India - Karnataka Economic Reforms for Sustained Growth

Document of The World Bank FOR OFFICIAL USE ONLY CONFIDENTIAL Report No. 16360-IN INDIA KARNATAKA ECONOMIC REFORMS FOR SUSTAINED GROWTH April 14, 1998 Poverty Reduction and Economic Management Division South Asia Region This document has a restricted distribution and may be used.by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World.Bank authorization. FILJE`COPY CURRENCY Rs/ USS Currency Qffiial Unified Market Prior to June 1966 4.76 June 6, 1966 to mid-December 1971 7.50 Mid-December 1971 to end-June 1972 7.28 1971-72 7.44 1972-73 7.71 1973-74 7.79 1974-75 7.98 1975-76 8.65 1976-77 8.94 1977-78 8.56 1978-79 8.21 1979-80 8.08 1980-81 7.89 1981-82 8.93 1982-83 9.63 1983-84 10.31 1984-85 11.89 1985-86 12.24 1986-87 12.79 1987-88 12.97 1988-89 14.48 1989-90 16.66 1990-91 17.95 1991-92 24.52 1992-93 26.41 30.65 1993-94 31.36 1994-95 31.40 1995-96 33.46 1996-97 35.50 Apr 1997 35.82 May 1997 35.81 Jun 1997 35.81 Jul 1997 35.74 Aug 1997 35.93 Sep 1997 36.42 Oct 1997 36.23 Nov 1997 37.15 Dec 1997 39.22 Jan 1998 39.36 Note: The Indian fiscal year runs from April 1 through March 31. Source: IMF, International Finance Statistics (IFS), line "rf"; Reserve Bank of India. ' A dual exchange rate system was created in March 1992, with a free market for about 60 percent of foreign exchange transactions. The exchange rate was reunified at the beginning of March 1993 at the free market rate. Vice President Mieko Nishimizu Director : Edwin Lim Sector Manager Roberto Zagha Staff Member Mona Haddad TABLE OF CONTENTS Currency Abbreviations Acknowledgment Karnataka at glance Executive sum m ary ................................................................................................................................... Chapter O ne: K arnataka's Developm ent Challenges ............................................................................ Chapter Two: Issues in State Finances .................................................................................................... 7 A . Issues in Tax Reform ............................................................................................................... 8 B. Expenditure Restructuring ..................................................................................................... 14 C. Public Enterprises .................................................................................................................. 20 Chapter Three: Sectoral Issues............................................................................................................... 25 A . Power..................................................................................................................................... 25 B. Roads ..................................................................................................................................... 28 C. Irrigation................................................................................................................................ 30 D. Health andEducation ............................................................................................................ 34 Append ix 1 ....................................................................................................................................... 41 Appendix 2 ....................................................................................................................................... 53 A ppendix 3 ....................................................................................................................................... 55 Statistical Appendix................................................................................................................................. 57 References ......................................................................................................................................75 LIST OF TABLES Table 1.1 India - State profiles.............................................................................:..........................2 Table 1.2 Additional financing requirem ents, 1997-2002 ..............................................................4 Table 1.3 Fiscal saving with the current reform program ...............................................................5 Table 1.4 Fiscal saving under a full-fledged reform program .........................................................6 Table 2.1 Karnataka's fiscal sum m ary............................................................................................7 Table 2.2 Tax reform .................................................................................................................... 13 Table 2.3 State em ploym ent..........................................................................................................14 Table 2.4 Transfers........................................................................................................................ 16 Table 2.5 Total subsidies...............................................................................................................17 Table 2.6 Distribution of land by size of holding, 1990/91 ..........................................................18 Table 2.7 Expenditure m easures...................................................................................................20 Table 2.8 Flows between GOK and public enterprises, 1992/93-1995/96....................................21 Table 2.9 Reform of the public enterprise sector..........................................................................23 Table 3.1 Impact of tariff increase on financial performance of KEB..........................................28 Table 3.2 Reform of the powersector ........................................................................................... 28 Table 3.3 Underfunding of O& M , 1990-95..................................................................................29 Table 3.4 Road sector policy m easures.........................................................................................30 Table 3.5 Irrigation budget............................................................................................................31 Table 3.6 O& M in irrigation.........................................................................................................32 Table 3.7 Irrigation sector policy measures..................................................................................33 Table 3.8 Dropout rate from standard I to standard IV.................................................................37 Table 3.9 Number of primary schools...........................................................................................37 Table 3.10 Reform of the health and education sectors..................................................................38 LIST OF FIGURES Figure 1.1 Private investment in India and Karnataka.....................................................................3 Figure 2.1 Revenue from major taxes in Karnataka......................................................................... 8 Figure 2.2 The food subsidy is poorly targeted..............................................................................18 Figure 3.1 The increasing gap between KEB's revenue and cost ..................................................26 Figure 3.2 The poor have fewer access to medical facilities..........................................................35 Figure 3.3 Education subsidy per capita by decile in Indonesia, 1989..........................................38 LIST OF BOXES Box 3.1 Initiatives for irrigation management transfer in Andhra Pradesh................................33 Box 3.2 Harnessing the private sector in health in India............................................................36 ABBREVIATIONS BDA: Bangalore Development Authority BMC: Bangalore Municipal Corporation BMRDA: Bangalore Metropolitan Regional Development Authority BWSSB: Bangalore Water Supply and Sewerage Board CST: Central Sales Tax CVA: Central Valuation Authority GPA: General Power of Attorney GOI: Government of India GOK: Government of Karnataka GSDP: Gross State Domestic Product IML: Indian-made Liquor KBJN: Krishna Bhagya Jala Nigam Limited KEB: Karnataka Electricity Board KPC: Karnataka Power Corporation KSBPE: Karnataka State Bureau of Public Enterprises KSRTC: Karnataka State Road Transport Corporation MIS: Management Information System MOST: Ministry of Surface Transport O&M: Operations and Maintenance PDS: Public Distribution System PWD: Public Works Department RBI Reserve Bank of India RV: Ratable Value SOS: Strategic Options Study SRV: Standard Ratable Value TPDS: Targeted Public Distribution System TFC: Tenth Finance Commission VAT: Value-Added Tax ACKNOWLEDGMENT This report was prepared by Mona Haddad (Task Manager) based on contributions from S. Poddar, consultant (sales tax and excise tax), A. Bagchi, consultant (property tax), William McCarten (other taxes), Kim Cuenco (urban development and municipal issues), Dimitri Tzanninis, IMF (current expenditures), Syed Mahmood (public enterprises), B. Bhatia, consultant (power), M. Krishna, consultant (roads), 0. Mathur, consultant (irrigation), Jeffrey Hammer (health and education), V.J. Ravishankar (projections), Rajni Khanna and Bhaskar Naidu (computational assistance). Production support was provided by Lin Chin. Peer reviewers were Luis Serven (PRD) and David Wildasin (Vanderbilt University). The sectoral analysis benefited from guidance from Tjaarda Storm van Leeuwen (power), Ernst Huning and Fabio Galli (roads), Keith Oblitas and Christina Wood (irrigation), Tawhid Nawaz and Salim Habayeb (health), and Keith Hinchliffe (education). Rui Coutinho (Principal Economist, SARVP) provided invaluable assistance. The document was prepared under the supervision of Roberto Zagha (Sector Manager, SASPR). The report benefited from and reflects discussions held with the authorities of the Government of Karnataka in March 1998. The team would like to thank Mr. Edwin Lim, Country Director, India, Ms. Joelle Chassard, Country Anchor, India, Mr. Djamal Mostefai, Senior Energy Specialist, and Mr. Shahrokh Fardoust, Principal Economist, for joining the discussions. We gratefully acknowledge the cooperation of the government officials for their valuable time and assistance. We are especially thankful for Mr. B. K. Bhattacharya, Chief Secretary, and Ms. Renuka Vishvanathan, Planning Secretary, for their continuous guidance and support. We are grateful to Mr. Nilayan Mitash and Mr. K. P. Krishnan for unfailing assistance with numerous information requests. We are indebted to Mr. Sudhir Krishna, Commissioner of Commercial Taxes, for helping us organize a one-week seminar on Value- Added Tax for government officials and the business community, prepared in conjunction with this report. Karnataka at a glance SOCIAL INDICATORS All- Karnataka India Population Growth Rate Population, 1995 (million) 48 929 3.00 (annual average growth) GSDP/GNP per capita, 1995 (US$) 302 350- Average annual growth, 1990-95 2 00 Population (%) 1.5 1.9 1 00 Most recent estimate (latest year available since 1988) Poverty: % of population below poverty line 32.9 36.1 Urban population (% of total population) 30.9 25.7 000 Infant mortality (per 1,000 live births) 73.0 79.0 80-84 85-90 91-95 Access to safe water (% of households) 71.7 62.3 -1 00 - Access to electricity (% of households) 24.1 23.7 r7= Kamataka Access to toilet facilities (% of households) 52.5 42.4 -0--All-India Literate population (% of total population) 56.0 52.2 Proportion Attending Primary School (aged 6-10) 74.1 61.3 Male 78.8 67.3 Female 69.3 54.4 STRUCTURE of the STATE ECONOMY (% of GSDP) 1980 1990 1994 1995 Growth rate of output (%) Agriculture 43.1 34.2 35.6 34.6 150 . Industry 24.0 26.5 25.0 24.5 Manufacturing 15.1 16.5 15.1 14.8 Services 33.6 40.1 40.1 41.6 90* 60 -- (average annual real growth)* 80-84 85-90 1994 1995 . Agriculture 4.3 3.0 -1.0 -2.1 3.0 Industry 5.9 8.8 5.1 1.3 0.0 - Manufacturing 7.5 10.9 4.5 3.7 S Services 7.2 8.4 4.7 5.7 0601 W M a -6 0 Gross State Domestic Product 5.7 6.6 2.8 2.0 GSDP per capita 3.4 2.0 1.3 0.6 All-Inha STATE FINANCE 85-90 91-95 1994 1995 Gross Fiscal Deficit and Debt (% of GSDP) Debt (% of GSDP) GFD Total Revenue 16.9 16.4 15.8 17.6 21 45 States Own Revenue 12.2 12.1 11.6 13.4 20 40 Central Transfers 4.7 4.4 4.1 4.2 203.5 19 -30 19 - "" 2.5 Total Expenditure 20.3 19.8 19.2 20.6 18 2.0 Revenue Expenditure 17.2 16.7 16.4 17.4 18 1.5 Interest payment & debt servicing 2.1 2.1 2.2 2.4 17 1.0 Capital Expenditure (net) 3.0 3.1 2.8 3.1 17 0.5 16 0.0 Revenue Deficit (-)/ Surplus (+) -0.3 -0.3 -0.7 0.1 91- 92- 93- 94- 95- Gross Fiscal Deficit (-)/ Surplus (+) -3.4 -3.4 -3.4 -3.0 92 93 94 95 96 r:-""Debt/ GSDP PRICES -0-Gross Fiscal Deficit GSDP Deflator 8.6 10.2 12.7 8.0 *Least-square growth rates; ** RBI State Finances Database. EXECUTIVE SUMMARY 1. Until the late 1970s Karnataka gfew at modest rates, much like the rest of India, but in the 1980s it was able to accelerate its growth, reaching during the 1980-94 period a per capita average rate of 3.6 percent compared to 3.3 percent for the country as a whole. This growth was mainly fueled by industrial expansion. Investment-friendly policies enabled Karnataka to take advantage of the industrial liberalization that was starting in India and to earn the reputation of a progressive state among investors. Its capital Bangalore is known today as the Silicon Valley of India. But this high industrial growth was not mirrored in agriculture which did not fully benefit from the green revolution as result not only of the state's limited water resources, but also of inherent inefficiencies in irrigation and agriculture technology. 2. The pattern of sectoral growth accentuated regional disparities in the state. Although poverty incidence declined from 48 percent in 1960 to 38 percent in 1994, and social indicators improved, the benefits were not well distributed across the state. The pace of poverty reduction in urban areas was not replicated in rural areas and there are large disparities within rural areas as well, for example, between the irrigated districts in the south, the chronic drought areas in the north-east, and the rainfed coastal area. Addressing inequities across the state remains a difficult development challenge that Karnataka has yet to resolve. Emerging Challenges 3. In addition to these longstanding issues, a new challenge facing Karnataka is to avoid a possible slowdown in private investment and reduction in competitiveness vis-i-vis other states. While private investment has been on a rising trend since the late 1980s in the rest of India, in Karnataka there is a real risk that it would decline, largely as a result of severe infrastructure bottlenecks. Power shortages have reached 17 percent of average use and 23 percent of peak demand, the second highest in India after Bihar. The road network has expanded at an average annual rate of 2.6 percent over the past two decades while traffic has increased at 10 percent. Urban services are increasingly under strain and in Bangalore only two-thirds of solid waste generated is being collected, the smallest proportion among large cities in India. Equally important, maintenance of all infrastructure facilities has been grossly inadequate. 4. The environment within which the old and new challenges facing Karnataka will have to be addressed is changing. The reforms underway in India since 1991 have radically transformed the framework within which the states' development policies are implemented. States can now attract private capital in sectors such as power, irrigation, roads, and in all areas of manufacturing, and their ability to do so determines to a large extent their growth performance. The changing role of the government implies that development spending needs to focus more on areas where the public sector has a comparative advantage, where it complements rather than substitutes for the private sector. Moreover, since the 1991 reforms the transfers from the center to the states have continuously declined and the states have to increasingly rely on their own resources to finance development services. These trends further underscore the need for state-level fiscal and policy reforms. 5. To a large extent, the issues of infrastructure bottlenecks and fiscal strain are not unique to Karnataka and can largely be attributed to the development strategy of the past. However, while some states were quick to address these problems in light of the new economic environment of India, - 11 - Karnataka has been slow to do so. In power, Orissa, Haryana, Rajasthan, and Andhra Pradesh are among those that are radically changing the role of the public sector in power generation and delivery. In irrigation, Maharashtra, Orissa, and Andhra Pradesh are instituting major sector reforms and inviting the private sector to participate in maintenance, operations, and even investment. In several states, such as Andhra Pradesh, Gujarat, and Rajasthan, an overall fiscal adjustment is taking place to rationalize public spending and improve its allocation to needy areas, such as operations and maintenance (O&M), health, and education. 6. By contrast, although Karnataka has put in place some important sector policies that would address major infrastructure bottlenecks and improve fiscal management, implementation has lagged behind other states. The 1995 Agriculture policy is forward-looking and addresses the major pricing, institutional, and regulatory issues in irrigation. Similarly, the 1997 power sector policy has all the necessary elements that would allow private sector interest in this area to translate into commercially viable ventures. But the translation of the policy design into action has left much to be desired. Reforms to Sustain Rapid Growth 7. In 1997 the Government of Karnataka (GOK) introduced a partial reform program which included among other measures a partial adjustment of power tariffs and the commercialization of the power sector, a reduction in the number of government positions by 5 percent, the establishment of a road fund, the opening of state highways to private investment, and the abolition of the surcharge on sales tax. The 1998 budget speech suggests further reform measures, such as a reduction in the number of sales tax rates, a freeze on all vacant posts except in health and education, and disinvestment of public enterprises producing consumer goods. Although the recent measures represent important steps, they fall short of what is required to establish the conditions that will enable Karnataka to join the fastest growing states of India. To do so, a more fundamental policy reform and a more aggressive implementation is needed. 8. The objective of the reform program should be to improve social conditions and eliminate infrastructure bottlenecks. This would require action on two fronts. First, a substantial public expenditure restructuring is needed to eliminate wasteful spending, improve cost recovery, and make room for priority programs in public infrastructure where the role of the private sector is limited, as well as in basic health and education. Second, major sector-specific reforms are needed to improve efficiency, availability, and reliability of service in infrastructure. In power, but also to some extent in irrigation (mainly in operation and maintenance), the improvement of Karnataka's infrastructure will require a broader private sector participation that, to materialize, would require policy, pricing, institutional, and regulatory reforms. 9. Fiscal reform measures. Karnataka has been generally prudent in managing its public spending and its revenue account has been in surplus. In comparison to other states, Karnataka has enjoyed a higher share of revenue to GSDP and a relatively more efficient tax system. This has contributed to sustain a current account surplus but has also alleviated the urgency to change inefficient trends in spending. While current spending as a share of GSDP is increasing, capital spending is declining and within current spending, the shares of interest payments and of the wage bill have increased. Spending in O&M remains inadequate and subsidies are not appropriately targeted. It is thereby critical that Karnataka's achievements on the revenue side be matched by reforms on the expenditure side, as well as improvements in cost recovery which remains weak in virtually all sectors. - iii - 10. Karnataka's own tax revenue mix is dominated by the contribution of the sales tax (60 percent) which underlines the recent increase in total revenue. Despite such a performance, the design and administration of the state sales tax could be improved by further rationalizing rates and exemptions, eliminating the turnover tax and industrial incentives, and strengthening tax administration. In the medium term, the sales tax could be replaced with a more efficient value-added tax, under a carefully designed transition to avoid a reduction in revenue. Other taxes, such as the stamp duty and agricultural income tax, could also be made more efficient by simplifying the tax system, broadening the tax base, eliminating concessions and improving administration. 11. In the 1990s, the composition of expenditures has changed in favor of salaries and pensions, subsidies, and transfers, while the share of public investment has fallen consistently since 1992/93. Central government policies--namely the implementation of the Fifth Pay Commission recommendations that is likely to be followed by the states and thus raise the share of wages, the declining central support to states which is increasing the reliance on more expensive sources of borrowings, and the rising interest rates--are likely to result in deterioration in expenditure composition. Throughout the 1990s expenditure on O&M has suffered, contributing to the infrastructure deficiencies in the state. To avoid further deterioration in the state's infrastructure, spending on nonwage O&M, needs to be brought to a level consistent with the Tenth Finance Commission (TFC) norms and integrated into the formal planning process 12. Employment growth in the public sector needs to be contained while maintaining the delivery of essential social services, operations and maintenance of the state's infrastructure. This can be achieved without retrenchment by taking advantage of natural attrition in the civil service of about 3 percent a year. The commitment of the state's government to its staff reduction policy will be crucial to ensure the success of such a strategy. Yet, efforts to control employment growth in the past have been ad hoc. In addition, GOK needs to begin considering alternative ways to fund its pension liabilities, that also cover employees of local governments and aided private educational institutions. 13. Transfers and subsidies are not effectively targeted to the poor. Like in other states, transfers in Karnataka comprise a wide range of programs financed through the center and the state with no well- established strategy or social priorities. To improve cost effectiveness and impact on the poor, transfers need to be consolidated into a smaller number of well-defined and better targeted schemes to avoid overlap in the schemes' objectives and beneficiaries. The state also needs to carefully evaluate centrally sponsored schemes before agreeing to cofinance them, rather than view them as an additional source of resources. Similarly, the food subsidy is ineffectively targeted and could be replaced by the center's Targeted Public Distribution System. The power and irrigation subsidy which disproportionately benefits those who can pay for such services and distorts their usage, needs to be drastically reduced. 14. Like many other state governments in India, GOK supports a large number of public enterprises, with the three public utilities--Karnataka Electricity Board (KEB), Karnataka Power Corporation (KPC), and Karnataka State Road Transport Corporation (KSRTC)--accounting for the larger part of government support. For example, the elimination of budgetary support to public enterprises would have enabled the government to increase health expenditures by over 20 percent in recent years. GOK needs to impose a hard budget constraint on all public enterprises and privatize enterprises engaged in activities that could be provided more efficiently by the private sector. The public enterprise reform needs to focus on the three public utilities. 15. Sector reform measures. Massive investment in the power sector is needed to accommodate projected growth in demand. Recognizing that the creditworthiness of state power enterprises must be - iv - restored to attract private power producers, GOK adopted in 1997 a new power sector policy that endorses (a) creation of an independent regulatory agency, (b) tariff reforms, including the phased elimination of cross-subsidies from commercial and industrial consumers to domestic and agriculture consumers, (c) introduction of competition among independent power producers, (d) divestiture of shares in KPC, and (e) restructuring and privatization of the distribution functions of KEB. Implementation of these reforms should restore the financial viability of the power sector and increase private investment, thereby reducing the burden of the sector on state finances. 16. Although GOK has taken some essential steps in the road sector, they are still insufficient to fully address its problems. A Strategic Options Study which formulates the government's priorities in the road sector has been prepared and a road fund financed through earmarking of various cesses has been established to upgrade, develop, and expand the existing network. Karnataka has also brought in the private sector to develop a major state highway between Bangalore and Mysore. Remaining steps include the increase in budgetary allocations to the road sector to meet the investment requirement and to bring O&M spending in line with the Tenth Finance Commission norms, and the reform of the Public Works Department to make it more efficient and open to private sector participation. 17. In irrigation, the above-mentioned 1995 Agriculture Policy would raise the state's irrigation potential while reducing its fiscal burden. It proposes radical changes to institutional incentives in the irrigation sector. The main elements of the policy include: (a) more than doubling the irrigation potential of the state to its ultimate potential within the next 5-8 years by increasing investment; (b) granting the Irrigation Department financial autonomy and converting it into a corporation on the condition that it should recover at least O&M expenses from direct beneficiaries; and (c) involving water users' associations in the management and ownership of canal networks. Unfortunately, implementation of this policy has been very slow and many other states have advanced on several fronts faster than Karnataka. 18. The justification for public expenditures on health and education is stronger on efficiency and equity grounds than for many other items in the budget. Planned spending on health and education is consistent with the principles of improving targeting to the poor and complementing rather than substituting the private sector. The strategy and policy direction envisioned by the Department of Health is consistent with this view and focuses on (a) augmenting the coverage of medical facilities in rural areas where most of the poor live; (b) increasing spending on communicable diseases as they disproportionately affect the poor; and (c) improving cost recovery at all levels of health care and outsourcing some services to the private sector. 19. Although education is an important area of government involvement, not all levels of education are equally worth of government support and the free provision of education at all levels is not the best instrument to promote education. Provision of primary education needs to increase but it also needs to become more cost effective by: (a) lowering repetition and dropout rates to allow more students to be accommodated and (b) reviewing the efficiency and effectiveness of incentive programs, such as free uniforms and free books. Increases in budgetary allocations to secondary education, however, are harder to justify as the externalities are not well established. Support of higher education needs to be targeted. 20. Karnataka is at a crossroads. It has made remarkable progress since Independence, moving from an agricultural towards an industrial state and acquiring in the process an investment-friendly reputation. However, it is facing today some old as well as new development challenges that need to be addressed within the post-1991 framework of the Indian economy. Reducing regional disparities in the incidence of poverty will require further spending on social sectors to increase the coverage of basic health and education services, more targeted social programs, and improved efficiency of irrigation to increase - v - agricultural productivity. Avoiding a decline in private investment will require the elimination of infrastructure bottlenecks and a more efficient delivery .of services. Sector policies need to be put in place to allow private interest in infrastructure to materialize, mainly in power but also in irrigation. This would free public resources to areas where there is less scope for private involvement, mainly basic social services and most roads. With its already strong supply of skilled labor and the dynamic industrial base in technologically-rich areas, the above set of reforms will allow Karnataka to take advantage of the opportunities created by the ongoing liberalization of the Indian economy and fully benefit from the strong interest of foreign businesses to invest in India. 1 KARNATAKA'S DEVELOPMENT CHALLENGES 1.1 At the time of Independence Karnataka's social indicators, per capita income, and levels of infrastructure were close to the all-India averages. As most Indian states, it derived a large share of its output (60 percent of GSDP) from agriculture. Until the 1980s, Karnataka grew at modest rates, much like the rest of India, but it emerged thereafter among the fastest growing states, reaching during 1980-94 a per capita annual growth rate of 3.6 percent, slightly higher than the national average of 3.3 percent. This growth was mainly driven by the industrial sector. Although Karnataka benefited from national trends such as partial deregulation of industry, substantial real depreciation of the rupee, and growth in public investment, it was mainly through its own policies that it was able to take advantage of the liberalization that was starting in India. 