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PlP Pg Government of Karnataka

GOVERNMENT OF KARNATAKA

FINANCE DEPARTMENT

MEDIUM TERM FISCAL PLAN

2013 - 2017

(2013 . )

(As presented to the Legislature during July 2013)

Medium Term Fiscal Plan 2013-17

Table of Contents

Foreword

Chapter 1- Introduction

a) Economic Outlook b) Growth Risks in the State Economy c) Inflationary Trends d) Trends in Growth Rate e) Fiscal Situation of the State in FY 12-13 and MTFP 12-16 Review f) Fiscal Management Review Committee g) Key Fiscal Challenges h) Fourteenth Finance Commission i) Efficient Management of Public Expenditure j) New Commitments

Chapter 2-Macro Economic Outlook

a) Karnatakas GSDP and Forecast b) Growth Prospects and Road Ahead

Chapter 3-Evaluation of Fiscal Performance

a) Fiscal Consolidation Roadmap and Status b) Other Institutional Reforms under KFRA c) Fiscal Performance of the State in FY12-13 vis--vis FY11-12 d) Performance of receipts, expenditures and fiscal indicators (FY09-10 to FY12-13) e) Fiscal Performance Table A

Chapter 4-Revenue Performance and Reforms

a) Tax Policy and Strategy b) Tax Effort c) Performance of Major Own Taxes

i. Commercial Taxes ii. State Excise iii. Stamps and Registration iv. Motor Vehicles Taxes

d) Cess Receipts e) Non Tax Revenues

i. Royalty on Major and Minor Minerals ii. Interest Receipts iii. Other Non Debt Capital Receipts

f) Accounting of Direct Releases of Central Government

Medium Term Fiscal Plan 2013-17

Table of Contents (Contd..)

Chapter 5- Expenditure Management

a) Trends in Government Expenditure. b) Plan, Non Plan, Development and Non Development Expenditure c) Sector-wise Outlay d) Beneficiary Oriented Schemes and Subsidies e) Resource Transfer to Local Bodies f) Committed Expenditure g) Capital Expenditure to GSDP h) Delegation of Fund Release powers to Administrative Departments

Chapter 6-Public Finance Management and Systemic Reforms

a) Overall Debt Scenario b) Composition of Debt c) Management of Borrowings d) Maturity Profile of Outstanding State Government Securities e) Creation of Consolidated Sinking Fund (CSF) f) Contingent Liabilities g) Cash Management h) Public Disclosure of Fiscal Situation on Quarterly basis i) Systemic Reforms

Chapter 7-Medium Term Fiscal Plan Projection 2013-17

a) Brief assessment of sustainability of certain fiscal parameters b) Balance between Revenue Receipts and Revenue Expenditures c) Use of Capital Receipts including Borrowings for generating productive assets

Medium Term Fiscal Projections for 2013-17 (TABLE-B)

Underlying Assumptions for the projections in MTFP13-17

Annexed Statements - Disclosures as required under Sec 5(2)(c) of KFRA

LIST OF TABLES

Table No. Description

1 GSDP at current market prices

2 Trends on Annual Growth Rates of Indias GDP and Karnatakas GSDP (at Constant Prices)

3 Fiscal Performance of State

4 Trends in Sector wise Composition of GSDP (Current Prices)

5 Trends in Sector wise Composition of GSDP (Constant Prices 2004-05 Series)

6 Compliance to KFRA fiscal and debt norms

7 Fiscal performance of the State in FY12-13 vis--vis 2011-12

8 Fiscal Deficit Trends

9 KFRA Ceiling on Total Liabilities

A Fiscal Performance 2009-13

10 Buoyancy of States Own Taxes

11 Commercial Tax Trends during FY12-13

12 Excise Trends during FY12-13

13 Stamps and Registration Fees Trends during FY12-13

14 Motor Vehicle Taxes Trends during FY12-13

15 Expenditure on Services

16 Outlay under Major Development Sectors

17 Explicit and Implicit Subsidies

18 Committed Expenditure as a ratio of Uncommitted Revenue Receipts

19 Composition of Gross Public Debt

20 Government Guarantees

B Medium Term Fiscal Plan Projections 2013-17

LIST OF ANNEXURES

Statement No.

Description

1 Tax Expenditure/Revenue Foregone under Deferment of Purchase Tax on Sugarcane pertaining to FY 11-12 & FY 12-13

1A Information on Tax Expenditure / Revenue Foregone by exemption or deferment of Value Added Tax (VAT), Central Sales Tax (CST) and Entry Tax (KTEG) pertaining to FY 2012-13

1B Abstract of Statement 1-A

1C Tax Waivers by State Government through the Reimbursement route / Loan route

2 Compliance Cost of Major State Taxes (Commercial Tax, Stamps duty, Motor Vehicle tax, Excise)

3 Revenue Consequences of Capital Expenditure and physical assets of major departments

4 Government Land Details

5 Future Expenditure Commitments of major policy changes during FY 12-13

6 Liabilities in Public Private Partnership

Statement of Compliance

1. The Medium Term Fiscal Plan 2013-17 is tabled before the Legislature in compliance with Section 3 of the Karnataka Fiscal Responsibility Act (2002).

2. Section 3 of the Act requires the MTFP to include the following elements, all of

which can be found in the document as shown below:

a. The medium-term fiscal objectives of the Government (Chapters 1, 3, 4, 5, 6 and 7).

b. An evaluation of the performance of the prescribed fiscal indicators in the previous year(Chapter 3)

c. A Statement of recent economic trends and prospects for growth and

development (Chapter 1 & 2).

d. The strategic priorities and key fiscal policies of the Government and an evaluation of their consistency and broad conformity to fiscal management principles set out in Section 4. (Chapters 4to 7).

e. Four - year rolling targets (Chapter 7 & Table B).

f. An assessment of sustainability relating to the balance between revenue receipts and revenue expenditures and the use of capital receipts including borrowings for generating productive assets. (Chapter 7)

3. Disclosures as per amended Section 5 (2) of KFRA (Annexed Statements)

4. Table A Fiscal Performance in the previous four financial years vis--vis the Budget Estimates (in Absolute terms and as a percentage of GSDP)

5. Table B Medium Term Fiscal Projections for four years including the current

year i.e. 2013-17 (in Absolute terms and as a percentage of GSDP)

Foreword to Medium Term Fiscal Plan 2013-17 (MTFP)

MTFP 2013-17 was presented to the Legislature in February

2013 as required under the Karnataka Fiscal Responsibility Act

(KFRA), 2002 and Karnataka Fiscal Responsibility Rules, 2003. At

that time MTFP was premised on the then prevailing economic

and fiscal challenges and on the proposed budget estimates for

the Financial Year 2013-14 being placed in the Legislature during

February 2013.

