literature builds on the Solow model of growth to assess the impact of debt on
economic growth along with standard variables such as human capital, investment, population
growth and additional controls. Empirical studies have largely been in consensus regarding the
adverse impact of public debt on growth. Reinhart & Rogoff (2010) in their study based on 20
developed countries found that debt above 90 per cent of GDP is inversely related to economic
growth. Many other studies have corroborated this inverted U-shaped relationship between debt
and growth. Among other international studies, Pattillo et al. (2011) focused on 93 developing
nations and found that debt above 30-40 per cent hindered economic growth, whereas Checherita-
Westphal et al. (2014) stated that debt beyond 50-65 per cent was unhealthy for growth by
analysing 22 European countries. Baum et al. (2013) and Woo and Kumar (2015) suggest that debt
above 90 per cent is detrimental for growth following panel estimations for 12 Eurozone countries
and 38 advanced and emerging countries respectively.
While empirical literature has largely been in support of the inverted U-shaped association between
debt and growth, some studies (Alfonso & Jalles, 2013; Herndon et al., 2014; Panizza &
Presbitero, 2013; Egert, 2015) do not find this relationship robust and highlight that the growth of
countries with higher levels of debt is not significantly different than the growth of lower debt
countries. Panizza & Presbitero (2013) suggest that there is no single debt threshold value at which
the economic growth begins to reduce, as the empirical results are subject to biases based on period
and country coverage, choice of the econometric technique employed and other data issues.
Indian Studies on Debt-Growth Relationship
A recent study on growth maximisation level of debt by Pradhan (2019) uses the output elasticity
of public sector capital to calculate the optimal debt level for India which is 65-67 per cent of GDP.
The threshold level prescribed is moderately higher than 60 per cent of GDP as recommended by
the FRBM Review Committee Report (2017). Pradhan (2019) uses the theoretical models of
Aschauer (2000) and Westphal et al. (2012) which link the public debt and economic growth
through growth optimizing behaviour of public and private capital to national income under the
“golden rule” of the budgetary deficit. The FRBM Review Committee Report (2017) employs
conventional non-linear (quadratic functional form) to estimate the threshold level of public debt.
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The idea is that higher public debt distorts economic activity to service the debt through
distortionary taxes or through cuts in productive spending, which can dampen investment and
growth (crowding-out effect). The idea translates into a so-called “Laffer curve” for the effect of
debt on growth. Along the left or “good” side of the curve, increases in the stock of debt are
associated with higher investment and higher growth, while higher debt service is associated with
distortionary taxation and reduced spending on productive investment is associated with the
“wrong” side of the curve.
Rangarajan & Srivastava (2005) recommended debt to GDP for India should reduce to 56 per cent
using the Domar analysis of debt sustainability, wherein the debt is considered stable if the growth
rate is higher than the interest rate in the economy.
State Level Studies on Debt Sustainability
Among state level studies, most have highlighted the role of state FRBM acts that have helped
achieve sustainability in public debt (Dasgupta et al., 2012, Makin & Rashmi, 2012). A recent
study by Kaur et al. (2018) for a panel of 20 Indian states over the period 2004-05 to 2015-16
stated that the debt of these states was sustainable in the long run using the inter-temporal budget
constraint and the fiscal response function. Renjith & Shanmugam (2018) used the fiscal response
function for a panel of 20 states over 2005-06 to 2014-15 to find that debt of only 12 states was
sustainable, whereas other states have to enhance their fiscal management to reduce the public
20
debt. The study also highlighted that the debt policy of the states that suffered from unsustainable
debt improved welfare through poverty reduction. This was achieved as the states managed to keep
the growth rate of debt lower than the growth rate of GSDP.
Earlier studies on debt sustainability for States using Domar sustainability analysis include Nayak
and Rath (2009) and Rajaraman et al. (2005) which have highlighted the importance of growth
rate GSDP to be greater than interest rate growth for sustainable debt.
To our knowledge, a study focusing on the growth effects of public debt at the state level has not
been undertaken, though numerous studies on debt sustainability exist. Also, there are a substantial
number of studies highlighting the detrimental impact of high levels of debt for the Central and
state governments. The FRBM Review Committee Report (2017) makes a mention that the
insufficiency of data at the state level has been the primary reason for not conducting such an
exercise at the state level. A study by Renjith & Shanmugam (2018) highlights that debt is not
always bad as states with unsustainable debt had improved welfare for their populace. Thus, this
study undertakes the analysis of the role of debt in the economic growth story for Karnataka state.
21
Chapter 3
Trends in Fiscal Indicators in Karnataka
This chapter describes the experience of Karnataka towards achieving fiscal targets by various
indicators and analyses the recent trends in deficits and debt. The objective to analyse the trends
in fiscal indicators is two-fold. One, it highlights the role of fiscal responsibility legislation
undertaken by Karnataka in restricting and reducing deficits and debt and two, it presents the
current trends in fiscal indicators and points towards any shifts observed in these indicators in the
recent past.
Deficits and Debt
Figure 1 presents the trends observed in deficit indicators2, i.e., gross fiscal deficit, revenue deficit
and primary deficits since 1990-91 up till 2019-20 (BE). Post-1992-93, both fiscal and primary
deficit show a downward trend which is ascribed to the economic reforms implemented since 1991.
However, in the late 90s and early 2000s, all three deficit indicators increased rapidly which was
on account of stagnation in own tax revenue receipts, a marginal decline in non-tax revenues
coupled with a decline in Central Government transfers (Chakraborty & Rao, 2006).
Figure 1: Key Fiscal Indicators, 1990-91 to 2019-20, Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years) and Directorate of Economics and Statistics
(Karnataka).
2 Gross fiscal deficit = total disbursement (excluding repayment of debt)—total receipts (excluding debt receipts) for a financial year. Revenue deficit = revenue expenditure—revenue receipts. Primary deficit = fiscal deficit—interest payments.
-4
-2
0
2
4
6
19
90
-91
19
92
-93
19
94
-95
19
96
-97
19
98
-99
20
00
-01
20
02
-03
20
04
-05
20
06
-07
20
08
-09
20
10
-11
20
12
-13
20
14
-15
20
16
-17
20
18
-19
(R
E)
pe
rce
nta
ge o
f G
SDP
Gross Fiscal deficit Revenue Deficit Primary Deficit
KFRA policy target
of 3% of GSDP for
fiscal deficit
22
Stagnant revenue efforts in Karnataka in the late 90s were due to insufficient tax efforts and erosion
of tax base due to the granting of tax exemptions to industries (GoK, 2005). While the receipts
saw stagnation, expenditure saw a steep increase. The implementation of recommendations of the
5th Pay Commission to Karnataka State Government employees caused severe strain on available
financial resources. The increase in expenditure especially on salaries, pensions and interest
payments imposed serious pressure on the state’s finances. The implementation of the KFRA
resulted in a fiscal correction that was observed for all deficit indicators. Gross fiscal deficit
reduced from a peak of 5.2 per cent of GSDP in 2001-02 to a comfortable 1.88 per cent by 2005-
06. Revenue deficit reduced to zero by 2004-05, a year in advance of the stipulated deadline and
has managed to stay that way ever since. The vertical distance between the fiscal deficit and the
primary deficit (which is the extent of interest payments) gradually tapered from 2004-05 onwards.
From 2003-04, the divergence between fiscal deficit and revenue deficit has increased, which
indicates that the government has been incurring higher amount of expenditure on capital account
while maintaining revenue account balance (or surplus).
The period post-2007-08 saw a rise in deficits due to the temporary suspension of strict adherence
to fiscal targets mandated in the MTFP due to the onset of the global financial crisis and its
dampening effects on the Indian economy. The amendments to the KFRA in 2009 relaxed the 3
per cent fiscal deficit target to 3.5 per cent of GSDP for 2008-09 to provide for the increased capital
expenditure under an economic stimulus package. This was further increased to 3.44 per cent for
2010-11 to counter the continuing recessionary trend. These deficit indicators showed a period of
stagnation during 2011-12 to 2015-16, post which these indicators depict a rising trend; fiscal
deficit increased from 1.83 in 2015-16 to 2.65 per cent in 2019-20 (BE), both primary and revenue
deficit increased from 0.81 to 1.45 per cent and -0.17 to -0.02 per cent respectively, for the same
period.
Figures 2 and 3 present the decomposition of the annual change in fiscal and revenue deficit to
bring out a more detailed picture since 2008-09 to 2019-20 (BE). Panel A (Figure 2) decomposes
the annual change in fiscal deficit into annual change observed in revenue and expenditure. This
is calculated as:
∆ (𝐹𝐷𝑡
𝐺𝑆𝐷𝑃𝑡) = ∆ (
𝐸𝑥𝑝𝑒𝑛𝑖𝑡𝑢𝑟𝑒 𝑡𝐺𝑆𝐷𝑃𝑡
) − ∆ (𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑡
𝐺𝑆𝐷𝑃𝑡)
23
Similarly in Panel B (Figure 2), the annual change in fiscal deficit is decomposed further into
various components of revenue and expenditure. This exercise is repeated in Figure 3 for revenue
surplus for the period 2008-09 to 2019-20 (BE)3.