1.2 The state provided direct incentives for investment through a "one window" approach, industrial parks, sales tax rebates, loans, and an investment-friendly stance. Indirect incentives included adequate infrastructure facilities, abundant and cheap hydro-electric power, a large pool of skilled workers, and peaceful labor relations. Large-scale public industrial units were set up, particularly in steel and cement, but most of Karnataka's industrial growth originated from small-scale industries (see Thimmaiah, 1989). The successful establishment of electronic industries--a high-value small-scale industry that requires skilled workers--earned Bangalore the reputation of the Silicon Valley of India. 1.3 The high industrial growth of the 1980s was not mirrored in agriculture. The sector did not fully benefit from the green revolution, largely as a result of geographic constraints but also of inherent inefficiencies. First, Karnataka's irrigation potential is limited and concentrated in a small area of the state. Only about 20 percent of Karnataka's cropped area is irrigated, one of the lowest share in India. This represents about 70 percent of the state's surface irrigation potential (GOI, 1996). But even if this potential is fully used, it would only cover a small share of the cropped area. In addition, Karnataka has vast areas which are drought-prone and has experienced droughts more frequently than other states in India. Second, the irrigated areas are not efficiently used. Public investment has tended to favor new large irrigation projects, and these were often left unfinished and maintenance has been neglected. Farming has been typically characterized by crammed cropping patterns, heterogeneous crops, and traditional methods that slowed the adoption of new technology. 1.4 To Karnataka's old development challenges new ones have been added that are threatening its performance. The overall accomplishment of Karnataka masks important regional disparities. Although poverty incidence has declined (from 48 percent in 1960 to 38 percent in 1994)' and social indicators have improved (Table 1.1), the benefits have not been well distributed across the state. Between 1957 and 1993, the poverty incidence in Karnataka declined at an annual rate of 0.64 percent in rural areas2 I Staff calculations based on the Expert Group (Planning Commission) methodology (see World Bank, India: Achievements and Challenges in Reducing Poverty, 1997). 2 Betwedn 1957 and 1993, the poverty incidence in rural areas declined at an annual rate of 2.12 percent in Andhra Pradesh, 1.49 percent in Gujarat, 2.41 percent in Kerala, and 1.45 percent in Tamil Nadu. -2- compared to 1.42 percent in urban areas (Datt, 1997). Although this urban-rural disparity in poverty reduction reflects national trends, it was more accentuated in Karnataka largely as a result of high industrial growth, which mainly benefited urban areas, and poor agricultural growth. After Rajasthan, Karnataka has the largest disparity in ranking between the incidence of rural and urban poverty (9th and 5th, respectively). Over the past four decades its annual rate of mean consumption growth was one of the lowest among states for rural areas (0.18 percent) and one of the highest for urban areas (0.91 percent). There are large disparities within rural areas as well--for example, between the irrigated agricultural districts in south Mysore, the chronic drought area of northern and eastern Karnataka, and the successful rainfed coastal area. Moreover, some of the new regions that joined the former princely state of Mysore to become part of Karnataka at the time of Independence had very low development indicators and their social and infrastructure needs were not adequately met. Addressing inequities across the state remains an old and difficult development challenge that Karnataka has yet to successfully resolve. Table 1.1: India - State profiles Per- Capita Female Literacy Infant Mortality Rate Poverty Incidence b State Population Income (percent) (per 1000 births) (Headcount index) (US) Rural Urban 1995/96 1995/96 1980/81 1990/91 1970/71 1990/91 1970/71 1993/94 1970/71 1993/94 India 929 350 29.8 39.3 129 79 54.8 36.7 45.0 30.5 Andhra Pradesh 72.0 289 24.2 32.7 106 71 57.2 28.9 45.8 30.8 Bihar 95.4 146 16.5 22.9 .. 73 67.3 63.5 52.6 39.7 Gujarat 44.8 411 38.5 48.6 144 67 61.4 35.4 53.0 30.7 Haryana 18.2 459 26.9 40.5 72 75 .. Karnataka 48.2 301 33.2 443 95 73 58.0 41.0 46.0 29.7 Kerala 31.0 279 75.7 86.2 58 17 72.7 31.1 61.0 23.1 Madhya Pradesh 72.5 229 19.0 28.9 135 104 62.4 45.4 51.3 39.8 Maharashtra 86.4 490 41.0 52.3 105 59 62.0 47.8 43.2 36.2 Orissa 34.4 191 25.1 34.7 127 115 64.8 40.3 54.4 40.8 Punjab 22.1 521 39.6 50.4 102 56 31.7 252' 28.6 , 11.4c Rajasthan 48.4 238 14.0 20.4 .. 90 65.3 47.5 44.1 294 Tamil Nadu 58.4 335 40.4 51.3 113 58 66.4 36.7 62.3 31.3 Uttar Pradesh 150.7 200 17.2 25.3 167 98 45.2 41.6 54.3 343 W est Bengal 73.6 251 36.1 46.6 . 65 62.6 27.3 32.4 22.5 a. Per-capita income data is based on per-capita gross state domestic product at current rupees and converted to USS by the average exchange rate. b. Staff calculations based on the Expert Group (Planning Commission) methodology. c. Including Haryana. Source: CSO; CMIE; 1991 Census; Planning Commission; World Bank Report on Poverty in India. 1.5 The new challenge is to raise private investment. Since the late 1980s Karnataka's private investment has stagnated while for all India it has risen sharply. This stagnation is worrisome and suggests that Karnataka is facing difficulties in maintaining its competitiveness vis-A-vis other states in attracting investment (Figure 1.1). Although Karnataka remains among the favorite states for private investors--for example, more than 50 percent of investors surveyed by Business Today (June 1996) indicated their interest in investing in Karnataka--this interest has not translated into a rise in the investment ratio. Industrial growth slowed down in recent years, reaching 7.6 percent in 1995/96 compared to 12.2 percent for the country as a whole. 1.6 The stagnation and risk of slowdown in private investment in Karnataka are largely attributed to severe infrastructure bottlenecks which have far outweighed existing government incentives. Power -3- shortages have reached 17 percent of average use and 23 percent of peak demand, the second highest incidence of power shortages in India after Bihar. The increased frequency of power cuts and greater reliance on expensive power generators raised production costs in the state and discouraged private investment. Other infrastructure facilities are also buckling up. The road network has expanded at an average annual rate of 2.6 percent over the past two decades while traffic has increased at 10 percent. Basic services in urban areas are increasingly under strain and only two-thirds of solid waste generated is being collected in Bangalore, the smallest proportion among large cities in India. In the past the government has sought to attract industries to the greater Bangalore area. As a result, by 1986 almost 40 percent of medium and large units and almost 25 percent of small-scale units were located in the Bangalore urban district, accounting for over a third of investment in the state. This trend has continued to the present and the government has recently been examining different policies to achieve a more balanced spatial distribution of industrial activities. Figure 1.1: Private investment in India and Karnataka 20 18 16 14 India (percent of GDP) 12 10 61 4- Karnataka (percent of OSDP) 2 o C4 e 0 n - cc 0% CD C4 . o0 00 00 00c 0 00 cc 00 00 00 0 % 0 % 0 0% L% Z, 0% 0 0% 0, 0% % 0 % 0% 0 % 0 Source: CSO, National Account Statistics and GOK. Note: 1993/94 is the last year for which private investment figures are available in Karnataka. 1.7 It is clear that to sustain the rate of progress achieved in the past Karnataka will have to accelerate the improvement in social conditions across the state and will have to create the necessary conditions to reverse the recent trends in private investment. Otherwise, there is a risk that the future growth of Karnataka's economy will be lower than in the past, and that improvements in the state's economic and social conditions will lag behind those achieved in other states in India. To address the challenge of social disparities a focus on policies that reduce rural poverty is needed. The diverse experience of Indian states has shown that the reduction of rural poverty can be accomplished by ensuring a robust growth in rural areas through increased agricultural productivity and by improving human resource development through increased spending on primary health and education and on well- targeted social programs (Datt and Ravallion, 1996). To address the challenge of reviving private investment, larger investment in infrastructure and more efficient provision of infrastructure services are needed. Greater private sector participation will be necessary to achieve these objectives. In order to succeed on both fronts GOK will need to overhaul the policy and regulatory frameworks in -4- infrastructure, mainly in power and irrigation, and to strengthen the management of public spending that in the past has suffered from poor prioritization. 1.8 The need to adjust Karnataka's development policies is further substantiated by the post-1991 economic realities of India. In particular, with private investors able to choose where to invest and licensing policies no longer directing them to a particular state, the quality of a state's economic management and the level of a state's infrastructure will play a crucial role in determining the volume of private investment that a state will be able to attract. In addition, the 1991 reforms have accentuated the declining trend in central government transfers, leading to larger borrowings from more expensive sources, and have raised interest rates. The resulting increase in the interest bill has meant that less resources are available to states to finance their development expenditures. These trends further underline the need for state-level fiscal and policy reforms. 1.9 Karnataka has been slower than other states at implementing sector policy reforms. In power, a sector that is attracting considerable private interest, investments have been well below their potential because of the slow pace at which the state has articulated and implemented an appropriate regulatory framework (see Chapter 3). While Orissa, Rajasthan, Haryana, and Andhra Pradesh have already taken concrete steps to restructure their State Electricity Boards, to establish independent regulatory agencies, and to privatize distribution and generation, Karnataka has yet to convert into reality its 1997 Power Policy. Similarly in the case of irrigation, a pioneer Agriculture Policy enacted in 1995 aiming at corporatizing the department of irrigation, improving cost recovery, and forming water users associations has barely been implemented. In contrast, in both Maharashtra and Andhra Pradesh such associations have already started operating. Some states such as Gujarat, Andhra Pradesh, and Rajasthan, have also moved ahead with an overall fiscal restructuring strategy. Re-establishing the foundation for growth 1.10 GOK has recognized the need to address the deficiencies in the provision of social services and the infrastructure bottlenecks. .bl 1 d ,financmng1requirements This will imply a combination of better management of existing public 4n1r97-002 services, additional public investment, and a much larger role for the billion at current prices) private sector. The public investment required to crowd in private Irrigatick investment and allow the state to grow at 6-7 percent per year, the Investment 30.0 same rate as India, is estimated to be approximately 50 percent larger O&M 2.5 than the current trends in Karnataka's budget. This is equivalent to an Roads: annual increase of about 2 percent of GSDP over current levels of Investment 19.6 capital spending and O&M (Table 1.2). O&M,9.4 Primy education: 1.11 In addition to the social sectors, there are critical public Techers . 2.4 spending needs in power, roads and irrigation (see Chapter 3). In Construction 10.3 power, GOK estimates at about Rs. 165 billion (US$4.3 billion) the Primary health: investments required to bridge the supply gap. Assuming that the Drugsand supplies 3.1 sector policies are implemented, Rs. 95 billion are estimated to come Grand total 782 from the private sector and Rs. 70 billion are estimated to be raised Average,per year- :15.6 from a combination of improved internal resource generation of the Average percent o power companies, credit from financial institutions, and plan resources GSDP peyear. 1 8 of the state. The power sector will continue to claim large public rce:Stafcalculations: resources in the medium term, but no additional financing will be needed over current levels if the power policies are put in place. In roads, public investment has not kept pace with the growth in the volume of -5- traffic in the past two decades, as mentioned before. More seriously perhaps, the existing network has been poorly maintained. O&M has been chronically underfunded, at 60-70 percent of the norms recommended by the Tenth Finance Commission. Over Rs. 30 billion (US$779 million) additional to current trends are estimated to be necessary to expand the network and address the problems of deferred maintenance. 1.12 As in the case of roads, the maintenance of the irrigation network has been underfunded by about 50 percent. Completing ongoing investment projects and raising O&M allocations to appropriate levels would require about Rs. 30 billion (US$779 million) additional to current trends. Similar funding problems exist in the case of the social sectors. The rate of expansion of basic education and health needs to be accelerated. To achieve universal primary education by 2002, an explicit government target for the Ninth Plan, and to provide a basic package of public health and clinical services in areas currently underprovided would require another Rs. 17 billion (US$441 million) additional to current trends. 1.13 In its 1997/98 budget, the GOK has initiated some policy reforms to address these constraints and revive private investment. These include (a) the partial adjustment of power tariffs' and the decision to restructure the power sector towards commercialization and privatization; (b) the reduction in the number of government positions by 5 percent; (c) the establishment of a road fund financed initially through a special cess on mining royalties; (d) the amendment of the State Highways Act to enable private investments and time-bound toll collection to finance road improvements; (e) the amendments to the Karnataka Municipalities Act and the Karnataka Corporation Act to improve the resource base of urban local bodies; and (f) the abolition of surcharge on sales tax. The 1998 budget speech proposes further measures, including a reduction in the number of sales tax rates, a freeze on vacant posts except in health and education, and disinvestment of public enterprises producing consumer goods. 1.14 While these reforms represent important steps, it is unlikely they will be sufficient to achieve the stated goal of accelerating growth from the historical average of about 5.5 percent to 7 percent in the Ninth Five-Year Plan period . (1997-2002). The projected fiscal Table 13: Fiscal saving with the current reform program saving (Table 1.3) is not enough to (percent of GSDP) meet the additional outlays. 1998/99 1999/00 2000/01 2001/02 Moreover, the fundamental Power sector restructuring 0.3 0.9 1.1 1.1 reforms needed to improve basic Staff rationalization 0.1 0.2 0.2 0.3 infrastructure and restore the Total 0.4 1.1 1.3 1.4 soundness of fiscal management Source: Staff calculations. have not been addressed. These include (i) the full implementation of the new power sector policy which entails the creation of an independent regulatory agency, tariff reforms that include the phased elimination of cross subsidization, and the restructuring and privatization of distribution functions; (ii) a substantial increase in investment and O&M spending on roads; (iii) an improvement in cost recovery and O&M spending in irrigation; (iv) the strengthening of municipal finances to improve delivery of civic services; (v) the broadening of staff rationalization efforts, excluding teachers and health workers; and (vi) an improvement in the efficiency of the tax system. In July 1997 the power tariff was adjusted upwards by 13 percent for nonagricultural consumers and by 200 percent for agricultural consumers. The agricultural tariff, however, is still less than half the target agreed upon by all states in the Common Minimum National Action Plan for Power issued by the Ministry of Power in December 1996 on the basis of agreements reached in two Chief Ministers' meetings. -6- 1.15 The estimated Table 1.4: Fiscal saving under a full-fledged reform program fiscal savings from the (percent of GSDP) full-fledged reform 1998/99 1990/00 2000/01 2001/02 program' (Table 1.4) Power sector restructuring 0.5 1.1 1.4 1.3 would not only help Staff rationalization 0.2 0.3 0.5 0.6 finance the additional Water tariff rationalization 0.0 0.0 0.1 0.1 expenditures but would Public enterprise reform 0.2 0.2 0.2 0.2 also result in a more Safety-net freeze (real per-capita) 0.1 0.2 0.4 0.5 efficient provision of Introduction of VAT public services. The speed Total 1.0 1.8 2.6 2.7 and sequencing of these Source: Staff calculations. reforms will need to be adjusted to take into account their net fiscal cost and the state's ability to finance it. By adopting and implementing these measures, Karnataka will be well poised to build on the achievements of the past. The fiscal and sector analysis that underpin the suggested policy measures are discussed in detail in the following chapters. The following assumptions are made: (a) raising agricultural power tariff to Re. 0.50 per kWh in 1998/99; (b) raising allocations for irrigation O&M to the TFC norm, accompanied by rationalization of user charges to recover 50 percent of recurring costs and transfer of O&M and collection responsibilities to water users' associations at the lower end of surface systems; (c) further enhancement in allocations for road sector investment (full requirement for rural roads) and O&M, raising total financing-plan and nonplan-to Rs. 48 billion in the Ninth Plan period; (d) increased allocations to meet the needs of new construction in the primary education sector; (e) achieving -1 percent growth in government staff excluding teachers and health workers; (f) elimination of budgetary support to public enterprises other than in power by 2001/02; (g) freezing safety-net spending in real per-capita terms from 1998/99 onwards; and (h) implementation of VAT by the year 2000, assuming it is revenue neutral (the experience of most countries which have adopted VAT has shown that it can be revenue enhancing even in the initial years, except when badly implemented). ISSUES IN STATE FINANCES 2.1 Karnataka's state finances have remained stable throughout the 1990s, with a relatively low fiscal deficit compared to other states and a positive revenue account. Karnataka has achieved a higher tax revenue as a share of GSDP than other states and has recently taken steps to improve efficiency in the tax structure. However, these achievements mask important sources of concern. Current spending has been maintained at around 16 percent of GSDP, but capital spending as a share of GSDP has steadily declined since 1992/93 (Table 2.1). Within current spending, the share of O&M in GSDP has stagnated despite deteriorating infrastructure. Although there is a need for a well-designed safety net, the recent increase in subsidies is partly due to weak targeting. Interest payments have been increasing in spite of a relatively stable debt ratio. This is mainly because of rising market interest rates and larger borrowings from more expensive sources--the share of plan loans from the central government, the least expensive source of credit, has decreased from 60 percent of total loans in 1985/86 to 30 percent in 1995/96. The burden of public enterprises is also large due to direct and indirect support by GOK. As a result of these trends, expenditure flexibility has been reduced and there is a risk that it will deteriorate following the implementation of the central Fifth Pay Commission recommendations, which is likely to be matched by the state and thus raise the share of the wage bill. Table 2.1: Kaiuataka's fliscal summary (percent of6SDP) 1990/91 1991/92 1992/93, 1993/94 1994/95 1995/96 1996/97 1997/98', Total-revenue and grants -16.7 15.9 16.4 16.0 --15.2 17.0 . 175 18.7 Tax r6venue 12.8 12.3 12.2 12.7 12.3 13:8 - 139 14.5 Share ofcentralgovernment revenue 2.8 2.6 -2.8' 2.7 2.6 3.0 3 3.2 State's revenue' 10.0 9.7 9.4 10.0 9.7 10.8 10.8 11.4 Nontax revenue 2.2 2.1 2. 1.4 1.4- <1.9 ,1. 19 Grants fror centil govemment 1.6 1.6 1.8 2.0 1.6 1.2 1.8 2.3 Total expenditure - - 18.6 17.6 20.2- 19.2 18.4 19.7 19.7 19.1. Current expenditure 16.1 14.6 15.8 15.1 15.3 16.6 17.0 n.d: Wages and ialaries, 2.9 -2.7 - 2.8 2.9 - 2.8 3.2.- - 33? n.a. Pensions 1.3 0.9 -1.Q 1.0 1.0 1.1 1.1 -n.a. Operations and maintenance 1.5 1.5 1.4 - 1.3 1.3 1.31 1.3 n.a Subsidies 1.2 1.7 J.6 0.5 0.9 1.2 1.4 n.a. Trainsfers 7.1 5.9 7.0 - 7.5, 7.4 7.7 7.6 n.a: Interest payments 2.1 1.9 2.0 2.0 2.0 2.2 2.2 2.3 Capital expenditure and net lending 2.5 3 0 4.4 4.0 3.1 32 2.7 1.8 Overall deficit (-) / surplus (+) -1.9 -1.7 -3.8 -.1 -3.2 -2.8 -2.2', -2.1 Revenue deficit (*) / surplus (+)/ 0.6 1.3 0.6 0.9 -0.1 0.4 0.5 n.a. Financing 1.9 1,7 3.8 3.1 3.2 .2.8 2.2 2.1 Market borrowings 0.6 0:5 - 0.5 -,0.5 0.4 0.6 0.6' 0.7 Loans from center (net) 1.3 1.2 -1.5 13 2.4 1.3 1.4 1.4- Other 0.0 0.0 1L8 1.2 0.4 1.0 0.2 0.0 Memo item: - State debt 20.7 18.4 19.2 191 20.0 19.8 18.8 20.5, Average interest rate of debt (percent) n.a. 9.2 10.9 104 10.5 11.0 11.1 12.2 Note: The- numbers shown inthis table may differ slightly from the Statistical Appendix and Karnataka at a Glance which used RBFdataby functional classification. - a. Budget estimates.' I Interest payments in year t divided by outstanding debt in year t,. Source: GOK budget documents- Jr -8- A. Issues in Tax Reform 2.2 Karnataka's own tax revenue mix is dominated by the contribution of sales tax (60 percent), followed by excise tax (15 percent), stamp duties (10 percent), and motor vehicle tax (7 percent). Other taxes (including taxes on professions, agricultural income, entertainment, and land revenue) make insignificant contributions to state revenue. Several steps towards improving the efficiency of taxation have recently been made. The number of sales tax rates were reduced, tax administration is being simplified and computerized, and some distortive taxes such as the surcharge were eliminated. But more needs to be done. An optimal tax mix strategy for Karnataka should focus on further simplifying the tax system, broadening the tax base, eliminating concessions, minimizing distortions in consumption and production decisions, and improving administration, with the highest priority assigned to the sales tax. Reform of administration of easily evaded taxes, such as stamp duties and agricultural income tax, is also needed. Revenue generation at the municipal level, with special focus on the property tax, could be strengthened and is discussed in Appendix 1. Nontax revenue is largely linked to sector policies (power and irrigation) and is discussed in Chapter 3. Figure 2.1: Revenue from major taxes in Karnataka 7 5 C4 1 Sales tax Excise tax Stamp duties Motor vehicles tax Profession tax M a ) q ) Source: GOK budget documents. Sales tax 2.3 The sales tax is the largest source of Karnataka's revenues, (accounting for 60 percent of own tax revenue and 6 percent of GSDP in 1995/96). The sales tax system includes the general sales tax levied on the sale of goods, the tax on the purchase of sugar cane, the entry tax, the Central Sales Tax (CST), the surcharge, and the turnover tax. The sales tax is levied at the first point of sale on all goods except alcohol, which is subject to a multipoint levy. The registration threshold for the tax is annual turnover of Rs. 200,000. In 1995/96 the rate structure was simplified to four standard rates (2, 4, 8, and 12 percent)' and five special rates applicable to products such as alcohol and motor fuels. Until April I The 1998 budget speech proposes a reduction of the sales tax rates to three (2, 4, and 10 percent). -9- 1997 when it was abolished a surcharge of 15 percent of sales tax was levied on most taxable goods. The CST is levied on interstate sales. The turnover tax is levied at progressive rates on dealers (wholesalers and retailers) with annual turnover of more than Rs. 1.5 million.2 Manufacturers are permitted to purchase some of their production input at a concessional rate of 4 percent to reduce the impact of cascading. The entry tax, which replaced the octroi previously imposed by local governments, is levied on goods that are not under the purview of state sales tax (tobacco, textiles, and sugar) and on certain goods when purchased from outside the state, like motor vehicles. 2.4 Industrial incentives in the form of tax relief cause significant loss in sales tax revenue and erode the buoyancy of the system. New industries are eligible for generous tax incentives, including an exemption or deferment of the sales tax on output. Incentives are also granted to existing firms that invest in expansion, diversification, or modernization, and to mega projects on a discretionary basis. Karnataka provides relief from taxation of production inputs or machinery as well as from taxation of output. The complex structure of multiple rates, exemptions, and incentives necessitates higher tax rates to achieve a given revenue target and increases tax administration cost and tax avoidance. The complexity created by the multiple rates and exemptions was evident from the fact that the Commissioner of Commercial Taxes had issued around 15,000 classification clarifications annually in recent years, but the situation has now improved. 2.5 The sales tax system is distortionary. Distortions that affect competition are introduced through the sales tax levy at first point of sale, since the first point could occur at different levels (manufacturer, wholesaler, retailer) and the taxable'value at that point could represent different proportions of the final retail price of the product. Moreover, the cascading structure of the tax system increases the cost of production and distorts competition because the effective tax burden on a given commodity depends on the degree to which a firm is vertically and horizontally integrated. Because cascading occurs to a similar extent in all states in India, it has little effect on interstate competition. Cascading makes all Indian firms uncompetitive in international markets, however. 2.6 Tax administration needs further modernization. Although tax administration in Karnataka is superior to that in many other states, it nevertheless puts too much emphasis on routine activities and procedural details that prevent managers from focusing on planning and control. The administrative system is based on a monthly return and payment process, combined with detailed annual returns, all of which are assessed. A partial system of self-assessment was introduced in April 1996 for dealers with turnover of less than Rs. I million and manufacturers with turnover of less than Rs. 2.5 million. The system of self-assessment has now been made applicable to all dealers, whether traders or manufacturers, with turnover less than Rs. 2.5 million. The registration process is costly, time consuming, and complex. Manual tax registers continue to be maintained in each local tax office, although they are in the process of being computerized. The organization of the local tax offices is based on the client-based concept, with a single officer responsible for all functions, including registration, returns, payments, and assessment. Checkposts, which are maintained at major interstate crossings to verify that cargo has been accurately reported, are inadequate and inefficient. Documentation collected at the checkposts takes up to a year to sort, and delays at checkposts cause serious traffic congestion. 2.7 The current state sales tax system could be replaced with a VAT, as recommended by the Committee of State Finance Ministers on Sales Tax Reform in its August 1995 report to the Union Finance Minister. As the Indian economy continues to be liberalized, pressures will mount to extend the tax beyond the first point of sale in order both to broaden the tax base by including value addition at 2 The 1998 budget speech proposes a reduction in the threshold to Rs. 0.5 million. - 10 - wholesale and retail stages and to minimize the incidence of taxation on business inputs. Throughout the world the value-added tax (VAT) has been found to be the most efficient form of sales tax that can achieve these objectives. 2.8 VAT should not be introduced selectively on an experimental basis. Selective application of VAT to certain commodities gives rise to classification disputes and creates opportunities for tax avoidance through misclassification of sales. Moreover, lessons learned from selective use of the tax would be of little relevance in assessing the potential benefits of a general VAT. The success of a VAT depends on careful planning and implementation. International experience shows that most countries that have introduced VAT have not suffered revenue shortfalls--on the contrary, many of them collected higher revenues than expected. To achieve the desired revenue results, however, it is necessary to make accurate estimates of the VAT base and set the rates accordingly. Careful preparation is needed before a full-fledged state-level VAT is introduced, mainly in terms of training tax officers and private companies, computerization of tax administration, and preparing a VAT legislation (more details on implementing VAT in Karnataka are given in Appendix 2). 