In view of a new Government in place, a fresh budget for the full

Financial Year 2013-14 is now being presented during July 2013.

In view of the recent changes in economic scenario and

reprioritisation of expenditure requirements in the fresh budget,

it was found necessary to bring out a fresh MTFP 2013-17. While

a large portion of MTFP 13-17 includes issues brought out in the

earlier MTFP presented in February 2013, the developments

thereafter and its impact on the fiscal management have also

been brought out in this edition of MTFP.

The statement of compliance at the beginning of the MTFP 13-

17 lists out the key elements covered in this document. MTFP

13-17 continues taking into cognizance the key challenges on the

Revenue and Expenditures side identified earlier. To analyse the

fiscal performance of the State during 2012-13, the Revised

Estimate figures for FY12-13 would continue to be used since final

accounts for the FY12-13 is yet to be compiled and certified by

Comptroller & Audit General of India.

The Karnataka Fiscal Responsibility (Amendment) Act, 2011 by amending Section 5 of KFRA now requires State to make certain additional disclosures as part of Fiscal Transparency. These additional disclosures made are in line with the recommendations of the Thirteenth Finance Commission and are reflected as separate statements annexed to the MTFP document.

1

Chapter 1

Introduction

a) Economic Outlook

Global & National Economic Scenario

1. This Medium Term Fiscal Plan is set in an environment where the Global economy is going

through challenging times with the European Area sovereign debt crisis only aggravating the

situation. To some extent concerted action by governments, central banks, regulators and

multilateral institutions have helped moderate this impact, but still there is continued

uncertainty at the global level. On the whole global growth remains tepid and multi-paced.

The Euro zone would continue to under-perform in 2013. However there are indications that

the overall economic conditions in 2013 may be better than they were in 2012 on account of

the upturn in the USA and continued growth in the emerging & developing world, especially

in Asia and Africa.

2. The gradual improvement in financial conditions that was setting in due to certain policy

actions has been recently subject to some turbulence in financial markets. The

apprehensions of global liquidity contracting with the United States Federal Reserve

indicating a phased withdrawal from its bond buying programme or easy money policy, has

fuelled large scale sell off of financial assets in emerging markets including in India leading to

sharp downward movements in their equity, bond and currency markets. These

developments have accentuated the spill-over risks from unconventional monetary policies

(UMPs) of advanced economy (AE) central banks posing new challenges to emerging

economies.1

3. Therefore emerging economies need to be prepared for spells of high volatility and

uncertainty going ahead. The macroeconomic risks to Indian economy have increased over

the last six months, mainly on the dimensions of domestic growth, external sector and

corporate sector performance. Domestic supply bottlenecks, policy uncertainty,

consequential dampened investment sentiment and slackening external demand

contributed significantly to the slowdown. There has been marked slowdown in growth as

industrial activity is subdued and services remain below trend.

1 Financial Stability Report of RBI June 2013

2

4. In the Financial Year 2012-13, the national GDP growth grew by just 5 per cent, the lowest in

a decade. Even during the start of FY13-14, growth remains below trend and vulnerabilities

on the external front have risen. The high current account deficit (CAD) and its financing

remain stress points for the Indian economy as evident from the recent depreciation of the

rupee. On the other hand, there are indications that inflation is moderating and the growth

slowdown appears to be at a trough. Credible progress has been made on the fiscal front by

the Central Government, which has been reflected in the upgrading of the outlook by credit

rating agencies. This fact is evinced from the optimistic growth outlook for FY 2013-14 in the

forecasts of the World Bank in its Global Economic Prospects Report. The World Bank sees

Indias economic growth rising to 5.7 per cent in 2013-14 buoyed by gradual strengthening

of external demand. Growth is thereafter projected to accelerate to 6.5 per cent in 2014-15

and 6.7 per cent in 2015-16. The Prime Ministers Economic Advisory Council (PMEAC) in its

recent report in April 2013 has stated that the expected pick-up in the pace of economic

activity during the course of the year should be able to take the economic growth from the

present level of around 5 per cent in 2012-13 to about 6.4 per cent in 2013-14. Going

forward, improvement in the quality of fiscal consolidation will be crucial for ensuring

macroeconomic stability and sustainable higher growth.

Impact on Sub-national economies:

5. The economic slowdown would have direct or indirect bearing on the sub-national

economies. In recent times several initiatives have been taken by the Government of India

(GOI) to improve economic climate, spur investments, and bring back the economy to the

high growth path. However this needs to be sustained on a long term basis and supported by

judicious mix of fiscal consolidation policies and in view of moderating inflation, a graduated

easing of monetary stance by the Central Bank. These are necessary for strengthening of

investment sentiment and laying the road for long term inclusive and sustainable growth.

6. Some of these measures including those recommended by PMEAC are as follows.

a) Integrated decision making on high impact infrastructure projects

b) Reducing non merit subsidies

c) Encouragement to investments by facilitating faster and timely approval mechanisms

like the recently set up Cabinet Committee on Investment.

3

d) Containing inflation especially in primary food articles through better supply side

management.

e) Improving Net Energy Availability within the country as it is linked to external payments

situation and widening Current Account Deficit (CAD).

f) Better coordination between the Centre and States for pushing through policy changes

b) Growth risks in the State Economy

7. With the given risks as anticipated at the time of State budget formulation in February 2012,

Karnatakas MTFP 2012-16 had assumed GSDP to grow 7.5 per cent in real terms for the year

2012-13 and thereafter at 8 per cent until 2014-15 expecting the economy to recover. Also

GSDP growth rate as conveyed by the Ministry of Finance, GOI was accepted by the State

and accordingly, the MTFP 2012-16 had assumed GSDP for the year 2012-13 to be at Rs.