In Figure 2 (Panel A), the decline in fiscal deficit (measured as a percentage of GSDP) by 0.57
percentage point during 2011-12 was due to a larger decline in expenditure (3.23 percentage point)
in comparison to revenue (2.66 percentage point). The decline in expenditure was mostly on
account of revenue expenditure (Panel B). It is observed that the fiscal deficit is highly sensitive
to revenue expenditure. An increase in revenue expenditure increases the fiscal deficit and vice
versa.
Figure 2: Contribution to Change in Fiscal Deficit, 2008-09 to 2019-20, Karnataka.
A: Revenue and Expenditure B: Disaggregated Components
3 Karnataka reached revenue account surplus in 2004-05 and the calculations decompose the annual change to revenue surplus.
-3.5
-2.5
-1.5
-0.5
0.5
1.5
20
08-0
9
20
09-1
0
20
10-1
1
20
11-1
2
20
12-1
3
20
13-1
4
20
14-1
5
20
15-1
6
20
16-1
7
20
17-1
8
20
18-1
9 (
RE)
20
19-2
0 (
BE)
per
cen
tage
of
GSD
P
Change in Revenue Change in Expenditure
Change in FD
-6.5
-4.0
-1.5
1.02
008
-09
20
09-1
0
20
10-1
1
20
11-1
2
20
12-1
3
20
13-1
4
20
14-1
5
20
15-1
6
20
16-1
7
20
17-1
8
20
18-1
9 (
RE)
20
19-2
0 (
BE)
per
cen
tage
of
GSD
P
Revenue expenditure Capital ExpenditureNon-Tax Revenue Tax RevenueChange in FD
24
Figure 3: Contribution to Change in Revenue Surplus, 2008-09 to 2019-20, Karnataka.
A: Receipts and Expenditure B: Disaggregated Components
Source: Accounts at a Glance, Karnataka (Various Years) and Directorate of Economics and Statistics
(Karnataka).
Figure 3 (Panel A) decomposes the annual changes to revenue surplus across revenue receipts and
expenditure, calculated as:
∆ (𝑅𝐷𝑡
𝐺𝑆𝐷𝑃𝑡) = ∆ (
𝐸𝑥𝑝𝑒𝑛𝑖𝑡𝑢𝑟𝑒 𝑡𝐺𝑆𝐷𝑃𝑡
) − ∆ (𝑅𝑒𝑐𝑒𝑖𝑝𝑡𝑠𝑡
𝐺𝑆𝐷𝑃𝑡)
Panel B decomposes it across various important components to revenue account where tax and
non-tax are part of the receipts and general services, interest payments and others (which includes
economic and social services expenditure) are the components of expenditure. Revenue surplus
(measured as a percentage of GSDP) increased by 0.5 percentage point during 2010-11 due to a
greater decline in expenditure (0.9 percentage point) than receipts (0.4 percentage point). Even
though the period witnessed a decline in non-tax receipts (Panel B), the increase in tax receipts
and a simultaneous decline in other expenditure led to a jump in revenue surplus. Interest payments
-3.0
-2.0
-1.0
0.0
1.0
20
08-0
9
20
09-1
0
20
10-1
1
20
11-1
2
20
12-1
3
20
13-1
4
20
14-1
5
20
15-1
6
20
16-1
7
20
17-1
8
20
18-1
9 (
RE)
20
19-2
0 (
BE)
per
cen
tage
of
GSD
P
Receipts Expenditure
Change in RD
-6.0
-4.0
-2.0
0.0
2.0
20
08
-09
20
09
-10
20
10
-11
20
11
-12
20
12
-13
20
13
-14
20
14
-15
20
15
-16
20
16
-17
20
17
-18
20
18
-19
(R
E)
20
19
-20
(B
E)
pe
rce
nta
ge o
f G
SDP
Tax receipts Non Tax ReceiptsGeneral Services Interest PaymentsOthers Change in RD
25
have also contributed to achieving greater balance in revenue account and witnessed a decline
during 2008-09 to 2011-12 period. The revenue account has witnessed a reduction in its surplus
post-2012-13 and has been maintained close to zero ever since. In the year 2018-19 (RE), all the
expenditure components except interest payments witnessed a rise, whereas in 2019-20 (BE),
interest payments show a slight increase.
Figure 4 depicts the position of total liabilities/total debt as a percentage of GSDP for Karnataka
Government from 1990-91 onwards. Total liabilities are inclusive of public debt in the
Consolidated Fund and the Public Account Liabilities, as well as financial liabilities of entities
owned or controlled by the State Government.
Figure 4: Total Outstanding Liabilities, 1990-91 to 2019-20, Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years) and Directorate of Economics and Statistics
(Karnataka).
The outstanding liabilities increased sharply from 1998-99 onwards, peaking at 33.14 per cent of
GSDP during 2003-04. Total liabilities reduced to 17 per cent in 2012-13 due to a rise in economic
activity, increased tax collection and overall effective administration of fiscal responsibility
legislature. The policy target of 25 per cent was breached only once during 2009-10, due to the
adverse impact of a global financial crisis. The movement in the total liabilities has been in tandem
with public debt, whereas the public account liabilities depict a downward trend since 2011-12.
Hence, the rise in total liabilities outstanding has been due to the spurt in the public debt component
since 2011-12. Public debt increased from 10.78 per cent of GSDP in 2011-12 to 17.78 per cent in
0
5
10
15
20
25
30
35
19
90
-91
19
92
-93
19
94
-95
19
96
-97
19
98
-99
20
00
-01
20
02
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04
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06
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20
08
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20
10
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20
12
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20
14
-15
20
16
-17
20
18
-19
(R
E)
Pe
rce
nta
ge o
f G
SDP
Public Debt Public Account Liabilities Total Liabilities
KFRA policy target
of 25% of GSDP for
total liabilities
26
2019-20 (BE), resulting in an increase in total liabilities from 17.59 per cent to 23.51 per cent in
the same period. Increase in borrowings from the market by the State Government post-2011-12
has been the primary reason for the increase in public debt.
Figure 5: Outstanding Public Debt and Public Account Liabilities, 1980-81 to 2019-20,
Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years).
Public debt has risen exponentially in absolute terms from 0.75 lakh crore in 2012-13 to 2.82 lakh
crore in 2019-20 (BE) (Figure 5). Thus, public debt contributes predominantly towards total
liabilities and therefore, the control and monitoring of public debt are essential in maintaining
desired levels of total liabilities of the State Government which has been rising in the recent past.
The other component contributing to the total liabilities of the Government is the Off Budget
Borrowings (OBB). This has witnessed a sudden spike in 2013-14 (Figure 6). The 13th FC
suggested both the Central and State Governments to include OBB in their budget calculation.
Following which, the Karnataka Government incorporated the recommendation by amending
KFRA in 2011 and made provisions for its inclusion in MTFP (2011-15) in a limited manner.
Subsequently, in 2014, KFRA was further amended to include the borrowings of PSUs, SPVs and
other equivalent instruments where the principal amount and/or interest payment was serviced out
of state budget.
0
50,000
1,00,000
1,50,000
2,00,000
2,50,000
3,00,000
19
90
-91
19
92
-93
19
94
-95
19
96
-97
19
98
-99
20
00
-01
20
02
-03
20
04
-05
20
06
-07
20
08
-09
20
10
-11
20
12
-13
20
14
-15
20
16
-17
20
18
-19
(R
E)
Rs
cro
re
Public debt Public account liabilities
27
Figure 6: Off Budget Borrowings, 1999-00 to 2019-20, Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years).
Note: Values in percentages depict OBB as a percentage of GSDP.
The 13th FC, as well as the Karnataka State MTFP (2003), highlight the importance of maintaining
debt at less than 25 per cent of GSDP. The two indicators used to identify and monitor debt
sustainability include interest payments as a share of revenue receipts and a ratio of total liabilities
to GSDP. While the MTFP 2000-2001 to 2004-05 suggests reducing interest payments, there are
no specific targets assigned for its reduction. Similarly, even in the case of public debt, the MTFP
does not provide a threshold level beyond which the government should restrain from borrowing
further, whereas for total liabilities, the total limit is capped at 25 per cent of GSDP and the
government should not exceed the set target, except in exceptional cases. The FRBM Review
Committee Report (2017) recommends the states to limit their public debt to below 20 per cent of
GSDP, whereas the same is 40 per cent of GDP for the Central Government. The report estimates
the sustainable threshold for the Centre using rigorous economic and debt sustainability analysis
but falls short of doing the same for States citing data issues. The 14th FC also maintains that the
debt of the State Government must be limited to less than 25 per cent of GSDP and provides 0.25
percentage point relaxation in the fiscal deficit, in case the states have restricted their debt to the
stipulated policy target. Interestingly, even after the inclusion of OBB, the total debt of the
government has not breached the 25 per cent threshold set by KFRA.
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
19
99
-00
20
00
-01
20
01
-02
20
02
-03
20
03
-04
20
04
-05
20
05
-06
20
06
-07
20
07
-08
20
08
-09
20
09
-10
20
10
-11
20
11
-12
20
12
-13
20
13
-14
20
14
-15
20
15
-16
20
16
-17
20
17
-18
20
18
-19
(R
E)
20
19
-20
(B
E)
Rs.
cro
re
1%0.11%
0.2%
1.16%
28
If the FRBM Review Committee report’s recommendation on limiting the State Government to 20
per cent of GSDP is considered, then Karnataka has exceeded that threshold since 2016-17 and
needs to reduce it. But considering the fiscal targets of 13th and 14th FC and the MTFP (2003),
Karnataka has maintained a sustainable level of debt since 2010-11.
