The high debt of the Kerala government hangs like the sword of Damocles over the State’s ability to borrow and invest. The State’s fiscal and revenue deficits are above the median for the major 28 States. While the 2026 budget envisages growth-led fiscal repair, the debt crisis requires an immediate solution, since the debt is mainly incurred to finance current expenditure rather than capital investment.

The financial stress is compounded by the autonomous operations of the Kerala Infrastructure Investment Fund Board (KIIFB) and Public Sector Enterprises (PSEs). The resulting losses are glaring. With revenue deficit grants from the Union Government now being cut, covering these losses becomes all the more critical. The massive liabilities, expenditures, and interest payments tie the hands of the government, as a status report to the State Assembly details. Strikingly, the government’s capital expenditure is a mere 1.3% of its Gross State Domestic Product, one of the lowest among Indian States.

The government needs to improve the effectiveness of the revenue-expenditure framework urgently. A bigger drawdown of Centrally Sponsored Scheme funds, whose utilisation has been chronically below entitlement, offers immediate financing without incurring new debt. The Special Assistance to States for Capital Investment scheme, which are 50-year interest-free capital loans from the Centre, remains underused. The 16th Finance Commission’s urban local body grants offer another avenue, provided municipalities collect taxes that back those transfers.

Moreover, the buoyancy of tax revenue can be vastly improved. Economic growth was almost 10% last year, but taxes grew by only 3%, signifying a tax buoyancy of only 0.3. The State must confront massive revenue arrears and slash off-budget borrowings, as flagged by the Comptroller and Auditor General. Kerala can also strengthen tax compliance by overhauling its Goods and Services Tax (GST) administration, increasing GST registrations, improving targeted tax information systems, and ensuring timely audits. GST revenue growth was 3% in 2025-26 compared with 6% nationally.

The government could also explore fee increases across departments to generate more non-tax revenue. Priority sectors would be port management, building permits, mining levies and forest produce. There could be higher user charges for high-end government services such as specialised skill training.

Beyond quick fixes, a fiscal reform agenda is in order, as a report from Sacred Heart college outlines. Dealing with the losses of the PSEs should have priority. An independent review is needed for KIIFB-funded projects. It is also high time to implement tested models of private participation in PSEs.

A second area would be sources of finance. As in Indonesia, a professionally governed State intermediary can help attract capital. Private investment can be made less risky by announcing transparency and predictability in policy. The government may lease, and not sell, land for industrial zones and IT parks. Urban local bodies could access capital markets through bonds backed by property tax, user charges, and land lease income. Kerala diaspora bonds could be RBI-compliant instruments through which NRIs can invest in projects.

Third, the expenditure side of the ledger needs a better look. For every ₹100 in revenue, ₹77 are pre-committed to salaries, pensions, and interest payments, cutting the State’s governing capacity. There is good rationale to embark on pension reform.

Fourth, errors of commission should be averted. Encouraging mining in fragile hilltops to earn revenue would be self-defeating. Similarly, allowing private participation in sand mining would be destructive as the damage wreaked by environmental destruction overwhelms any taxes gained. While it is tempting to cut welfare programs in the name of fiscal austerity, it would be a mistake to reverse the schemes that give safety nets to the extremely poor.

Kerala’s development potential is well-known, but the fiscal crisis is a roadblock to realising it. The State must immediately enact steps to increase revenue within the existing fiscal framework.

Vinod Thomas is a former senior vice president of the World Bank; C. Veeramani is Director of CDS, Thiruvananthapuram.