5,20,766 crore (at current prices). These numbers had their basis in the growth projections

recommended by Thirteenth Finance Commission for Karnataka. For the financial year 2013-

14, Government of India has conveyed the GSDP figure for Karnataka at Rs.601633 crore.

This estimate has its basis in the Central Statistical Offices (CSO) estimate of GSDP for FY11-

12 at Rs.458903 crore. On this GSDP figure, nominal growth of 14.5 per cent has been

assumed to arrive at GSDP for FY12-13 and thereafter another 14.5 per cent nominal growth

is assumed on GSDP for FY12-13 to arrive at GSDP for FY13-14. State has adopted this figure

of Rs.601633 crore as its GSDP for FY13-14 for finalizing all its estimates.

8. In contrast to the above assumptions of GOI, the Advance Estimates of GSDP released by

the Directorate of Economics and Statistics (DES) in State Government for FY 12-13 place

Karnatakas GSDP at Rs.5,27,492 crore (at current market prices). If the annual inflation is

assumed to be around 7.5 per cent and economy is expected to grow at around 6 per cent,

then the GSDP for FY13-14 would work out to around Rs.5,93,413 crore which is lesser than

the GSDP estimate of Rs.601633 as conveyed by GOI.

9. Table 1 shows the comparative position between GSDP numbers conveyed by GOI and as

estimated by DES.

4

Table1 GSDP at current market prices (Rs. In crore)

Year As conveyed by Ministry of Finance, Government

of India

As per Directorate of Economics and Statistics

(DES), Karnataka*

(1) (2) (3) 2011-12 458903 4,63,242 (QE) 2012-13 525444 5,27,492 (AE) 2013-14 601633 N.A

*QE- Quick Estimate, AE-Advance Estimate, N.A Not Available as yet.

10. While preparing the budget 2012-13, the annual change in the GSDP growth of Karnataka

was assumed to be 7.5 percent in real terms over that of 2011-12. However the real GSDP

growth rate as per the Advanced Estimates has turned out to be much lower at 5.9 per cent.

The growth has been constrained by a significant slowing down of growth in Agriculture

mainly due to adverse weather conditions and lesser off-take of expenditure as compared to

outlay. Karnataka has witnessed serious drought situation on account of deficit rainfall over

the last two years. The condition has worsened on account of deficit rainfall from south-west

monsoon during June and July 2012. 123 taluks of 28 Districts were declared as drought hit

in the previous year i.e. 2011-12. On account of deficit rainfall in 2012-13, another 34 taluks

were declared as drought hit subsequently. Hence a total of 157 taluks in 28 districts were

declared as drought hit in the last two years. Overall there was a shortfall of around 30 per

cent in the south west monsoon rainfall in 2012. This has a significant impact on the primary

sector which constitutes almost 15 per cent of GSDP, as a major part of agriculture in

Karnataka is rain fed and thus heavily dependent on these rainfalls.

11. Though the annual growth in agriculture has moderately recovered to 1.8 per cent as per

2012-13 AE as compared to the negative growth rate of (-) 2.2 per cent at constant prices

during 2011-12, the overall growth in the primary sector has got constrained. The industry

sector is estimated to stay at same level of 2011-12, i.e. at 2.4 per cent due to negative

growth in mining sector. There is also a decrease in the growth rate of the service sector

from 9.5 per cent in 2011-12 to 8.9 per cent in 2012-13. While the long term economic

fundamentals of the State economy in Industrial and Services sectors are strong, unless

there is a well laid out fiscal roadmap for reorienting outlays and reprioritising expenditure

5

designed for monitorable outcomes, the likelihood of the States economy bouncing back to

high growth trajectory in the medium term would be tough.

c) Inflationary Trends

12. The MTFP 2012-16 had assumed an inflation rate of 6.5 per cent for FY12-13 and 6.0 per

cent in the medium term. The most notable factor during FY12-13 was the persistence of

high rates of inflation, especially of food items, and the direct impact this may have had on

profitability and thereby on investment behaviour. While it would be desirable to see the

Wholesale Price Index (WPI) headline number to weaken in 2013-14, this may not quite

happen. Price corrections are being made in administered products like in refined petroleum

products, fertilizer and electricity. The minimum support prices (MSP) of important food

grains, particularly rice (paddy) and wheat have also seen upward revision, with attendant

impact on the market price of wheat and rice. The supply chain for perishable food products

still remains incomplete, as also the reform of their market structures.

13. The combination of the above factors would tend to keep inflation on the higher side. On

the other hand, the momentum and direction of inflation appears to have clearly moved

down for manufactured prices in the absence of significant cost pressures. If the currency

stabilizes and trade balances improve somewhat, weaker manufactured goods inflation will

have a dampening impact on domestic headline, and especially on core inflation. The

headline inflation would move to around 6.0 per cent, with primary food inflation around 8

per cent, fuel at about 11 per cent and manufactured goods at around 4 per cent2.

14. At the State level, the drought in the State leading to declining growth in Agriculture may

also have been a contributing factor to slow supply side response. The slight moderation in

inflation is expected to provide more leeway to monetary and fiscal policy makers in coming

days to bring in changes to stimulate economic growth while ring fencing the impact of

inflation. However since fiscal consolidation seems to be a priority for the Government of

India, steps like increase in administered price of diesel, cutting down of non merit subsidies

and increase in MSP of foodgrains would moderate any expectation of a early reduction in

inflationary pressures. Also the effect of new initiatives like direct cash transfer of subsidy on

inflation is uncertain at this stage.

2 PMEAC April 2013

6

15. RBI has kept key lending rates slightly on the higher side to moderate money supply. This has

contributed to some extent in the slowing down of the economic growth. The high interest

policy regime had some bearing on the State finances as the Government needed to

continue various farmer friendly interventions like the concessional crop loan scheme, which

are so designed that the State Government absorbs a large part of the impact of high

interest costs. The State has also introduced a cooperative crop loan waiver scheme to

protect farmers from the impact of the severe drought condition in various taluks of the

State. In this background the graduated monetary policy easing undertaken by RBI balancing

on the one hand the inflationary risks to the economy and the facilitation of investment

through reduced cost of borrowing on the other is welcome.