Financing Fiscal Deficit
The fiscal deficit is financed primarily through (i) capital receipts (usually of debt nature), (ii)
public account surpluses and (iii) cash balances. Capital receipts comprise of a) public debt, b)
loans and advances (repayments of loans provided by State government), c) miscellaneous capital
receipts (includes disinvestments), d) inter-State settlements and e) appropriation to a contingency
fund.
Table 2 presents the composition of total capital receipts across various phases4. The average
annual capital receipts under Phase I (1980-81 to 1991-92) were Rs. 1,171 crores and have
substantially increased to 34,646 crores by Phase VII (2015-16 to 2019-20 BE). It is also observed
that the share of public debt in total capital receipts has increased from 86.7 per cent in Phase I to
99.3 per cent in Phase VII. Thus, the capital receipts are primarily in the form of public debt with
marginal contributions from other components.
Table 2: Components of Capital Receipts, 1980-81 to 2019-20, Karnataka.
Phase
Public
Debt (Rs.
Crore)
(% of
total)
Misc.
Capital
Receipts
(Rs.
Crore)
(% of
total)
Loans &
Advances
(Rs.
Crore)
(%
of
total)
Total
Capital
Receipts
(Rs.
Crore)
I 1980-81 to 1991-92 1,014.85 86.67 0.11 0.01 154.19 13.17 1,170.99
II 1992-93 to 1996-97 2,079.03 92.02 0.02 0.00 180.28 7.98 2,259.33
III 1997-98 to 2003-04 5,755.27 96.46 0.00 0.00 211.52 3.54 5,966.79
IV 2004-05 to 2007-08 5,384.60 97.61 61.45 1.11 70.61 1.28 5,516.65
V 2008-09 to 2011-12 8,163.68 95.82 102.98 1.21 253.45 2.97 8,520.10
VI 2012-13 to 2014-15 17,542.03 99.09 43.71 0.25 116.90 0.66 17,702.64
VII 2015-16 to 2019-20
(BE) 34,415.47 99.34 107.59 0.31 122.44 0.35 34,645.51
Source: Accounts at a Glance, Karnataka (Various Years).
4 The phases have been demarcated following Kaur, Mukherjee, & Ekka (2018) and RBI, (2019).
29
The components of public debt include (i) internal debt and (ii) loans and advances from GoI. The
internal debt consists of (a) market loans, (b) borrowings from financial institutions (LIC, GIC,
NCDC, NABARD, etc.), (c) ways and means from the RBI, whereas the loans and advances for
GoI consist of (a) plan loans, (b) non-plan loans and (c) loans for central schemes. Figure 7
presents the composition of public debt by internal debt and loans & advances from GoI.
Figure 7: Components of Public Debt, 1990-91 to 2019-20, Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years).
Based on the recommendations of 12th FC, the Centre was asked to refrain from being an
intermediary for future loan requirements of the States and suggested that the states raise capital
from markets directly. Thus, post-2000-01, there is a drastic reduction in loans and advances by
the GoI. From nearly 30 per cent of the total public debt in 1999-2000, loans and advances have
been reduced to nil in 2019-20 (BE). The entire contribution towards public debt is skewed towards
the internal debt, of which market loans have the highest share. Figure 8 depicts the concentration
of capital receipts towards markets loans over the last decade.
-40%
-20%
0%
20%
40%
60%
80%
100%
19
90
-91
19
92
-93
19
94
-95
19
96
-97
19
98
-99
20
00
-01
20
02
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20
04
-05
20
06
-07
20
08
-09
20
10
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12
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20
14
-15
20
16
-17
20
18
-19
(R
E)
pe
rce
nta
ge o
f to
tal i
nte
rnal
de
bt
Net internal debt Net loans & advances from GOI
30
Figure 8: Share of Market Loans in Total Capital Receipts, 1990-91 to 2019-20, Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years).
From around 10 per cent in early 1990s, the contribution of market loans increased to 27.4 per cent
of total capital receipts by 1999-2000, maintaining a level of above twenty per cent until 2006-07,
where it reached nil. This is because the Karnataka Government in the year 2006-07 absorbed Rs.
2592.76 crores from NSSF, thus reducing the need for further market borrowings. The share of
market loans jumped to 84 per cent in 2008-09 on the backdrop of increased liquidity, high
economic growth and large scale public expenditure. The dip in its share during 2010-11 is again
due to borrowings from NSSF, post which the share of market loans is nearly 80 per cent of capital
receipts. Figures 4 and 5 highlight the increased component of debt, especially of market
borrowings in total capital borrowings over the last decade.
Debt Servicing and Interest Payments
The above sections have highlighted the increasing trend in deficits as well as debt components
especially market loans (under public debt). The rising share of debt in capital receipts entails an
increase in interest payments as well. Figure 9 presents the share of interest payments to revenue
receipts and GSDP.
0102030405060708090
100
19
90
-91
19
92
-93
19
94
-95
19
96
-97
19
98
-99
20
00
-01
20
02
-03
20
04
-05
20
06
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20
08
-09
20
10
-11
20
12
-13
20
14
-15
20
16
-17
20
18
-19
(R
E)
pe
rce
nta
ge o
f to
tal c
apit
al
rece
ipts
31
Figure 9: Interest payments, 1980-81 to 2019-20 (BE).
Source: Accounts at a Glance, Karnataka (Various Years).
The left side axis measures the interest payments as a share of revenue receipts, whereas the right
side measures it as a percentage share of GSDP. In both the measurements, interest payments show
a similar pattern of a rise peaking during 2002 to 2004 period and a sharp decline, followed by a
period of stagnation. The reduction in interest payments is accrued to the Debt Swap Scheme
(DSS) implemented by the Central government to assist states in achieving fiscal compliance by
covering loan having high-interest obligation (13 per cent or more). The scheme helped the states
in paying their high-cost loans from the Central government using low interest bearing small
savings and market loans. Debt consolidation and relief facility (DCRF) recommended by the 12th
FC also assisted States in benefiting from debt rescheduling, debt relief and interest relief from the
Central government from the year of the adoption of the FRBM Act in their respective States.
Since 2011-12, interest payments have displayed very slight movement. As a share of revenue
receipts, it has moved from 8.7 per cent in 2011-12 to 10.5 per cent in 2019-20 (BE), whereas as
a percentage share of GSDP it has marginally increased from 1 per cent to 1.2 per cent over the
same period.
Figure 10 depicts the various components of the interest payments and presents the changing
composition of interest payments.
0.0
0.5
1.0
1.5
2.0
2.5
3.0
0
5
10
15
20
25
19
90
-91
19
92
-93
19
94
-95
19
96
-97
19
98
-99
20
00
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02
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06
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08
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10
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12
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20
14
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20
16
-17
20
18
-19
(R
E)
pe
rce
nta
ge o
f G
SDP
pe
rce
nta
ge o
f R
eve
nu
e r
ece
ipts
% of GSDP % of Revenue receipts
32
Figure 10: Components of Interest payments, 1990-91 to 2019-20, Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years).
A marked increase in the share of interest payments towards market loans can be seen from 27 per
cent of the total interest payments in 2005-06 to 75 per cent in 2019-20 (BE). There has been a
considerable decline in interest paid towards NSSF. Its share in total interest paid reduced from 35
per cent in 2005-06 to 8.5 per cent in 2019-20 (BE). The trends in fiscal indicators highlight that
while the 12th FC recommended the shift towards market loans to overcome the high-interest costs
of the Central loans, these have become an increasing component of the public debt. Increased
market borrowings have simultaneously increased the share of interest payments towards its
servicing since 2009-10.
A deeper look into the maturity profile of the market loans (Figure 11) indicates that repayment of
market loans begin to increase in the medium term peaking at 2026-27, where market loans close
to Rs. 28 thousand crores will mature. For the period 2023-24 to 2028-29, nearly 69 per cent of
that total market loans outstanding as on 31st March, 2019 become due for repayment which could
impose a financial stress on the fiscal balances for the State. The interest profile of the market
loans (Figure 12) indicates that around half of the market loans bear interest of 8 to 8.99 per cent.
This highlights rising redemption pressures due to maturity in the medium term, with more than
half of the loans bearing relatively higher interest burden.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
20
05
-06
20
06
-07
20
07
-08
20
08
-09
20
09
-10
20
10
-11
20
11
-12
20
12
-13
20
13
-14
20
14
-15
20
15
-16
20
16
-17
20
17
-18
20
18
-19
(R
E)
20
19
-20
(BE)
pe
rce
nag
e o
f to
tal i
nte
rest
pay
me
nts
Market loan NSSF SS and PF Loans & adv. (GOI) Others
33
Figure 11: Maturity Profile of Market
loans, as on 31st March 2019, Karnataka.
Figure 12: Interest Rate Profile of Market
Loans, as on 31st March 2019, Karnataka.
Source: Accounts at a Glance, Karnataka (Various Years) and RBI (2019).
Impact of Loan Waiver Scheme
Loan waiver schemes are intended to reduce the debt burden of beneficiaries enabling them to
undertake productive activities, thereby boosting real economic activity (RBI, 2019). Yet, the
impact of loan waiver has an adverse impact on the State fiscal balances which is disbursed usually
in a phased-out manner spanning over three to five years. Karnataka announced a loan waiver of
Rs. 18,000 crores in 2017-18 and further expanded it to Rs. 44,000 crores (amounting 3.4 per cent
of GSDP) in 2018-19.
