From Bad to Worse: Kerala’s Fiscal Reckoning Has Arrived

In 2016, Kerala was told that its finances were in “dire straits.” The White Paper on State Finances published then accused the previous government of leaving behind a strained treasury, unrealistic budgets, unpaid liabilities, poor revenue mobilization and a State forced to use borrowing merely to meet routine expenditure. It said the borrowing ceiling available from the Centre was almost sufficient only to meet day-to-day expenditure, leaving little for roads, bridges and capital works.

A decade later, the language has become more polished, the tables more elaborate, and the institutional diagnosis more sophisticated. But the conclusion is far more disturbing. Kerala has not merely failed to correct the weakness identified in 2016. On the numbers now placed in the 2026 Fiscal Health Status Report, the State appears to have moved from a fiscal stress story to a fiscal architecture failure.

The 2016 White Paper had one important warning. It said budgets had lost their sanctity. Schemes were announced without resources. Annual Plan sizes were fixed beyond the State’s capacity. Additional resource mobilization was promised, but not adequately realized. In one memorable phrase, the State was said to be “living on a financial lie.” That was a harsh political indictment, but it was also an economic warning.

The tragedy is that the warning was not heeded.

The 2026 report now records outstanding liabilities of about ₹5.07 lakh crore, committed expenditure of around 77% of total revenue receipts, interest payments at 20.9% of revenue receipts, and capital expenditure at only 1.3% of GSDP. In plain English, Kerala is spending most of its income before policy begins. Salaries, pensions and interest payments consume the fiscal oxygen. Development expenditure then survives on what is left, and capital expenditure becomes the casualty.

Debt by itself is not immoral. States can and should borrow for productive public investment. The real question is: what did the borrowing create? The 2026 report’s most serious charge is that Kerala violated the basic principle of public borrowing - “borrow to invest, growth will repay.” If borrowing creates assets, jobs, productivity and future tax revenue, debt is manageable. If borrowing funds revenue deficits, old liabilities and routine obligations, debt becomes a trap. Kerala is now dangerously close to that trap.
The treasury numbers reveal the lived reality of the crisis. The 2026 report says the true test of government finance is not what the budget says, but what the treasury can pay and when. It notes that a government may present technically compliant fiscal deficit figures while drawing emergency RBI credit for much of the year, running negative treasury balances and accumulating arrears across payment obligations.

This is not a mere cash-flow problem. This is the fever of a deeper disease.

What makes 2026 worse than 2016 is the institutional layer added to the crisis. In 2016, the complaint was largely about treasury stress, unpaid bills, weak tax administration and unrealistic budgeting. In 2026, the crisis includes off-budget borrowing, KIIFB liabilities, PSU losses, revenue pre-emption and a weakening revenue base. The State’s fiscal stress has not only grown; it has become more complex and less transparent.

KIIFB lies at the heart of this debate. It was presented as an infrastructure innovation - a way to build now and pay over time. That idea is not inherently wrong. Infrastructure requires long-term financing. But democratic finance requires transparency. Debt cannot be moved outside the ordinary budget merely because it is politically inconvenient to show it.

The 2026 Status Report is blunt. It says KIIFB has fundamental flaws in its constitution, that revenue streams such as Motor Vehicle Tax and Petroleum Cess were earmarked directly to KIIFB, and that this breaches the cardinal principle that State revenues must flow into the Consolidated Fund. It also says KIIFB can no longer perform its original role of raising funds outside the budget because off-budget borrowings are now counted within the State’s permissible borrowing limit. More seriously, it observes that KIIFB appears to exercise independent governmental authority, virtually as a “dual government,” with repayment ultimately falling on the State.

Separate research on KIIFB, citing CAG findings, goes further. It alleges that KIIFB borrowings constituted off-budget borrowing used to bypass Article 293 limits, that ₹25,874 crore of State liabilities were understated, and that the actual fiscal deficit including off-budget borrowings was 6.92% of GSDP against a reported figure of about 3.45%. These are grave claims. They require institutional scrutiny, not political sloganizing.