16. For the State, the hardening of interest rates with regard to State Development Loans

availed in the third and fourth quarter of the FY12-13 was becoming evident. For instance

during first two quarters of FY 2012-13, the cost of borrowings which were hovering around

8.60 to 8.75 per cent have gone up to 8.90 per cent during the third and fourth quarters.

State has not yet tested the market during the first quarter of FY13-14 under its borrowing

programme.

d) Trends in growth rates:

Table - 2

Trends on Annual Growth Rates of Indias GDP and Karnatakas GSDP (at Constant Prices)

2007-08 2008-09 2009-10 2010-11 Q.E* 2011-12

AE* 2012-13

Proj 2013-14

Proj India's GDP**

9.3 6.7 8.6 9.3 6.2 5.0 6.4

Karnataka's GSDP*

12.6 7.1 1.3 9.7 5.5 5.9 -

* QE: Quick Estimate and Advance Estimate as per DES for Karnataka ** CSO estimate till 2012-13 and PMEAC estimate for 2013-14

17. The Table 2 shows the trends in the annual growth rate of Indias GDP and that of

Karnatakas GSDP. During the period 2007-09 States growth rate has been higher than that

of the country. During 2009-10, States growth sharply dipped on account of drop in growth

rates of industry and services. In the year 2010-11, State grew faster and its GDP growth rate

was higher than that of India. However there is significant slowing down of growth both for

7

the State and the country as a whole in FY11-12. During the FY12-13, the countrys GDP hit a

decade low of 5 per cent, while State is expected to do slightly better at 5.9 per cent due to

some recovery in agricultural sector. The moderate growth rates of the State and country as

a whole since 2011-12 is in line with the prevalent global economic scenario impacting

emerging market economies. The following chapter discusses the growth prospects of

economy in detail.

e) Fiscal Situation of the State for the FY 2012-13 and Review of MTFP 2012-16

18. The Budget 2012-13 and the MTFP 2012-16 were presented when national economy was

expected to recover to high growth path. However, the performance of the state economy

has been in line with the national economy and has shown less than expected revival. The

GSDP estimates of Directorate of Economics and Statistics (DES) indicates that in 2012-13

Karnatakas economy grew by 5.9 per cent (at constant prices) only over that of the previous

year as against an anticipated growth rate of 7.5 per cent in the MTFP 2012-16. In view of

this, the growth for FY12-13 in the revised estimates for FY12-13 were moderated to 6 per

cent in real terms

19. Hence, the overall performance of the fiscal indicators in MTFP 2012-16 was expected to be

marginally lower. However with the anticipated tax and non-tax revenues during the year,

the State is expected to maintain a revenue surplus of Rs.943 crore and fiscal deficit as a

percentage of GSDP would be kept at 2.93 per cent in the revised estimates for 2012-13.

Thus while revenue surplus is being maintained, on fiscal deficit as percentage of GSDP,

State would have marginally done better than in Budget Estimates for 2012-13.

Table 3 Fiscal Performance of State

(Rs. in Crore)

Item 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 BE 2012-13

RE GSDP

Nominal* 227854 271246 302146 335747 380871 434270 520766 520766

Fiscal Deficit (FD) 4688 5331 8732 10874 10688 12300 15312 15239

FD as % of GSDP 2.06% 1.97% 2.89% 3.24% 2.81% 2.83% 2.94% 2.93%

Revenue Surplus 4152 3776 1632 1619 4172 4691 931 943

* The GSDP figures have been revised from 2002-03 onwards due to change in base to 2004-05

8

20. Despite the slowing down of the economy, the performance of the State on fiscal indicators

as seen from the revised estimates for revenue surplus and fiscal deficit as compared to

budget estimates in 2011-12 within KFRA limits. This has resulted to some extent from the

high tax effort of the State and curtailing of lower priority revenue expenditure. The fiscal

performance of the State was influenced by a mix of expenditure management policies as

well as revenue enhancing interventions. However the area of concern is the dip in the

revenue surplus which has reduced drastically from Rs.4691 crore in FY11-12. The revenue

surplus estimated in RE 12-13 would have been fully appropriated towards financing capital

expenditure thereby reducing the need for the State to borrow to that extent.

f) Fiscal Management Review Committee:

21. As required under the recent amendment to the KFRA, State Government constituted the

Fiscal Management Review Committee (FMRC) headed by the Chief Secretary. The

Committee would review fiscal and debt position of the State and the States progress on

the fiscal correction path and thereafter advice on the corrective measures as may be

required. FMRC has reviewed the fiscal and debt position of the State and its progress on

fiscal correction path as required under the Karnataka Fiscal Responsibility Act (KFRA). The

Committee has deliberated in detail on the fiscal and debt parameters and thereafter

advised the Finance Minister on the remedial measures to be adopted to ensure adherence

to the parameters stipulated in KFRA.

22. The FMRC during the mid-term review of the fiscal 2012-13 focussed broadly on the

challenges in the current year, resource and expenditure, prudent fiscal management, deficit

management and adherence to KFRA amongst others. After detailed deliberations the FMRC

resolved on the following issues:

i. Coordinate with neighbouring states in evolving non-competitive fiscal

incentive policy as decided in recent meeting of the South Zone Council.

ii. Relook into the issue of granting exemptions to State Road Transport

Corporations (SRTCs) keeping in view its impact on the States tax base.

iii. Follow up with departments for improving their non-tax revenues.

iv. Avoid and moderate inclusion of large expenditure commitments in

supplementary estimates.