2.9 Pending a systematic assessment of the VAT, the improvement in design and administration of the current sales tax system, which has already begun, should continue. The process of rationalizing tax rates, initiated by the government last year, can be extended by reducing the number of basic rates from four to three and by eliminating exemptions, as recommended by the Committee of the State Finance Ministers on Sales Tax Reform. The turnover tax, which is highly distortionary and may be encouraging noncompliance, should be eliminated. Suppression of taxable turnover to escape the turnover tax results in a loss of both the turnover tax and the sales tax. By encouraging compliance, elimination of the turnover tax may thus lead to a lower revenue loss than its contribution to total revenues. 2.10 Karnataka should work with other states to limit industrial incentives. Industrial incentives in Karnataka were enhanced in response to an intensification of interstate competition following economic liberalization that ended the licensing system determining the geographical dispersal of investment approvals in India. The resulting "rate wars" led to significant revenue loss for all states and to a misallocation of resources by altering the profitability of different companies depending on their age, scales of operation, and industry. Because the amount of benefit is calculated as a percentage of total fixed capital formation, incentives discriminate against labor-intensive sectors and technologies. Although Karnataka alone may not be able to resist demands for industrial incentives, it can play a leadership role in ensuring that states collectively adhere to recommendations of the Committee of State Finance Minister to terminate fiscal incentives. If the government has any flexibility in granting such incentives, tax incentives should be provided mainly in the form of tax relief on inputs. Incentives in the form of deferment or exemption of tax on output, which cause competitive distortions between existing and new firms and encourage noncompliance by existing firms, should not be offered. The government could create a tax expenditures account cataloguing all concessions provided through the tax system so that revenue losses associated with tax incentives and exemptions are transparent. Maharashtra has published such an account on an ad hoc basis. 2.11 Administrative reforms should focus on modernization and voluntary compliance. The primary objective of modern tax administration is to encourage voluntary compliance. Doing so requires establishment of simple procedures, proper education of taxpayers (registered dealers) about their roles and responsibilities, use of a selective system of tax verification and investigation, and effective monitoring of staff activities. Computerization plays an important role in achieving these objectives and should be expedited. All of the procedures, forms, and rules used in Karnataka need to be systematically reviewed and reengineered. The system of self-assessment of sales tax should be extended to all dealers - 11 - and a good method for selecting a sample of tax returns should be adopted. Tax forms should be simplified and accompanied by simple instructions that taxpayers can understand. Local offices should be reorganized on a functional basis--functions would include registration, return processing, payments, collections, scrutiny, interpretation, investigation, intelligence, and computer systems. Checkposts should be ultimately abolished. Some states (such as Rajasthan) have abolished checkposts with little loss in revenues. Excise tax 2.12 The excise tax, the second largest source of Karnataka's own tax revenues, is levied on revenue from the production of alcohoL Additional excise revenues accrue from the auction of the right to retail country liquor (arrack) and from license fees for manufacturing or distributing alcohol. Arrack is produced from rectified spirits by a state enterprise; Indian-made liquor (IML) and beer are produced by private distilleries and breweries. In 1995/96 excise revenues totaled Rs. 8.2 billion, of which Rs. 5.9 billion came from arrack, Rs. 1.8 billion from IML and beer, and Rs. 0.5 billion from license fees. Excise revenues have not been very buoyant and decreased from 1.8 percent of GSDP in 1990/91 to 1.5 percent of GSDP in 1995/96. This decrease is partly attributable to the lack of inflation adjustment of the excise duty rates (since the excise duty is a specific tax); the basic structure of excise duty rates, license fees, and auction system for country liquor appears to be sound, and duty rates are competitive with those prevailing in neighboring jurisdictions. The system of auctions is well structured to obtain the highest possible shop rentals. Stamp duties 2.13 Stamp duty revenue comes from fifty-five instruments mandated by state legislation and from various financial instruments, such as shares, debentures, and insurance premiums, mandated by national legislation. More than 90 percent of revenue from stamp duties and registration fees comes from conveyance of immovable- property and the associated registration fees; most of the remaining 10 percent of revenue comes from judicial stamp duties. The estimated buoyancy of stamp duties and registration fees is 1.34, higher than the 1.24 average for the major states between 1980/81 and 1992/93. 2.14 A single valuation agency could be established to value land and buildings. Karnataka is in the process of converting its base valuations for stamps from the recorded "consideration" identified by the purchaser (with possible adjustment by the deputy collector) to a system of notified or guideline values defined in terms of the estimated prevailing rents for properties grouped by geographic locations and observable characteristics, such as plinth area. Valuation is the responsibility of committees of state officials in each locality. The new guideline valuations had been completed only for Bangalore by the end of 1996. A single valuation agency, with professional staff, could be given responsibility for valuing land and buildings, and the agency could be used by local governments to levy property tax and by the state government to levy stamp duty on conveyance (see property tax in Appendix 1). 2.15 High effective rates on property transfers could be lowered to reduce the "lock-in" effect. Cumulative statutory rates, inclusive of cesses to urban and rural bodies, are 15 percent of accepted valuations in rural areas and 14 percent in most urban areas. These high rates discourage efficient allocation of property and encourage evasion both through undervaluation and complete avoidance of registration. Reducing rates would lead to an expansion in the tax base, which would partially offset the potential loss in revenue. The ceiling for cumulative stamp tax rates could be reduced initially to 10 percent, .as proposed by the draft stamp tax reform initiative of the Union Government, and ultimately to 8 percent or lower, once new valuations are established. This reduction in the burden associated with - 12 - property transfers could be accompanied by parallel reforms of the municipal property tax aimed at increasing the annual burden of the property tax on property owners. 2.16 The current cess to local bodies could be replaced by transfer measures proposed by the State Finance Commission. The current 2 percent stamp duty cess on property transfers--which is earmarked to Taluk (second-tier) Panchayats and allocated on the basis of population--is raising the effective stamp duty rate and exacerbating economic inefficiencies. A better alternative to finance local bodies has been proposed by the State Finance Commission which recommends elimination of the 2 percent cess (as well as other earmarked taxes), creation of a single pool of revenue from the state's noninterest revenue, and devolution to the three levels of Panchayats according to a multiple-criteria formula. 2.17 Secondary financial market instruments need to be exempted from stamp duty. Transaction costs associated with stamp duties on the transfer of bonds, debentures, and shares impede the development of a mature secondary market in debt and equity instruments, and little, if any, revenue is currently realized from these transactions. The danger that onerous compliance costs under the stamp regime will thwart the natural tendency for this secondary debt market to mature and impede Bangalore's development as a financial center should be weighed against any potential revenue gains from continued taxation. Based on these considerations the authorities must decide whether to support proposals for the exemption of duty on secondary market instruments. Most industrial countries, with the notable exception of the United Kingdom, have elected not to tax these transactions with stamp duties. In 1997/98 GOK took a step in the right direction by reducing the conveyance charge on securitized debt from 10 percent to 1 percent. Other taxes 2.18 Motor vehicle tax consists of a once-in-a-lifetime tax on private use of motor cars and two-wheel scooters and on commercial use of autorickshaws, and a quarterly tax on all other commercial vehicles, including trucks and regularly scheduled buses (known in India as stage carriages). Revenue from motor vehicle tax was around 0.6 percent of GSDP in 1996/97. Motor vehicle tax rates are normally amended every two years; revising them annually would help increase buoyancy. The design of the motor vehicle tax reflects a strong commitment to the benefit principle, where the tax burden is proportional to the wear and tear that various types of vehicles impose on the road system. A special surcharge on luxury vehicles and vehicles that cause excessive environmental damage could be introduced within the current rate structure. Care should be taken, however, not to make administration overly complex through excessive classification of vehicles. The system copes effectively with sales tax avoidance on out-of- state vehicle purchases by levying a compensating entry or sales tax when the vehicle is registered in the state. 2.19 Anyone with a profession who is subject to the Union Income Tax is liable for the profession tax, which is collected from employees in the formal or organized sector by deduction at source. Compliance among the self-employed is much better in Karnataka than in several other states, indicating effective enforcement. In April 1997 rates were increased from a range of Rs. 72-250 a year to a range of Rs. 300-2,500 a year. Revenue from the profession tax could be further increased by levying the highest rate allowed under the Indian Constitution (Rs. 2,500) on a larger proportion of taxpayers, especially self-employed professionals. To motivate the self-employed to comply with this tax GOK could earmark proceeds from the tax for better-targeted poverty alleviation expenditure programs or expansion of primary education. Banks could be used to collect the tax, as is done in Maharashtra. - 13 - 2.20 A state agricultural income tax is levied on income from plantation crops. The rate structure under the regular agricultural income tax is steeply progressive, with rates ranging from 10 to 50 percent. About 3 percent of the cultivated land in the state is allocated to plantation farming, and coffee is the most important crop. Plantation owners with holdings of 50 acres or less have the option of paying tax on their net agricultural income or paying a presumptive tax determined in terms of a fixed rupee amount per acre with a progressive structure. Holdings of less than 15 acres are exempt. Plantation owners eligible to elect the presumptive tax currently enjoy a tax burden equivalent to about 25 percent of the burden they would face under the regular income tax. This dual system has lead to the fragmentation of plantation estates--both by actually breaking up estates and through sham, or banami, transactions (transactions which exist only to avoid taxation)--and needs to be reconciled. 2.21 The tax burden for agricultural and nonagricultural corporations should also be reconciled. Corporate tax rates in the nonagricultural sectors, which are under the Union income tax, have recently been lowered from 46 percent in 1995/96 to 35 percent in 1997/98 while corporate tax rates in the agricultural sector, which are under the state income tax, have been lowered from 65 percent in 1995/96 to 50 percent in 1997/98. This reduction in the rate is a step in the right direction towards reducing the tax burden gap between agriculture and nonagriculture corporations, but it is not a sufficient one. A flat tax rate at around 35 percent on all firms operating plantations in the state could be considered. If progressivity is desired an increasing average tax rate and a flat marginal rate could be imposed by providing a basic exemption defined in terms of income or acreage to all taxpayers. The reduction in the corporate tax for agriculture would also reduce the incentive of large corporations to fragment in order to be eligible for the presumptive tax. .- Table 2.2: Tax reforin Objetive - Policy measures Simplif, eliminate distortions in, and * In the short term; rationalize rates and exemptions by reducing-6tlmimber of increase-buoyancy of sales tax system. basic rates fom, fourto three and eliminating exemptions; eliminate the turnover tax; .and work with other states to limit industrial incentives.- * In the medium term, replace the current sales tax systei with a' VAT (see Appendix 2). Increase transparency P Create a tax expenditures account Encourage voluntary compliance * Simplify tax forms and establish simpler procedures; reassess penalties to ensure that they encourage compliance, and strictly enforce penalties Incriease administrat ve efficiency * Reduce emphasis on routine activities and procedures, which prevent managers from focusing on planning and control; use a selective system of tax verification and investigation; extend self-assessment of sales tax to all dealers and adopt a good method of sampling,tax returns: Expedite computerization; improve training of assessment officers;,and-monitor staff activities. * Restructure offices on function-based concept rather than client-based concept. * In the short term, computerize checkposts. In the medium term, eliminate checkposts, which are inadequate,,inefficient, and cause traffic congestion.,. Stam duties Increase efficiency of stamp tax and * Establish a single valuation agency to value land and buildings across localities. registration fees. * Lower rate on,property transfers to reduce the "lock-in" effect. Exempt secondary financial market instruments from stamp duties. Other taxes Improve effectiveness of motor vehicle * Revise the rates annually instead of biennially in order to improve buoyancy. tax.* Impose surcharge on luxury vehicles and vehicles that cause excessive-, environmental damage. Increase revenue from profession tax Increase rate structure to achieveiceiliig'of Rs. 2,500 for a,larger proprtion of taxpayers; and motivate sefiployed to comply with tpiby earmarking proceeds for poverty alleviition or expansion of primary educatiow Improve neutrality of and revenue * Reconcile the tax burden under the presumptive agriculture incometax and the from agricultural income t regular income tax; and reconcile the tax burden borne b y agricItural aid nonagricultural corporations.. - 14 - B. Expenditure Restructuring 2.22 As noted above, expenditure flexibility is decreasing and the composition of spending is changing at the expense of investment and O&M. So far, GOK has tackled expenditure issues by trying to stabilize spending rather than undertaking fundamental reforms. In view of developments at the central level that will exacerbate the reduction in expenditure flexibility (the implementation of the Fifth Pay Commission, the declining central support to states, and the increasing interest rates) GOK needs to redirect current spending away from unproductive activities toward those that enhance growth and effectively reduce poverty. Wages, salaries, and pensions 2.23 The state's salary bill has risen modestly since 1990/91 and amounted to about 23 percent of tax revenue in 1995/96. However, including the district-level Zila Parishads and aided private educational institutions, both of which receive transfers from the state to finance their wage bill, raises GOK's effective wage bill to close to 40 percent of tax revenue. In the past five years, growth in public employment (Table 2.3) has been around 3 percent a year. During this period, GOK has attempted to contain recruitment. A measure was taken in 1990/91 to restrict the creation of new posts and filling of vacant posts without the permission of the Finance Department. In 1997 a decision was taken to abolish 5 percent of sanctioned posts (equivalent to 35 percent of vacant posts). Table 2.3: State employment (in thousand) 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 Sanctioned posts 537 541 563 576 613 652 672 663 State government 268 260 268 273 294 305 297 294 ofwhich: Education 27 27 27 26 26 26 18 24 Health 44 25 25 25 25 25 26 26 Zila Parishads 269 281 295 303 319 347 375 369 of which: Education 143 150 152 154 167 173 186 179 Health 38 37 38 40 41 41 44 44 Number of pensioners 237 250 266 280 297 314 318 n.a. Source: Data provided by the Karnataka authorities. 2.24 A large part of the increase in employment since 1990 was tied to the conversion of temporary employees to regular employees following a Supreme Court decision, or to hiring in the police department. At the district level, where primary responsibility for some of the most labor-intensive government functions such as education and health have been shifted as a result of recent decentralization efforts, employment grew by over 4.5 percent a year. This growth took place partly to offset the freeze in the number of teachers in previous years and partly to extend education and health services to areas where coverage had been limited. 2.25 With the likely implementation of the Fifth Pay Commission recommendations the ad hoc measures used so far to control the size of the civil service need to be replaced by a more systematic approach to avoid an explosive growth in the wage bill. Like other states, Karnataka's Pay Commission The Supreme Court of India ruled in 1990 that government departments and agencies should convert into regular staff all temporary employees working on July 1, 1984, after they completed ten years of service. - 15 - has generally matched the civil service pay scales used by the center. If Karnataka adopts the recommendations of the Fifth Pay Commission--which are roughly estimated to increase the states' wage bill by over 2 percent of GDP on average--the additional fiscal cost would be substantial and would further expand if local bodies and aided private educational institutions are included.' An increase of such magnitude will crowd out other essential expenditures unless public sector employment is reduced. In view of the long-term fiscal impact of the revised government pay scales, GOK needs to set an appropriate target for rationalizing employment--the Fifth Pay Commission, for example, has recommended downsizing the central civil service by 30 percent over 10 years. 2.26 A feasible strategy to control employment growth could rely primarily on control over new recruitment in departments and activities that do not provide essential services. Such a strategy could succeed without retrenchment, since significant scope remains for achieving savings through natural staff attrition in the civil service (of about 3 percent a year). A formal pool of surplus labor could be established and used to fill vacancies. To allow flexibility new positions could continue to be created, but priority would be given to filling them with surplus labor. A systematic review of organizational functions could be established to eliminate outdated posts. Vacant posts remaining unfilled for a given period of time--say, one year--could be abolished to bring the number of sanctioned posts closer to the true needs of each department. The current policy of restricting the hiring of temporary employees would remain in place given the legal requirement to regularize casual workers after a period of time. The success of such a strategy depends on GOK's commitment to adhere closely to its policy of rationalizing employment and would require implementation monitoring by a high-powered ministerial committee. 2.27 GOK could begin to consider ways to fund its pension liabilities. In addition to state employees, pension liabilities cover employees of local governments and retired employees of aided educational institutions. The number of pensioners increased by about a third between 1990/91 and 1995/96. Despite this increase, expenditure on pensions remained stable at about 1 percent of GSDP due to a substantial erosion in real terms of per capita pension benefits. The figure is expected to rise over the next several years, however, because of the likely implementation of the Fifth Pay Commission at the state level and the increased number of government retirees following the rapid growth in public sector employment in the past two decades. Currently pension liabilities are funded from the Consolidated Fund. Following the recommendation of the Fifth Pay Commission, a pension fund with contributions from both employees and GOK could be established. Partial funding of pension liabilities by employees and the returns on the pension fund's investments would limit GOK's expenditure burden to the size of its own contribution, thereby freeing resources used at the state's discretion. Such a fund would also increase savings and capital accumulation, improve intergenerational equity, and enhance transparency in government spending. Transfers 2.28 Transfers sustain a substantial part of the state's existing social safety net but need to be revamped to better serve the poor. Most of the expenditure on transfers (or grants-in-aid) is confined to four main areas (Table 2.4): general education (including transfers to private educational institutions for payments of teachers' salaries); social security and welfare (including community work and construction schemes to provide wage employment to poor people); and housing (which grew recently on account of conversion of housing loans into grants). Like other states, Karnataka's system of transfers comprises a 4 The 1998 budget speech estimates the financial burden of the Fifth Pay Commission recommendations at Rs. 14 billion for Karnataka. An Official Pay Committee has been appointed recently to make recommendations on this issue to GOK. - 16 - wide range of numerous programs financed through the center and the state with no well-established strategy or social priorities. To improve cost effectiveness and impact on the poor, grants-in-aid need to be consolidated into a smaller number of well-defined and better-targeted schemes to avoid overlap in objectives and beneficiaries. Table 2.4: Transfers (Rs. billion) 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97a General public services 1.4 1.6 2.5 1.8 2.6 2.5 3.3 Education 6.9 8.3 9.5 11.1 12.9 14.6 17.0 Health 0.9 1.0 1.5 1.5 1.7 1.8 2.1 Social security and welfare 2.8 4.3 5.1 5.9 6.0 9.0 9.4 Housing 1.5 1.8 1.6 2.4 3.8 4.1 6.2 Agriculture 1.6 1.9 2.2 2.0 2.0 2.2 3.4 Electricity and water supply 0.1 0.1 0.2 0.2 0.2 0.1 0.1 Mining 0.9 0.3 0.5 0.5 0.5 0.7 0.9 Transport and communication 0.4 0.5 0.7 0.5 0.7 0.6 0.7 Relief on calamities 0.5 0.9 0.8 0.5 0.4 0.5 0.5 Other 0.3 0.3 0.3 0.3 0.6 0.9 1.0 Total 17.2 21.1 24.8 26.9 31.3 37.0 44.6 a. Numbers for 1996/97 are budget estimates. Source: GOK budget documents. 2.29 Education transfers need to be redesigned About half of education transfers support secondary and higher education, and half support elementary education which is almost entirely run by local bodies. Grants to private educational institutions, which pay for teachers' salaries, account for about 30 percent of education transfers. Only private institutions established before 1987/88 are eligible to receive these grants-in-aid, which are distributed according to the number of teachers employed by the institutions. This process discriminates against new educational institutions while older ones can keep on expanding their staff at the state's expense. On efficiency and equity grounds state education transfers could be reallocated so that (a) higher-level educational institutions receive less support and lower-level educational institutions receive more support; (b) grants-in-aid to private educational institutions are no longer made on a lifetime basis but rather for a specified, limited time in order to increase their incentive to improve cost recovery, especially in higher education; and (c) private educational institutions in primary education established after 1987/88 become eligible for grants-in-aid. An overall analysis of education spending is provided in Chapter 3. 2.30 The state should carefully evaluate centrally sponsored schemes before agreeing to cofinance them. Most centrally sponsored schemes, which are designed by the central government to meet national social priorities, require matching contributions from states. Although states can decide not to participate in centrally sponsored schemes, they generally view the schemes as an additional source of resources and implement them without carefully examining their financial implications or their relevance to state priorities. In Karnataka two-thirds of major budgetary headings in the grants in aid category were linked to centrally sponsored schemes in 1995/96, with matching contributions from GOK accounting for 13 percent of the state's total expenditure on grants-in-aid. To improve rationalization and efficiency of spending in these schemes the state could select centrally sponsored schemes based on a thorough analysis of associated costs and benefits. - 17- Subsidies 2.31 Since 1990/91 explicit subsidies grew only slightly and accounted for 1.4 percent of GSDP in 1996/97 (Table 2.1), of which the food subsidy accounted for over 45 percent, the power subsidy for 32 percent, and the transport subsidy for 8 percent. However, when subsidies are computed using the cost recovery approach,' a more dramatic picture is revealed (Table 2.5). Between 1990/91 and 1996/97 total subsidies as a share of GSDP have increased from 1.8 percent 3.1 percent. This is equivalent to almost a quadrupling in per capita subsidy during a period when per capita GSDP doubled. Most of this increase is accounted for by subsidies which are not well targeted (such as food) or which are not justified on social grounds (such as power and irrigation--reform of the power and irrigation sectors is addressed in Chapter 3.) Table 2.5: Total subsidies' (Rs. billion)_ 1990/91 1991/92 -1992/93 1993/94 1994/95 1995/96 1996/97 Total subsidy 4.3 7.2. 6.9 6.5 10.5 13.8 17.3 Education 1.3 .7_1. __ 1.7,- 1.9 2.2 2.4 2.7 Health - ' 0.8' 1.1 1.2 1.3 1.5 1.6 2.1 Irrigation 0.3 0.2' 0.4 0.5 0.5 0.5 1.1 Food' 0.6 0.7 0.6 0.7 1.4 2.7 3.0 Housing 0.2 0.5:, 0 0.8 1.0 0 1.8 Power 0:5 2.2 1.2 0.4 2.1 41 4.8 Mining and mainufacturing 0.4 0 ,OO5 0.4- .0.3 0.7- 0.6 0.8 Transport and communication 0.0 0.2 0.5 0.0 0.5 0;4 0.5 Other 0.1 0.1 0.4 0.5 0.6 0 4 0.4 Total subsidy/GSDP (in percent) 1.8 24 2 177 2.4 2.8 .1 Per capita subsidy (in Rs.) 95' -158 -151 -138 222 285 352 Per capita GSDP,(in,Rs.) - 5,213 627 7'153 8,140 9,292 0;088 11,333 a. Total subsidy includes explicit and'implicit subsidies - - - - Source: Staff estimates. 2.32 The food subsidy is ineffectively targeted and could be replaced to a large extent by the center's envisaged targeted public distribution system. GOK subsidizes food by setting issue prices of food grains sold through the Public Distribution System (PDS) below central issue prices. The state subsidy is regulated through the issuance of special green cards to eligible beneficiaries and it is in principle restricted to people living below the poverty line in rural areas and urban slums. No strict norms regulate the issuance of green cards, however, and about 60 percent of the population (85 percent in rural areas) receive the state subsidy. These figures suggest that almost half of those receiving the state food subsidy do not officially qualify for it. The distribution of green cards by district income (Figure 2.2) shows a concentration of green card holders in the middle-income districts.6 5 The cost recovery approach defines budgetary subsidies as the difference between the cost of supplying a good or service and the recovery from such a delivery. This approach takes into account only O&M (including staff salaries) incurred in delivering a good or service from which gross receipts are deducted. Return to capital invested by the government is not taken into account. 6 It is possible that only poor people in better-off districts have access to the system, but this effect is unlikely to be strong enough to overcome district averages. - 18 - 2.33 Targeting of the state food subsidy could be Figure 2.2: The food subsidy is poorly targeted improved by controlling and monitoring the issuance of 200 green cards. Introduction of 40 self-targeting mechanisms, 150 -including subsidizing only coarse grains consumed mainly by the poor, locating 6 50 hypothetical desirable relation PDS shops only in poor areas, and expanding food-for-work C o programs, would also 0 1000 2000 3000 4000 improve the effectiveness of District income per capita (Rs. per year) the subsidy in targeting the poor. Revision of the issue Source: Food and Civil Supplies Deptartment, GOK. prevuld be idere price could be considered to keep it in line with the market price and to reduce leakages that occur because of the high differential between the two. Adoption by the central government of the dual pricing system envisaged under the targeted PDS (TPDS), whereby only people living under the poverty line would be eligible for an additional subsidy from the center of Rs. 3.5 per kilogram, would create a built-in incentive mechanism for better targeting at the state level to qualify for the TPDS and would reduce the need for an additional subsidy by the state. 