Karnataka budget of 2018-19 stated that the farmers who had defaulted on repayment of loans as
of December 2017 will be waived off. The farm loan waiver was announced in the backdrop of
consecutive droughts which had led to increasing rural distress due to the inability of farmers to
repay these loans. The main provisions in the budget were that it applied to farmers who had loans
up to Rs. 2 lakhs and in case the repayment had been made, then the account will be credited with
Rs. 25 thousand or the loan amount whichever is less.
0
4
8
12
16
20
0
5
10
15
20
25
302
01
9-2
0
20
20
-21
20
21
-22
20
22
-23
20
23
-24
20
24
-25
20
25
-26
20
26
-27
20
27
-28
20
28
-29
20
29
-30
20
30
-31
20
31
-32
20
32
-33
20
33
-34
pe
rce
nta
ge o
f to
tal m
arke
t lo
ans
Rs.
Th
ou
san
d c
rore
Market Loans % of total market loan
0
20
40
60
80
100
6 to 6.99 7 to 7.99 8 to 8.99 9 to 9.99
Rs
Tho
usa
nd
s cr
ore
50.8
13.3
34.6
1.3
Note: Vales above bars indicate percentage to total market loans.
34
Table 3 presents the number of loan waivers released and the amount of waiver released from
primary agricultural cooperative societies (PACS) and other banks from December 2018 to May
2020.
Table 3: Details on Crop Loan Waivers, December 2018 to May 2020, Karnataka.
Period No. of Batches Number of loan waivers
Amount of waiver
released (Rs. crores)
Primary Agricultural Cooperative Societies
2018 5 59,858 349.56
2019 17 15,36,082 7,061.31
2020 2 37,243 184.97
Total 24 16,33,183 7,595.84
Other Banks
2018 1 627 2.93
2019 12 8,78,254 6,135.90
2020 2 37,711 720.87
Total 15 9,16,592 6,859.70
Grand Total 39 25,49,775 14,455.54
Source: GoK (2020).
Table 4 highlights that over 25 lakh farmers had benefitted from the loan waiver scheme, which
as of May, 2020 disbursed over Rs 14.5 thousand crores. Though it ensured some relief and respite
to the distressed rural sector, it has a fiscal bearing which is analysed in Table 3.
Table 4: Fiscal Impact of Loan Waiver, 2017-18 to 2019-20, Karnataka.
Particulars 2017-18 2018-19
(RE)
2019-20
(BE)
1. Loan waiver provided in Budget (Rs. Crore) 3,917 11,965 12,650
2. Loan waiver (% of GSDP) 0.4 1.1 1.0
3. Fiscal deficit (includes loan waiver impact) (% GSDP) 2.4 2.9 2.7
4. Fiscal deficit (without loan waiver impact) (% of GSDP) 2.0 1.8 1.7
5. Percentage change (between FD with and without loan waiver) 16.9 38.6 37.7
Source: RBI (2019).
Notes:
1. Fiscal deficit (without loan waiver impact) is calculated by deducting row (2) from row (3).
2. Fiscal deficit values have been rounded off to the first decimal place.
35
Table 3 presents the impact of loan waiver on the fiscal deficit for Karnataka. In 2017-18, Rs.
3,917 crores were budgeted for loan waiver amounting to 0.4 per cent of GSDP. In the absence of
loan waiver provisioning, the fiscal deficit would have been 2 per cent of GSDP rather than 2.4
per cent (indicating a 16.9 per cent increase in the fiscal deficit on account of loan waiver).
Similarly, the increase in fiscal deficit during 2018-19 and 2019-20 was 38.6 and 37.7 per cent
respectively. While the loan waivers are undertaken to benefit the farmer community and restrict
agrarian distress, it has an adverse impact on fiscal balances for Karnataka State.
This chapter analysed the gradual increase in fiscal deficit and the simultaneous decline in revenue
surplus post-2012-13. The decline in fiscal deficit in the last decade was achieved on the back of
reducing revenue expenditure, especially on the economic and social services rather than
enhancing tax and non-tax revenues. Fiscal deficit post-2003-04 is primarily financed out of
market loans and could lead to redemption stress on account of these loans attaining maturity in
the medium term. It was also noted that loan waiver schemes impose a fiscal burden on the State
finances by increasing fiscal deficit during roll-out years.
36
Chapter 4
Debt Sustainability for Karnataka
This chapter analyses the debt sustainability for Karnataka. The FRBM Committee Report (2017)
as well the 14th FC highlight the importance of using debt as an anchor to maintain fiscal discipline.
This is because, since 2010-11, the State governments including Karnataka have witnessed a
sudden surge in public debt, especially in the form of market loans which could result in increased
interest payments, reduced revenue surplus and add to fiscal pressures.
Solvency, Sustainability and Stability
The three issues related to increasing government debt are solvency, stability and sustainability.
Though all the three concepts are interlinked, they are disparate in their conceptualisation and
definition. Solvency indicates that the government can repay its debt. In a finite time horizon, the
public debt must become non-positive in the previous year so that there is no public debt remaining
that needs to be serviced in the current year. In other words, the government is capable of
generating enough non-debt receipts to repay all its debt obligations towards the end of the finite
time period. In an infinite time horizon, the current public debt must be serviceable through current
and future primary surpluses, i.e., discounted future values of primary surpluses must be equal to
the present value of public debt.
Sustainability of public debt means that the government does not borrow additional debt to repay
its old debt also known as the “Ponzi Game”. Ensuring sustainability of public debt requires a
balance between costs on additional borrowings and the returns to be generated through increased
economic growth leading to increased government revenues that can then be used to repay the
public debt (Rangarajan & Srivastava, 2005). Thus, sustainability is repaying public debt through
increased government surpluses.
Stability of public debt is maintaining a stable debt to GDP or GSDP ratio or its gradual reduction
over time, implying that the debt is reducing as a share of GDP or GSDP. Stabilisation implies a
constant or declining debt to GSDP ratio serving as a measure of debt carrying capacity of the
State Government. A situation of constant debt to GSDP ratio implies increasing debt in absolute
37
terms, whereas a stable absolute debt indicates a decline as a proportion to GSDP. While
stabilisation of debt indicates movement towards sustainability, it only acts a necessary condition,
whereas continuous reduction in debt stock ensures debt sustainability.
To assess sustainability, mainly three approaches are used, viz., Domar debt sustainability
condition, sustainability indicators analysis and present value budget constraint approach. This
chapter assesses the sustainability of public debt for Karnataka using all the three approaches.
Domar Model of Debt Sustainability
According to this approach, to achieve sustainable public debt to GSDP ratio, the interest rate must
be lower than the growth rate (i < g). Another condition is that the primary deficit of the
government should be declining or stagnant. The fiscal deficit is the borrowings (minus
repayments) used to pay for servicing accumulated debt and primary deficit (FD = IP + PD).
Domar debt sustainability can be expressed as:
g – i > 0; where g is the growth rate of GSDP and i is the rate of interest.
rt = (IP)t / (OD)t; where r is average interest payment, IP is interest payments, OD is outstanding
public debt.
Thus, fiscal deficit can be written as the current primary deficit plus interest liability inherited on
the outstanding debt stock:
FDt = PDt + i.Dt-1 (1)
Dividing equation (1) with the GSDP,
𝑓𝑡 = 𝑝𝑡 + 𝑖.𝐷𝑡−1
𝐺𝑆𝐷𝑃𝑡−1(1+𝑔) , (2)
𝑓𝑡 = 𝑝𝑡 + 𝑖.𝑑𝑡−1
(1+𝑔) (3)
Where ft is FD/GSDP, pt is PD/GSDP for time period t.
Adding total debt stock to fiscal deficit for year t;
38
𝑑𝑡=
𝑖𝐷𝑡−1𝐺𝑆𝐷𝑃𝑡−1(1+𝑔)
+𝑓𝑡, (4)
Rearranging equation (4);
𝑓𝑡= 𝑑𝑡− 𝑑𝑡−1= 𝑝𝑡 +
𝐷𝑡−1(1+𝑖)
𝐺𝑆𝐷𝑃𝑡−1(1+𝑔)−
𝐷𝑡−1𝐺𝑆𝐷𝑃𝑡−1
, (5)
If the primary deficit is zero and i = g, the difference between dt and dt-1 is reduced to zero and
debt is stabilised. Thus, with a zero primary deficit, borrowing to pay interest on the accumulated
debt will not raise the debt stock as long as i = g. Reinstating the sustainability condition as:
𝑑𝑡 − 𝑑𝑡−1 = 𝑑𝑡−1(𝑖 − 𝑔) + 𝑝𝑡, (6)
The case for debt stabilisation is [dt - dt-1=0] and if it is zero. Then:
−𝑝𝑡 = 𝑑𝑡−1{𝑖 − 𝑔} (7)
It means that it is possible to stabilise debt with a positive primary deficit if growth in GSDP is
sufficient to compensate primary deficit after covering up interest. However, if the interest rate is
higher than the GSDP growth rate, a zero primary deficit is inadequate; a negative primary balance
(indicating surplus in primary account) is required for debt stabilisation.