9

v. Focus on consolidating existing institutions and improving their effectiveness.

vi. Control on starting new institutions and admitting private institutions to GIA.

vii. Regulation on creation of new posts, and filling up vacancies in non-core

mandate areas.

viii. Approvals for new initiatives and works requiring implementation over

multiple years to be based on fiscal sustainability of the total expenditure

rather than expenditure during the year of approval only and thereby avoid

build up of fiscal stress due to unfunded expenditure commitments.

ix. Advise the departments to base their proposals for new initiatives within

their respective 12th Five Year Plan allocations to be communicated by

Planning Department, instead of seeking additional funding on recurring

basis.

x. Move over to medium term (3 to 5 years) appraisal and approval cycle for the

schemes from the currently practiced annual cycle.

xi. Revisit and control the preference for implementation of schemes and

programmes through society and SPV mode and managing funds through

bank and personal deposit accounts outside the Consolidated Fund.

23. FMRC reiterated these recommendations again when it met in February. The committee

noted the need for implementing these recommendations for enhancing robustness of fiscal

position, mobilizing more resources for capital formation and improving expenditure

effectiveness during the MTFP period. In view of this, the Committee resolved as follows:

i) A time bound action plan to be put in place by Finance Department and Planning

Department involving the Administrative Departments for implementation of these

recommendations.

ii) Cabinet approval for specific mandate to be obtained.

iii) Thereafter detailed guidelines to be issued to all Administrative Departments for

implementation of Action Plan.

24. The management of State Finances is broadly guided by the recommendations of

the FMRC. All these recommendations of FMRC are essentially aimed at increasing

10

the capital expenditure, minimizing lower priority revenue expenditure, increasing

non-tax revenue, ensuring fiscal sustainability and pursuing prudent planning and

appraisal mechanisms to improve outcomes. The Honble Chief Minister who is

also the Finance Minister of the State has approved the above recommendations

of FMRC. These have been considered in the fiscal projections for the MTFP

period. Over a period of time, concerted efforts need to be made to translate

these valuable suggestions into an actionable roadmap.

g) Key Fiscal Challenges

25. The State has to balance the requirement of providing adequate funds to critical

sectors of the economy while adhering to fiscal prudence norms. The following are

some key challenges identified, which the State has to tackle in the ensuing years.

Some of these challenges including those identified earlier have continued to remain

in focus during the current year. These are as follows.

a. Low non tax revenues: While the State has one of the highest own taxes to

GSDP ratio, the ratio of non-tax revenue to total receipts has not been

increasing over the years on anticipated lines. Apart from enforcement and

monitoring of own tax efforts, special emphasis needs to be given for

mobilizing non-tax revenues during the coming years. Government is

committed to rationalizing user charges and reviewing the same regularly. In

this regard, Government is also guided by the recommendations of

Expenditure Reforms Commission.

b. Limitations on use of borrowed funds for capital formation: In order to

meet the competing needs of various priority sectors for investment in

capital assets apart from reliance on its own resources and Central funds,

State goes in for borrowings. However borrowings are not open ended but

are limited by the ceiling imposed by KFRA. While borrowing, State has to

ensure that the twin parameters of Fiscal Deficit and Total Liabilities as a

percentage of GSDP are both retained within permissible limits during the

course of the year.

c. Fiscal impact of official pay committee recommendations: In view of the

acceptance of the recommendations regarding revision of pay and other

allowances by the State Government, the existing dearness allowances and

11

installment due as on 1st January 2012 was merged in the basic pay and

pension along with 23.25 per cent increase. The additional outgo from the

budget during FY12-13 from the ensuing pay revision was estimated to be

around Rs.4300 crore. The large committed expenditure requirement for

salary would mean that the State would have to prudently manage its other

plan and non plan commitments to maintain its revenue and fiscal balance.

d. Large budget size and supplementary requirements: State presented budget

exceeding One Lakh Crore for the first time in FY12-13. Ample own resources

were mobilised and with grants from Centre and borrowings within KFRA

ceiling, resources were found for financing the budget. However additional

plan commitments in the nature of supplementary estimates keep cropping

up. It would be difficult to mobilise additional resources as also identifying

savings in other plan schemes during the course of the year to keep meeting

the enhanced requirements during the year.

e. Ensuring effective targeting of the subsidy net: In recent times there has

been a large increase in the number of beneficiaries under various subsidy

schemes like Social Security Pensions and Bhagyalakshmi. Steps have been

taken to identify deserving beneficiaries to ensure effective targeting of the

subsidies. Subsidies given to power sector for consumption of electricity by

farmers primarily for below 10 HP IP sets have also been growing. The

subsidy claims are ever increasing as the consumption by IP sets is not

measured but only estimated. The Energy Department has not taken up

metering of such IP sets. As a result, there exist a strong possibility of even

the losses, both technical and commercial, and thefts getting included in the

IP set consumption and thereby inflating the bill to the government.

Expenditure on Explicit and Implicit subsidies put together is over Rs.14,800

crore. Hence expenditure on subsidies needs to be moderated in the medium

to long term to make them fiscally sustainable. The Resident Data Hub

Scheme, UID scheme and Direct Cash Transfer scheme would help in better

identification of beneficiaries and targeting of subsidies directly.

f. Plan commitments under XII Five Year Plan: The 12th Five Year Plan outlay

for Karnataka at Rs. 2,55,250 crore (current prices) is 87 per cent higher than

12

the 11th Five Year Plan expenditure at current price of Rs.1,36,352 crore. The

per capita plan outlay of Karnataka at Rs. 6,810 in FY 2012-13 is one of the

highest among major States. The Plan Size for FY12-13 at Rs.42030 and

subsequent increases in the following years would have to be met largely by

improving the balance from current revenues (BCR). Hence curbing non

essential non plan expenditure and improving States Own Tax Revenue

(SOTR) would require sustained focus and follow up.

g. Unfunded or partially funded liabilities: At the macro level, Government of

Karnataka has maintained the fiscal discipline mandated by the Legislature

through Karnataka Fiscal Responsibility Act during the past 5 years. However,

in these years, the government has taken up several commitments much

beyond its fiscal capacity requiring additional funding over and above the

current level of the resources. Some of these partially funded commitments

are the Crop Loan Waiver Scheme, Power Sector dues, Support for Housing

sector, Support for Grant in Aid institutions and Infrastructure Projects.

h. Other potential areas of fiscal stress are as follows:

i. Requirement to transfer 40 per cent of Non Loan Net Own Revenues

(NLNORR) to local bodies as per the recommendations of Third State Finance

Commission.

ii. Mandatory earmarking of funds for Special Component Plan And Tribal Sub

Plan along with provision of Pooled Funds to Social Welfare Department.

iii. Minimum maintenance expenditure to be provided for Roads and Bridges

and Irrigation projects as prescribed by 13th Finance Commission and

minimum budgetary allocation to be made for Elementary Education, Forest

and Renewable Energy as prescribed by 13th Finance Commission.

iv. Specific earmarking of funds would be required to be made within available

budget for development of backward areas as required under Article 371 J

of the Constitution of India.