2.34 Subsidization of irrigation and power is disproportionately benefiting those who can pay for such services and is distorting their usage. The distribution of land by size of holding (Table 2.6) reveals that if irrigation water and the power needed to operate power pumpsets were allocated equally across the state, the more than Table 2.6: Distribution of land by size of holding, 1990/91 65 percent of farms that are Size of holding Percentage of farms Percentage of area smaller than 2 hectares (small Marginal (<1 hectare) 39.2 8.7 and marginal farmers) would Small (1-2 hectares) 27.5 18.7 receive less than 30 percent of Semi-medium (2-4 hectares) 20.1 26.0 the subsidy. While the cost of Medium (410 hectares) 11.0 30.6 coordinating and regulating Large (>10 hectares) 2.2 16.0 the use of power and Source: 1991 Census of India, GOI. irrigation systems and some of the fixed costs of infrastructure are necessary public expenses, provision of virtually free power and water to farmers encourages them to use these resources wastefully. As a result of wasteful usage, power and irrigation services have become inadequate and unreliable, while reliance on more expensive and less efficient backup generators has increased, especially in the industrial and commercial sectors. Instead of distorting efficiency and equity through power and water subsidies, GOK could support agriculture by investing in the infrastructure needed by the sector (rural roads and markets' development, for example) while ensuring better supply of water and power through improved cost recovery and institutional effectiveness. Operation and maintenance 2.35 Spending on nonwage O&M has stagnated at around 1.3 percent of GSDP, leading to serious deterioration in the state's infrastructure. The annual budgetary allocation for maintenance rose at a rate only slightly higher than inflation rather than according to specified sectoral norms (O&M in specific - 19 - sectors is analyzed in more detail in Chapter 3). Moreover, actual maintenance allocations were reduced to offset expenditure overruns in other areas of current expenditure, and nonwage operating costs went unmonitored. 2.36 Reducing O&M spending is a false saving. Inadequate maintenance has been an almost universal (and costly) failure of infrastructure providers in developing countries (World Development Report, 1994). Failings in maintenance are often compounded by ill-advised spending cuts. Curbing capital spending is justified during periods of budgetary austerity, but reducing maintenance spending would have to be compensated for later by much larger expenditures on rehabilitation or replacement. Because inadequate maintenance shortens the useful life of infrastructure facilities and reduces the capacity available to provide services, more has to be invested to provide those services. 2.37 O&M spending norms need to be integrated in the budget To avoid further deterioration in the state's infrastructure, which is constraining growth, sectoral O&M norms need to be established where such norms do not exist, and adequate O&M allocations (in line with Finance Commission norms) need to be made in the budget. The Planning Commission is currently considering integrating O&M allocations into the formal planning process at the state level. Such a measure, which would make spending of maintenance budgetary allocations compulsory, represents a step in the right direction. Expenditure management 2.38 Spending cuts need to reflect' a systematic reassessment of program needs and priorities. GOK's expenditure management and control system is characterized by a bottom-up approach to budgeting (mainly nonplan), which results in incremental rises in expenditure. In principle the state's expenditure control and management system includes cash-flow profiles (albeit limited to a few large programs), complete separation of accounting and auditing, some internal controls in the spending agencies, internal audit and management information systems, computerization of accounts, and the year-end evaluation of major plan programs and projects. In practice, some measures and procedures have not proven effective as some have not become fully operational and others are simply not used. 2.39 Recent steps to improve expenditure could be complemented by additional measures. The state has recently taken steps to control spending and improve public expenditure management. Since September 1, 1996, plan programs have been reviewed, and more than 70 redundant schemes have been identified for elimination. The resulting savings will be redirected toward other plan schemes in the 1997/98 budget. A Cabinet subcommittee chaired by the Minister of Finance has been established with a mandate to review programs and expenditure procedures in the state government and to recommend ways to achieve savings by eliminating unproductive expenditures. 2.40 Additional public expenditure management reforms that could be considered by the Cabinet subcommittee include (a) integrating plan and nonplan budgeting by taking into account the implications of plan expenditure on the nonplan budget; (b) introducing rolling medium-term expenditure plans, which would reveal the full expenditure implications of existing programs; (c) creating expenditure profiles, which would identify the sources of program cost escalation; (d) developing performance indicators and targets, which would permit the economic and social returns of a program to be assessed; and (e) introducing firm cost limits for spending agencies to facilitate more effective cash management and make short-term borrowing needs more predictable. - 20 - Table 2.7: Expenditure measures Objective Policy measures Eaghill Control employment growth in view of * Utilize the scope for natural staff attrition by: establishing a pool of surplus the Fifth Pay Commission labor and using it to fill vacancies; allowing flexibility in creating new recommendations. positions; reviewing organizational functions systematically to eliminate outdated posts; abolishing vacant posts remaining unfilled for a given period of time; and keeping the policy of restricting hiring of temporary employees. Consider ways to fund pension * Establish a pension fund with contributions from both employees and GOK. liabilities. Trantfers Improve transfers' cost effectiveness * Consolidate grants-in-aid into a smaller number of well-defined and better- and impact on the poor. targeted schemes to avoid overlap in objectives and beneficiaries. Redesign education transfers. * Reallocate transfers to private educational institutions so that: higher-level educational institutions receive less support and lower-level educational institutions receive more support; transfers are no longer made on a lifetime basis but for a specified, limited time to increase incentive for cost recovery; and primary education institutions established after 1987/88 be eligible for transfers. Improve rationalization and efficiency * Assess costs and benefits of centrally sponsored schemes before agreeing to of spending in centrally sponsored cofinance them. schemes. Subsidia Improve targeting of the food subsidy * Control and monitor the issuance of green cards; introduce self-targeting to better serve the poor and to qualify mechanisms; and expand food-for-work programs. Revise the issue price to for the center's TPDS. keep it in line with market price and reduce leakages. Reduce irrigation and power subsidies * see irrigation and power sector reforms in Chapter 3. and replace them with infrastructure investment in rural roads. (2&M Increase spending on O&M. * Follow TFC norms for O&M in various sectors (see Chapter 3). * Implement the Planning Commission consideration of integrating O&M allocations into the formal planning process at the state level. FEVenditure mana=ement Increase efficiency of expenditure * Integrate plan and nonplan budgeting; introduce rolling medium-term management expenditure plans; create expenditure profiles; develop performance indicators and targets; and introduce firm cost limits for agencies. C. Public Enterprises 2.41 Like many other state governments in India, GOK supports a large number of public enterprises. As of end 1994/95 the Karnataka State Bureau of Public Enterprises (KSBPE) listed 76 state-level public sector enterprises, including 30 manufacturing enterprises, 17 service enterprises, 17 "development" enterprises,' 2 financial institutions, 7 marketing and advertising enterprises, and 3 public utilities. GOK's financial stake (loans and equity) in public sector enterprises stood at Rs. 40 billion in 1994/95. The three public utilities--Karnataka Electricity Board (KEB), Karnataka Power Corporation (KPC), and Of the 17 development enterprises, 12 are engaged in commercial activities such as leather, cashew, coir, and films, and 5 are engaged in noncommercial activities, such as scheduled castes/tribes development. - 21 - Karnataka State Road Transport Corporation (KSRTC)--account for the bulk of the fiscal burden the public enterprise sector imposes on the budget. As of end 1994/95 the public utilities accounted for 70 percent of the government's equity stake and 72 percent of its loans outstanding to public enterprises. They also account for most of the employment, financial losses, and flows of funds from the state. Of the 170,000 people employed in the 76 public enterprises at the end of 1994/95, 67 percent were on the payroll of the 3 public utilities. 2.42 The 76 public enterprises incurred losses of Rs. 1.7 billion in 1994/95, a figure that is concealed by the Rs. 750 million in profits earned after subsidies. KEB and KSRTC receive almost all of the direct subsidies, which are used to compensate KEB for providing subsidized electricity to agricultural consumers and to compensate KSRTC for providing concessionary services to certain categories of passengers. Losses by KEB and KSRTC were substantial in 1994/95. KEB lost Rs. 1.6 billion (profits were Rs. 430 million after subsidies); KSRTC lost Rs. 1.0 billion (Rs. 700 million after subsidies). KPC was profitable in 1993/94 and 1994/95. The manufacturing enterprises, which receive only small direct subsidies from GOK, suffered losses in 1993/94 and 1994/95. The commercial development enterprises earned a profit for the first time in 1994/95, and the service and financial enterprises have enjoyed increasing profitability over time. 2.43 Direct financial flows from GOK to public enterprises include equity contributions, loans, and subsidies. Indirect flows include loans at below market interest rates and the tolerance of arrears in loan repayments, interest, and tax payments. No benefits are provided in the form of preferential tax rates or tax exemptions. Flows from public enterprises to GOK include loan principal repayment, interest payments, payments of taxes, dividends, royalties, and commission fees on loan guarantees. In 1992/93 net outflows from GOK to public enterprises were equivalent to 6 percent of the state's revenue (Table 2.8). Net outflows declined in 1994/95 but increased substantially in 1995/96 and were equivalent to Table 2.8: Flows between GOK and piblic enterprises.1992/93-1995/96 (Rs. million) Payment type 1992/93 1993/94 1994/95 1995/96 Oufrows from,GOK 7889 7101 7120 10078 Equity 2054 3272 2726 2381 KPC 722 2990 08 188 KEB 0 0 1184 1175 IKRT 320 500 1455 Subsidies, 1390 640 2460 4460 KPC -8 8 8 8 KEB 1113 .- ,339 2081 4090 KSRTC 250 250 350 350 Loans 4445 -3189 1934 3237 KPC- 28871369 621 17751 KEB 801 1246 602 831 KSRTC '0 -0 0 0 Inflows to GOK 4714 6190 7157 8914 Principal repayments 575 2375 1460 2355 Interest payments 1639 1085 2817 3025 Dividends. 40 20 30 30 Taxes, royalties, fees 2460 '2710 2850 3504 Net outflowfrom-GOK 3175 911<-. -37 1 t64 As percent of state revenue 5.9 1 0.1 14 As percent of health spending 85.8 22. -0.8 21.2 'Memo item: Equity and subsidies minus dividends as percent of state revenue - .6.4 6.2 7 8.2 Source: Putlic Enterprises Survey, GOK. - 22 - over 20 percent of health spending in that year. An alternative way of measuring the budgetary burden of public enterprises is to look only at flows made to these enterprises that would not have been made if the companies were privately owned. Such outflows consist of equity contribution and direct and indirect subsidies (but not loans); inflows consist of dividend payments (but not principal repayments and interest and tax payments). Using this approach, net outflows between 1992/93 and 1995/96 rose from over 6 percent of state revenue in 1992/93 to 8 percent in 1995/96. 2.44 Ad hoc debt relief provided to public enterprises by GOK is not improving debt-service performance and is reducing transparency. About 6 percent of loans outstanding to GOK were in arrears at the end of 1994/95. Moreover, enterprises unable to fulfill their debt-service obligations to GOK are often given relief through conversion of loans to equity. Between 1991/92 and 1995/96 almost half of all loans to KEB (over Rs. 4 billion) were converted to equity. Also, because financial institutions are increasingly demanding government guarantees on loans to public enterprises, outstanding government guarantees on loans taken out by public enterprises in Karnataka amounted to about Rs. 45 billion at the end of 1994/95, equivalent to 40 percent of government revenues. Policy reforms 2.45 Public enterprise reform needs to focus first on the three public utilities. The restructuring of KEB and KPC will have to be part of an overall reform of the power sector (see Chapter 3). The restructuring of KSRTC is discussed in Appendix 3. Other reform measures are discussed below. 2.46 GOK needs to impose a hard budget constraint on all public enterprises. First, explicit subsidies need to be linked to the provision of a clearly defined social service and should not finance operational inefficiency. Second, implicit subsidies (such as interest rate subsidies on government loans and tolerance of arrears on loan repayments and interest payments) need to be phased out. Third, the practice of converting loans to equity as a response to an enterprise's inability to meet debt-service obligations need to be reevaluated. Fourth, a mechanism to regularly monitor all flows between GOK and public enterprises need to be put in place in order to assess the current and future budgetary burden of public enterprises. 2.47 GOK needs to privatize enterprises engaged in activities that could be provided more efficiently by the private sector. First, all manufacturing enterprises, regardless of their current financial performance, could be considered as candidates for privatization. Second, enterprises, or product lines within an enterprise, that are nonviable could be liquidated. Third, the rationale for development, service, and marketing enterprises, which represent about two-thirds of Karnataka's public enterprises, could be reassessed. A High Power Committee under the chairmanship of the Chief Secretary of Karnataka is deliberating on the issue of privatization of state public enterprises and has identified 23 companies to be privatized. The 1998 budget speech highlights the ongoing effort to disinvest in public enterprises producing consumer goods. 2.48 A privatization strategy that incorporates some of the lessons learned from privatization efforts in other countries could be formulated in a policy statement. First, restructuring public enterprises before privatizing them in order to obtain a better price needs to be avoided. Pre-privatization restructuring may be appropriate only to the extent that it involves such measures as labor shedding, debt restructuring, and organizational restructuring. Restructuring that involves new investment is best left to the enterprise's new owners. Second, there should be no bias against privatizing profitable enterprises. Selling off profitable enterprises will generate private sector interest and strengthen the credibility of the program. Third, private owners need to be allowed to purchase a controlling interest of the privatized enterprise. - 23 - GOK could thus divest at least majority ownership in the enterprises in the first phase, with full divestiture within a few years the ultimate goal. 2.49 Labor issues need to be dealt with upfront to ensure the success of privatization. Reform of public enterprises is likely to lead to labor shedding in the short run. Experience from other countries suggests that labor issues are not insurmountable. Privatization has often led to expanded employment in the privatized enterprise in the medium run. Moreover, a state-level renewal fund can be established to provide severance benefits to enterprises undertaking a reduction in manpower coupled with retraining and small business advisory services with links to job opportunities in order to ease the transition-- Gujarat has established a state-level renewal fund and has successfully retrenched surplus workers of non-profitable state-owned textile companies. Table,2.9: Reformof thellublic eiterprise sector Objective : -Policy measures Impose a hard budget constraint on all * Link explicit subsidies to provision of clearly defined and efficiently: public,enterprises. provided,social services.- * Phase out implicit *sulbsidies, sch as interest rate subsidies on government loans and tolerance of arrears on loan repaymets and interest payments. * Reevaluate the practice of converting loans to equity in response,t6 an enterprise's inability toineet debt-service obligations. *,Establish a'mechanis to regularly monitor flows between G3)K and public enterprises. - Reduce burden on state finances and * Consider privatizing all manufacturing, enterprises; regardless of improve quality of service provision currentfinancia performance. through a privatization strategy.' Reases the rationale for development, service, aid9 arketing enterpri ses. * ituidate noiviable enterpises or product lines within enterprises. * Avoid restructuringlenterprises before privatization. * Allow the sell off ofprofitable enterprises. * Allow privat.owners to purchase;controlling interests of privatized enterprses initially,wih full divestiture the ultimate goal Focus efforts on reforming KEB, KPC, * "See power section in Chapter 3 for reform of KEB And KPC, and and KSRTC. Apendix -3 for reform of KSRTC. SECTORAL ISSUES 3.1 In order to reverse the decline in private investment, enhance agricultural growth, and accelerate the improvement in social indicators in the state, GOK would need to provide efficient infrastructure services--including power, roads, and irrigation--as well as increase the coverage and quality of basic education and health care. To meet this challenge, major sector reforms need to be undertaken and the most crucial ones are in power and irrigation. Not only is the need to improve efficiency in power and irrigation the greatest, but these are sectors where there is large scope for private sector participation and for big fiscal savings that would enable a shift in sectoral composition of public expenditures. More resources would thus be allocated to essential sectors in which the role of the private sector is limited, such as roads and primary education and health. The scope for such restructuring is broad: losses by the State Electricity Board reached 90 percent of health expenditures in recent years, while cost recovery in irrigation is less than 20 percent of noninterest current spending. A. Power 3.2 The power sector is facing two major crises-severe power shortages and heavy financial losses by the state power companies. The power shortage in Karnataka-- 17 percent of average use and 23 percent of peak demand--is the second highest in India (after Bihar) and is seriously hampering the state's industrial growth. The power sector is managed by two state-owned entities, the Karnataka Power Corporation (KPC), responsible for generation, and the Karnataka Electricity Board (KEB), responsible for transmission and distribution. Financial losses mainly by KEB--which reached Rs. 5 billion in 1995/96--are imposing a heavy fiscal burden on GOK. Most of the sector's problems are tied to the state's power pricing policies, low collection rate of electricity bills, high transmission and distribution losses, and lack of financial support for the investment programs of KEB and KPC. 3.3 The fiscal burden of the power sector hurts the investment program of KPC and KEB. GOK supports the power sector mainly by providing loans to KEB and KPC for capital expenditure through plan allocations and by providing revenue subsidies to KEB to compensate for financial losses incurred from supplying power at subsidized rates to agriculture consumers.' GOK further supports KEB and KPC by allowing them to accumulate arrears in interest and loan repayments, by converting part of their debt into equity, and by letting KEB retain electricity duty payable to GOK (estimated at over Rs. 1 billion a year). As a result of the poor cash flow and the mounting fiscal burden, GOK has been unable to support adequate capital expenditures in the power sector and the gap between budgeted and actual capital expenditure by KPC and KEB has grown--in 1995/96 actual capital expenditure by KPC was Rs. 1.4 billion, just over a third of the budgeted expenditure of Rs. 3.8 billion. I Since 1989/90 KEB has received a rural electrification subsidy from GOK to cover revenue lost from supplying power to the rural sector and to ensure a 3 percent rate of return on net fixed assets as per the statutory requirement of the Electricity (Supply) Act. - 26 - 3.4 KPC's financial performance has generally been satisfactory. In 1995/96 its rate of return on net fixed assets reached 8 percent. However, internal resources available for capital expenditure are declining mainly due to slow payment of bills by KEB. KPC's accounts receivable from KEB rose from Rs. 2 billion in 1991/92 (50 percent of sales revenue for the year) to over Rs. 7 billion in 1995/96 (80 percent of sales revenue for the year). This has led to increased pressures on KPC to raise loans from institutional creditors to finance its capital expenditure.? KPC's loan repayment has been growing, thus further eroding its net internal resources (revenue receipts less current spending, depreciation, and loan repayment)--from a surplus of Rs. I billion in 1991/92 to a deficit of Rs. 3 billion in 1995/96. 3.5 KEB's financial performance is poor and deteriorating. Its rate of return on net fixed assets without the revenue subsidy from GOK has been negative and falling, declining from -13 percent in 1991/92 to -29 percent in 1995/96. This is largely attributable to tariffs that do not cover costs. While KPC has been revising its tariff for sale of electricity to KEB in line with the cost of generation, KEB's tariffs to final consumers have not been adjusted accordingly. Since 1983/84 average unit revenue has been less than average unit cost of supply and the gap between them reached 37 paise/kWh in 1995/96 (Figure 3.1). This is mainly on account of heavy subsidization of Figure 3.1: The Increasing gap between KEB's revenue and cost 160 agriculture and domestic consumers for which the effective subsidy' has reached Rs. 10 billion and Rs. 400 120 - PeUnitAveagCos - 00 -Per Umit Average eeu million respectively in 1995/96 g - Unmetered supply of electricity to so agriculture consumers, faulty meters, 60 and theft have also reduced KEB's 4 potential revenues. In addition, bill 20 collection is low, with accounts 0 receivable as high as 46 percent of revenue billed, and accounting i E systms re otdaed.Soure Karnataka Electricity Board systems are outdated. 3.6 The virtually free supply of power to agriculture hurts the competitiveness of the industrial and commercial sectors in both domestic and international markets. First, the highly subsidized tariff structure for the agriculture sector does not provide any incentive to agriculture consumers to use electricity efficiently, thus exacerbating the power shortage faced by industry. Moreover, the industrial sector bears the brunt of power cuts--since March 1996, as much as 70 percent of power cuts have been imposed on high-voltage industrial consumers. During 1970-1995 the industrial and commercial sectors' share of electricity consumption fell from 79 percent to about 31 percent while the agriculture sector's share rose from 6 percent to 46 percent. Second, the commercial and industrial sectors cross-subsidize agriculture and pay the highest tariffs in India. Although the agriculture sector accounts for almost half of electricity sales it brings in only 1 percent of KEB's revenues. In contrast, 65 percent of KEB's revenues come from the industrial sector, which consumes only 28 percent of total electricity, and 10 percent of revenue come from the commercial sector, which consumes only 3 percent of total electricity. As a result of unreliable and expensive power, more and more industrial consumers have been installing 2 KPC and KEB borrowings from market and financial institutions are guaranteed by the state at a commission fee of about 1- 1.5 percent of the loan amount. Effective subsidy is defined as average unit cost of supply less average unit revenue realized multiplied by electricity sales. In 1995/96, average nonagriculture tariff in Karnataka was 239 paise/kWh compared to the all-India average of 182 paise/kWh, and agriculture tariff was 1.7 paise/kWh compared to the all-India average of 21.3 paise/kWh (Annual Report on the Working of SEBs and Electricity Departments, Planning Commission, Government of India, 1997). In July 1997, tariffs were increased. - 27 - captive power plants to meet their energy requirements--in 1995/96 captive power generated about 7 percent of the utility energy available in the state and 25 percent of the electricity used by consumers. Future prospects 3.7 Massive investment in the power sector is needed to accommodate projected growth in demand and would necessitate radical and comprehensive reforms. GOK has estimated at about Rs. 165 billion the investment required under the Ninth Five-Year Plan (1997/98-2001/02) to meet anticipated growth in electricity demand of 10 percent a year. Of the total amount, KEB and KPC plan to invest about Rs. 70 billion on new generation capacity and expansion of the transmission and distribution network and the private sector is expected to invest the rest. KPC and KEB plan to support this investment through (i) increased internal resource generation by linking tariffs to the cost of supply and gradual phasing out of subsidies to the agriculture sector, (ii) greater reliance on credit from financial institutions as their creditworthiness improves, and (iii) continued plan resources of the state government which will cover almost one half of total capital expenditure under the Ninth Plan. 3.8 For the above public and private investment to materialize, fundamental reforms are needed in the power sector. The problem of inadequate capital expenditure in the power sector cannot be solved by GOK alone and private investment must be attracted to the sector so that generation, transmission, and distribution capacity can be augmented to meet the growing demand for electricity. Recognizing the need to restore creditworthiness of state power enterprises GOK has adopted in 1997 a new power sector policy that endorses (a) creation of an independent regulatory agency, (b) tariff reforms (including the phased elimination of cross-subsidies from commercial and industrial consumers to domestic and agriculture consumers), (c) introduction of competition among independent power producers, (d) divestiture of shares in KPC, and (e) restructuring and privatization of the distribution functions of KEB. 3.9 This policy recognizes that some segments of the power sector (transmission and distribution) are natural monopolies like other grid industries (for example, telecommunications) and need therefore to be regulated. A main objective of the regulatory regime would be to ensure that each of the regulated segments, whether state-owned or privately-owned, should earn reasonable rates of return to ensure the mobilization of resources required for the expansion of the system. This policy also recognizes that the financial sustainability of the sector will ultimately depend upon the financial and operational performance of distribution activities, which requires the restructuring and privatization of the distribution business. These are crucial reforms on which the future of the power sector depends. Implementation of the policy reforms, however, has been at best partial so far. 3.10 In July 1997 the power tariff was revised by 13 percent for non-agricultural consumers and by 200 percent for agricultural consumers (to 21 paise/kWh). Although this is much higher than the 7.5 percent average annual increase achieved over the past five years for the nonagriculture sector, it is still not enough. The investment plan of KEB and KPC is based on the assumption that KEB will be able to mobilize additional resources during the Ninth Plan by raising tariffs by at least 15 percent a year for non-agricultural consumers and by immediately achieving the target of 50 paise/kWh that has been agreed to by all states for agriculture consumers. Without these additional revenues the investment program of the power sector will not take place without putting further pressure on GOK's budget, as seen from the projections in Table 3.1.' s The projections assume that the consumption mix changes as the share of agriculture declines and the share of industry rises. . -28- 3.11 In order to achieve the investment target in the power sector and successfully address the severe power shortages in the state, rapid implementation of the power sector policy is crucial. Any slippage in the planned investment program is likely to have a serious impact on the extent of the power deficit and the overall economic development of the state. The reforms are long overdue. Table 3.1: Impact of tariff increase on financial performance of KEB (Rs. billion) 1997/98 1998/99 1999/00 2000/01 2001/02 Scenario I: 7.5% increase in tariff every year, agriculture 50palse/kWh Net profit (after depreciation & interest) -7.8 -10.3 -13.4 -20.0 -21.6 Revenue subsidy required for 3% ROR 8.5 11.0 14.2 20.9 22.5 Scenario H: 10% increase in tariff every year, agriculture 50paise/kWh Net profit (after depreciation & interest) -7.8 -9.4 -11.0 -14.5 -13.6 Revenue subsidy required for 3% ROR 8.5 10.1 11.8 15.7 14.6 Scenario IH: 15% increase in tariff every year, agriculture S0 paise/kWh Net profit (after depreciation & interest) -7.8 -7.6 -5.9 3.6 5.8 Revenue subsidy required for 3% ROR 8.5 8.3 6.7 4.5 - Source: Staff calculations. Table 3.2: Reform of the power sector Objective Policy measures Improve KEB's creditworthiness by * Increase nonagriculture tariffs at least 15 percent and agriculture tariffs increasing revenue generation. to 50 paise/kWh, and gradually phase out cross-subsidy of domestic and agricultural consumers by commercial and industrial consumers. * Improve bill collection. * Implement comprehensive loss reduction program that includes installation of meters, repair of faulty meters, and control of theft. Attract private investment in the power sector * Create an independent regulatory agency, introduce competition among in order to accommodate projected growth in independent power producers, restructure and privatize the distribution demand, functions of KEB, and divest GOK-held shares in KPC. B. Roads 3.12 The road network in Karnataka has failed to keep pace with economic growth. Karnataka has a 122,383 kilometer road network, which is divided into four main categories, national highways (less than 2 percent), state highways (9 percent), major district roads (23 percent), and rural roads (66 percent). Road density is 64 kilometers per 100 square kilometers of area (43- kilometers of surfaced roads), slightly higher than the national average of 62 kilometers. Road density per 100,000 population is 299 kilometers, higher than in India as a whole (241 kilometers) and in Andhra Pradesh (224 kilometers), but lower than in Maharashtra (303 kilometers), Tamil Nadu (326 kilometers), and Kerala (463 kilometers). In 1992/93 the number of registered motor vehicles per 1,000 population was about 33 (45 in 1995/96), higher than the national average (27) and that of neighboring states like Andhra Pradesh (25) and Kerala (23) but lower than Maharashtra (38). In the past two decades the road network has expanded at an average annual rate of 2.6 percent while the vehicle population and traffic intensity have increased by 11 and 10 percent a year respectively. - 29 - 3.13 The main problem in road expenditures is their very low budgetary allocations rather than their composition. GOK spends about 0.5 percent of GSDP on the development and maintenance of its road network, a much lower share of GSDP than in the fourteen other major states (which spend 0.8 percent of GSDP on average) or in the six fastest growing states (which spend 0.9 percent of GSDP on average). Between 1990/91 and 1995/96 total expenditures on roads (plan and nonplan) rose 58 percent, from Rs. 1.4 billion to Rs. 2.1 billion. About 42 percent of total road expenditures go to capital investment, and about 39 percent of current expenditures go to nonwage O&M. Although this composition of expenditures is acceptable from an economic and sectoral point of view, the levels of expenditures are inadequate. 