A new approach, some simple innovations and a few tricks of the trade was all that it took to balance the state budget, says Haseeb A Drabu, National Editor, Business Standard, who, in January, was appointed economic advisor to the Jammu & Kashmir Government.
In about four months, he worked out a zero-deficit budget for a state which has never had one in the last 50 years. An inside account of the measures that restored the budgetary balance.
I was at the Finance Commission's Golden Jubilee function when K C Pant pulled me aside. Pant wanted an urgent word about the annual plan of Jammu & Kashmir.
Pant came straight to the point: "I have looked at your numbers and they are really scary. All that you can have this year is an annual plan of Rs 50 crore (Rs 500 million)! I want to help you as much as I can, but you have to come up with something concrete and credible."
This was April and we were already battling against time.
By the time I was hired by the J&K government, work on the annual budget was well under way.
In fact, a month-and-a-half earlier, when I met the state Finance Minister Muzzaffar Hussain Beig in Jammu, work on the budget was almost complete and all the demands for grants had been printed.
I looked at the numbers and the alarm bells began flashing.
Immediately, I suggested that the government should seek a Vote on Account because the numbers looked really bad.
It made no sense to present a budget with a budget deficit of Rs 1,600 crore (Rs 16 billion) or a fiscal deficit of over Rs 2,000 crore (Rs 20 billion). Beig also reacted instantly. He got up at once and we both walked across to the chief minister's room.
Mufti Mohamed Sayeed asked the obvious question: Why did I want to postpone the budget? I quickly gave him the outline of the problem as I saw it.
Firstly, the plan size hadn't been finalised and that meant we would have a fictitious number in the budget. And once the plan size was assumed in the budget without resources in sight, it was bound to be financed by higher borrowings from institutions and that would vitiate fiscal balance.
Secondly, there were large information gaps that needed to be plugged before a complete fiscal position could be worked out. The government, for instance, had no estimates of the off-budget borrowing and guarantees given by it. Therefore, we could have faced a default. There might have been borrowings that weren't provided for in the budget.
This wasn't a hypothetical scenario. In January the state had staved off a default because the last budget hadn't provided for the redemption of one series of power bonds. In such a situation to present a budget would be like walking blindfold in an open field littered with land mines.
The chief minister didn't beat about the bush. He immediately called in the chief secretary and told him that a regular budget would not be presented. The Cabinet was informed and the proposal to go in for Vote on Account for three months was cleared the same day.
From a position of fiscal crisis in March to the first ever zero-deficit budget in June, which even the Prime Minister found time to comment upon and hail was an eventful journey. In these three months, we raised a record level of resources both internally and from the Centre, changed the entire financing pattern of expenditure, did away with excessive recourse to overdrafts and reduced the loan financing of the plan by almost 50 per cent to the lowest level in any state plan.
Getting the plan size in order was the first task. The state Planning Department had recommended a plan size of Rs 3,000 crore (Rs 30 billion). To have a plan this size, given that the non-plan gap was Rs 1,100 crore (Rs 11 billion), meant that we needed about Rs 4,100 crore (Rs 41 billion). The normal Central assistance that the state was entitled to worked out to only about Rs 1,300 crore (Rs 13 billion)! The rest would have to be financed through borrowings and the states' own revenues which would have been near impossible.
So the first principle became clear: we needed a smaller plan. The question was how small a plan would be acceptable, given that this was the new government's first annual plan. Everyone believes that a bigger plan is a better plan irrespective of how it is financed. Also, a larger plan is equated with the state government's political clout at the Centre.
If all this wasn't enough, the prime minister stepped into the picture with some unexpected generosity. During his visit to Srinagar, he announced that J&K would have a plan size of Rs 2,600 crore (Rs 26 billion). Of course, the prime minister doesn't have to work out how the plan will be financed!
Mufti had a single point agenda: we have to bring back the culture to pay for government services. This formed the basis of an unprecedented resource mobilisation effort. We decided to pursue a narrow and focused resource mobilisation strategy focused on sales tax and toll levies. More than tinkering with the rates, we set about changing and streamlining the systems.
First of all, we abolished all activity and area specific exemptions. This had huge political implications, since regions like Ladakh were going to be impacted and also powerful groups in Jammu would be the losers. But there was no option since the huge maze of exemptions granted to regions and to all kinds of commodities had narrowed the tax base which would not have given more revenues even if rates were revised.
If Ladakh and Jammu were impacted disproportionately by the abolition of exemptions, the second reform -- toll rationalisation -- affected the valley population adversely. We started off toll rationalisation by merging the additional and special toll into one category of toll on goods and increasing it by 20 per cent.
Along with this we moved away from the ad-weightum basis of the toll in which the levy is completely non-buoyant and most inequitable as high-cost, low-weight and low-cost high-weight goods are treated alike. So diamonds and rock salt faced the same levy!
We introduced a semblance of equity in the system by levying a either toll on ad-unitum (for items like poultry imported into the state at the rate of Rs 2 per bird); or on ad-valorem basis (toll at 1per cent of value on textiles imported into the state).
Along with the toll restructuring, a cess of Re 1 per litre on petrol was levied and a professions tax on incomes of above Rs 1 lakh (Rs 100,000) was introduced.
Apart from these recurring revenues, a one-time income stream was worked out to generate funds for the power network. The budget envisages that about Rs 800 crore (Rs 8 billion) to Rs 1,000 crore (Rs 10 billion) will be raised over a period of three years by vesting ownership rights to the occupants of state land who currently have lease rights only.
These resources were however not taken account of in the revenue estimates presented.