One must be legally careful here. Unless a court finally holds so, it is not proper to call KIIFB a fraud as a concluded fact. But as an economic observer, one can certainly say this: KIIFB raises serious questions of fiscal opacity, constitutional propriety, legislative oversight and inter-generational accountability. Even if every KIIFB project were useful, the mode of financing remains open to challenge. Public purpose does not cure fiscal opacity.

The asset-liability argument also needs closer examination. It is not enough to say every loan is matched by an asset. A hospital, road, bridge or school may be socially valuable, but unless it generates revenue, it cannot repay debt. The debt is then serviced by the State exchequer. In other words, the asset may belong to the people, but the liability belongs to the taxpayer.

The State also has a valid complaint against the Centre. GST compensation ended. Revenue Deficit Grants have disappeared. Cesses and surcharges have reduced the effective divisible pool. Borrowing ceilings have tightened. These are real federal finance issues and Kerala is entitled to argue them forcefully. The 2026 report itself acknowledges that GST compensation and Revenue Deficit Grants had provided a cushion, and their withdrawal complicated the State’s fiscal position.

But this cannot become the whole explanation. Central transfers may have tightened the fiscal oxygen supply. They did not create Kerala’s high committed expenditure, weak own-revenue performance, low capital expenditure, loss-making PSUs or off-budget borrowing architecture. The Centre may have exposed the crisis. It did not manufacture all of it.

The deeper question is political economy. Kerala has built a moral claim around welfare, social justice and human development. That claim is valid and valuable. But a welfare State must also be a productive State. Social spending cannot be sustained indefinitely on debt, remittances and consumption. Kerala produces educated people, but not enough jobs for them at home. It consumes well, but produces insufficiently. It has human capital, but lacks a fiscal model to convert that human capital into durable domestic growth.

The social cost of fiscal stress is already visible. The 2026 report says plan expenditure for SC/ST/OBC and minorities as a percentage of total plan expenditure declined from 9.24% in 2017–18 to 3.85% in 2025–26 RE. It also notes compression in social services, plan assistance to local governments, agriculture and education. This is the cruel irony of fiscal indiscipline: it eventually hurts the very sections in whose name politics is conducted.

So, is Kerala beyond correction?

No. But Kerala is beyond cosmetic correction.

Another White Paper will not solve this. Another political blame game will not solve this. Another round of borrowing will not solve this. The first reform must be truth in numbers. Every liability must be disclosed - treasury arrears, contractor dues, DA and DR arrears, PSU guarantees, KIIFB obligations, KSSPL liabilities, bill discounting dues and all off-budget commitments. The Budget must once again become the central instrument of democratic financial control.

Second, Kerala must stop unfunded announcements. No new scheme should be announced without a funding source, five-year cost estimate, outcome metric and sunset review. Fiscal populism without financing is not welfare; it is deferred taxation on the next generation.

Third, KIIFB must be brought back within budgetary discipline. Existing commitments should be honoured. Useful project-management capacity may be retained. But fresh off-budget borrowing must stop. Expensive debt should be refinanced where possible. Project selection must be transparent. CAG performance audit and legislative scrutiny are non-negotiable.

Fourth, PSUs must be classified honestly. Essential public utilities may require support, but subsidies must be transparent and targeted. Commercial PSUs must be professionally managed. Non-strategic chronic loss-makers cannot be allowed to drain public resources forever in the name of ideology.

Finally, Kerala must build a growth compact. The 2026 report itself says there is a limit to belt-tightening and that the long-term solution lies in growth, investment and employment. It calls for private investment, cooperative investment, industrial infrastructure, power-sector reform and a stronger role for local governments in promoting economic activity.

That is the real way forward.

In 2016, the LDF said it inherited a bad economy. In 2026, the record suggests that Kerala is being handed back a worse one — not merely because the debt number has grown, but because the debt has been institutionalized through structures that diluted transparency and postponed accountability.

The State is not bankrupt in spirit. Its people are educated, enterprising and globally connected. But the government’s fiscal model is exhausted.

The final verdict, therefore, is this: Kerala is not beyond repair. But Kerala is beyond denial. And unless the State restores fiscal truth, budgetary discipline and growth-oriented governance, the next White Paper will not be a warning. It will be an obituary of the Kerala model as we knew it.