Table 5 presents the sustainability of Karnataka’s public debt by using Domar’s condition for debt
sustainability. The computations show the sustainability condition for each year from 1980-81 to
2019-20. Karnataka has maintained debt at sustainable levels according to Domar condition as the
sustainability condition has featured a negative sign, indicating that the growth rates achieved
during the study period have remained higher than the interest rates and the primary deficits have
been maintained at admissible levels, except for the years 2000-01 to 2003-04. This period
witnessed a decline in the growth rate of GSDP, as well as peaking of primary deficit (2.15 per
cent of GSDP), as well as public debt (3 per cent of GSDP) in 2001-02. The Domar condition is
necessary, but not a sufficient condition (Maurya, 2013). To further analyse the sustainability of
Karnataka’s public debt, the following section looks into the debt sustainability indicators.
39
Table 5: Domar Condition for Debt Sustainability for period 1981-82 to 2019-20 (BE),
Karnataka.
Year GSDP growth
rate (g)
Average
interest rate (i)
Primary
deficit (pt)
Public debt
(dt-1)
Debt
sustainability
𝑑𝑡−1{𝑖 − 𝑔} + 𝑝𝑡
≤ 0
1981-82 15.43 4.40 0.51 0.70 -7
1982-83 11.78 4.15 1.92 1.39 -9
1983-84 19.93 4.50 1.70 1.45 -21
1984-85 12.70 5.16 3.17 2.48 -16
1985-86 6.87 5.08 2.57 2.31 -2
1986-87 14.66 5.69 1.69 1.80 -14
1987-88 14.22 6.06 1.36 1.11 -8
1988-89 16.83 6.36 0.90 1.26 -12
1989-90 14.15 6.71 1.07 1.91 -13
1990-91 15.27 7.28 0.40 1.48 -11
1991-92 29.15 7.49 1.02 1.38 -29
1992-93 9.78 7.65 1.83 1.52 -1
1993-94 24.35 7.93 0.99 1.32 -21
1994-95 16.64 8.16 1.02 1.96 -16
1995-96 17.32 8.78 0.55 1.20 -10
1996-97 15.94 8.75 0.86 1.36 -9
1997-98 12.08 8.74 0.23 1.31 -4
1998-99 20.25 8.54 1.30 1.75 -19
1999-00 15.26 8.53 1.70 2.02 -12
2000-01 7.03 8.37 1.29 2.01 4
2001-02 4.14 7.80 2.15 3.00 13
2002-03 7.13 8.46 1.25 2.36 4
2003-04 8.36 8.55 0.46 2.65 1
2004-05 26.96 7.89 -0.09 2.05 -39
2005-06 17.49 7.02 -0.03 1.89 -20
2006-07 15.99 7.28 0.15 0.60 -5
2007-08 19.10 7.02 0.23 0.29 -3
2008-09 14.66 6.00 1.03 1.68 -14
2009-10 8.78 6.87 1.28 1.29 -1
2010-11 21.67 6.87 0.94 0.73 -10
2011-12 12.79 6.80 1.03 1.00 -5
2012-13 14.75 6.54 1.10 1.40 -10
2013-14 17.44 6.40 1.13 1.65 -17
2014-15 11.91 6.01 1.11 1.87 -10
2015-16 14.36 5.96 0.81 1.62 -13
40
2016-17 10.59 5.69 1.44 2.05 -9
2017-18 13.41 5.65 1.31 1.29 -9
2018-19 (RE) 7.42 5.48 1.74 2.48 -3
2019-20 (BE) 12.80 5.54 1.45 2.43 -16
Source: Author’s calculations.
Debt Sustainability: Indicator-Based Analysis
To undertake the debt sustainability analysis, the entire study period from 1981-82 to 2019-20
(BE) is divided into seven phases. The first three phases depict the time period before the
implementation of the KFRA and the following four phases capture the impact on debt
sustainability after its implementation. Table 6 presents the indicator-based debt sustainability
analysis.
Table 6: Indicator-based analysis of debt sustainability, 1981-82 to 2019-20 (BE),
Karnataka.
Phase i-g<0
(1)
PB/GSDP >=0
(2)
IP/RR (declining)
(3)
D-G<0
(4)
1981-82 to 1991-92 -6.02 -1.95 8.68 -1.75
1992-93 to 1996-97 -2.53 -1.38 11.92 -1.59
1997-98 to 2003-04 4.58 -1.57 16.42 8.25
2004-05 to 2007-08 -8.79 -0.09 12.23 -11.06
2008-09 to 2011-12 -4.11 -1.32 9.86 -3.33
2012-13 to 2014-15 -4.19 -1.12 8.84 4.49
2015-16 to 2019-20 (BE) -2.93 -1.35 9.49 9.00
Source: Accounts at a Glance, Karnataka (Various Years) and Author’s calculations.
Note: i is the rate on interest calculated as a ratio of interest payment at t to debt at t-1; IP is interest
payments; RR is revenue receipts; D stands for rate of growth of public debt and G pertains to rate of
growth of nominal GDP.
The indicator-based analysis of Karnataka’s debt sustainability highlights the growing concern for
rising public debt. Column (1) records the difference between the rate of interest and the growth
rate of GSDP. The Domar condition necessitated that the rate of interest must be lower than the
growth rate of GSDP. This has been true across all the seven phases, but it is essential to point out
that in the last phase (2015-16 to 2019-20) the gap between the two has reduced to 2.93 from 4.19
in the preceding phase. This indicates that either the interest rates are rising or the growth of GSDP
41
is falling or both. In the case of Karnataka, it is largely the fall in the growth rate of GSDP that is
reducing the gap.
Column (2) measures the primary balance as a share of GSDP which should be a positive number
indicating primary surpluses. Across all the phases, Karnataka has not experienced a situation of
a primary surplus, except in the period 2004-05 to 2007-08 when it reduced to -0.1 per cent.
Subsequently, the average primary deficit as a percentage of GSDP increased to -1.12 in the sixth
phase (2012-13 to 2014-15) and further to -1.35 in the last phase (2015-16 to 2019-20). While the
interest payments as a percentage share of revenue receipts have declined from a peak of 16.42 per
cent (1997-98 to 2003-04) to 8.84 per cent in 2012-13 to 2004-15, there is a slight cause for concern
as the interest payments have risen again to 9.49 per cent for the last phase, which is only slightly
below the tolerable limit of 10 per cent as prescribed by the 14th FC. The major reason to be
concerned with respect to debt sustainability is on account of the growth of the rate of debt as
compared to the growth rate of GSDP presented in the column (4). The difference between debt
and GSDP growth rate increased from 4.49 to 9 per cent, indicating an increased appetite for debt
funds in the wake of slowing growth. These developments signal potential debt sustainability risks.
Inter-temporal Budget Constraint Approach
The empirical works on inter-temporal budget constraint with respect to government deficit began
with the seminal work of Hamilton & Flavin (1986). Their primary hypothesis states, “The sum of
all current and expected non-interest outlays in present value terms must not exceed the sum of all
discounted revenues”. Cashin & Olekalns (2000) viewed the sustainability of fiscal policy and
public debt if the funding of interest payments is not made from the new debt issuances (i.e., no-
Ponzi scheme). This approach imposes restrictions on the time series properties of government
expenditure and revenues, requiring that the government expenditure, revenues and debt stock are
all stationary in the first differences (Kaur, Mukherjee, & Ekka, 2018). The stationarity property
also restricts the extent of deviation of government expenditure from revenues over time. In case
government expenditure and revenues are I (1) and cointegrated, then the error correction
mechanism would push government finances towards the levels required by the inter-temporal
budget constraint and ensure fiscal and debt sustainability in the long term (Cashin & Olekalns,
2000). The IBC derived by them is as follows:
42
𝐺𝑡−𝑅𝑡 = ∑ (1 + 𝑟)−𝑠+1∞𝑠=0 (∆𝑅𝑡+𝑠 − ∆𝐺𝑡 + 𝑟∆𝐵𝑡+𝑠−1) (8)
Where, 𝐺𝑡 is the government expenditure, the total capital outlay of the Government of Karnataka
including interest payments in time period t, 𝑅𝑡 is the total revenue and 𝐵𝑡 is the accumulated net
public debt of the Government in time period t.
We employ annual data for the period 1980-81 to 2018-19 for the State of Karnataka, where all
variables (government expenditure, revenue and public debt) are expressed in real term (deflated
using WPI series) and converted into logarithmic form. Table 7 presents the unit root tests for the
variables to test for the stationarity properties.
Table 7: Unit Root Tests
Variables Levels
(without
intercept)
Levels (with
intercept)
First Differences
(without intercept)
First Differences
(with intercept)
Government
Expenditure (G)
ADF 5.384
(1.000)
1.152
(0.997)
-1.602
(0.102)
-6.034***
(0.000)
PP 6.106
(1.000)
1.896
(0.999)
-3.787***
(0.000)
-6.024***
(0.000)
KPSS 0.761**** 0.287
Government
Revenue (R)
ADF 9.233
(1.000)
0.872
(0.994)
-1.525
(0.118)
-5.673***
(0.000)
PP 9.403
(1.000)
0.924
(0.995)
-2.679***
(0.009)
-5.68***
(0.000)
KPSS 0.763*** 0.202
Stock of Public
Debt (B)
ADF 2.79
(0.998)
0.569
(0.987)
-1.221
(0.199)
-2.955**
(0.049)
PP 5.393
(1.000)
1.309
(0.998)
-1.123
(0.233)
-3.004**
(0.043)
KPSS 0.766*** 0.219
Source: Author.