3.14 O&M has been chronically underfunded Nonplan expenditures on maintenance are discussed with the Planning Commission at the beginning of every five-year plan. O&M allocations have been less than half of the maintenance and repair Table 3.3: Underfunding of O&Nt 1990-95 expenditure norms established by the Tabl 3: df in Ministry of Surface Transport (MOST) (Rs million) Ninth Finance Actual provision O&M gap and the Finance Commissions (Table Year Commission (including (percent) 3.3). The 1997/98 budget announced recommendation bridges) an increase in the allocation for road 1990/91 653 520 25 maintenance, raising it to Rs. 1.4 billion in 1997/98, compared to Rs. I billion in 1991/92 783 741 7 the previous year. Even after this* 1992/93 940 801 17 increase, however, the level of O&M 1993/94 1,128 875 29 allocations falls short by one-third of 1994/95 1,354 920 47 the Rs. 2.1 billion norm recommended Source: Public Works Department, GOK. by the Tenth Finance Commission. 3.15 The PWD has weak planning, implementation, and assessment capabilities demanded by the required infrastructure projects. Employment in the department has grown by 6 percent a year since 1991. The road sector accounts for more than half of PWD employment, with over 15,000 staff and 500 casual workers (staff estimates). Following the recent Supreme Court decisions regarding the accrual of continuity and tenure rights by long-term contract labor, the practice of hiring contract labor was abolished. Like road sector agencies in other states, the PWD in Karnataka lacks adequate planning, project development and implementation capacity, and road network asset management capabilities for the scale of road infrastructure investments needed. Moreover, the agency has not been effective in using private sector capacities and resources to deliver and maintain the level of road infrastructure required to meet current--let alone projected--road transport requirements. Future prospects 3.16 Significant increase in resources will be needed to fund the road sector. A statewide Strategic Options Study (SOS) was completed in. 1996 to identify the highest-density roads. The results of that study are expected to form the basis for preparation of externally assisted investment projects. Current trends in road sector allocations, which are already strained by ongoing road investment and O&M demands, will not be able to support the project counterpart funding obligations and other liabilities. GOK has also prepared a draft policy on State Road Rehabilitation Program which covers the 40,000 kms of state highways and major district roads managed by the PWD. The requirement for rehabilitating these roads in a phased manner, giving first priority to those where traffic volumes are higher, is estimated by GOK at almost Rs. 4 billion in 1997-2000. Given that these roads carry over 60 percent of the state's traffic and are in critical need of capacity increase, they will require a much larger budgetary allocation which could reach Rs. 20 billion for the Ninth Plan period. In addition, a Master Plan for -30- Rural Roads, prepared in 1996 by the state, estimates the requirement for strengthening the rural road network managed by the District Administration at Rs. 21 billion. Compared to a total requirement of over Rs. 40 billion on road investment and deferred maintenance, the draft Ninth Five-Year Plan allocates only about Rs. 10 billion. 3.17 GOK is raising resources for the road sector by establishing road funds and encouraging private sector participation. In the 1997/98 budget, GOK has announced the establishment of a Road Fund for upgradation and development of the existing network as well as for expansion, financed through earmarking of additional cesses on royalty charged on minerals, petrol, and diesel, and enhancement of license fees on cars and agricultural market fees. The road fund is a step forward towards raising resources for the road sector and is rightly financed by direct beneficiaries. However, it still needs to be operationalized. Karnataka has also introduced policies aiming at facilitating private investment in roads and has brought in the private sector to develop a major state highway between Bangalore and Mysore. However, the scope for large-scale investment by the private sector is limited as has been the experience in other developing countries, and the public sector will continue to be the main provider of road services. 3.18 Modernizing the PWD should remove a major impediment to efficient management of the road network. To overcome capacity constraints, private professional engineering firms need to be contracted to undertake feasibility studies and design large costly sections of road suitable for construction by machine-intensive methods alone. Downsizing through natural attrition and changing the skill mix through retraining of in-house PWD engineering staff will be required. This new approach will be consistent with a smaller but very important role for the PWD as planner, administrator, and manager of the road network. In addition to undertaking feasibility studies and designing roads, the private sector would supervise construction and maintenance, and supply material and equipment. Such a division of responsibilities is common to developed countries and is generally efficient. Table 3.4: Road setor policy measures Objective Policy measure Strengthen sector finances * Increase budgetary allocations for the road sector to meet recommended O&M norms and to finance capital expenditures for upgrading of high-density road corridors identified in the Strategic Options Study and the State Road Rehabilitation Program. * Operationalize the state road fund. Accelerate private sector * Operationalize the policy in support of private sector participation for select road/roadside participation infrastructure development and operation. * Extend PWD's private sector outsourcing to road sector planning, development, and maintenance activities such as road investment design, construction, and works supervision. * Strengthen the procurement, contract awarding, and management capability of PWD staff. * Introduce transparency in awarding contracts and investment opportunities in the sector. Develop technical * Provide in-service training for PWD staff on project planning and management; contract capacities of PWD staff procurement, awarding, and management; and works quality control and improved business practices. C. Irrigation 3.19 Karnataka is endowed with seven river basins of which Krishna basin drains 50 percent of the total area of the state, followed by Cauvery basin with 19 percent, a west flowing river basin with 13 percent, Pennar (south and north) basin with 6 percent, and Godavari and Polar basins draining 4 percent. The surface irrigation potential is estimated at about 2.5 million hectares, comprising 1.6 million hectare under major and medium irrigation and 0.9 million hectare from minor irrigation. The share of irrigated. cropped area rose from 9 percent in the early 1960s to 14 percent in the early 1980s. Since then, the -31 - progress in irrigation has been moderate, with the share of irrigated area now standing at around 20 percent and actual irrigation now standing at 70 percent of its potential. 3.20 Major and medium irrigation constitutes about 90 percent of capital and current expenditure on irrigation, and accounts for the bulk of irrigation receipts. In addition to budgetary investment (Table 3.5), Rs. 6.7 billion have been invested on the Upper Krishna project during the last two years by Krishna Bhagya Jala Nigam Limited (KBJN)--a newly created autonomous public utility corporation--mainly through issuance of bonds. The investment in major and medium irrigation has benefited only 10 percent of the total number of Taluk (second tier) Panchayats and 70 percent of the Taluks have not benefited at all, mainly due to topographic constraints. On the other hand, the benefits of minor irrigation have spread more evenly in the state. Table 3.5: Irrigation budget (Rs. million) 1985/86 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 Revenue receipts 77 176 318 176 142 141 222 223 Current expenditurea 1207 2080 2696 3089 3243 3737 4084 5584 Capital expenditure 1838 2627 3737 5172 7064 7444 7655 8483 a. Current expenditure includes interest payments. Source: GOK budget documents. 3.21 The irrigation sector suffers from weak cost recovery and inefficient expenditure prioritization. First, revenue receipts from irrigation--which consist of all receipts from the sale of water, charges, and betterment levies--cover an insignificant and declining share of current spending in irrigation,' reaching only 4 percent in 1996/97. Water charges in irrigation bear no relationship to cost and are linked to area and type of crop, not to actual water consumption. Moreover, they have not been revised for over a decade, like in many other states, although wages and salaries, O&M costs, and interest payments have all increased. The perception that farmers cannot afford the full cost of irrigation services is not well founded--throughout India, the cost of irrigation services to farmers has been estimated at barely 2 percent of gross output value of irrigated agriculture and less than 4 percent of the incremental output value attributable to irrigation (Government of India, 1992). Second, the current structure of investment expenditure in the irrigation sector is not optimal for resource development nor conducive to effective resource use. Priority is given to new investments at the expense of maintenance, rehabilitation, modernization, and upgrading of existing works. As a result, projects continue limping along and some systems may be approaching the point of collapse. 3.22 To accelerate agricultural growth, Karnataka proposed a radical transformation of institutional incentives in the irrigation sector in its 1995 Agricultural Policy Resolution. The main elements of this forward-looking policy include (a) reaching the ultimate irrigation potential of the state within the next 5-8 years by increasing irrigation investment; (b) granting the Irrigation Department financial autonomy and converting it into a corporation on the condition that it should recover at least O&M expenses from direct beneficiaries; and (c) involving water users' associations (WUA) in the management and ownership of canal networks. 6 The Irrigation Department is required to pay interest to the Finance Department on the loans it acquires for irrigation and therefore includes interest payments in its currert expenditure. Interest payments account for 80 percent of current spending, wages and salaries for 10 percent, and O&M for another 10 percent. - 32 - 3.23 So far, however, implementation has been very slow and has focused mainly on raising irrigation investment for the Ninth Plan. GOK has estimated the "critical" investment requirement for major and medium irrigation during the next three years at Rs. 85 billion." However, it has proposed Rs. 55 billion for the Ninth Plan (1997-2002). This leaves a gap of Rs. 30 billion. While investment to create additional irrigation potential is to receive such a high priority, maintenance of existing assets remains underfunded. Allocations for irrigation O&M are only two-thirds of the norm recommended by the Tenth Finance Commission for Table 3.6: O&M in irrigation 1997/98 (Table 3.6) and need to be Major and Minor Total increased by at least 50 percent (to medium Rs. 2 or 3 billion over the Ninth Plan Surface irrigation potential period). There is a danger that this (million of ha.) 1997/98 1.6 0.9 2.5 may nevertheless be neglected in the Total O&M spending (Rs. million) first three years of the plan, when the 1992/93 271 99 371 demand to complete projects in the 1997/98 423 155 578 O&M spending per ha. (Rs. per ha.) major river basins may pre-empt all 1992/93 202 110 312 other demands for funds. Moreover, 1997/98 262 167 429 GOK has only recently decided to TFC norm in 1997/98 (Rs. million) 584 302 885 carry out the reforms that would TFC gap in 1997/98 empower water users' associations to (in Rs. million) 161 147 308 take over the management of the (in percent) 38 95 53 lower end of surface irrigation Source: TFC report and Irrigation Department, GOK. systems on a pilot basis. About ten such associations are planned to be established. Finally, a proposal to revise water rates is presently under the consideration of a Cabinet sub-committee. 3.24 Further reforms and speedy implementation are needed to improve the efficiency of the irrigation sector in Karnataka. Most of the required measures are captured in the 1995 Agriculture Policy. Improving cost recovery is vital for the sustainability of the irrigation sector. Water charges need to increase to fully recover O&M costs, interest, and capital depreciation, as recommended by the 1992 Report of the Committee on Pricing of Irrigation Water created by the central government. Furthermore, water prices need to be based on the volume of water actually delivered and indexed to a cost of living indicator that can be well-understood by farmers, such as kilograms of rice or wheat. Finally, the collection system needs to be enhanced. In order to link higher water charges with improved service delivery in canal irrigation, revenue from water charges could be earmarked to nonwage O&M. 3.25 Institutional reforms, such as the creation of WUAs, would provide the basis and necessary financial incentives for improved cost recovery as well as improved accountability in the delivery of water services to farmers. The importance of farmers' participation was underlined in the 1987 National Water Policy as well as Karnataka's Agriculture Policy. Several initiatives have already been put in place in Orissa, , Tamil Nadu, Haryana, West Bengal, Maharashtra, and Andhra Pradesh (Box 3.1), ahead of Karnataka. To ensure transparency, WUAs need to prepare seasonal and annual water and financial budgets. 3.26 The state needs to undertake a major reprioritization of its public spending in the irrigation sector according to the following order of priority: (i) institutional strengthening and capacity enhancing activities in support of the reorganization of the Irrigation Department to better manage the state water resources; (ii) adequate funding of O&M of existing irrigation systems; (iii) rehabilitation and modernization of selected existing systems, including systems' turnover to farmers' WUAs; (iv) Because of water sharing agreements of major river basins with neighboring states, Karnataka has to use its allocated share by the year 2000. - 33 - completion of ongoing, viable projects - on a priority basis--drastically reducing Box 3.1: Ifiitiatives.for irrigation management transfer in the number of projects under Andhra Pradesh construction to a manageable number While almost all states have now adopted the principles of firigation of viable projects which can be management.iransfer, Aldhra Pradesh is the first one to have made' completed over a short time horizon them a state - policy by issuing the Andhra Pradesh Farmers' within the amount of resources Management Irrigation- Systems Act, 1997. This Act, which is, available; (v) continuation in a limited applicable to all public'irrigation systems, calls for-the establishment of a federaied-,structure of Water Users' Associations -(WUAs)-a way of project construction where i bi three tier structure for major systems, a two tier system for medium frastructure facilities and basic schemes, and a-one tier-system-for minor.irrigation systems. . construction facilities have been taken The transfer,-of 'O&M responsibilities to--the WUAs will 1be_, up. Orissa is already adopting a similar immediate, though their transfer to-the distributory and project level expenditure reprioritization program to Committees Will happen,- only - after a joint -managemint ,phase. correct the mistakes of the past. Initially the assessmeit.aind collection of water charges.will be done jointly with the Revenue Department before being filly enitrusted to 3.27 The role of the private sector in the WUAs. Of the collection proceeds, it is planned toalistrib6te-30 irrigation could also be further percent to WUAs and keei 60 percent for O&M-20 percent at the,' distributory livel and 40-percent-at the headworks and main canals-., explored. First, in operation and and provide the rest to the-local Panchayats. financing of major and medium . When the O&M responsibilities are fully turned over to thethree-tier- irrigation, there is the possibility of WUA-system; the Irrigation Department's role wil be limited to that. forming managerially and financially of - technical 'advisors ,whereas all decisionsq relating 'to water autonomous irrigation entities, based on distribution, preparation and implementation of annual O&M plans, a federation of WUAs to distributory and fixing and collection of water fees are in the hands of tie WUAs. and project levels. Private, commercial The Andhra,Pradesh,government- is also planning to reorganize its and rojet leels.Privte, ommecial Irrigationidib&dCommand Area IDevelopment Despartment to suit the firms can also be invited to operate provision of the new Act. irrigation canals through a transparent bidding process. Second, the creation Source: World Bank, Water Resource Management SectorRevieo (draf t), 1997. of autonomous companies or utility- ( 1 type entities can be an effective option for introducing administrative and financial autonomy, increasing accountability, introducing a less politicized environment to set and collect water charges, and mobilizing private sector funds. A few states, such as Andhra Pradesh, Maharashtra, Gujarat, as well as Karnataka have experimented with autonomous utility-type entities but achieved mixed results. A necessary condition for the success of such corporations is to grant them full power to set and collect appropriate water charges and to operate a full irrigation command area in order to avoid overlapping operations with the state's irrigation department. Third, in minor irrigation, investment in wells could be entirely left to the private sector while investment in tanks could be done through WUAs rather than government activities. Such investments could be encouraged through a cost sharing formula between WUAs and the government. Table 3.7: Irrigation sector policy measures Objective Policy measure Develop a sector strategy * Prioritize investment, with the highest-priority given to funding O&M and institutional strengtheniig, followed by rehabilitation ad modernization of existing schemes,'completion of ongoiog projects, and lastly feasible new major and medium schemes. * Improve the planning and management capacity of the Irrigation Department. * Restructure operations along ver basin lines. Improve the institutional * Promote participatory irrigation management such as WUAs that Would provide the basis framework and necessary financial incentives for improved cost,recovey and accountability in the delivery of water services. - 34 - Table 3.7: continued Strengthen sector finances * Ensure that WUAs prepare seasonal and annual water and financial budgets. * Price water on a volumetric basis. * Increase water rates to cover at least O&M costs, At the same time, improve the quality of service delivery. Ensure effective collection. * Increase the budgetary allocations to meet the required O&M norms. Accelerate private sector * Accelerate formation of WUAs at distributory and minor canal levels. participation * Handover O&M responsibilities at distributory and minor canal levels to WUAs. * Allow private firms to operate irrigation canals through transparent bidding process. * Encourage the creation of financially and managerially autonomous irrigation entities. * Encourage private investment in minor irrigation, especially tanks, through a cost sharing formula between WUAs and the government D. Health and Education 3.28 The justification for public expenditures on health and education on efficiency and equity grounds is stronger than for many other items in the state budget. Planned spending on health and education is fully consistent with the principles of improving targeting to the poor and complementing private markets. The state government can help local policymakers target spending by finding out where spending makes the most difference and developing ways in which the public sector can complement the private sector. Improving resource allocation in health 3.29 Expenditures on health and family welfare are inadequate. Karnataka is performing slightly better than the national average in terms of health status and epidemiology profile.! Public spending on health and family welfare is about 6 percent of current expenditures and 1.2 percent of GSDP. Secondary and tertiary services (hospitals) accounted for 31 percent of the health budget in 1995/96, primary health centers for 38 percent, family welfare program (which is 100 percent centrally sponsored) for 20 percent, medical education for 9 percent and administration for 2 percent. Per capita public expenditure on health is equivalent to Rs. 124 (about US$3.5) and is well below the amount recommended by the World Development Report (1993) to provide a basic package of public health and clinical services for low income developing countries (US$12 per capita annually). 3.30 The recurrent budget is chronically underfunded Most of the health budget is absorbed by salary costs and the recurrent budget is chronically underfunded. Very little is spent on investment and nonwage operation and maintenance. As a result, health facilities face operational deficiencies, including underfunding of drugs and supplies, shortage of medical equipment, and general deterioration of physical infrastructure. At about 6 percent of current expenditures, cost recovery is low mainly due to low structure of fees, narrow range of services for which fees are charged, and inadequate mechanism for enforcing the collection of fees. In hospitals, there is currently no charge for outpatients and the last revision of charges for inpatients was made in 1988. 3.31 Budgetary allocation within the health sector can be enhanced in order to improve access to the poor while increasing available resources. The strategy and policy direction envisioned by the Department of Health are consistent with this view and focus on: (a) augmenting the coverage of medical facilities in rural areas where most of the poor live; (b) increasing spending on communicable diseases as they disproportionately affect the poor; (c) complementing rather than substituting the private sector; and 8 See for example: World Bank, New Directions in Health Sector Development at the State Level, 1997. - 35 - (d) improving cost recovery at all levels of health care and outsourcing some services to the private sector. 3.32 Public medical facilities in poor districts Figure 3.2: The poor have fewer access to medical facilities could be improved The poor in Karnataka have access to fewer medical facilities per 0 0.25 capita than do the better off equal access per capita (Figure 3.2). The Department . 0.2 - - . of Health has called for 0is increasing efforts to reach the 0 1 poor in rural areas, a strategy 0.os with bi3s towaids poor that should be pursued o aggressively. 0 500 1000 1500 2000 2500 3000 3500 4000 3 SDistrict income per capita (Rs. per year) 3.33 Spending on control of communicable disease Source: Department of Health, GOK. could be increased Reduction of communicable diseases alleviates poverty and improves equity and efficiency. Although poor people suffer more from all health problems, the gap between rich and poor is widest for communicable diseases, which affect poor people at twice the rate at which the rich are affected (Murray and other, 1992). Increased spending on control of communicable diseases is justified on equity grounds because unlike across-the-board subsidies for medical care, which disproportionately benefit the rich, such spending redistributes income toward the poor. Control of communicable diseases also involves large externalities. Urban and rural local bodies can play an important role in this area, as has been demonstrated by Surat city in Gujarat. 3.34 Public health care needs to take into account the role of the private sector. Nearly 80 percent of health care expenditures in India are made by the private sector (Box 3.2), and almost 82 percent of people in rural areas visit private practitioners for out-patient care (National Sample Survey, 42nd round). Health care expenditures by the private sector are similar in Karnataka.' In non-hospital care, recognition of the role of the private sector has several policy implications. First, public facilities should be located where affordable private alternatives do not exist and are not likely to be available in the foreseeable future. Second, state funds provided to Panchayats--currently formulated on the basis of number of facilities per capita--need to be finetuned to reflect the private sector role. Third, highest priority must continue to be placed on improving health care in remote areas with no private health sector and little access to towns. In hospital care, because private medical insurance is still limited in India and the majority of people are not able to bear the cost of hospitalization, the government will have to continue to provide hospital care for a large portion of society, not just the poor 3.35 Substantial fees could be introduced at hospitals for patients who seek care without referral from lower-level facilities. Charging substantial fees for unreferred hospital care will divert first contact with the health system to lower-level facilities and lead patients to seek care at more appropriate levels. The savings to the system will not come from the generation of fees at hospitals (which will be low) but from rerouting treatment to cheaper venue. The referral system would need to be strengthened. The success of this policy will depend on consumers' sensitivity to the fees charged. No state-level data on health expenditures by the private sector was available at the time of this study. - 36 - 3.36 Charges at primary health centers and other basic public facilities should reflect the presence of Box 3.2: Harnessing the private sector in private sector substitutes. In areas in which there are health in India alternatives to public care, raising public sector fees will be less likely to compromise public health. The private sector for health in India has a Because little is known about the effect of fee increases significant presence. Private spending, mainly from out-of-pocket sources, accounts for 4.7 percent of on utilization patterns in Karnataka, such increases GDP or 78 percent of overall health spending. The should be carefully monitored by looking at utilization private health sector is heterogeneous and includes of all forms of medical care. The Department of Health allopathic and traditional systems of medicine. For- is already implementing an increased fee structure and profit, fee-for-service practitioners play a dominant has wisely decided to let facilities retain revenues for role in the provision of individual curative care. The overall strategy of the Government of India is improving quality. Experience in other countries has to increasingly take into account the existing level shown that utilization by poor people can increase when of private provision and finance in health care fees are accompanied by the quality improvements they delivery, and facilitate an environment that is finance." conducive to enhanced private sector participation. Several states are beginning to implement health strategies which include: (i) expanding the scope of 3.37 Outsourcing some services to the private the private sector where it has a comparative sector may result in cost savings. Some services, such advantage, such as tertiary health care, as laundry and food, can be provided less expensively superspecialty and support services; (ii) increasing by contracting the services out to the private sector. the contracting out of specific publicly provided services to the private sector where economically (Using contract physicians would also save money, but attractive and administratively feasible, such as employment restrictions bar their use). The Department support services and limited mainstream diagnostic of Health already has provisions in place for using and clinical services; (iii) promoting the private and private contractors, and their use should be expanded non-government organization sectors to participate where appropriate. in preventive and promotive services and in underserved areas; (iv) encouraging the private sector to adopt appropriate therapeutic norms and Improving resource allocation in education regimens recommended by the national programs for specific diseases; and (v) expanding the 3.38 Education indicators in Karnataka are above government's capacity to monitor, register and national averages, but illiteracy still remains high. certify private health care with regard to resources, Karnataka has made impressive advances in education provision and practices. in the past decade, many of which are directly Source: World Bank, India: Policy and Finance attributable to policy measures. Enrollments, retention, Strategies for Strengthening Primary Health Care and literacy rates have increased substantially. But Service, 1995. although educational indicators are above national averages," universal primary education has not been achieved and 44 percent of the population remains illiterate. To achieve universal enrollment, the education gap between the rich and the poor must be closed. The gap between the proportion of the rich (top 20 percent) and the poor (bottom 40 percent) who have completed grade 1 is high for all India at 0.483, but even higher for Karnataka at 0.502. This would require additional quality expenditures in primary education. 