Some Methodological Limitations of the Financial Status Report

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The budgetary white paper has caused much stir in the political landscape of Kerala. The report claims of a looming financial crisis in the system. However, the analysis squarely can be fit into what is known as the Treasury View. The logic is straightforward: a rising burden on the state finances reduces the state's capacity to make investments in the future. The government then must function within its fiscal capacity to make efficient decisions. The white paper is making a similar methodological error to what the Chancellor of Exchequer in England made almost 100 years before. A research study done by C. E Mattei in 2018 showed that the Great Depression was the result of such a mistake^[1].

The Treasury View makes one foundational error: it treats the state like a household. A household that borrows beyond its means is in trouble. But a modern capitalist economy works differently. When the government spends,  even when it borrows to do so, that money does not disappear. It passes through hands, generates incomes, creates demand, and returns to the government through taxation^[2]. When the spending is tightened, the distributional question then is, therefore, who bears the burden of adjustment?

The white paper systematically ignores this reality. The policy prescription therefore precedes their diagnosis.

The role of multiplier in the modern economy

The issue at hand is a conceptual debate running deeper in economic science. The report assumes that money is a transactional tool. It assumes in its “narrative”^[3] that, ₹10 transaction made by the government against the public generates ₹10 worth of income^[4]. However, this is wrong. Modern capitalistic societies can be understood as monetary economies^[5]. If the government makes a ₹10 transaction to the public, and that money passes through 3 people^[6], each person is getting a ₹10 income. Although the initial transaction is of ₹10, passing through different hands, the total income it has generated is ₹30 and not ₹10. Every time the ₹10 is spent, it becomes an additional income to the next recipient. Each transaction is simultaneously a payment by one person and an income for another. The invested amount comes back to the government through its taxation. This is the fundamental difference between a modern monetary economy and a simple exchange system.

The report tacitly assumes that the fiscal investments made by the government has zero or negative multiplier effect to the economy. Apart from the budgetary means, the government through Kerala Infrastructure Investment Fund Board(KIIFB) has made project related payments of ₹42,904.63 crores^[7] as on 31.03.2026. A study by Mishra (2019) estimated the long-run capital outlay multiplier for Indian states at 1.77, using a panel dataset of 17 non-special category states. If we go by that figure, the total income that the project would create in the long run for the economy is ₹72,936.8 crores^[8]. This is approximately 10.64% of Kerala’s total income in 2024-2025. That is a big amount. This does not mean that KIIFB investments caused the additional 10.64% of income. An appropriate plausibility would be that an amount multiple times larger than KIIFB’s investments has boosted aggregate demand, leading to larger income for the general public. Like our ₹10 example, larger government investments come back to the government in the form of taxation if economic growth gains traction. This may not be a short run phenomena and can occur with a lag. The report systematically dislodge this possibility. This is a grave methodological issue.

An important historical example is Ireland during the 1990s. The country managed to reduce their debt-GDP ratio by 20 points in 5 years. This is due to a combination of low interest rate and high growth rate. A larger debt to GDP can make economies sensitive to changes in interest rate and growth. “[E]ven moderately slower growth or higher interest rates can easily raise the debt ratio faster than even very large surpluses can reduce it”, here the government must spend more to boost its growth and not be prudent in its finances^[9].

A methodological sound analysis would have strived to find the relationship between interest rate, growth and debt in Kerala Economy. The “crisis” is an amalgam of these variables interacting together. Not something to be assumed away.

Why bigger number may not be the right focal point

The report stresses multiple points about the growing expenditure by the government against its income. However, it is not unique to Kerala. Figure 1 plots the government spending as a share of GDP for select States. As the system becomes complex, governmental expenditures become diverse. Institutions have to be built around a rapidly growing capitalistic system.

Figure 1: Growing government expenditure as a share of GDP in historical time for select States^[10] Source: RBI e-STATES (expenditure actuals); RBI GSDP at constant 2011-12 prices. Expenditure in ₹ crore; GSDP converted from ₹ lakh to crore.

The growing deficit number has to be counterbalanced by quantifying per rupee returns on investments and how it would be paid out over time. This requires economists to model possible growth trajectories. The concern is to find whether the finance burden is manageable in the long run and not in the short run. Reducing government spending without analysing these dynamics may harm than protect the economy.

Consider that you are a parent. Your child’s college fee might be a burden on your purse. In the logic of the report, the consistent effort by the parent must be to reduce their investments in their child. However, this would be a miscalculation. The human capital stock that your child gains - in the long run - by attending college might exceed the investment you make in the short run. The right direction then is to find the returns on the rupee investments made by the government.

How did the off budget investments contribute to Kerala’s growth? This is not discussed in the report. Understanding this gives us the whole picture of the system rather than its parts.

Assets Created and the Burden of Adjustment

As we agreed in the beginning, each rupee spent is an addition to someone else’s income. If we flip the question the report asks in its head, we get a distributional concern.

In every balance sheet, there are assets and liabilities. Liabilities such as loans, interest payments, subsidies are all flow variables. They are outlays by the government. The government may also finance these by borrowing out of budgetary space.  For a household, liabilities can affect our future consumption. That is, the quantity of goods that we consume in the future is reduced. If we extend this logic to the government, growing liabilities reduce the government's fiscal space in the future, constraining its policy matrix. Although this is what the report assumes, this need not be the case. When a person draws from the bank a housing loan, it does not only convert as an interest payment due in the borrower’s ledger. The loaned investment adds to the assets of the borrower’s balance sheet. This is an increment in the wealth of the household. An additional stock as opposed to flow.