Notes: ADF: Augmented Dickey-Fuller test statistic, ADF Lag Length: (Decision based on Schwartz Info
Criterion, Lag Length= 9), PP: Phillips-Perron test statistic, Bandwidth selection based on Newey–West,
KPSS: Kwiatkowski-Phillips-Schmidt-Shin test statistic, Bandwidth selection based on Newey–West.
***,**,* Denotes significance at 1, 5 and 10 per cent respectively.
Values in parentheses are p-values.
ADF and PP test: Ho: Series has a unit root.
KPSS: Ho: Series is stationary. Critical values for 1%, 5% and 10% are 0.739, 0.463 and 0.347
respectively.
43
The study period from 1980-81 to 2018-19 has witnessed many structural shifts in the economy,
both at the national and state level. The Zivot-Andrews test (Table 8) is also conducted to check
the unit root in the presence of a structural break. For all the variables, it was found that the non-
stationarity could not be rejected. Hence, the stationarity properties of the variables are tested in
the presence of these structural breaks using Breakpoint unit root tests and presented in Table 9.
Table 8: Zivot-Andrews Unit Root Test for Presence of Structural Break.
Variables ZA Test
Statistic
(Intercept
only)
p-value Break
year
ZA Test
Statistic
(Intercept
and trend)
p-
value
Break
year
Government Expenditure
(G)
-2.728 -0.364 1989 -3.223 -0.042 1995
Government Revenue (R) -2.91 -0.015 1993 -3.635 -0.018 2005
Stock of Public Debt (B) -3.833 -0.095 1991 -4.289 -0.324 1999
Source: Author.
Notes: Probability values are calculated from standard t-distribution and do not consider the breakpoint
selection process.
Chosen Lag Length: 0 (max lag=9). Citical values at 1%: intercept only = -5.34; intercept and trend = -
5.57, at 5%; intercept only = -4.8; intercept and trend = -5.08, at 10%: intercept only = -4.58; intercept and
trend = -4.82.
Ho: Series has a unit root with the structural break in the intercept.
Table 9: Unit Root Test with Structural Break
Variables Levels (with
intercept)
Break Year First Differences
(with intercept)
Break Year
Government Expenditure (G) -0.53
(> 0.99)
1999 -6.638***
(< 0.01)
2006
Government Revenue (R) -1984
(0.983)
2003 -6.626***
(< 0.01)
2005
Stock of Public Debt (B) -1.355
(> 0.99)
2013 -4.081
(0.13)
2014
Source: Author.
Notes: Break selection: Minimise Dickey-Fuller t-statistic. Lag Length: 0 (Automatic- Based on the
Schwarz information criterion, max lag = 9). Break Type: Innovational outlier. Vogelsang (1993)
asymptotic one-sided p-values.
Having established that both government expenditure and revenue are non-stationary series (even
after checking for a structural break), a long-run cointegrating relationship can be estimated.
The Gregory-Hansen cointegration test checks for cointegration in the presence of a structural
break, i.e., to estimate cointegration between government revenue and expenditure one has to
44
account for structural breaks, given the fact that the study period from 1980-81 to 2018-19 includes
the 1991 era where new economic policies of liberalisation, globalisation and privatisation were
implemented. Also, the year 2002 marked the adoption of FRL in the Karnataka State. It is
essential to check where these periods have an impact on altering the relationship between revenue
and expenditure. First, a check for cointegrating equations is done following Johansen (1995).
Johansen (1995) cointegration test rejects the null of no-cointegration. Table 10 presents the Rank
test (both Trace and Maximum Eigenvalue test)
Table 10: Johansen Cointegration Test
Hypothesised No. of CE(s) Eigenvalue Maximum Eigen
Statistic 0.05 Critical Value Prob.
None * 0.355 15.836 14.264 0.028
At most 1 * 0.102 3.885 3.841 0.049
Source: Author.
Notes: Trace test and Max-eigenvalue test indicate 2 cointegrating equation(s) at the 0.05 level.
* denotes rejection of the hypothesis at the 0.05 level.
MacKinnon-Haug-Michelis (1999) p-values.
The cointegration between government revenue and expenditure is estimated following Hakkio &
Rush (1991):
𝐿𝑜𝑔(𝑅𝑡) = 𝛼 + 𝛽 𝐿𝑜𝑔(𝐺𝑡) + 𝜀𝑡 (9)
The results of the Gregory-Hansen cointegration test with structural breaks are presented in Table
11. The cointegration is estimated only following a level shift.
Table 11: Gregory-Hansen Cointegration Test with Structural Break
Test Statistic Break Year
ADF -4.881 1988
Zt -4.004 1987
Za -24.616 1987
Source: Author.
Notes: For the Gregory and Hansen (1996) cointegration test the critical values at 1%, 5%, and 10%
significance levels: ADF, Zt = -6.51, -6.00, and -5.75; for Za = -80.15, -68.94 and -63.42 respectively.
Hypothesised No. of CE(s) Eigenvalue Trace Statistic 0.05 Critical Value Prob.
None * 0.355 19.721 15.494 0.011
At most 1 * 0.102 3.885 3.841 0.049
45
The test highlights that there is no cointegration between the variables in the presence of a
structural break. The test was expanded to include a level shift with the trend and a regime shift in
the model, yet the results did not depict a significant cointegrating relationship among the
variables. Thus, one can go ahead with estimating cointegration between the variables for the entire
study period (1980-81 to 2018-19) rather than two sets of time periods due to the absence of any
significant structural break.
The results for the Error Correction Model (ECM) is presented in Table 12. The long-run
coefficient is significant and so is the error correction term, indicating a movement towards
equilibrium in case of short-run disturbances. It nearly takes 2.5 years to overcome the short-run
disturbances and return to the long-run equilibrium path for the government revenue variable. In
the case of short-run coefficients, it is found that only the government expenditure (lagged values)
have an impact on the revenue, whereas the past value of government revenue bears no significant
impact.
Table 12: Long-run Coefficient and Error Correction Model.
Dependent variable D(Log R)
Long-run coefficient Error Correction Coefficients
Log G (-1) -1.191*** (-36.175) ECT(-1) -0.378*** (-3.947)
Constant 2.335 Constant 0.113*** (5.011)
D(Log R(-1)) -0.012 (-0.083)
D(Log R(-2)) -0.031 (-0.207)
D(Log G(-1)) -0.277** (-2.11)
D(Log G(-2)) -0.228* (-1.88)
Source: Author.
Notes: Values in parenthesis are t-statistic, and ***,** and * indicate significance at 1%, 5% and 10% level
respectively.
Residual tests: Jarque-Bera normality test=0.748 (p-value = 0.688).
Breusch-Godfrey serial correlation test = 1.3 ( p-value chi- sq = 0.522).
Breusch-Pagan-Godfrey heteroscedasticity test =0.400 (p-value chi-sq = 0.998).
The cointegration analysis indicates that government revenue and expenditure have a long-run
relationship and thus implies the sustainability of government debt. It was observed that
government expenditure and revenue move together without deviating from the long-run
46
equilibrium path. The structural break test highlighted that major policy shifts did not bring a
significant shift in the movement of government revenues and expenditure or their relationship.
Fiscal Policy Response Function
Under this approach proposed by Bohn (1998), the sustainability of debt is analysed based on its
relationship with the primary surplus. The study states that if there is a positive relationship
between primary surplus (as a percentage of GDP) and debt (as a percentage of GDP), then this is
a sufficient condition for government debt sustainability.
𝑠𝑡 = 𝑎0 + 𝑎1𝑑𝑡 + 𝑒𝑡 (10)
Where, s is the primary surplus relative to GDP, d is the debt to GDP. According to Bohn
(1998), debt is sustainable if 𝑎1 > 0 and is statistically significant. This approach is used to
analyse the sustainability of Government (public) debt for Karnataka State.
The model is specified as:
𝑠𝑡 = 𝑎0 + 𝑎1𝑑𝑡 + 𝛽1𝑦𝑣𝑎𝑟𝑡 + 𝛽2𝑔𝑣𝑎𝑟𝑡 + 𝑒𝑡 (11)
Where 𝑦𝑣𝑎𝑟 and 𝑔𝑣𝑎𝑟 are the business cycle indicators and are deviations of actual output and
primary expenditure5 from their respective trends. The 𝑦𝑣𝑎𝑟 variable is included to incorporate
fluctuations in revenue and calculated by extracting the deviation of real GSDP from its trend,
calculated using Hodrick-Prescott (H-P) filter. Positive values would indicate phases on boom,
whereas recessions would be indicated through negative values. Variable 𝑔𝑣𝑎𝑟 is included to
account for the deviation in primary expenditure on the primary surplus. It also calculated by
extracting the deviations in real primary expenditure from its trend (calculated using H-P filter).
Positive values would indicate increased primary spending by the government over and above the
normal expenditure and vice-versa for negative values.
Before undertaking econometric estimations, the time-series properties of variables are analysed
through the unit root tests (Table 13).