13

h) Fourteenth Finance Commission:

26. Fourteenth Finance Commission has been set up by Government of India recently.

Constitutionally the primary role of the Finance Commission is to recommend the sharing of

tax proceeds between the Centre and the States. The 14th Finance Commissions

recommendations would have a major bearing on devolution of Central Taxes to the State

for a five-year period beginning April 1, 2015. The five-member committee is to submit its

report by October 31, 2014. The State has been pressing in the past that a balanced

approach to inter se allocations amongst States should be adopted by the Finance

Commission. This would require almost equal weights for equity and efficiency

considerations. While need factors like population, area and HDI address the equity aspect,

equal consideration needs to be given for efficiency imperatives like tax effort and fiscal

discipline. Also looking at the wide ranging terms of reference of the Committee like pricing

of public utilities such as electricity and water in an independent manner, subsidies, GST

compensation etc, significant changes could also be expected in the fiscal consolidation

framework.

i) Efficient Management of Public Expenditure

27. Dr Rangarajans Committee on Efficient Management of Public Expenditure has given

excellent recommendations to reorient management of the public expenditure for

improving the development outcomes. The Union Government has been requested to take

up definite measures for implementation of the recommendation regarding accountability

of the public expenditure through a more granular and transparent system of government

accounts. Also as recommended by the Committee on Restructuring the Centrally Sponsored

and Central Sector Schemes headed by Sri. B.K Chaturvedi, the procedure for transfer of

funds to the States should be reformed to ensure full accountability of States. Currently fund

transfers are taking place directly at District level or to other independent bodies or societies

making it difficult for the States to monitor utilization of funds. For better accountability, all

transfers by Government of India should be routed through State Governments and not

directly to the independent societies at the State or District level.

j) New Commitments

28. While managing the fiscal stress on account of unfunded liabilities built up over the years,

adequate resources have to be provided for the new announcements of the new

Government in place. Additional resources would be earmarked for enhancement in subsidy

14

to be provided by State for supply of rice at Rs.1 per kg, enhancement of incentive to milk

producers from Rs.2 to Rs.4 per litre benefiting 45 lakh farmers, enhancement in housing

subsidy from Rs.75,000 to Rs.1.2 lakhs per unit and for one time waiver of overdue loans

availed by disadvantaged sections from Corporations of Social Welfare Department

amounting to Rs.1314 crore and benefiting 7.6 lakh borrowers. The allocations in new and

revised budget for FY13-14 would ensure that these commitments are fully met and hence

would not be carried over as liabilities for future years and not add to the extant fiscal stress.

15

Chapter 2

Macro Economic Outlook

a) Karnatakas Gross State Domestic Product (GSDP) and Forecast

29. The growth prospects of the State economy are closely intertwined with that of the national

economy, which are influenced mainly by the performance of the three sectors of

agriculture, industry and services. As noted earlier, this year the embedded risks from global

economic uncertainty and slowdown in the pace of national economic growth, pose a major

challenge to macro policy making and micro operations.

30. The Advance Estimates of Karnatakas GSDP released by the Directorate of Economics and

Statistics (DES) indicates a drop in the nominal growth rate of Karnataka in 2012-13 as

compared to 2011-12. The GSDP growth rate (at current prices) in the year 2012-13 over

that of 2011-12 is estimated to be 13.9 per cent as compared to 14.0 per cent in the

previous year.

31. Table4 shows trends in sector wise contribution to GSDP and sector wise composition of

GSDP along with growth rates at current prices. As has been the trend, Tertiary Sector

constituting almost 59 per cent of GSDP continues to drive economic growth of the State.

However the year on year (y-o-y) growth in Services sector has been slower in FY12-13 at

17.7 per cent as compared to 18.8 per cent in the previous year. As compared to this, both

the agricultural sector and industrial sector growth have shown higher y-o-y growth.

However the increase in the agricultural sector has to be seen in the light of a large drop in

growth rate in this sector in 2011-12 over 2010-11.

16

Table - 4 Trends in Sector wise Composition of GSDP (Current Prices)

(Rs. in Crore)

Industry 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Q.E 2012-13

A.E

Primary 42322 51478 54617 59282 76866 78357 84625

Secondary 69765 80733 91859 93579 107850 121488 132897

Tertiary 115150 138417 163836 184655 221754 263397 309971

Total GSDP 227237 270629 310312 337516 406470 463243 527492

Percentage share of different sectors

Primary 18.62 19.02 17.60 17.56 18.9 16.9 16.0

Secondary 30.70 29.83 29.60 27.73 26.5 26.2 25.2

Tertiary 50.67 51.15 52.80 54.71 54.6 56.9 58.8

Total 100 100 100 100 100.0 100.0 100.0

GSDP Annual Growth of different sectors

Agriculture 2.8 17.1 6.8 11.0 26.7 7.9 8.2

Industry 25.3 18.4 12.9 1.0 17.6 8.4 9.2

Services 15.7 20.2 18.4 12.7 20.1 18.8 17.7

Total 16.0 19.1 14.7 8.8 20.4 14.0 13.9

QE: Quick Estimate, AE: Advance Estimate

32. Table-5 shows sector wise trends in GSDP at Constant Prices. The real GSDP growth rate has

recorded only a moderate increase from 5.5 per cent in FY11-12 to 5.9 per cent in FY12-13.

The real growth over the previous year has been at the same level of 2.4 per cent for the

industrial sector. After recording a negative growth in FY11-12, agricultural sector has seen a

moderate increase in its growth rate and achieved 1.8 per cent growth in the current year.