3.39 Education is the concurrent responsibility of the states and the central government. About 50 percent of state education expenditure goes to primary education, 30 percent to secondary education, and 20 percent to higher education and vocational training. As a share of GSDP, spending on education in 10 In Cameroon, for example, improved reliability of drug supplies paid for by the increased user fees more than compensated for the negative effects of the price increase. 1 The proportion of population aged 6 to 10 that is in school is 0.758 in Karnataka and 0.686 for all India; and the average highest grade completed for population aged 15 to 65 that ever attended school is 8.391 for Karnataka and 8.292 for all India (calculated from National Family Health Survey, 1992/93). - 37 - Karnataka fell from 4.7 percent in 1985/86 to 4.3 percent 1992/93; as a share of total state spending, education expenditures declined from 22.9 percent to 21.7 percent. Per capita spending of Rs. 277 education is also lower than in several other major states (Rs. 368 in Kerala, Rs. 313 in Maharashtra, and Rs. 298 in Tamil Nadu). 3.40 Although education is an important responsibility of government, free provision at all levels is not the best way of using public resources to promote education. Based on cross-country empirical evidence on the private and social returns to education, the scope for the role of government in education is significantly less in higher education than in primary education. Public spending on primary education is easily justified as externalities associated with basic literacy are found to be large. Recent studies in India (Foster and Rosenzweig, 1995) show that literate farmers increase the speed of adoption of their neighbors' new technologies, indicating that benefits extend beyond the individual obtaining the education. Similar studies among farmers in Uganda and Thailand indicate the same. Subsidies to primary education when enrollments approach universality are among the best known ways to reach the poor (Van de Walle and Nead, 1995, Hammer, Nabi, and Cercone, 1995). GOK's current strategy in the education sector is consistent with the above-mentioned international experience. The redirection of spending toward primary education, the freezing of new construction of secondary schools, and the planned reductions in the subsidy to higher education represent appropriate policies should be implemented. 3.41 Provision of primary education needs to increase and become more cost effective. Progress in primary .-Tg6k.3* Doot rate from standard education is tied closely with policy initiatives. Although stadardV little improvement was made in reducing the dropout rate Tr Percentageof dropouts ..tI1947/48- 67 until 1980 (Table 3.8), a dramatic fall in the rate occurred . 1950/51. 69 after the introduction of the Total Literacy Campaign and 58 other innovations of the mid-1980s. Further improvements 1970 76;1 59 are likely to become more expensive due to higher costs g 986/8 44 associated with providing services in more remote areas. I .. 17' Increasing budgetary resources for primary education will !Soiie Department of Education. GOK. require significant changes in the conduct of overall fiscal policy rather than in education policy. But increased cost effectiveness in the provision of schooling will also be necessary. GOK could (a) lower repetition and dropout rates to allow more students to be accommodated and (b) increase the efficiency and effectiveness of incentive programs, such as free uniforms and free books. 3.42 Increasing budgetary allocations to secondary education is harder to justify. First, externalities (benefits beyond those reaped by the student) are not well established. Second, because of possible crowding out of the private sector, public investment per student educated may be considerably higher than simple costs may imply--some fraction of these students would have gone to school anyway at their own expense. Table 3.9 suggests that substitution between public and private schools was prevalent in pr primary education, as the increase in public schools since 1960 has been accompanied by a fall in the absolute 1 Jet number of private schools." Although extra schools in I t 149 , the rural areas are unlikely to have continuing substitution effects at the primary level, substitution is very likely to be a problem for secondary as is demonstrated by international experience. The Department of Education's intention to freeze the number 12 Many of these have been taken over by the state. - 38 - of public secondary schools at current levels and spend additional resources only for expansion of existing facilities seems prudent. Enrollment rates in secondary school should be monitored, however, to make sure progress is maintained and further investments in the future need to take place if lack of public financing is shown to be a barrier. 3.43 Support of higher education needs to be targeted Because the benefits of higher education accrue largely to the individual rather than to the community at large, state subsidization of higher learning is hard to justify. While information on the background of students in Karnataka is not available, studies in many countries indicate strong regressivity of higher education expenditures--in Indonesia, a country with a very similar mix of public and private involvement, the highest share of higher education benefits goes to the top two deciles (Figure 3.3). Figure 3.3: Education subsidy per capita by decile In Indonesia, 1989 1200 1000 800 13Primary I Junior secondary 600 1 Senior secondary 400 * Tertiary 200 O L .1l . Poorest Richest Source: World Bank, Indonesia: Public Expenditures, Prices, and the Poor, 1993. 3.44 As an alternative to provision of free higher education to all students, and based on experience in other countries, GOK can contemplate the introduction of some combination of cost recovery and provision of loans and loan guarantees to help students overcome credit market problems. In some cases, student loan guarantees by the state may be sufficient. In other cases where credit is the problem, loan schemes are a more natural solution. Some countries like Australia have been experimenting with loan schemes where repayment is done as an increased tax rate on income. In this way, not only is credit made available but the government also shares some of the risk involved in specialization inherent in higher education. Loans and loan guarantees would represent an implicit subsidy in the form of default rates higher than a commercial bank would accept but are much less costly than the free slots currently provided to all students. It is crucial that the poor do not get penalized from this policy. To target the poor, need-based scholarship aid could be offered. Support of research--which, unlike higher education, has large externalities--could be provided through direct grants. Table 3.10: Reform of the health and education sectors Objective Policy measure Improve the health status of the poor * Improve health care in remote areas with no private health sector and little access to towns, and increase the number of medical facilities in poor districts. * Increase spending on control of communicable diseases, which disproportionately affect the poor. * Locate public health facilities where private alternatives do not exist. - 39- Table 3.10 continued Objective Policy measure Increase efficiency of spending on health * Introduce substantial fees at hospitals for patients who seek care care without referral from lower-level facilities in order to redirect patients to appropriate facilities; strengthen the referral system. * Set fees at primary health centers that reflect private sector substitutes. * Outsource some services, such as laundry and food, to the private sector. Education Reallocate education grants (see Chapter 2) * Reduce grants to private higher-level institutions, and increase grants to lower-level institutions. * Eliminate lifetime support to aided private schools to encourage improved cost recovery. * Allow private institutions in primary education established after 1987/88 to become eligible for support. Increase efficiency of spending on primary * Reduce repetition and dropout rates to allow more students to be and secondary education accommodated. * Review the efficiency and effectiveness of incentive programs, such as free uniforms and books. Target spending on higher education * Reduce free higher education, the externalities of which are minimal. * Provide loans and loan guarantees to help students overcome credit market problems. * Offer need-based scholarship aid to target the poor. Provide direct grants for research. Appendix 1 Revenue Augmentation for Municipalities The Example of Bangalore Municipal Corporation 1. About 30 percent of Karnataka's population is urban. There are 214 urban local bodies', of which the six city corporations account for nearly 45 percent of the urban population (of them Bangalore alone accounts for over 35 percent). Responsibilities of city corporations are mainly street lighting, health and sanitation, drainage, garbage clearance, formation and maintenance of roads, bridges, culverts and parks, and developing shopping complexes. Bangalore Municipal Corporation (BMC) also runs schools, maternity homes, and cr6ches. Water supply and sewerage in Bangalore are the responsibility of a separate authority, Bangalore Water Supply and Sewerage Board (BWSSB), while development of the city is the responsibility of the Bangalore Development Authority (BDA). City and town municipalities, however, have to provide water supply and sewerage, though health and education in their case are the responsibility of the state Table 1: Revenue components of Bangalore Municipal Corporation government. The main 1994/95 (RE) 1995/96 (BE) sources of revenue of city Rs. million percent Rs. million percent corporations and State grants 524 31 613 29 municipalities are octroi Property tax 400 24 500 23 compensation,2 taxes on Entertainment tax 100 - 6 120 6 HUDCO loans 118 7 142 7 houses and lands (or Nehru Rozgar Yojna 13 9 10 0 property tax), and India Population Project 75 4 110 5 entertainment tax. Some Fees and other receipts 448 27 636 30 revenue also accrues from Total 1678 100 2132 100 advertisement tax, Source: Bangalore Municipal Corporation. surcharges on stamp duty, and fees (Table 1). 2. Municipalities budget is too limited to enable them to provide civic services at a reasonable leveL Although expenditures of most local bodies are within their revenue receipts, they are not sufficient to adequately provide civic services--roads are in bad condition, garbage is piling up, and water supply in town municipalities is insufficient. BDA has estimated a comprehensive development plan for upgradation of the city's civic and infrastructure by 2001 which would require investment of Rs. 663.4 billion (at 1995 prices). Far from generating any surplus, BMC is short of funds even to provide the current services at a satisfactory level. The finances of all urban local bodies are under severe strain because of fast growth of their expenditures compared to their revenue sources. The state compensation for octroi has not been adequate to meet their expenditure requirements and has increased the municipalities' dependence on the state budget. 3. Given the tremendous need to improve urban infrastructure services, the present low level of expenditures and declining availability and rising cost of financing, major reforms are clearly needed in the urban sector to improve the quantity and efficiency of public expenditures. There is also need for 1 The urban bodies are categorized as follows: 6 City Corporations (population exceeding 300,000); 40 City Municipalities (population between 50,000 and 300,000); 81 Town Municipalities (population between 20,000 and 50,000); 87 Town Panchayats, Notified Area Councils, etc. (population between 10,000 and 20,000). 2 The octroi was abolished in 1970 and replaced by a state compensation to municipalities. - 42 - better governance and more effective municipal management in urban service delivery. The State Finance Commission (SFC) report recommends increasing grants to urban local bodies, rationalization and streamlining of municipal functions, and improving internal resource mobilization. Table 2: Area, population, revenue, and expenditure of urban local bodies, 1993/94 Revenue Expenditure Category Area in sq.kms. Population Rs. percent Rs. percent (thousand) (thousand) million million City Corporations 594 5003 2209 68.8 2043 67.6 City Municipalities 356 2143 444 13.8 437 14.5 Town Municipalities 1880 3714 542 16.9 523 17.3 Other 209 295 16 0.5 17 0.6 All 3039 11155 3211 100.0 3020 100.0 Source: Municipal Statistics 1993/94 (Directorate of Economics and Statistics, Bangalore). 4. Urban local bodies can substantially raise revenue by better exploiting resources within their existing powers, the most important being property tax. It is desirable for urban local governments to have at their disposal significant sources of own revenue which can be freely adjusted in order to facilitate the provision of important local public services, and these revenue instruments should operate in an economically and administratively efficient fashion, i.e., they should distort economic decisionmaking as little as possible, and should not be unduly cumbersome to implement. Furthermore, in order to clarify the economic costs of local public services, these sources of revenue should be transparent to citizens and taxpayers. A. Property Tax 5. The property tax has several virtues as a source of revenue for local governments, provided that it can be adequately administered. Property taxes, imposed at relatively uniform rates on broadly- defined classes of taxable property, can provide local governments with a revenue base which is closely correlated with the overall level of local economic development. In addition, property taxes can help promote efficient locational decisions by households and businesses. Those who own property in a locality are commonly those who impose important public service burdens on the local authorities, since they obtain access to public services by virtue of their residence. To some extent, a system of property taxation provides a form of user charge for local public services which is conducive to efficient locational choices. Another related attractive feature of the property tax is that it helps focus the burden of financing local public services on those who make the provision of those services necessary. 6. There is considerable scope for raising more revenue from property tax. Bangalore has been growing at a fast rate in recent years and is considered the premier metropolitan city of India, attracting large investments from the country and abroad. Due to the fast process of urbanization that accompanies industrial growth, urban real estate constitutes a large pool of taxable capacity. Tax on urban real estate has been a major source of financing urban government expenditure in many cities of the world-- especially South Korea and Taiwan. If city civic services are to improve and the huge backlog in investment requirements for the city's infrastructure are to be met, efforts must be intensified to improve the yield of the property tax. 7. Like in other municipal bodies in the state, property tax constitutes the most important source of revenue for BMC after state government grants. Per capita revenue from property tax in BMC is about Rs. 130 (in 1994/95), which is higher than that of Madras but lower than Pune (Rs. 152), Ahmedabad (Rs. 275) and Bombay (Rs. 153). As a proportion of district income, the property tax in BMC is about - 43 - 0.7 percent. Property tax revenue is 0.3 percent of GSDP for the state as a whole, compared with 0.25 percent for the country as a whole. Given the high level of economic activity, income, and property values in Bangalore, the Table 3: Growth rate of property tax in current property tax revenue Bangalore Municipal Corporation in the city is not high and its (percent per annum) growth rate has slowed down Demand Collection Number of RV in the past five years (Table holdings 3). Moreover, the growth in 1970/71 to 1980/81 9.2 12.0 4.7 13.8 property tax demand and 1980/81 to 1990/91 23. 7 18.9 3.4 14.9 collection has decelerated 1990/91 to 1995/96 11.2 9.6 7.2 11.9 despite increased growth in Note: RV is ratable value. the number of holdings. Source: Bangalore Municipal Corporation. 8. The property tax is levied by BMC on the ratable value (RV) and cesses levied on the base are then added. The tax rate levied by BMC is 20 percent for residential premises and 25 percent for non- residential buildings. On the tax levied by the Corporation, there are the following cesses which are passed on to the state government: 10 percent for education, 15 percent for health, 4 percent for beggary, and 4 percent for library--totaling 33 percent. The cesses are justified on the basis of the fact that teachers' salary in the BMC-run schools, beggars' homes and libraries are financed by the state government. This argument however does not apply to health expenditures which are incurred entirely by the Corporation. Also, a good part of the running expenses of schools falls on the Corporation. In addition to these cesses, BDA collects a "general tax" at the rate of 10 percent of RV in respect of properties developed in the "revenue pockets" within the BMC. Initially revenue collection and assessment of properties in areas developed by BDA are undertaken by BDA until the areas are handed over to the city corporation. BDA has separate assessment staff for that purpose. Although they are stated to follow the rules and procedures of BMC, the first assessment constitutes the starting point for the revision, if any, by BMC. 9. The proportion of collection to the amount of tax demanded has been no more than 60 percent in recent years, compared with 70-75 percent in the early 1980s (Table 4). There are several reasons for the slackening in collecting the amounts for which demand is raised. First, there is no interest burden on delayed payments and thus a higher tendency to go in appeal against assessment. Second, there is no systematic follow up of the demand raised. Third, the Corporation is not required to issue any tax bill to taxpayers on a regular basis. Fourth, the penal provisions against default are obviously not a deterrent, both because they are weak and because they are not enforced. Table 4: Property tax, Bangalore Municipal Corporation (Rs. million) Year Demand Collection Balance Collection/ Demand (percent) 1970/71 29.0 17.2 11.8 59.5 1980/81 80.8 56.7 24.1 70.2 1990/91 553.2 323.6 229.7 58.5 1991/92 609.2 361.6 247.6 59.4 1992/93 673.8 409.3 264.5 60.8 1993/94 764.6 449.7 314.9 58.8 1994/95 848.5 437.3 411.2 51.5 1995/96 928.3 539.6 388.7 58.1 Source: Bangalore Municipal Corporation. - 44 - 10. Despite its acknowledged merits the property tax buoyancy has suffered a setback in Bangalore, indeed in India as a whole, for two main reasons. First, the tax is based on the RV which is derived notionally from what a property can reasonably fetch annually if rented out. Through successive judgments, the courts have ruled that "fair rent" in this context has to be taken as what is permissible under the rent control laws. Application of this rule--which extends to both tenanted as well as owner- occupied houses--has resulted in freezing the base of the property tax to absurdly low levels, virtually negating any scope for periodic revision. Second, there is widespread practice of understating the rents and capital values in property transactions. In the absence of an open and reliable real estate market, it is difficult for the tax authorities to ascertain the actual rent levels prevailing at a particular point of time. Even the assessment of newly constructed properties which do not come under the purview of rent control laws for the first few years has thus become problematic. 11. The design of the tax base has limited its revenue potential and resulted in a high degree of subjectivity and arbitrariness in assessments, opening up wide scope for abuse, collusion, and harassment. While the assessment often seems arbitrary, the reductions allowed on appeals in many cases are ad hoc. In a survey of 65 property tax cases in Bangalore the RV assessments were reduced by one-third by the Appeals Committee without assigning any ground. Not surprisingly, the property tax is regarded by most householders as an unfair and capricious imposition. In a large number of cases, assessments are often challenged and taken to court leading to accumulation of appeals and arrears of tax. Some 12,000 cases are pending before the appellate authorities, locking up substantial amounts of revenue for the Corporation. 12. There are several other factors peculiar to Bangalore which have adversely affected revenue growth from the property ta. They include (i) poor coverage of the tax in terms of number of properties assessed; (ii) acquisition of properties without registration on the basis of General Power of Attorney; (iii) occupation of new properties without occupation certificate; (iv) lags in general revision; (v) multiplicity of appellate stages; (vi) absence of any provision to compel payment and laxity in collections; (vii) plethora of exemptions, including properties of the central and state government offices; (viii) inroads into the tax base of the Corporation by the state through various surcharges. The state's reform proposal 13. The state government is considering radical measures for reform of the property tax. The key element of the proposal is to delink the base of the property tax from rent. Instead of RV being derived from annual rental value, the base of the tax will now be standard ratable value (SRV) which will be laid down for properties situated in different localities, classified according to their nature of construction and use. A valuation matrix setting out the SRV per unit area for each of these categories of properties will be drawn up and published, and the taxpayers will be required under the law to self-assess their tax applying the prescribed tax rates to the ratable value of the property in question which can be derived from the matrix of SRVs taking into account its size, location, nature of construction and use. A register of assessments will be prepared and published. In order to determine the SRVs in a transparent and fair manner, valuation committees will be set up with a representative of taxpayer, a registered valuer, and a cost accountant. The committee will make recommendations regarding the SRV per unit area of land and plinth area of buildings in different locations keeping in view the classification of localities. The proposed SRVs will be published for public comments and will be finalized after taking into consideration the objections, if any. The SRV matrix for lands and buildings will be notified in a prescribed form. SRVs will be revised periodically. 14. Complementing these structural reforms, an assessment register will be prepared based on the reforms of property holders and departmental surveys. The register will be brought out as a booklet of - 45 - the Corporation and will be made available to the public. This would generate pressure for correct declaration by property holders regarding the size, type, and use of their holdings. The proposed reform is expected to help remove inequities and anomalies that mark the system of property taxation in Bangalore at present and to get over the constraints on the revenue base stemming from linking ratable values to the concept of fair rent as interpreted by the courts. A recent judgment of the Supreme Court has upheld standardized area-based assessment of property tax made by the Patna Municipal Corporation. In order to penalize default in paying up the taxes assessed it is proposed to charge interest on defaulters at the rate of 12 percent per annum instead of the current 5 percent. 15. The reform proposal marks a major effort towards improvement of the equity, transparency, and revenue buoyancy of the property tax, however, it is vulnerable to legal challenges and is weak on procedural and administrative reforms. The most serious weakness is the large number of factors laid down as relevant for determining the SRVs. Moreover, they cannot all be quantified in terms of their significance for their rental/capital values and the weight attached to each will be determined by the Valuation Committees. The Committees will have to form a judgment of their own and different Valuation Committees may take a different view of the relative importance of the factors in question. As a result, there may not be consistency in the weights attached for the factors influencing the SRVs of different locations. As the weights underlying their determination will remain unknown there will be no transparency in the assessment of the SRVs and variations in the SRVs for different locations, types, and uses of buildings will be difficult to sustain before the courts. Ultimately the differences or parity between different locations and types of buildings for different uses will have to be justified in terms of either their earning capacity as reflected in the rent or their market discounted potential earning capacities as revealed through their capital values. It would also be difficult to work out the cost of providing civic services for each ward or their subdivision in view of the usual "joint cost" problems. Proposed changes 16. Several modifications are suggested in the proposed scheme to simplify it and remove its weaknesses so that it can achieve its objective of de-linking the tax base from rent control, limiting the scope for abuse and at the same time stand the test of law. If fully implemented, the revenue of BMC (and the other five municipalities) can increase by at least 50 percent. 17. Instead of switching to standard ratable values, the R V can continue to be the base but should be assessed on the basis of standard values of land and engineering norms for construction cost of different building types. Variations in the rental/capital values of use can be taken care of through rates differentiated for commercial, industrial uses. The value ofland in different localities of Bangalore city is now laid down in a notification of the Department of Revenue for purposes of stamp duty and registration fee. These take into account the differences in land values because of location and other relevant factors. Similarly, engineering norms are laid down by the PWD for different types of construction. Some allowance may be made for repairs by deducting 20 percent from the cost of construction for new buildings and 25 percent for buildings which are more than 5 years old. Special provision may be needed for hotels, cinemas and clubs. The RV of a property can be defined as a percentage (say 8) of the capital value so derived. Applying the standards of land and building, to the land area or plinth area of the holding, the capital value and thus its RV can be easily assessed by anyone. In the case of multi-storyed buildings the land value may be apportioned according to the total plinth area of the building or appropriate formula for apportionment. 18. The property tax needs to be levied at the prescribed rate applied to the capital value oriented RV. The tax rates may be varied to take into account the nature of its use. Thus the rate may be 10 to 15 percent for residential houses and 20 to 25 percent for non-residential holdings (and to proportionate - 46 - areas in the case of mixed use). Owner-occupied houses may be given a rebate of say 20 percent from the RV. For partly owner-occupied holdings, the rebate may be allowed in proportion to the ratio of the owner-occupied part to the total plinth area. To encourage prompt payment, a rebate of say 10 percent of the tax payable may be allowed if deposited within the due date. All exemptions from property tax should be withdrawn except for orphanages and homes for destitutes. Government properties should pay at least a service charge at the rate of 75 percent of the normal rates. The structure of the tax should be simplified by removing all cesses. In any case there is no reason why the health cess should be passed on to the state government when the expenditure on health is borne entirely by the Corporation. To avoid hardship, the increase in the tax payable on assessment under the new scheme should not increase from the existing levels by more than 100 percent at one time in the case of residential properties and not more than 200 percent in the case of non-residential premises. In the case of tenanted properties the incremental tax burden resulting from the change may be passed on by the landlords to the tenants. The Rent Control Act should be suitably amended for the purpose. 