5 Primary expenditure is total non-debt expenditure (both capital and revenue) excluding interest payments.
47
Table 13: Unit Root Test
Variables
Levels
(without
intercept)
Levels
(with
intercept)
First
Differences
(without
intercept)
First
Differences
(with
intercept)
Primary deficit (s)
ADF -1.923*
(0.053)
-3.531**
(0.012)
-8.717***
(0.000)
-8.581***
(0.000)
PP -1.832*
(0.064)
-3.544**
(0.012)
-8.442***
(0.000)
-8.317***
(0.000)
KPSS 0.418* 0.238
Public debt (d)
ADF -0.206
(0.605)
-2.314
(0.173)
-4.045***
(0.000)
-3.971***
(0.004)
PP -0.45
(0.513)
-2.01
(0.282)
-4.046***
(0.000)
-3.971***
(0.004)
KPSS 0.173 0.071
Deviations in GSDP (yvar)
ADF -3.307***
(0.002)
-3.258**
(0.024)
-7.056***
(0.000)
-6.957***
(0.000)
PP -3.359***
(0.001)
-3.311**
(0.021)
-10.402***
(0.000)
-10.208***
(0.000)
KPSS 0.141 0.348*
Deviations in Primary Exp.
(gvar)
ADF -3.781***
(0.000)
-3.73***
(0.007)
-5.547***
(0.000)
-5.466***
(0.000)
PP -3.028***
(0.003)
-2.987**
(0.045)
-7.621***
(0.000)
-7.407***
(0.000)
KPSS 0.048 0.198
Source: Author.
Notes: ADF: Augmented Dickey-Fuller test statistic, ADF Lag Length: (Decision based on Schwartz Info
Criterion, Lag Length= 9), PP: Phillips-Perron test statistic, Bandwidth selection based on Newey–West,
KPSS: Kwiatkowski-Phillips-Schmidt-Shin test statistic, Bandwidth selection based on Newey–West.
***,**,* Denotes significance at 1, 5 and 10 per cent respectively.
Values in parenthesis are p-values.
ADF and PP test: Ho: Series has a unit root.
KPSS: Ho: Series is stationary. Critical values for 1%, 5% and 10% are 0.739, 0.463 and 0.347
respectively.
The unit root test indicates that all variables except public debt (d) are stationary at levels6. There
is a combination of 1(0) and I(1) variables and thus, regression analysis at levels would yield
incorrect estimation results. Autoregressive Distributed Lag (ARDL) estimation technique to
estimate a long-run relationship between the variables.
Table 14 presents the results for the ARDL estimations. Across all the specifications, it is observed
that primary deficit and public debt share a negative association in the long run albeit insignificant.
6 Public debt (d) was also tested for structural break using Zivot-Andrews test, but the null of unit root could not be rejected even
after including a structural break.
48
In all the specifications, a long-run equilibrium relationship can be observed and the ECT term is
negative and significant. This implies that the deviations in the primary deficits over the short run
are corrected towards the long-run equilibrium path. This implies that the primary deficit for
Karnataka tends to not spiral into unsustainable deficits as there exists a long-run equilibrium path
and any deviations from it gets corrected in the short-run (in column (1)).
Table 14: ARDL Estimations: Long Run and Error Correction Coefficients
Dependent variable: Primary deficit as a percentage of GSDP
Variables ARDL (1,0)
(1)
ARDL (1,1,3)
(2)
ARDL (1,0,0,1)
(3)
Long run coefficients
Constant 4.05**
(0.024) 5.335** (0.048) 2.097 (0.217)
d -0.167
(0.125) -0.25 (0.132) -0.048 (0.642)
yvar 0.29* (0.082) 0.024 (0.624)
gvar -0.038 (0.279)
Error correction coefficients
ECT(-1) -1.46 ***
(0.000) -0.302*** (0.000) -0.269*** (0.005)
D(d) -0.381*** (0.006)
D(yvar) -0.003 (0.889)
D(yvar(-1)) -0.086** (0.033)
D(yvay(-2)) -0.037 (0.132)
D(gvar) -0.072*** (0.000)
F Bounds test
F statistic 5.572 3.826 1.635
Bound critical values lower upper lower upper lower upper
1% 5.593 6.333 4.77 5.855 4.31 5.544
5% 3.937 4.523 3.435 4.26 3.1 4.088
10% 3.21 3.73 2.835 3.585 2.592 3.454
Residual Diagnostics
Jarque-Bera normality
test 9.292*** (0.009) 10.10*** (0.006) 0.928 (0.629)
Breusch-Godfrey serial
correlation test
(obs*R2)
3.279 (0.194) 2.037 (0.565) 1.641 (0.65)
Breusch-Pagan-
Godfrey
heteroscedasticity test
(obs*R2)
0.872 (0.647) 4.166 (0.761) 8.177 (0.147)
Source: Author.
F statistic lower and upper bound critical values for finite sample n=40:
Maximum lag selection is automatic and model selection using AIC.
***,**,* Denotes significance at 1, 5 and 10 per cent respectively.
Values in parenthesis are p-values.
49
Table 14 presents the coefficients of the ARDL estimations. Three models are run with the
inclusion of additional regressors to check the robustness of the coefficients. In column (1), the
primary deficit is estimated as a function of public debt alone. There exists a long-run relationship
as the F-statistic is higher than the upper bound critical value at 5 per cent. The coefficient of
public debt is positive but insignificant. Thus, one cannot comment on the role of public debt in
ensuring primary balance sustainability, yet the short-run error correction term (ECT(-1)) is
negative and significant. Thus, one can state that nearly 46 per cent of the short term disequilibrium
is being corrected in a year. The previous year primary balance has a positive and significant
impact on current primary balance (Appendix Table A1), implying that increase (decrease) in last
year deficit (surplus) will also increase (decrease) current year’s deficit (surplus). Columns (2) and
(3) include the business cycle variables. With the inclusion of only ‘yvar’ in column (2), it is
observed that there still exists a long-run relationship between the three variables, but at 10 per
cent level of significance and the ECT(-1) is also negative and significant, implying corrections of
short-run fluctuations towards long-run equilibrium path. In column (3), it is observed that with
the inclusion of ‘gvar’ variable, one cannot reject the null of no long-run relationship between
variables as the value of F-statistic is low even at 10 per cent level of significance. For all the
estimations it can be observed that the inclusion of ‘gvar’ and ‘yvar’ variables did not change the
sign of the debt variable nor did the inclusion of these variables make it significant. This provides
evidence that sustainability of primary deficit is largely based on its own previous year deficits
than debt and business cycle variables for the state of Karnataka.
50
Chapter 5
Growth Effects and Fiscal Policy Management
This chapter uses the previously discussed Domar condition of debt sustainability to simulate
scenarios with changing growth rates, interest rates, varying levels of primary deficits and debt.
The analysis presents how debt sustainability is affected due to a change in the economic growth
in particular and other determinants.
Chapter 4 discussed the various measurements that established that Karnataka’s debt was
sustainable in the long run, whereas in this chapter, projections are made regarding the
sustainability of public debt by altering other determinants: (i) growth rate, (ii) interest rate and
(iii) primary deficit in equation (12).
−𝑝𝑡 = 𝑑𝑡−1{𝑖 − 𝑔} (12)
Debt is sustainable if:
𝑑𝑡−1{𝑖 − 𝑔}+𝑝𝑡 ≥ 0 (13)
A negative solution to equation (13) implies the sustainability of public debt. Table 15 presents
different scenarios and the resultant impact on debt sustainability using equation (13). Keeping in
mind that the growth rate of GSDP has been declining from 2015-16 to reach 7.42 per cent in
2018-19 (RE) and the uncertainty regarding the economic impact of COVID-19 of Karnataka’s
economy, two scenarios for GSDP growth rate are selected at 7 and 5 per cent. In the case of rest
of the variables, an average of the period 2009-10 to 2019-20 (BE) was used a benchmark and
projections for the immediate year were made through linear extrapolation calculated using data
from 2009-10 for the next time period is used as the changes scenario. The period after 2008-09 is
used to calculate the new scenario as there was a shift in these variables post the global financial
crisis which is considered as a structural break.
Table 15 highlights some interesting scenarios. In the first case where the GSDP growth was
altered from 7 to 5 per cent keeping other values unchanged, the debt sustainability indicator
deteriorated from 1.94 to 6.79 (higher debt sustainability is ensured when values are zero or
51
negative). A two percentage point change in GSDP leads to nearly 5 percentage point change in
the debt sustainability indicator.
In the second scenario along with the GSDP growth rates, the interest rate is changed to 6 per cent
from 7.3 per cent. Given the economic distress caused by COVID pandemic and the complete halt
of economic activities, the RBI will continue to reduce interest rates to increase liquidity and to
push for greater economic activity. Thus, an assumed reduction to 6 per cent for the interest rate
is used in the analysis. A comparison between GSDP growth rates suggests that at lower interest
rates, there is debt sustainability achieved for Karnataka at 7 per cent GSDP growth rate, whereas
if the economy moves at 5 per cent of GSDP growth rate, a decline in interest rate to 6 per cent
may not be sufficient to ensure debt sustainability. A comparison between scenarios 1 and 2 finds
that debt sustainability for Karnataka is achieved with a simultaneous increase in GSDP growth
rate and a reduction in interest rate.
Table 15: Debt Sustainability Analysis under Different Scenarios, Karnataka.