However the growth in the largest contributor to GSDP i.e. the services sector has actually

slipped to 8.9 per cent from 9.5 per cent last year. This could be attributed to the global

slowdown in economy leading to lower demand. Lower growth of agriculture sector

combined with near same growth in industrial sector and decline in services sector growth

has effectively pulled down the overall GSDP growth rate to below 6 per cent during

FY12-13.

17

Table -5

(` in Crore)

Trends in Sector wise GSDP (Constant Prices 2004-05 Series)

Industry 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

Q.E 2012-13

A.E

Primary Sector 35287 40244 40995 42285 46613 44451 45258

Secondary Sector 62066 68170 71917 71094 77225 80331 82243

Tertiary Sector 105307 119788 131509 134183 147647 161628 175943

Total 202660 228202 244421 247562 271485 286410 303444

Percentage share of different sectors

Primary Sector 17.41 17.64 16.77 17.08 17.2 15.5 14.9

Secondary Sector 30.63 29.87 29.42 28.72 28.4 28.0 27.1

Tertiary Sector 51.96 52.49 53.80 54.20 54.4 56.4 58.0

Total 100 100 100 100 100.0 100.0 100.0

GSDP Annual Growth of different sectors

Agriculture -2.8 12.4 2.3 4.1 11.0 -2.2 1.8

Industry 17.0 10.8 5.1 -1.5 8.3 2.4 2.4

Services 10.5 13.8 9.8 2.0 10.0 9.5 8.9

Total 10.0 12.6 7.1 1.3 9.7 5.5 5.9

QE: Quick Estimate, AE: Advance Estimate

b) Growth Prospects and the Road Ahead

33. The State is at cross roads where the twin challenges of fiscal consolidation and adequate

investment in core sectors are both equally important. Inclusive growth is an outcome of

focussed policy initiatives which target the priority sectors with large potential for creation

of opportunities, both social and economic. However the immediate challenge for the State

is to find steady source of revenues to provide for enhanced outlays in essential socio-

economic sectors. The KFRA limitations make it imperative that unfunded and partially

funded commitments are reviewed and yet to start and less productive spending

programmes are rolled back. Else the fiscal position of the State will continue to be in stress

leaving little scope for new development initiatives to be taken up and thereby stifle future

growth prospects.

18

34. It is also necessary to find ways and means to accommodate absolutely essential

commitments within budgetary outlays. State would also have to provide for extensively on

growth enhancing capital projects by utilising the fiscal space available to borrow.

35. The proposed migration to GST regime which would bring in opportunities on one hand for

uniform and seamless market for goods and services across the country, would also pose

restrictions on the governments ability to influence its fiscal policy stance and on the

flexibility in enhancement of additional resource mobilization.

36. From its initial estimate of 9 per cent growth, the Planning Commission has fixed a growth

target of 8.2 per cent for 12th FYP period with higher growth being back loaded i.e. 9 per

cent for last two years of the Plan period. In this, agriculture growth is targeted at 4 per cent

during Plan period. If the State has to achieve this, then it needs to emphasize more on

methods to revive the sector from the low growth cycle it is faced with. This is a fairly

ambitious target when national GDP growth projections for FY13-14 are itself realistically

around 6.5 per cent. Overall the Commission has approved total plan outlay of Rs.255250

crore at current prices for Karnataka over the 12th FYP period. With such a large plan

allocation, the challenge for the State would be to moderate its non plan commitments in

the medium to long term so as to make resources available to finance Plan Size of the State.

Also State is in the process of finalising and sending the inter-sectoral allocation of plan

funds for 12th FYP period to Planning Commission for consideration.

37. During the last few years the government has taken major policy decisions to encourage

private investment and productivity for triggering growth in priority sectors of agriculture

and industry. The allocation in the Agriculture sector is being enhanced to primarily focus

and re-direct investment in this sector. The effects of such policy interventions have to some

extent helped reverse the negative trend in real growth of (-) 2.2 per cent seen in FY11-12 to

a positive 1.8 per cent in FY12-13 in the agricultural sector. Hence in the medium to long

term, the growth outlook seems stable. Policy focus on inclusive and sustainable growth,

particularly in addressing the sources of imbalances between regions, between rural and

urban economies, the gender differentials and the quality of governance at sub-national

level are going to drive the economic performance.

19

Chapter 3

Evaluation of Fiscal Performance

a) Fiscal Consolidation Roadmap and Status: 38. The State Government has been on the path of Fiscal Consolidation ever since the passing of

Fiscal Responsibility Legislations (FRLs) like Karnataka Fiscal Responsibility Act (KFRA), 2002

and Karnataka Ceiling on Government Guarantee Act (KCGGA), 1999. It is to the States

credit that such FRLs were brought in much before Government of India had enacted the

Fiscal Responsibility and Budget Management Act (FRBM) 2003. Therefore State has chosen

on its own volition to bring in fiscal discipline in the management of its finances.

39. Based on the Thirteenth Finance Commissions recommendations for following a time bound

fiscal road map, the State Government vide KFR (Amendment) Act, 2011 has incorporated

statutory year-wise ceilings for key fiscal and debt indicators like Fiscal Deficit, Revenue

Deficit and Outstanding Debt as percentage of GSDP for the years leading up to 2014-15.

This was necessary not only to instil fiscal discipline but also to comply with Government of

Indias directions. Necessary amendments indicating ceilings for key fiscal and debt

parameters to the States FRLs were made as a condition-precedent for release of state

specific grants and debt relief measures in future. The States were expected to maintain the

fiscal targets within such new statutory ceilings.

40. The particulars of the key fiscal and debt norms to be followed and the compliance by the

State are shown below in Table 6:

Table - 6 Particulars Statutory norm Compliance by State

Revenue Deficit (RD) Reduce RD to Nil by 31st March, 2006 Achieved in FY04-05 itself. Maintained adequate Revenue Surplus thereafter.

Fiscal Deficit (FD) Reduce FD to not more than 3 per cent of estimated GSDP by 31st March, 2006.

Maintained FD below 3% since FY04-05*

Total Liabilities to GSDP (TL/GSDP)

To ensure that TL/GSDP does not exceed 25.2% of GSDP by 31st March, 2015.