19. The assessments need to be made on the property owner or on the occupier when the owner cannot be identfed When the owner is untraceable the onus of proving that he/she is not the owner will be on the occupier. In order to discourage frivolous appeals, where the assessee loses in appeal, there should be a provision to charge interest at the rate of 2 percent per month (as in the case of income tax) for the owner (or occupier as the case may be) from the date of assessment. It should also be mandatory to deposit at least at 50 percent of the tax when an assessment is disputed before the appeal is entertained. The preparation of a properties register is very useful. However non-filers and defaulters should be followed up if the particulars regarding properties are computerized. Computerization will also help to track payments and defaults and get tax bills prepared and issued regularly. The Corporation ought to take the responsibility for issuing tax bills at least half yearly or at least once at the beginning of a year. There should be sample checks of the returns filed with reference to the particulars declared and stringent penalties imposed for wrong declaration. The checking should be monitored by higher level officers. 20. Slums may be assessed on a community ownership basis or the landlord, if identifiable, may be required to pay the tax with the stipulation that not more than a specifted fraction (say 30 percent) can be recovered from the tenants. There are at present about 45000 thatched houses constituting slums. Some effective way of bringing them under the tax net without causing hardship needs to be devised. Perhaps the societies, organizations, or individuals looking after them can be asked to pay in lumpsums depending on the land area, and the money collected could be spent on their improvement. 21. A central valuation authority (CVA) needs to be established to ensure that land values and construction norms are determined on the basis of uniformly applied principles for Bangalore and other municipal towns (and in the course of time for agricultural lands as well). The CVA's valuation should be adopted for stamp duty and registration fees and for land acquisition. The Authority should have experts, officials and representatives of taxpayers and should undertake training of municipal officers. The CVA will publish tentative norms of land values for different localities with a reasonable classification and invite comments and suggestions, and may even give hearings to taxpayer bodies. Once determined, the standard of land value and engineering norms will not be appealable. Appeals will be permitted only against the assessment of the building size and the determination of the type of construction and nature of use. 22. Institutional reforms need to accompany structural reforms in the property tax There is considerable overlap in the functions of BDA and BMC. The BDA is supposed to develop new areas and hand them over to the corporation, but the scope for BDA's activities is fairly limited at present. Besides, while the BMC levies improvement charge for multi-storyed buildings and other, the BDA -47- collects betterment levy from beneficiaries of development, both being empowered under the Town and Country Planning Act. Multiplicity of activities for levying betterment or improvement charge is undesirable. It would be much more economical if BDA is brought under BMC and its staff redeployed. It would also obviate the need for any property tax assessment to be made by an agency other than BMC, especially that BDA does not have the legal authority to make property tax assessments. Similarly, the role of the Bangalore Metropolitan Regional Development Authority (BMRDA), which acts as a nodal agency for guiding the BMC, BDA and the municipalities and Notified Commuters coming within the Bangalore agglomeration, should be reconsidered in light of the decentralization reforms envisaged under the 74th Constitutional Amendment whereby urban local bodies would have a larger role in local- level planning. Under such a scenario, the function of the BMIRDA would be to provide overall guidance to ensure that local-level activities of BMC and its contiguous areas are consistent with overall regional development objectives. B. Other Revenue Sources Impact fees 23. Different mixes and rates of growth of commercial and industrial activity necessitate different levels and types of local public service provision, including infrastructure services such as transportation, water, sewerage, and power in different parts of a metropolitan area. The same is true with respect to the size and composition of the population within a metropolitan area. These underlying economic and demographic characteristics also affect the ability of localities to finance urban public services. 24. Impact fees can provide a useful adjunct to a property tax. However, these have not been employed effectively by urban local bodies in Karnataka. Although development and betterment fees in Bangalore are intended to cover a reasonable part of the cost of infrastructure and civic amenities, in reality, they are set so low that their impact on the city's finances is insignificant. For example, a "change of land use fee" towards a road cess for a commercial development is only Rs. 200,000/acre and for residential use is Rs.100,000/acre in peripheral areas. Betterment charges for "change of land use" towards infrastructure development for commercial and residential developments are only Rs. 75/sq.m. (or Rs. 6.88/sq.ft) and Rs.4/sq.m. (or Rs. 0.91/sq.ft) respectively. Even in the initial stages of residential developments for middle income areas, land values are much higher. 25. Typically, impact fees are charges assessed on new developments to defray the cost of extending water and sewerage systems, roads, and other infrastructure. In a city where infrastructure and services for new developments are paid for from general property tax revenues collected on all property (i.e., including previously-developed properties), developers of new properties are partially subsidized by existing property owners. This encourages inefficient new development and inefficient location choices, and creates incentives for existing property owners and residents to oppose new developments, even if these developments are efficient in the sense that the end-users of the newly-developed properties would willingly bear all of the costs associated with development. Impact fees can reduce or eliminate the fiscal burden on existing owners of property arising from the extension of public services to new residents or business establishments, and in doing so they can reduce the resistance that existing residents, or their elected local representatives, will bring to bear on new developments. By establishing a closer connection between the benefits and costs of local service provision, impact fees can expedite efficient development of land and inhibit inefficient development. 26. Charges for the cost of providing services to new developments can be administered in a variety of ways that are more or less equivalent in their economic effects. One way to do this is to require the residents in a new development to pay a fixed charge each year, perhaps for a limited number of years, to - 48 - cover the cost of infrastructure investment undertaken by the local government. Alternatively, the charge could be imposed as a one-time fee to be paid by developers at the time that land development occurs. As a third option, a local regulatory body charged with land use control could mandate that land developers provide basic infrastructure as a condition of approval for land development. In this case, there is no formal flow of revenue to the local government, nor does the local government actually undertake the provision of the infrastructure, but the practical effect is roughly similar: the infrastructure is provided, and the users of the property end up compensating the provider (in this case, the developer) who recovers the cost of infrastructure provision in selling or renting the property. 27. These different administrative devices create somewhat different financial flows for the local government, the end-users of property, and developers. Requiring developers to build infrastructure or to pay an up-front charge to the local government for infrastructure investment is likely to raise the sale price of property so that developers can recoup their costs; under such arrangements, purchasers of property might need to resort to increased borrowing to finance the initial purchase of property, which would enable them in effect to borrow the money to pay for the cost of infrastructure provided by developers. They would then repay this cost (plus interest) over time to the financial institution from which they borrowed. In effect, then, private lending institutions provide the immediate capital for infrastructure investment, a debt which is then serviced by individual property owners. The feasibility of such borrowing would presumably vary by type of property owner. The provision of infrastructure for commercial and industrial development may attract relatively large companies with good access to capital markets whereas a modest residential development may be inhabited by households with limited borrowing power. However, poor urban dwellers often rent their residences rather than own them, and that landowners may well be in a position to borrow on the capital market. 28. By comparison, impact fees paid over a period of time to local authorities would require the local authorities to provide the capital for the initial infrastructure investment, the cost of which would then be serviced by local property owners through periodic payments. Any of these arrangements can in principle be made to work efficiently, but one or the other may be preferable depending on the nature of the development in question and the access of developers or property owners to capital markets. User fees 29. By linking the benefits and costs of public services, user fees promote more efficient utilization of public services and more efficient location choices. They also promote more efficient local public decision-making for the same reasons that property taxes and impact fees can: when users do not bear the cost of the services provided to them, some other parties must, which creates incentives for users to demand inefficiently high levels of services and for those bearing the costs to wish to supply inefficiently low levels of services. Thus, for instance with respect to water pricing, it is likely that higher charges that reflect the true costs of water provision would not only limit the demand of existing and prospective users. They would also provide a source of funds to water authorities which could be used to finance needed improvements in water capacity and delivery, without having to rely on transfers of funds from other sources (e.g., the state government) who face competing demands for funds and who might therefore refuse to provide adequate funding even for local water development that local users would willingly pay for. 30. ' These benefits from user fees can be realized for any form of local public service that can be effectively priced. Such services include water, trash collection, parking, and public transportation. For some services, the imposition of user fees may not be feasible; emergency police and fire services, for example, cannot be priced but must generally be provided on demand. For such services, property taxes and other local taxes may serve as imperfect but still useful indirect user fees as discussed above, in that - 49 - local property owners (for example) are more likely to depend on local public safety services than non- residents, and can use the property tax as a means to express their demands for these services. User fees can also be difficult or impossible to collect from the very poorest residents of an urban area. Where necessary, base levels of provision can still be offered at reduced prices or even for free (e.g., trash collection in slums) in order to meet minimal service provision standards. But reliance on user fees where feasible allows those with higher demands for services to bear the cost of those services and thus to facilitate the provision of higher-quality local public services for at least some users. 31. An added advantage of user fees is that they can facilitate the private production of services whose provision may nonetheless still be publicly organized. Even if public bodies are involved in determining the level and nature of refuse collection, water provision, and other services, the establishment of user fees to cover a large share of the cost of these services can facilitate contracting out of the actual delivery of services to private firms operating under some public constraints. This can offer cost-saving advantages as private firms are not subject, for example, to the same constraints on labor compensation and utilization as applies to the public sector. Furthermore, contracting out allows governments a much higher degree of flexibility in adapting service provision to changes in local needs and demands. Contracting out can be implemented even when services are financed from general tax revenues, but the benefits and feasibility of contracting out become particularly apparent when user prices are heavily used. 32. Municipalities need to have some discretion in raising user fees. In spite of the passage of the 74th Constitutional Amendment at the state level, discussions with state and municipal officials indicate that additional changes are required to strengthen functional and financial performance of urban local bodies. The costs of inadequate local financial autonomy are starkly exemplified in the case of Mangalore Municipal Corporation whose payment for bulk water supply from the KWS&DB' has been in arrears because of the dismally low level of charges. Although an increase in water charges was locally initiated with public support, it was subsequently revoked by the state pending a state-wide increase in water tariffs.- The issue of local accountability is twice removed from the state, and for municipalities to be able to provide high quality services, they need to have some discretion in raising tariffs to cover at the very least the supply and O&M costs of water supply. This problem is not atypical, and contributes to the limited resources available to the KWS&DB for capital investments statewide. Other fees 33. There are a few other sources of revenue which can be tapped by BMC and other municipal bodies. First, BMC collects at present only about Rs. 10 million by way of license fee for shops and establishments. The rates for the fees were fixed in the early 1950s and have not been revised since then. Several new activities like computer software development and sale are not included in the list of trades/businesses requiring a license. The list should be amended to bring all business units in its purview. Alternatively, the list should be removed and anyone carrying on any business with a sign board at a fixed place should be required to obtain a license unless otherwise exempted. The license fee should be related to location of the premises, its area and nature (hotels and restaurants ought to be required to pay a higher fee than others). Second, the rates of improvement charge levied by BMC on higher buildings and commercial complexes were fixed long ago and are low (Rs. 200 per sq. ft). They should be raised. Third, rents charged by BMC for premises let out by it to shopkeepers and others are There are two water supply agencies operating in the state: the Karnataka Urban Water Supply and Drainage Board (KUWS&DB) and Bangalore Water Supply and Sewerage (BWSSB). Both these agencies are accountable to the state government and obtain most of their financing in the form of loans from HUDCO, a central public enterprise. -50- also extremely low and bear no relationship to the prevailing market rates. In MG Road, the main road in Bangalore, the current market rate of rent varies from Rs. 10 to 20 per sq. ft. whereas BMC charges at the rate of only Re. I per sq.ft. in many cases. Income from corporation's properties can be raised to Rs. 100 million (as against Rs. 10 million at present) with suitable revision of the rates. Stamp duties and octroi 34. Local authorities in Karnataka, as elsewhere in India, have traditionally relied on stamp taxes and octroi as important revenue sources. Recently, octroi has been eliminated and replaced by special grants from the state government to make up for lost revenues; stamp taxes continue to be utilized heavily in some localities. Both of these taxes are likely to give rise to significant economic inefficiencies and are therefore unattractive local taxes. 35. Stamp duties are inefficient since they tax the turnover of assets, creating lock-in effects. Fees for the recording of transactions are appropriate and, especially since the recording of transactions (e.g., property exchanges) can facilitate local administration, the fees should be adequate to support efficient and professional services to the public. However, while the transfer of property is an activity that does produce economic value (since a property that is sold must be more valuable to the new owner than to the former owner), the value of the transfer itself is generally far below the value of the property changing hands. A tax on the latter simply discourages efficient ownership patterns of assets and is likely to generate very substantial avoidance and evasion efforts by taxpayers. 36. Octroi taxes interfere with the free flow of goods and services across local government boundaries. Like tariffs in international trade, they interfere with efficiency gains from specialization and division of labor by providing artificial fiscal incentives for localities to be self-sufficient. In addition, such taxes are costly to administer both for government and for taxpayers, and are prone to administrative inconsistencies and corruption. The SFC report explains clearly why the octroi, having been abolished, should not be reinstated. Of course, the pressing need for funds at the local level and the demonstrated revenue-raising capacity of the octroi may induce some localities to seek its reintroduction. However, since the state government has a very strong interest in maintaining a free internal market within Karnataka, it is appropriate for the state government to prevent localities from utilizing such a tax. C. Other Municipalities 37. While municipal finances in all city corporations can substantially improve with reforms outlined above, generating additional resources for city municipalities (CM), town municipalities (TM) and town panchayats (TP) is difficult and they will continue to depend heavily on grants from the state government. Over time, the corporations and municipalities should be encouraged to depend on their own resources with a hard budget constraint. Smaller municipalities, which account for more than half of the urban population, need more attention than they have received so far. 38. Although the level of property tax is not high in CMs, TMs and TPs--roughly Rs. 50 per capita or Rs. 4 per month compared with Rs. 55 in Andhra Pradesh and Kerala, Rs. 69 in Gujarat and Rs. 117 in Maharashtra--the scope for raising the level of property tax in these towns is limited. However, reforms in assessments and administration in all CMs and TMs along the lines suggested above will improve the collection ratio which is currently only about 60 percent. 39. Small municipalities face many problems in discharging their civic functions, as exemplified by Devanahalli, a TM 35 km to the north of Bangalore which is going to have an international airport. For a -51 - budget of Rs. 1.8 million it raises Rs. 1.2 million from property tax but its resources are grossly inadequate to meet its needs. It is unable to provide drinking water regularly--once in two or three days-- or pay the salaries of its staff--once in two months or so. It has 34 km of unmetalled roads which are in a very bad shape and its drains are overflowing. 40. The taxable capacity of the TM is evidently limited, the main occupation of the residents being agriculture. It does not, however, get large grants from the state government (Rs. 0.2 million only last year). The only way to improve the civic services in the TM is to provide substantial capital grants that enable the municipality to develop its infrastructure and acquire land for development and sale by auction thereafter. License fees for shops and establishments and a surcharge on electricity consumption can be enhanced. Water rates (now at Rs. 10 per tap) can be raised. A tax on farmers in the form of land revenue assessed on the basis of average yield and prices should be allowed. Appendix 2 A Value Added Tax for Karnataka 1. The current state sales tax system could be replaced with a VAT in the medium term, as recommended by the Committee of State Finance Ministers on Sales Tax Reform in its August 1995 report to the Union Finance Minister. As the Indian economy continues to be liberalized, pressures will mount to extend the tax beyond the first point of sale in order both to broaden the tax base by including value addition at wholesale and retail stages and to minimize the incidence of taxation on business inputs. Throughout the world the value-added tax (VAT) has been found to be the only form of sales tax that can achieve these objectives. 2. Because of constraints imposed by the Indian Constitution VAT would apply only to goods. Services, real property, and intangible personal property would remain exempt from VAT, and the tax rate on essential or declared goods could not exceed 4 percent pending a revision of the central government's Essential Commodities Act of 1955. Tobacco, textiles, and sugar, which are subject to additional excise tax by the center in lieu of the state tax, would remain exempt from state VAT and would not be eligible for tax rebates. Works contracts could also be treated as exempt. Exports from India would be zero-rated under the destination principle of VAT. 3. CST on interstate sales could continue to be levied at current rates pending the outcome of the Finance Ministers Conference group reviewing interstate trade. Interstate consignment transfers could be either zero-rated or tax exempt (thus discouraging the use of consignment arrangements). Farmers and small traders below the current registration threshold of Rs. 200,000 in annual turnover would also be exempt. Voluntary registration of farmers of plantation crops, which would allow such farmers to become taxable, should be considered. Because most of their output is sold to manufacturers for further processing, any tax charged by them would be creditable to customers. 4. The general rebate system under a VAT eliminates the need for sales tax exemptions or deferrals granted under the industrial incentive program. Tax relief on input taxes would become redundant, as all manufacturers would be eligible for a rebate for input taxes under the VAT. Tax relief on output would also become redundant for industries producing raw materials, component parts, and machinery to be used in manufacturing, as any tax charged by them would be credited to their customers. Tax incentives would benefit only firms producing finished consumer goods sold directly to final consumers within the state (rather than to wholesalers or retailers). 5. Lessons from other states and countries should be heeded Karnataka may consider phasing in input tax relief by providing only partial relief to manufacturers for the tax paid on purchases of raw materials and machinery, as Maharashtra did when it introduced the VAT. Because deviations from the normal VAT system introduce complexity, however, they should be adopted only if they are necessary to avoid revenue shortfall. 6. Karnataka should adopt the credit invoice system, the system adopted by virtually all countries with a VAT. Under this system a valid purchase invoice is required for claiming any rebate. This requirement imparts a self-policing feature to the VAT that would be highly desirable in India to encourage voluntary compliance by dealers. The subtraction method lacks this self-policing feature and can become complex where tax is levied at multiple rates. In Maharashtra the use of the subtraction - 54 - method (in conjunction with the credit invoice method) was partly responsible for the less than fully satisfactory experience with VAT. 7. The registration threshold for VAT should not be set too high or too low. Maharashtra set a very high registration threshold (annual turnover of more than Rs. 10 million) for its VAT. Although the high threshold minimized administration burden, it led to strong incentives to suppress sales below the threshold. On the other hand, if the threashold is set too low, it will lead to administrative hurdles which may increase incentives for evasion. Ideally, the threshold in Karnataka should be the same as it is under the current sales tax system. 8. VAT should not be introduced selectively on an experimental basis. Selective application of VAT to certain commodities gives rise to classification disputes and creates opportunities for tax avoidance through misclassification of sales. Moreover, lessons learned from selective use of the tax would be of little relevance in assessing the potential benefits of a general VAT. 9. The success of a VAT depends on careful planning and implementation. International experience shows that most countries that have introduced VAT have not suffered revenue shortfalls--on the contrary, many of them collected higher revenues than expected. To achieve the desired revenue results, however, it is necessary to make careful estimates of the VAT base and set the rates accordingly. Careful preparation is needed before a full-fledged state-level VAT is introduced. Preparation would entail (a) developing educational material that could be disseminated to tax officers, trade officials, companies, and the general public; (b) conducting separate workshops for tax officers and for trade and industry officials; (c) developing a plan for computerizing sales tax administration; (d) preparing model VAT legislation; (e) designing the tax return and other necessary forms; and (f) identifying the types of documents VAT taxpayers need to retain. 10. Most of the benefits of the VAT stem from establishment of a new infrastructure for its administration and creation of an environment that encourages voluntary compliance. To gain a better understanding of the implications of introducing a VAT, GOK should form working groups in the Department of Commercial Taxes to identify the design features of the tax; review the experiences of other states; assess the impact of VAT on government revenues, prices, employment, investments, and economic growth; solicit the participation of the business community in the development of the tax design; assess the computerization and other requirements for tax administration; and develop a timetable for implementation of VAT. Given the quality of the resources available to the tax department, Karnataka could build the infrastructure necessary to implement VAT within two years. Appendix 3 The Karnataka State Road Transport Corporation 1. Losses by KSRTC represent the bulk of losses to the public enterprise sector in Karnataka. KSRTC has incurred losses after subsidies in 9 of the past 10 years, and presubsidy losses of Rs. 1.0 billion in 1994/95 represented more than 60 percent of aggregate presubsidy losses of the entire public enterprise sector. Poor financial performance reflects inadequate tariffs, the provision of concessionary services to certain classes of passengers, and operating inefficiencies, including excess employment and collection problems. Although a substantial number of KSRTC's 60,000 employees are redundant, the company has not been able to retrench its workers effectively. Pilferage of revenue collected, which is an acute problem in Karnataka like in most other states in India, has also adversely affected financial performance. 2. Deterioration in KSRTC's operating fleet and increased competition from the private sector have slowed KSRTC's business in the 1990s. KSRTC's fleet of about 10,000 buses is aging, and maintenance is inadequate. As a result, the share of canceled schedules doubled over the past 5 years (reaching 12 percent in 1995/96), the incidence of breakdowns increased by more than 50 percent, and the growth in the number of passengers carried per day declined from an average of 13 percent per year in the 1980s to a little over 2 percent per year in the 1990s. The poor and unreliable quality of service has allowed the private sector to siphon off business from KSRTC despite its higher tariffs. The extent of KSRTC's competition with the private sector varies across districts.' In return for its monopoly position, KSRTC is required to serve certain unprofitable routes. Private operators compete with KSRTC by providing more frequent service on shorter routes and higher quality service on longer routes. Even where KSRTC has an official monopoly it faces considerable competition from the private sector, because flouting of the rules by private operators is common and violations are difficult to prevent. 