Consider the housing boom Kerala experienced in the 1970s. Malayalees are uniquely known for their massive mansions compared to other places in India. This is an accumulation of wealth on a large scale in our economy. It would be a folly to assume that this does not affect our consumption levels. Households consume out of their disposable income and their stock of wealth. Each additional rupee that the government invests from the loan amount adds to the State's assets and future consumption. Unlike what the report assumes, loans are not merely future payments. They add to the stock of wealth which determines our future consumption.

The report notes that KIIFB’s “68% of approved amounts flow to just three departments: Public Works (34%), Industry (25%), and Health and Family Welfare (9%)”(page 99). If the deficit investments are to be reduced in these sectors, who bears the burden of adjustment?

Public amenities are mostly used by all the people. The report claims that the crisis would disproportionally affect the poor^[11]. However, it does so without any proper diagnosis on the counterfactual growth rates with a prudent fiscal system. Greece is the latest example of a failed policy mix. The fiscal consolidatory policies led to a fall in wages and pensions. Unemployment climbed to 27% and debt-to-GDP ratio increased from 130% of GDP in 2009 to 180% at the end of 2014^[12]. The cost Kerala could pay for a similar policy failure could be large. Any unintended suppression of wages and employment may severely affect Kerala’s consumption led economy.

Cautious, not Prudent Fiscal Policy

A fiscal consolidation measure does not necessarily improve the current state of debt-GDP ratio. That is an assumption made and not an empirical reality. What happened to Greece is a lived reality.

As stated earlier, improvements in debt-GDP ratio depends on the interdependencies between interest rate, economic growth and debt. The control over the interest rate is not in the constitutional autonomy of States in India. The only policy lever in front of the current government is in improving economic growth. Economic growth rates must exceed the growth rate of interest rate for the current economy to be sustainable. Even if it increases short term fiscal burden.

The government must then not be fiscally prudent but cautious with its investments. The question of unemployment must take the centerpiece in its policy matrix. Reasonably, boosting MSME growth is a good starting point. They employ more people and are geographically more evenly distributed. Investments must flow to productivity increasing sectors in the economy. Improvements in productivity would have a compounding effect in the growth of the State. Investments that benefit everyone, such as roads, parks, and transportation, can be politically more palatable, but may not be highly productivity inducing^[13]. The report is right in stressing the importance of productivity inducing investments.

The government’s aim at scientifically analysing the growing debt by the State needs much appreciation. However, the report has important methodological paucities that are worth considering. The government cannot be imagined as a borrowing household that allocates its income between current and future consumption. We must diagnose if Kerala has any propensity to what happened in Greece.  The aim of the government is to cushion the system. Although the report notes the same case in Chapter 6, it does not reflect in its diagnosis. This does not mean that lavish spending is the solution. Investments must be weighed against its productivity and employment generative capacity.

Fiscal prudency would have a direct impact on the people. It is therefore important to make a rigorous analysis on who bears the burden of adjustment. The government can also make a special committee that can gather data specifically for Kerala. This can be immensely valuable for further understanding of Kerala’s macroeconomy. Currently available data poses important limitations in analytical rigour.

The author is a post-graduate in Economics from Azim Premji University, Bengaluru. The author thanks Hami Ameen and Nandu Sasidharan for their valuable comments. Opinions are personal.

^[1] Mattei, C. E. (2018). Hawtrey, austerity, and the Treasury View, 1918 to 1925. Journal of the History of Economic Thought, 40(4), 471-492.

^[2] Keynes, J. M. (1936). The general theory of employment, interest and money. Macmillan.

^[3] Government of Kerala. (2026). Financial status of Kerala: A report. Kerala Legislative Assembly. http://www.niyamasabha.org/codes/16kla/Kerala_Status_Paper_consolidated%20Eng.pdf . Page 42, Table 1.3

^[4] This is an example. The choice to use ₹10 as a one is arbitrary.

^[5] Keynes, J. M. (1933). A monetary theory of production. The Collected Writings of John Maynard Keynes, 13, 408-411.

^[6] The number 3 here is an example. The choice of the number is completely arbitrary.

^[7] Government of Kerala. (2026). Financial status of Kerala: A report. Kerala Legislative Assembly, Page 94, Table 4.2

^[8] GSDP figure for Kerala stood at ₹6,85,283.16 crores in RBI’s database for 2024-2025. 72,636.8/6,85,283.16 is approx. 10.64%

^[9] Mason, J. W., & Jayadev, A. (2026). Against money. University of Chicago Press.

^[10] The choice of States is based on their geographical closeness to Kerala.

^[11] Government of Kerala. (2026). Financial status of Kerala: A report. Kerala Legislative Assembly, Page 128

^[12] https://www.piie.com/microsites/2022/greek-debt-crisis-no-easy-way-out

^[13] Hausmann, R., & Rodrik, D. (2003). Economic development as self-discovery. Journal of Development Economics, 72(2), 603-633.