This heavy dose of taxation was balanced by some radical but inexpensive tax offs which made the budget acceptable to the people.
First, we abolished land revenue and thus virtually ended the system of nambardari which has bred corruption and oppression in the rural areas. This move cost slightly more than Rs 1 crore (Rs 10 million). Indeed, like many other states, the cost of collection of land revenue is higher than the receipts. So on a net basis, it may not turn out to be a loss of revenue at all.
Second, we abolished the toll on the export of horticultural produce and walnuts. It was a unique tax on exporters and hurt the state's biggest business. The logic of abolishing this toll was to make horticulture -- which is facing tremendous international competition -- price competitive.
Third, in the overwhelmingly grim social situation prevailing in the state, we made existing avenues of entertainment cheaper by giving a general tax holiday from payment of entertainment duty for one year.
Finally, given that the hotels and restaurants are in deep distress because tourists are staying away, we gave a them a sales tax holiday for a year.
Accounting for these give-offs, the net resource mobilisation effort was about Rs 250 crore (Rs 2.50 billion). To this we added, recovery of arrears especially in power. Typically, all recoveries are a part of the non-plan receipts, but we treated then as plan receipts akin to additional resource mobilisation. This bolstered the plan revenue receipts and enabled us to fund a larger plan.
On the expenditure side, we did some serious financial re-engineering. We kept the primary non-plan revenue expenditure, including salary, pensions and interest payment, at last year's level. This was done by not providing any money for about 20,000 posts lying vacant.
Also we reduced the scope for increasing plan revenue expenditure -- largely salaries -- by not transferring committed liabilities to the non-plan account. The idea was to not have fresh recruitments but transfer the existing employees whose salary was a part of the non-plan expenditure, to the plan side.
We managed to keep freeze interest payments by proposing to move away from the system of overdrafts from the J&K Bank for which the state annually pays an interest of Rs 137 crore (Rs 1.37 billion) and replace it by a much cheaper system of Ways and Means system of the RBI.
We also pursued an aggressive debt swap strategy by virtue of which the state will be able to repay a substantial part of the most expensive debt.
And as far as 'other' non-plan expenditure -- largely establishment expenditure-is concerned, we reduced it by a massive 13 per cent in nominal terms which amounts to a 20 per cent cut in real terms. This was achieved by providing less for running expenditure like that on cars, petrol, telephones, etc.
Armed with a large additional resource mobilisation effort, a serious effort at expenditure compression, a fiscal plan and a new plan financing mechanism, we approached the Planning Commission and the ministry of finance. Our effort to build non-plan surpluses to finance bigger plans in the future and reduce the state's dependence on the Centre was greatly appreciated by the ministry and the Planning Commission.
The general feeling was that the discourse had decisively been changed from political autonomy to fiscal autonomy.
Starting from the premise that we wanted to have a revenue surplus to meet a large part of our capital expenditure, we worked out the financing scheme in an integrated fashion and not segmenting it on the basis of institutions but on the basis of fiscal rationality.
The scheme is unlike any other scheme worked out in the past and found favour with the Planning Commission.
We also proposed a new mechanism for accessing centrally-sponsored schemes in which, like all special category states, J&K gets a negligible share. This happens because the state's can't provide its share for these schemes. We provided Rs 100 crore (Rs 1 billion) upfront in the plan to meet the state's share in centrally sponsored schemes.
This amount has been put in an escrow account and the state can hope to get Rs 500-600 crore (Rs 5-6 billion) from these schemes. This will be over and above the plan outlay of Rs 2,500 crore (Rs 25 billion) that we had provided for in the budget.
In the new approach, the plan size was not achieved by taking recourse to loans, especially expensive negotiated loans. The net result of our approach was that we reduced the loan financing of the plan from 51 per cent last year to just about 28 per cent this year.
This became possible largely because, for every rupee that the state raised, the ministry gave the state three rupees. It took us all of three minutes to convince the Union finance minister of our fiscal strategy and intent and he approved an additional assistance of Rs 750 crore (Rs 7.5 billion)!
Even after having got such a massive assistance of Rs 3,100 crore (Rs 31 billion) - the highest ever that J&K has got -- it goes to the credit of the political leadership to stick to a plan size of Rs 2,500 crore (Rs 25 billion). This helped us restore the fiscal balance and present a zero-deficit budget for the first time in 50 years.
Spending patterns
One key feature of the J&K budget was that the Government levied taxes and cesses and earmarked the revenues from these for very specific purposes. The idea was to convince people that whatever they paid would not be used to finance the government's own expenditure.
The budget proposes to levy a professional tax on anyone who earns more than Rs 1 lakh (Rs 100,000) annually. All this money will go into a corpus, the Self-Employment Promotion Fund and will be used for the unemployed by creating employment opportunities.
Similarly, the budget proposes to tap the latent desire of people to get rich quick by starting an off-line and on-line lottery system in the state. There may be moral issues involved in this kind of a venture. But the government has earmarked all the lottery revenues for a Social Security Support System.
Also, a cess of Re 1 per litre has been imposed on the sale of motor spirit. The revenues from this cess will go to create an Infrastructural Development Fund for the development of internal roads. The collections would be earmarked for repairing and maintaining internal roads in Jammu and Srinagar.
The budget hopes to collect about Rs 1,000 crore (Rs 10 billion) in the next three years by vesting ownership of state lands that are currently leased to occupants. These revenues will be earmarked for financing new power projects.
State governments issue guarantees but they need to provide for the danger of default. The budget introduced a guarantee fee for every guarantee that it provides. The money accrued goes to a Guarantee Redemption Fund which is being used to bolster the finances of those government undertakings which are in financial distress.
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