3. Subsidies by ASRTC do not make up for low tariffs and concessionary services. Although tariffs have been revised in March 1997 by about 23 percent, they were last revised prior to that date in February 1993, when they rose 18 percent to 17.36 paise/km. During the previous ten years, tariffs had been raised only three times (17 percent in February 1984, 26 percent in October 1985, and 26 percent in May 1990). GOK has repeatedly rejected KSRTC's requests for tariff revisions on the grounds that increases are not acceptable to the public and that KSRTC can improve its performance by reducing costs and improving collections. KSRTC is also required by GOK to subsidize certain groups of consumers, such as students who receive the bulk of the subsidy and the police. According to KSRTC, the revenue lost as a result of providing these concessionary services amounted to Rs. 1.3 billion in 1995/96 (16 percent of actual revenue), up from Rs. 0.8 billion. (13 percent of actual revenue) in 1992/93. Subsidies provided by GOK to KSRTC to compensate for these concessionary services ranged between Rs. 250 million and Rs. 350 million in recent years, far below the revenue losses reported by KSRTC. 4. Reform of ASRTC is urgently needed First, more routes should be opened up to the private sector so that KSRTC is exposed to greater competition. Second, estimates of the true costs of providing concessionary services and serving unprofitable routes should be made and the level of subsidies I In nine of the twenty districts in Karnataka and in the city of Bangalore all routes are serviced exclusively by KSRTC, and in six districts some routes are serviced exclusively by KSRTC. -56- determined accordingly. Analysis should identify the cost of inefficiency. Third, further budgetary support, including subsidies to compensate for social service provision, and increases in tariffs should be made contingent on the successful implementation of a cost-cutting program. Fourth, employees retrenched as part of a cost-cutting program could be granted access to credit that allows groups of retrenched workers to purchase their own buses and operate routes opened up to the private sector. STATISTICAL APPENDIX Table of Contents Table Al 1: Karnataka: Gross State Domestic Product Table Al.2: Karnataka: Gross Fixed Capital Formation Table A2. 1: Area Under Crops in Karnataka Table A2.2: Production of Crops in Karnataka Table A2.3: Yield of Crops in Karnataka Table A3.1: Karnataka: Overall Finances Table A3.2: Karnataka: Revenue Receipts Table A3.3: Karnataka: Revenue Expenditure Table A3.4: Karnataka: Capital Expenditure Table A3.5: Karnataka: Outstanding Debt Table A4. 1: Revenue Realized from Power Consumers and Cross Subsidization Table A4.2: Flows of Funds Statement Between GOK and KEB Table A4.3: Financial Performance of KEB Table A4.4: Energy Demand-Supply Position in Ninth Plan Table A5.1: Wholesale and Consumer Prices Table Al. Karnataka: Gross State Domectic Product (Rs. billion) 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 (At current prices) Gross State Domestic Product 62.10 71.69 80.12 96.10 108.31 115.75 132.71 151.58 177.09 202.14 232.99 300.90 329.99 381.32 441.73 489.90 Agriculture and Allied Services 26.79 30.77 32.21 40.17 43.58 42.04 50.33 55.51 64.63 69.80 79.67 109.76 119.25 137.75 157.45 168.53 Agriculture 2527 2910 2881 3646 3968 3751 4567 5031 59 11 6420 7278 10089 10970 12768 145 52 15554 Forestry & logging 1 15 129 302 330 335 389 404 456 482 490 611 778 823 832 948 949 Fishing 037 038 038 041 056 064 062 063 071 069 079 108 1 32 1 75 245 350 Industry 14.88 16.42 19.63 23.22 26.54 31.12 33.70 36.96 44.50 54.65 61.81 78.33 87.27 96.39 110.59 121.44 Mining & quarrying 041 040 064 066 086 100 1 12 1 10 128 140 1 90 251 229 3 16 356 402 Manufacturing 937 1033 11 92 1435 1604 1879 2032 2326 2773 3447 38 51 4844 5328 5799 6676 7428 Construction 331 352 438 504 585 694 8 12 8 16 951 1131 1251 1633 2051 21 79 2401 2494 Electricity,gas and water supply 139 176 206 251 293 340 304 335 470 607 699 855 889 1029 1269 1419 Services 20.84 24.90 28.92 33.37 39.04 43.59 49.80 60.20 69.24 79.09 93.41 115.33 125.76 150.34 177.26 203.95 Transport, storage & communication 274 344 411 476 562 664 760 939 1067 11 88 1492 18 12 21 34 2569 31 84 37 16 Trade, hotels and restaurants 725 858 954 11 52 1284 1374 1605 1924 2269 2660 31 11 40,59 44 18 5224 6274 6904 Banking & Insurance 193 254 321 355 486 541 602 694 809 973 1257 1640 1554 2001 2430 2786 Other services 891 1034 1205 1354 1573 1779 2013 2464 2779 3088 3481 4023 4469 5241 5837 6989 (At 80-81 prices) Gross State Domestic Product 62.10 66.17 68.05 72.78 78.08 75.69 82.44 88.15 95.67 101.30 102.60 114.94 117.83 126.60 131.92 139.32 Agriculture and Allied Services 26.79 29.61 28.77 30.19 32.82 28.81 33.05 32.90 34.75 35.58 33.48 39.50 40.87 44.16 44.26 44.49 Agriculture 2527 2824 2756 2900 3152 2748 31 77 3167 3353 3429 32 16 38 15 3951 4275 4282 4295 Forestry & logging 1 15 101 091 091 095 094 093 090 086 086 089 089 090 091 096 093 Fishing 037 036 030 028 035 040 035 033 037 044 042 047 046 050 048 060 Industry 14.88 14.54 15.98 17.38 18.10 18.66 19.11 21.18 24.21 26.01 27.29 30.01 30.32 31.69 33.63 36.19 Mining & quarrying 041 035 035 037 037 039 041 038 041 040 043 045 044 047 054 051 Manufacturing 937 910 1025 1163 1187 1207 1222 1453 1681 1796 19 19 2128 21 51 2231 2364 26 13 Construction 331 3 15 335 329 360 389 407 385 4 18 453 430 481 482 5 10 5 13 532 Electricity,gas and water supply 139 160 1 67 1 72 189 191 200 202 240 272 296 302 3 11 333 378 372 Services 20.84 22.36 23.64 25.57 27.53 28.61 30.70 34.46 37.12 40.11 42.25 45.88 47.09 51.22 54.57 59.15 Transport, storage & communication 274 298 3 19 345 372 385 4 13 444 484 509 5 37 594 640 7 11 774 849 Trade, hotels and restaurants 725 797 837 912 962 949 1048 11 77 13 18 1452 1509 1707 1729 1897 2064 21 57 Bankmg & Insurance 193 201 1 86 255 300 355 3 78 439 480 572 637 676 686 709 742 771 Other services 891 941 1023 1046 11 19 11 73 1230 1386 1430 1479 1543 1611 1654 1805 1876 21 37 Source Central Statistical Organization Table Al.2 Karnataka: Gross Fixed Capital Formation (Rs. billion at current prices) 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 Gross Investment - Total 1011 1149 13.70 17.15 17.49 19.77 20.45 20.80 25.54 28.72 33.39 44.87 55 19 58.74 Agriculture and Allied 2.36 2.72 2.59 2 80 3.09 3.75 4.41 4.20 4.67 5.73 6 60 8.26 10.42 12 59 Industry 3.88 4.19 5.68 8.38 676 7.92 6.85 7.56 10.02 11.27 12.55 1769 2277 2091 Services 387 4.58 5.42 5.97 7.65 8.11 9.19 9.03 10.85 11.72 14.24 18.93 2201 25.23 Gross Investment - Public 5.99 6.37 8.02 8.96 9.73 9.72 10.73 11.06 11.76 1246 1472 24.17 2895 30.97 Agriculture and Allied 1.40 1.42 1.48 1.70 1 82 2.11 2.23 1.89 221 271 279 394 5.41 722 Industry 2.60 261 3.70 4.25 3.51 337 3.46 466 3.85 4.08 4.50 909 11.06 9.34 Services 1.98 2.35 2.83 3.02 4.39 424 5 05 4.51 5.70 5.68 743 11.13 1248 14.41 Gross Investment - Private 4.12 5.12 5.68 818 7.77 10.05 9.71 9.73 13.78 16.26 18.68 20.71 2624 27.77 Agriculture and Allied 0.95 1.30 1.11 1.10 1.26 1.64 2.18 2.32 2.46 3.03 3.81 432 5.00 5.37 Industry 1.28 1 58 1.98 4.13 3.25 4.55 3.39 2.90 6.17 7.19 8.05 859 11.71 11.57 Services 1.89 2.23 2.58 2.96 3.26 3.86 4.14 4.52 5.15 604 6.81 780 9.52 10.82 Source. Central Statistical Organization. -61 - Table A2.1 Area Under Crops in Karnataka ('000s hectares) Food Grains Total Rice Jowar Ragi Others Groundnut Cotton 1980-81 6622 1101 1648 1063 2810 765 956 1981-82 7500 1167 2113 1148 3072 872 1040 1982-83 7366 1111 2253 1030 2972 831 932 1983-84 7594 1194 2251 1125 3024 878 905 1984-85 7482 1183 2344 1081 2874 595 834 1985-86 7225 1096 2314 1109 2706 1013 674 1986-87 7857 1166 2640 1175 2876 1034 414 1987-88 7599 1048 2465 1116 2970 1056 476 1988-89 7293 1238 2106 1150 2799 1281 654 1989-90 7556 1183 2339 1167 2867 1187 697 1990-91 7034 1173 2155 1054 2651 1212 596 1991-92 7190 1269 2090 1061 2770 1332 586 1992-93 7351 1317 2306 1038 2690 1276 630 1993-94 6984 1374 2086 1029 2496 1228 571 1994-95 7039 1296 2165 944 2634 1200 636 1995-96 6784 1269 1984 964 2568 1178 674 Source: CMIE, India's Agriculture Sector 1997. -62 - Table A2.2 Production of Crops in Karnataka ('000s tonnes) Food Grains Total Rice Jowar Ragi Others Groundnut Cotton 1980-81 5880 2208 1269 1094 1309 444 469 1981-82 7308 2364 1792 1428 1724 658 621 1982-83 6021 2101 1599 945 1376 542 520 1983-84 7252 2292 1788 1434 1738 739 725 1984-85 6873 2375 1745 1267 1486 897 787 1985-86 5862 1943 1474 1200 1245 707 549 1986-87 7624 2313 2108 1552 1651 738 448 1987-88 6353 1894 1570 1204 1685 911 543 1988-89 6827 2510 1538 1178 1601 1023 896 1989-90 7106 2377 1628 1399 1702 936 923 1990-91 6399 2415 1353 1043 1588 828 690 1991-92 7927 2826 1692 1438 1971 1110 795 1992-93 8499 3069 1926 1536 1968 1142 865 1993-94 8659 3183 1895 1567 2015 1167 773 1994-95 8107 3168 1638 1353 1949 946 822 1995-96 8768 3019 1739 1630 2381 1156 849 Source: CMIE, India's Agriculture Sector 1997. -63 - Table A2.3 Yield of Crops in Karnataka (kgs/hect.) Food Grains Total Rice Jowar Ragi Groundnut Cotton 1980-81 890 2010 770 1030 580 80 1981-82 970 2030 850 1240 750 100 1982-83 820 1890 710 920 650 90 1983-84 960 1920 790 1270 840 140 1984-85 920 2010 740 1170 1510 160 1985-86 810 1770 640 1080 700 140 1986-87 970 1980 800 1320 710 180 1987-88 840 1810 640 1080 860 190 1988-89 940 2030 730 1020 800 230 1989-90 940 2010 700 1200 790 230 1990-91 910 2060 630 990 680 200 1991-92 1100 2230 810 1350 830 230 1992-93 1160 2330 840 1560 890 230 1993-94 1240 2320 910 1520 950 230 1994-95 1150 2440 760 1430 790 220 1995-96 1290 2380 880 1690 980 210 Source, CMIE, India's Agriculture Sector 1997. - 64 - Table A3.1 Karnataka: Overall Finances (Rs. billion at current prices) 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 RE BE Revenue Receipts 20 13 2284 2557 2964 3336 3892 4776 5422 6325 6968 8543 10294 11766 A Tax Revenue 1432 16 10 1866 21 97 2565 2992 3683 4030 4830 5425 67 19 7774 91 09 States'own Tax Revenue 1076 1206 14 15 1699 1932 2332 2901 3098 38 12 4289 5274 6044 7126 Share of Central Taxes 356 404 451 499 633 660 782 932 1017 11 36 1445 1730 1983 B Non-Tax Revenue 582 674 691 766 771 900 1093 1392 1495 1543 1825 2520 2657 Interest Receipts, Dividends 145 1 72 1 87 206 247 236 231 357 3 38 403 696 573 487 Grants from Centre 224 259 255 321 269 383 472 589 761 695 589 12 12 1472 Other 212 243 249 240 256 281 390 446 396 445 540 735 698 Revenue Expenditure 2098 21 91 2667 3002 3483 3971 4954 5592 6208 7265 8481 10756 11965 A Social Services 8 14 925 1145 1228 1356 1539 1893 2082 2379 2754 3250 3857 4624 Education 380 434 572 639 719 802 961 1098 1278 1448 1703 1940 2230 Health and Family Welfare 137 1 56 190 207 227 243 295 360 391 458 496 606 779 Food and Nutrition 034 051 059 055 064 070 078 030 025 037 058 069 080 Welfare of SCs, STs and BCs 057 078 096 087 096 1 36 1 32 162 223 247 266 367 338 Others 206 207 228 239 249 288 426 432 461 563 727 874 1198 B Economic Services 590 631 723 8.26 1002 1159 1521 1685 1801 2063 2446 3498 3194 Agriculture and Allied Services 1 67 1 80 2 12 270 305 282 373 496 589 623 875 844 889 Rural Development 140 144 164 1 62 1 23 251 276 3 15 441 418 331 598 732 Irrigation and Flood Control 146 1 60 1 72 1 99 210 233 270 309 324 374 4 14 530 694 Energy 002 007 008 006 010 064 226 1 30 061 1 70 320 975 234 Other 136 140 1 68 1 88 355 328 377 435 386 478 505 551 646 C General Services 643 575 737 869 1041 11 75 1422 1700 1905 2301 2670 3190 3855 Interest Payments 162 204 248 291 349 436 5 15 594 7 18 871 1048 1214 1450 Administrative Services 1 34 1 54 1 92 210 268 285 356 409 479 549 624 755 984 Pensions 1 13 1 13 161 223 254 277 334 464 436 496 590 743 915 Other 234 104 137 145 170 176 217 233 272 384 409 478 507 D Other Revenue Expenditure* 051 060 062 080 084 098 1 18 125 124 147 1 15 210 291 Revenue Surplus (+) or Deficit(-) -085 093 -1 10 -039 -146 -079 -1 78 -170 1 16 -296 062 -462 -1 99 Capital Expenditure (net) 465 593 407 460 477 480 739 12 16 1370 1217 15 19 866 1125 Irrigation and Flood Control 1 84 206 161 196 237 264 374 5 17 706 744 796 706 696 Power 000 000 000 000 000 244 245 072 232 120 141 016 000 Transport 038 043 025 025 041 077 082 091 130 1 18 143 055 109 Other Capital Expenditure 056 084 057 048 061 069 085 107 120 154 161 132 1 92 Loans and Advances (net) 187 260 163 191 139 -1 75 -047 429 1 83 080 279 -043 1 29 Fiscal Surplus (+) or Deflcit(-) -550 -500 -5 17 -498 -624 -558 -917 -1386 -1254 -15 13 -1457 -1328 -1324 Deficit Financin - Internal Debt (net) 058 069 095 1 12 1 32 140 175 1 71 208 179 272 335 425 Loans From Centre (net) 278 209 149 190 374 3 14 371 489 504 10.52 614 764 907 Small Savings and PFs (net) 050 065 101 1 12 1 18 140 1 53 164 1 87 227 268 271 298 Other 165 157 1 71 084 -001 -036 2 18 562 354 055 302 -043 -305 Source Reserve Bank of India, RBI bulletin on state finances, various years - 65 - Table A3.2 Karnataka: Revenue Receipts (Rs. billion at current prices) 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 RE BE RevenueReceipts(I+11) 2013 2284 2557 2964 3336 3892 4776 5422 6325 6968 8543 10294 11766 I TaxRevenue(A+B) 1432 1610 1866 2197 2565 2992 3683 4030 4830 5425 67 19 7774 9109 A StatesownTaxRevenue(1+2+3) 1076 1206 1415 1699 1932 2332 2901 3098 38 12 4289 5274 6044 7126 1 Taxes on Income 014 017 0.24 026 039 047 057 072 087 109 1 55 161 1 83 Agricultural Income Tax 007 009 0,11 010 016 007 009 011 009 0 17 050 038 043 Taxes on Proffessions, Trades, callingsandemployment 007 009 012 015 024 040 048 061 078 092 106 123 140 2 Taxes on Property and CapitalTransactions 059 072 103 125 142 160 223 241 257 392 565 580 680 LandRevenue 008 011 017 018 0.15 015 017 017 016 020 029 030 030 Stamps and Registration Fees 0 51 0 61 0 86 107 1.26 144 206 224 241 3 72 537 550 650 Urban Immovable Property Tax 000 000 000 000 0,00 000 000 000 000 000 000 000 000 3 Taxes on Commodities and Services(I to7) 10.03 1117 1288 1548 1751 2125 2621 2785 3468 3788 4553 5303 6263 1 SalesTax 596 647 776 987 1081 1317 1653 1776 2278 2506 2954 3703 4373 2 Stateexcise 189 207 244 257 328 430 510 515 639 713 820 860 946 3 TaxesonVehicles 097 135 139 158 158 192 227 221 260 291 456 3.50 480 4 TaxesonGoodsandPassengers 026 032 041 047 057 065 082 110 133 117 168 1.85 213 5 TaxesandDutiesonElecticity 048 048 032 043 065 053 076 086 071 070 063 120 151 6 EntertainmentTax 039 033 037 037 041 042 048 050 059 047 045 028 032 7 Other Taxes and Duties 009 0 15 0 19 0 18 022 026 023 028 029 044 047 057 068 B Share in Central Taxes 356 404 451 4.99 633 660 782 932 10 17 1136 1445 1730 1983 IncomeTax 092 108 128 136 195 203 252 299 383 422 601 722 838 EstateDuty 001 001 001 000 000 000 000 000 000 000 000 000 000 UnionExciseDuties 263 295 322 3.62 438 457 530 633 634 7.14 844 1007 11.46 II Non-Tax Revenue (C+D) 5.82 6 74 6 91 766 7 71 900 1093 1392 1495 1543 1825 2520 2657 C States own Non-Tax Revenue 357 4 15 436 445 5 02 5 17 621 803 734 848 1235 13.08 11 85 1 Interest Receipts 145 172 187 206 247 2.36 231 357 338 4 03 696 5 73 487 2 DividendsandProfits 001 001 003 001 002 003 001 003 0.05 007 003 008 009 3 General Services 042 056 038 043 048 055 082 102 069 097 100 140 137 4 Social Services 023 026 024 033 029 029 031 040 053 054 102 109 104 5.FiascalServices 000 000 000 000 000 000 0.00 061 000 000 000 000 000 6 EconomicServices 147 160 184 162 177 194 276 240 269 288 335 477 448 of which ForestryandWildLife 056 053 053 046 052 058 062 069 092 095 106 1.22 125 MajorandMediumlmgationProjects 005 008 013 014 016 017 030 016 014 013 017 0.20 022 MinorIrngation 003 000 001 001 001 001 002 001 001 001 001 002 002 Power Projects 027 025 018 025 0.27 0 04 0.70 037 039 0 02 0.01 1 17 035 Village and Small Industries 0 17 0 18 0 16 0 16 024 050 0.33 021 0 22 033 0.22 029 030 Industries 0 09 0 11 0 16 0 17 021 026 0.32 041 050 080 1 13 100 134 D GrantsmfromtheCentre(Ito4) 224 259 255 321 269 383 4.72 589 761 695 589 12 12 1472 1 State Plan Schemes 0 82 080 066 074 080 090 125 1 76 200 209 172 307 354 2 Central Plan Schemes 046 057 058 0.78 036 045 059 052 077 116 070 1.81 309 3 Centrally Sponsored Schemes 0.89 1.01 1 20 1.30 1.16 2 05 224 2.83 3 91 336 2.93 665 749 4 NECPlanScheme 000 000 000 000 000 000 000 000 000 000 000 000 000 5 Non-PlanGrants 008 022 011 038 038 044 063 078 094 036 054 059 060 Source. Reserve Bank of India, RBI bulletin on state finances, various years - 66 - Table A3.3 Karnataka: Revenue Expenditure (Rs. billion at current prices) 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 RE BE Revenue Expenditure [A+B+C+D] 2098 2191 2667 3002 3483 3971 4954 5592 6208 7265 8481 10756 11965 A Developmental 1404 1556 1868 2054 2358 2698 34 14 3767 41 79 48 17 5696 73 55 78 19 I Social Services 814 925 1145 1228 13 56 15.39 1893 2082 2379 2754 3250 3857 4624 Education, Sports, Art and Culture 380 434 572 639 7 19 802 961 1098 1278 1448 1703 1940 2230 Medical and Public Health and Family welf 137 1 56 190 207 227 243 295 360 391 458 496 606 779 Water Supply and Sanitation 058 062 061 053 054 061 081 096 1 19 181 221 262 423 Housing 027 0 13 017 020 019 024 051 041 038 072 074 129 1 99 Urban Development 005 008 006 0 17 018 018 040 023 028 047 1 18 140 167 Welfare of SCs, STs and Other BCs 057 078 096 087 096 136 1 32 162 223 247 266 367 338 Labour and Labour Welfare 015 016 020 019 021 020 025 025 023 026 026 030 041 Social Security and welfare 085 092 1 10 1 04 1 14 1 16 1 34 1 60 1 62 1 73 206 236 284 Food and Nutrition 034 051 059 055 064 070 078 030 025 037 058 069 080 Reliefon account ofnatural calamities 008 006 003 016 012 036 073 060 055 033 046 044 046 Others 008 010 012 010 012 012 022 026 037 031 035 034 037 2 Economic Services 590 631 723 826 1002 1159 1521 1685 1801 2063 2446 3498 3194 Agriculture and Allied Activities 167 180 2 12 270 305 282 373 496 589 623 875 844 889 Rural Development 140 144 164 162 123 251 276 3 15 441 418 331 598 732 Special Areas Programmes 004 006 008 008 009 009 010 008 010 010 010 012 014 Irngation and Flood Control 146 160 172 199 210 233 270 309 324 374 414 530 694 Energy 002 007 008 006 010 064 226 1.30 061 1 70 320 975 234 Industry and minerals 066 065 063 082 233 185 184 1 81 191 2.19 237 237 274 Transport and Communications 047 063 072 0.75 090 101 148 204 1 36 193 198 225 262 of which Roads and bndges 045 0.61 070 072 088 099 126 151 132 141 150 169 200 Science, Technology and Environment 001 003 001 001 001 001 001 002 002 003 006 008 009 General Econonic Services 0 18 003 023 0.23 022 032 034 040 047 053 054 068 087 B Non-Developmental (General Services) 643 5.75 737 869 1041 11 75 1422 1700 1905 2301 2670 31 90 3855 1 Organs of states 0.22 024 0.33 037 046 045 063 062 074 107 1.11 1.51 126 2 Fiscal Services 043 051 067 072 084 086 102 1 12 131 192 195 198 231 3 Interest Payments and servicing ofDebt 331 233 284 326 388 481 567 652 785 957 11 51 1343 1599 Appropriation for reduction or Avoidance 168 029 036 035 039 046 0.52 058 067 085 1.03 129 1 50 Interest Payments 162 204 248 2.91 349 436 5 15 594 7 18 871 1048 1214 1450 ofwhich tocentre 080 134 1.50 171 189 250 295 344 413 486 636 727 854 4 Administrative Services 134 1 54 192 210 268 285 356 409 479 549 624 7 55 984 ofwhich Police 075 0.87 1.09 1 15 1.42 1.47 1 81 201 248 299 3.37 432 5 11 5 Pensions and Miscellaneous General Service 1 13 1 13 161 223 254 277 3.34 464 436 496 590 743 9 15 C Compensation to Local Bodies 051 060 0.62 080 084 098 1 18 125 124 1.47 1 15 2 10 291 D Reserve with Finance Department 000 000 0.00 000 000 000 000 0.00 000 000 000 000 000 Source Reserve Bank of India, RBI bulletin on state finances, various years - 67 - Table A3.4 Karnataka: Capital Expenditure (Rs. billion at current prices) 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 RE BE Total Disbursments 796 864 770 776 918 1008 1294 1508 1881 15 95 1925 1427 1520 Capital Outlay(A+B) 278 333 244 268 338 655 786 787 11 88 11 37 1240 909 997 A Developmental 271 3 23 238 260 328 643 772 768 11 65 11 15 12 16 887 981 1 Social Services 024 028 0 16 015 0 16 018 032 039 052 069 082 063 1 01 Education, Sports, Art and Culture et 001 002 001 001 002 002 004 006 009 011 009 004 008 Health and Family Welfare 013 017 009 008 009 007 005 007 010 0 11 017 007 026 Water Supply and Sanitation 000 000 000 000 000 000 000 000 000 000 000 000 000 Housing 005 003 001 001 004 004 012 013 010 011 014 017 019 Urban Development 000 000 000 000 000 000 000 000 000 000 005 000 000 Welfare of SCs, STs and Other BCs 005 006 004 004 001 004 008 0 10 022 033 036 032 040 Social Security and Welfare 000 000 000 000 000 001 003 002 001 001 001 002 003 Other 000 001 001 000 001 001 001 000 001 002 001 000 004 2 Economic Services 247 295 221 245 3 12 626 740 729 11 13 1046 1133 824 880 Agriculture and Allied Activities 006 0 10 007 006 007 013 013 015 009 013 016 015 018 Rural Development 003 010 002 003 006 000 000 002 002 003 000 006 006 Special Area Programmes 000 000 000 000 000 002 000 000 000 000 000 000 000 Major and Medium Irngation and Floo 1.84 206 161 196 237 264 374 5 17 706 744 796 706 696 Energy (Power projects) 000 000 000 000 000 244 245 072 232 1 20 141 016 000 Industry and Minerals 016 025 028 019 023 027 027 034 034 047 038 026 050 Transport 038 043 025 025 041 077 082 091 130 1 18 143 055 1 09 Roads and Bridges 022 028 009 010 012 037 045 053 058 075 065 049 078 Other transport 015 0 15 016 014 029 040 036 038 072 043 078 006 031 Communications 000 000 000 000 000 000 000 000 000 000 000 000 000 Science, Technology and Environment 000 000 000 000 000 000 000 000 000 000 000 000 000 General Economic Services 001 001 -003 -003 -002 -002 -001 -001 000 000 -001 000 000 B Non-Developmental (General Services) 007 010 006 008 0 10 011 0 14 0 19 023 022 025 022 016 C Discharge of Internal Debt 026 026 023 025 027 009 011 032 037 016 045 017 047 D Repayment of Loans to the Centre 226 154 171 176 189 146 157 180 185 169 194 221 261 E Loans by State Governments 266 351 332 306 363 198 341 509 471 273 446 281 2 15 ofwhich Power Projects 172 231 265 232 247 122 170 369 262 122 261 120 000 Source Reserve Bank of India, RBI bulletin on state finances, various years - 68 - Table A3.5 Karnataka: Outstanding Debt (Rs. billion at current prices) Internal Loans from Provident Total Debt Central Govt. Funds etc. 1985-86 4.29 17.74 2.99 25.02 1986-87 5.33 19.83 3.64 28.8 1987-88 6.75 21.32 4.65 32.72 1988-89 9.12 21.00 4.07 34.19 1989-90 10.44 24.75 5.26 40.45 1990-91 9.88 30.1 6.35 46.33 1991-92 11.63 33.81 7.89 53.33 1992-93 13.58 38.7 9.17 61.45 1993-94 15.66 43.74 13.4 72.8 1994-95 17.45 54.26 15.67 87.38 1995-96 20.17 60.4 18.35 98.92 1996-97(R.E.) 23.53 68.04 21.06 112.63 1997-98(B.E.) 27.77 77.11 24.04 128.92 Source: RBI, Report on Currency and Finance Volume II, various issues. - 69 - Table A4.1 Karnataka: Revenue Realized from Power Consumers and Cross Subsidization (Paise/kWh) 1974-75 1979-80 1984-85 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 Revenue realized - Categorywise Domestic 30.0 50 4 47.1 75.6 82 1 85.8 87.8 86.7 87 6 Commercial 40.2 794 118.5 204 1 215.6 261.0 3429 396.7 400.1 Agriculture 15.3 26.4 7.8 6.6 4.8 3 8 2 8 1 8 1 7 Light Industry 18.4 40.6 63.7 140.5 159.4 166.1 202.1 219.3 2209 Heavy Industry 4.7 15 8 48.5 109.9 139.3 189.5 226.3 233.8 273 8 Average 13.6 252 46.0 708 82.4 934 1068 105.1 109 1 Cost 139 246 476 82.5 92.0 1001 112.1 1264 1459 Cross Subsidizations Domestic 16.1 25 9 -0.5 -7.0 -9.9 -14.3 -24.3 -39.7 -583 Commercial 26 3 54.9 70.9 121 6 123.6 160 9 230.8 270 3 254.2 Agriculture 1.4 1.8 -397 -75.9 -87.3 -963 -1094 -124.6 -1442 Light Industry 4.5 16.0 16.2 57.9 67.4 66.0 90.0 92.9 75.0 Heavy Industry -9.2 -8 7 1.0 27.3 47.3 89.4 114.2 107 4 127.9 Source- Bhatia, B. 1997. - 70 - Table A4.2 Karnataka: Flows of Funds Statement Between GOK and KEB (Rs. million) 1991-92 1992-93 1993-94 1994-95' 1995-96 Inflow from GOK Loan 570.5 807 1246.3 601.8 831.2 Equity 2000 0 0 1184.7 1175.4 Rural Electrification loss subsidy 2150 1113.3 339 2081 4090.4 Interest subsidy2 67.2 75 52 52 52 Bhagya Jyothi subsidy 3.5 4.8 5 10 10 Grant-in-aid I 1 1 0 0 Electricity duty3 0 179 0 0 0 Total (A) 4792.2 2180.1 1643.3 3929.5 6159 Outflow to GOK KPC dues 0 0 0 0 3666.3 Loan repayment 3502.2 2.2 77.4 1262.5 1175.4 Interetst payment 168.8 347.9 514.3 1279.2 416.5 Guarantee fees 6.9 10.1 9.9 18.3 38.6 Royalty 14.3 14.8 13.1 20.5 13.4 Electricty duty 0 662.1 669 650 578.1 Central Government Subsidy payment 0 23 34.6 17.9 1.7 Total (B) 3692.2 1060.1 1318.3 3248.4 5890 Net Cash Flow to KEB (A-B) 1100 1120 325 681.1 269 Loan 450 620 325 0 120 Subsidy 650 500 0 0 150 1. Rs. 681 million was not released during 1994-95 due to non-provision in the budget of GOK, which was later released in 1995-96. However, KEB was permitted to account this amount during 1994-95 accounts. 2. Differential rate of interest paid to commercial banks - Government pays 3 to 4% differential. 3. Since 1992-93 Government has allowed to retain electricity duty. Source: Bhatia, B. 1997. - 71 - Table A4.3 Karnataka: Financial Performance of KEB (Rs. million) 1991-92 1992-93 1993-94 1994-95' 1995-96 Revenue Receipts 11809 13300 16080 19697 24900 (RE subsidy received) 868 516 357 206 800 Revenue Expenditure 10147 11131 13472 15865 20219 Gross Operating Surplus 1662 2169 2609 3832 4681 Depreciation 366 640 762 1540 1775 Interest Paid - to institutional creditors 688 778 965 1375 1970 - to state government 365 434 544 486 424 Net Income (with subsidy) 243 316 339 431 512 Net Income (without subsidy) -625 -199 -18 224 -288 ROR on Net fixed Assets (with subsidy) 3.0% 3.0% 3.0% 3.0% 3.0% ROR on Net fixed Assets (without subsidy) -12.9% -19.7% -1.0% -11.4% -29.3% Gross internal resources 1183 4327 415 2040 3924 Loan repayment 363 480 700 1004 1334 Net Internal Resources 820 3848 -285 1036 2590 Source: Bhatia, B. 1997. - 72 - Table A4.4 Karnataka: Energy Demand-Supply Position in Ninth Plan 1997-98 1998-99 1999-00 2000-01 2001-02 Installed Capacity (MW) KPCL - Hydro 2420 2666 2798 2858 2858 - Thermal 840 840 1260 1260 1260 - Total 3260 3506 4058 4118 4118 KEB - Hydro 221 221 221 221 221 - Thermal 128 128 171 171 171 - Total 349 349 391 391 391 Gross Generation - KEB 1250 1250 1420 1505 1505 - KPCL Energy available for sale -Netgenerationof KEB 1221 1221 1385 1467 1467 -PowerpurchasefromKPCL 13372 13826 15263 17374 17413 - Central generating stations 4200 5440 7034 7634 7634 - Neighboring state 0 0 0 0 0 - IPPs 1847 5698 7946 13532 16787 Transmission and Distribution Losses 3798 4805 5788 7301 - 7881 Energy Sales 16842 21380 25840 32706 35420 Energy Demand Busbar 24516 26300 27879 29543 31208 Surplus/Deficit at Busbar (Million Units) -3876 -115 3749 10464 1203 Surplus/Deficit at Busbar (%) -15.8 -0.4 13.5 35.4 38.8 Scenario H - Slippages in Capacity Addition Program Energy available for sale - Net generation of KEB (80%) 977 977 1108 1174 1174 -PowerpurchasefromlKPCL(80%) 10698 11061 12210 13899 13930 - Central generating stations (80%) 3360 4352 5627 6107 6107 - Neighboring state - IPPs (50%) 369 1709 3178 6766 10072 Energy Demand at Busbar 24516 26300 27879 29543 31208 Surplus/Deficit at Busbar (Million Units) -9112 -8201 -5755 -1597 75 Surplus/Deficit at Busbar (%) -37.2 -31.2 -20.6 -5.4 0.2 Source. Bhatia, B. 1997. - 73 - Table A5.1 Karnataka: Wholesale and Consumer Price Indices Year WPI: Agri CPI: Industrial CPI: Urban Non- CPI: Agricultural Labourer Commodities Workers Manual Employees Food General (1981-82=100) (1960=100) (1984-85=100) 961-62=100) 1986/87 130 721 1987/88 153 786 1988/89 170 883 1989/90 177 934 1990/91 202 1,013 812 781 1991/92 245 1,221 183 1,015 953 1992/93 259 1,335 203 1,240 1,143 1993/94 268 1,411 216 1,146 1,093 1994/95 346 1,558 238 1,290 1,223 1995/96 369 1,728 263 1,548 1,440 1996/97 386 1,881 293 1,634 1,529 1997/98 405 1984* 310** 1,635*** 1,558*** *: Eight months average **: Upto July 1997 ***: April to Oct. 97 Source: Directorate of Economics and Statistics, Government of Karnataka REFERENCES Datt, G., 1997, Poverty in India and Indian States: An Update, International Food Policy Research Institute, Washington, D.C. Datt, G. and M. Ravallion, 1996, Why Have Some States of India Performed Better Than Others at Reducing Rural Poverty? World Bank Policy Research Working Paper 1594, Washington, D.C. Expert Group on the Commercialisation of Infrastructure Projects, 1996, The India Infrastructure Report; Policy Imperatives for Growth and Welfare, Government of India. Foster, A. and J. Rosenzweig, 1995, Learning by Doing and Learning From Others: Human Capital and Technical Change in Agriculture, Journal of Political Economy, 103:1176-1209, December. Government of India, 1996, Report of the Working Group on Major and Medium Irrigation Programme for the IXFive-Year Plan (1997-2002), Central Water Commission, Ministry of Water Resources, New Delhi. Hammer, J., I. Nabi, and J. Cercone, 1995, Distributional Effects of Social Sector Expenditures in Malaysia, 1997 to 1989, in van de Walle and Nead, (eds.), Public Spending and the Poor: Theory and Evidence, Baltimore, Johns Hopkins University Press. Litvack, J. and C. Bodart, 1993, User Fees and Improved Quality of Health Care Equals Improved Access: Results of a Field Experiment in Cameroon, Social Science and Medicine, 3 7(3): 369-3 89. Murray, C., G. Yang, and X. Qiao, 1992, Adult Mortality: Levels, Patterns and Causes, in R. Feachem, T. Kjellstrom, C. Murray, M. Over and M. Phillips, (eds.), The Health of Adults in the Developing World, New York, Oxford University Press. Nagaraj, R., A. Varoudakis, and M.A. Veganzones, 1998, Long-Run Growth Trends and Convergence Across Indian States, OECD Development Center, Technical Paper 131, France. Pritchett, L. and D. Filmer, 1998, Education Enrollment and Dropout in Indian States: Measures from the National Family Health Survey, draft background paper for the 1998 Poverty Report, World Bank, Washington, D.C. Thimmaiah, G., 1986, Performance ofKarnataka's Economy, in M. Adiseshiah, (ed.), The Economies of the States of the Indian Union, Lancer Press, India. van de Walle, D. and K. Nead, (eds.), 1995, Public Spending and the Poor: Theory and Evidence, Baltimore, Johns Hopkins University Press. World Bank, 1997, India: Achievements and Challenges in Reducing Poverty, Washington, D.C. , 1995, India: Policy and Finance Strategies for Strengthening Primary Health Care Services, Washington, D. C. , 1997, India: Water Resources Management Sector Review, draft, Washington, D.C. - 76 - , 199 1, India: Irrigation Sector Review, Washington, D.C. , 1995, India: Transport Sector, Washington, D.C. , 1997, India: Urban Infrastructure Services Review, Washington, D.C. , 1996, India: Energy Sector: Issues and Options, Washington, D.C. , 1997, India: New Directions in Health Sector Development at the State Level, Washington, D.C. , 1997, Primary Education in India, Washington, D.C. , 1993, Indonesia: Public Expenditures, Prices, and the Poor, Washington, D.C. , 1993, World Development Report 1993: Investing in Health, New York, Oxford University Press. CATALOGUERSIFILE CONFIDENTIAL Report No.: 16360 IN Type: SR