GSDP growth
rate (g)
Average interest
rate (i)
Primary deficit
(pt)
Public debt (dt-
1) Debt sustainability
1. GSDP scenarios
7 7.30 1.21 2.43 1.94
5 7.30 1.21 2.43 6.79
2. Interest Rate scenarios
7 6 1.21 2.43 -1.22
5 6 1.21 2.43 3.64
3. Primary Deficit scenarios
7 6 1.5 2.43 -0.93
5 6 1.5 2.43 3.93
4. Public debt scenarios
7 6 1.5 2.57 -1.07
5 6 1.5 2.57 4.07
Source: Author.
Under the third scenario, the primary deficit increases from 1.21 per cent of GSDP to 1.5 per cent.
It is observed that debt sustainability is achieved at 7 per cent growth rate of the economy and
becomes worse at 5 per cent growth rate, even at a reduced interest rate of 6 per cent.
In the last scenario, public debt is increased from an average of 2.43 per cent of GSDP to 2.57 per
cent. According to Domar condition, debt is sustainable at a 7 per cent growth rate with a 6 per
52
cent interest rate. This sustainability is achieved even when the primary deficit has increased from
1.21 to 1.5 per cent, whereas at 5 per cent growth rate even with a reduced interest rate, an increase
in public debt marginally by 0.14 percentage points will lead to debt unsustainability.
Figure 13 depicts the analysis in Table 15 regarding the growth effects on debt sustainability. In
the baseline scenario, only the GSDP is changed. Given that the other values are held constant, it
can be seen from the figure that reducing GSDP to 5 per cent leads to the movement of public debt
towards greater unsustainability. At reduced interest rates, it is found that debt moves into a
sustainable region at a higher GSDP growth rate of 7 per cent. Across the three scenarios depicting
changes in interest rate, primary deficit and public debt, only higher GSDP growth rate helps
Karnataka achieve debt sustainability.
Figure 13: Debt Sustainability Analysis under Different Scenarios, Karnataka.
Source: Author.
The analysis in Table 15 and its depiction in Figure 13 highlight an important aspect of debt
sustainability, which is that increases in growth rate have a very significant impact in ensuring that
public debt remains sustainable. With the given room for manoeuvring primary deficit and public
debt which can be controlled by the State, as the State cannot control interest rate movements, the
way forward to ensure debt sustainability is through improving the economic growth for
Karnataka. A focus towards achieving higher economic growth secures debt sustainability at
higher levels of primary deficit and public debt.
-2
-1
0
1
2
3
4
5
6
7
8
GSDP Interest rate at 6% Primary deficit at 1.5% Public debt at 2.57%
pe
rce
nta
ge o
f G
SDP
7 % GSDP growth rate 5% GSDP growth rate
Baseline scenaio
unsustainability
sustainability
53
Chapter 6
Conclusion and Way Forward
The experience of Karnataka State with the execution of fiscal regulations and enactment of the
KFRA in 2003 marked a path towards a more sustainable debt. The decline in fiscal deficit was
achieved on the back of reducing revenue deficits by restricting revenue expenditure. The total
outstanding liabilities of the government were also reduced from a peak of 33 per cent of GSDP
in 2003-04 to 17.6 per cent in 2011-12. All the fiscal targets set under the MTFP of 2003-04 were
achieved within the stipulated timelines. Yet, since 2014-15 there has been a consistent rise in the
fiscal deficit and public debt due to reduction in tax receipts with the implementation of GST,
increased expenditure due to farm loan waivers and award of the Seventh Pay Commission.
The trends in public debt show that there has been a marked shift towards market loans at
competitive interest rates which has also resulted in a drastic reduction in debt servicing and
interest rate payments. The reduction in interest rates has also been achieved due to assistance in
the form of the Debt Swap Scheme (DSS) and Debt Consolidation and Relief Facility (DCRF) by
the Central Government. Yet, one must pay close attention to detail, the maturity profile of the
existing debt will increase drastically from 2023-24 and peak during 2026-27. From 2024-25 to
2028-29, nearly 69 per cent of the total existing market loans will become repayable, amounting
to Rs. 1.15 lakh crore. In addition, more than 50 per cent of the total market loans have 8-8.99 per
cent interest rate associated with them. Thus, in the medium term, Karnataka needs to prepare for
the debt repayment and also keep a check on interest payments which have witnessed a gradual
rise since 2015-16.
The econometric analysis undertaken in this report highlights two major points with respect to
public debt sustainability, (i) Karnataka Government’s revenue and expenditure are cointegrated
in the long run and follow an equilibrium path. The short-run deviations in expenditure and revenue
are corrected in the medium term. This implies that the expenditure of the government does not
follow an independent path and is closely linked to the revenue generated, thus ensuring the long-
run sustainability of government spending. If there was no cointegration between revenue and
expenditure, it would have resulted in increased borrowings culminating in unsustainable debt; (ii)
primary deficits are affected by previous years’ primary deficits and business cycle fluctuations
do not have a significant impact in increasing or reducing these deficits. This implies that a
54
reduction in primary deficits in the current year leads to a further decline in primary deficits in
future. This is in line with the cointegration results, as expenditure is closely bound to the revenue
generated, there is limited scope for increased primary deficits. The Karnataka Government has
restrained from overspending during times of boom and has maintained a steady expenditure even
during lower growth periods. Also, considerable efforts have been made to consistently improve
the tax base to match the increase in spending, thereby limiting the divergence between revenues
and expenditures.
The analysis on the role of economic growth on fiscal policy using the Domar model of debt
sustainability and varying scenarios of GSDP growth and other variables highlight two major
outcomes: (i) given other things are constant, a decline in the growth rate of GSDP from 7 to 5 per
cent leads to a movement towards unsustainability of debt; (ii) projected changes in other variables
suggest that even if interest rates were lowered, primary deficit and public debt was increased, yet
at low GSDP growth rate, debt will continue to become unsustainable. This underscores the
importance of having a strong growth rate for the State to maintain public debt sustainability.
The situation that the world faces today is ominous and uncertain. The onset of a new challenge in
the form of the COVID-19 pandemic could result in increased government expenditure unmatched
with revenue amid slower economic growth. This could lead to breaching of the set fiscal targets
as these have deteriorated in the recent past. The enforcement of lockdown and other restrictions
of movement of goods and persons will inevitably create a setback for the economic growth for
the nation as well as the State. There is no clarity yet on the extent of the economic impact, but
given the fact that Karnataka’s fiscal indicators were already declining, there are two ways about
the fact that the adverse health and economic situation created by pandemic will deteriorate these
indicators further.
Policy Recommendations
The MTFP 2001-02 to 2004-05 clearly mentions that a virtuous cycle of fiscal sustainability and
stability leads to increased economic growth. This is achieved by releasing more resources for
investment in the priority sector and developmental expenditure which leads to economic growth
and development resulting in increased revenue buoyancy, thus promoting the government to
continue on the path of fiscal correctness. It is essential for the government to maintain a vigil over
55
the fiscal targets which are showing a gradual deterioration since 2014-15. There are clear signals
that debt repayments in the medium term and increasing interest payments may adversely affect
the fiscal consolidation undertaken by the State through the KFRA, 2003. It is recommended that
the government expenditure in general and capital expenditure, in particular, are prioritised
towards activities which have a higher impact on economic growth. From our analysis, it is found
that higher economic growth has a significant impact in achieving debt sustainability, even if
accompanied by a rise in fiscal deficit or public debt.
Though Karnataka balances its deficit by keeping a negligible or no revenue deficit, it is essential
that capital spending is guided towards activities having maximum impact on State income to
justify the increase in public debt.
Given the foreseeable revenue shortages with lagged payments with GST share, declining tax
receipts due to slower economic growth and higher expenditure (7th pay commission, farm loan
waivers, relief measures towards COVID-19 pandemic), the government must remain committed
to achieving long-run economic growth to overcome short and medium-term deviations and
deficits in order to ensure fiscal stability and public debt sustainability over the long run.
Possible Extensions and Way Forward
The spread of the pandemic has resulted in much loss of lives and livelihoods. The analysis
presented in this report can be extended include the impact of COVID-19 pandemic on the
Government’s balance sheet. It will be policy-relevant to study the possible impact of relief
measures on fiscal indicators. The study could also be extended to estimate the loss in GSDP and
the resultant effect on the sustainability of public debt and fiscal deficit.
56
Appendix
Table A1: ARDL Estimations: Final Equation and Conditional Error Correction
Variables ARDL (1,0)
(1)
ARDL (1,1,3)
(2)
ARDL (1,0,0,1)
(3)
Constant -1.866**
(0.011) -1.611 (0.03) -0.564 (0.207)
s(-1) 0.539***
(0.000) 0.698*** (0.000) 0.731*** (0.000)
d 0.076*
(0.075) 0.381*** (0.006) 0.013 (0.628)
d(-1) -0.305** (0.019)
yvar 0.003 (0.889) -0.007 (0.631)
yvar(-1) -0.005 (0.859)
yvar(-2) -0.049 (0.164)
yvar(-3) -0.037 (0.132)
gvar 0.071*** (0.000)
gvar(-1) -0.061*** (0.000)
R-square 0.351 0.639 0.801
Adj-R-square 0.314 0.549 0.77
D-W statistic 1.899 2.233 1.788
57
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