Already achieved this in FY10-11 much ahead of timeline prescribed.

Outstanding Guarantees (OG)

OG on 1st April of any year should not exceed 80% of Revenue Receipts of second preceding year.

Since enactment of Karnataka Guarantee of Ceiling Act, 1999 this limit has never been breached.

*Except in the FY 2008-11 where it was fixed based on the advice of the Central Government.

Adherence to fiscal prudence during challenging economic environment

41. As seen at Table 6 the State is well on track with respect to the Fiscal Consolidation

roadmap. It has consistently recorded Revenue Surpluses since 2004-05. It was only in the

years 2008-09 and 2009-10, based on the advice of the Central Government, the Fiscal

20

Deficit limit of 3 per cent was enhanced to 3.5 per cent of GSDP in 2008-09 and to 4 per cent

of GSDP in 2009-10 to give a fillip to the public spending to tide over the prevailing economic

slowdown. Further, for the year 2010-11, recognising the difficulties faced by the State

Government in compressing the fiscal deficit by 1 per cent (to 3 per cent of GSDP) in one

year itself, the Government of India had advised the State Government to comply with the

fiscal responsibility norms over a two year period. As a result, for the year 2010-11, the

State Government had been advised to incur a fiscal deficit of up to 3.44 per cent and only

from the FY11-12 onwards would Fiscal Deficit be maintained below 3 per cent as per the

KFRA.

42. However inspite of the fact that the Government of India had allowed the states to have

higher fiscal deficit and incur revenue deficit in those difficult years, the State reined in its

Fiscal deficit to below 3 per cent in FY10-11 itself and managed to maintain a Revenue

Surplus throughout the years 2008-11 thereby utilizing the increased borrowing space

entirely towards capital expenditure only.

b) Other Institutional Reforms under KFRA

43. KFRA was amended in the year 2011 to bring in more transparency in management of

governments finances and liabilities. The newly introduced Section 5(2)(c) of KFRA now

mandates the State Government amongst others to make specific disclosures on tax

expenditure / revenue foregone during the year, compliance costs of major State taxes,

revenue consequences of capital expenditure, future expenditure commitments on account

of major policy decisions during the year and explicit and implicit liabilities in PPPs. State

Government has been providing this information in successive MTFPs presented before the

State Legislature. All these statements appear as Annexures to this document.

44. The other important requirement under the amended KFRA was to constitute a Fiscal

Management Review Committee (FMRC) headed by the Chief Secretary. This committee has

been set up with a mandate to review the fiscal and debt position of the State and the

States progress on the fiscal correction path and thereafter advice on the corrective

measures as may be required. As seen in Chapter 1, FMRC has given various

recommendations which are aimed at increasing the capital expenditure, minimizing lower

priority revenue expenditure, increasing non-tax revenue, ensuring fiscal sustainability and

pursuing prudent planning and appraisal mechanisms to improve outcomes.

21

45. With a view to bring in transparency and de-mystification of States financial position, State

is also placing its statement of receipts and expenditure on a quarterly basis on its website at

kar.nic.in/finance. The statement would enable public at large to assess the financial

performance of the State and note the compliance of State with regard to fiscal and debt

indicators as prescribed in KFRA.

c) Fiscal performance of the State in FY12-13 vis--vis 2011-12

46. Table 7 shows the States fiscal performance for Financial Year 2012-13 vis-a-vis the targets

set then and the likely performance of the FY 12-13 (R.E) vis--vis the budgeted target.

Table - 7 Fiscal performance for previous year (Rs.in Crore)

2011-12 2012-13

Particulars B.E Accounts B.E R.E Revenue Surplus 1279 3144 931 943

Fiscal Deficit as percentage of GSDP

2.87% 2.92% 2.94% 2.93%

Total Liabilities to GSDP 24.05% 23.62% 22.66% 22.59% Outstanding Guarantees as percentage of revenue receipts of second preceding year

18.72% 13.51% 16.32% 16.32%

47. The performance on key fiscal and debt parameters of Revenue Surplus, Fiscal Deficit and

Total Liabilities as a percentage of GSDP in RE 12-13 is in compliance to statutory ceilings

prescribed in KFRA. The State would continue to maintain a Revenue Surplus, albeit small

quantum, at a level slightly higher than budgeted estimate, thereby ensuring that entire

current expenditure of the State was being met only from Revenue Receipts and the

Revenue Surplus and Capital Receipts were employed purely for capital expenditure.

Revised estimate of Fiscal Deficit as a percentage of GSDP is also expected to be kept within

the BE limit of 2.94 per cent.

48. On the debt management side, the 13th Finance Commission had laid down the road map

for reducing the debt to GSDP ratio for Karnataka to 25.2 percent by the year 2014-15. The

year-wise ceiling of debt to GSDP ratio to be adhered to for FY 12-13 being 25.7 per cent.

The actual debt to GSDP ratio is proposed to be kept within this at 22.66 per cent in BE12-

13. This is being maintained in RE12-13 too by maintaining this ratio at 22.59 per cent.

Hence the State is ahead of the road map suggested by the 13th Finance Commission and

22

has met the norms with regard to debt management before the prescribed time line.

However in absolute numbers, the total liabilities have crossed the figure of Rs.1 lakh crore.

Hence borrowings in future would have to be need based only and spent on capital

formation.

d) Performance of receipts, expenditures and fiscal indicators (FY09-10 to FY 12-13)

49. Rule 4 of The Karnataka Fiscal Responsibility Rules prescribe the form and contents of the

MTFP. As per Rule 4(e), analysis of various fiscal parameters are to be provided for the year

before the previous year (accounts), the previous year (budget estimates and accounts) and

the current year (budget estimates and revised estimates), the next year (budget estimates)

and a projection for three subsequent years. Table B and Chapter 7 contain these analysis.

However for descriptive analysis of trends in various receipts, expenditure and other fiscal

indicators, revised estimates of current year and three previous year accounts data are used

in this chapter.

Revenue Receipts:

50. Revenue Receipts consists of four major components viz. Own tax revenues, non tax

revenues, Devolution from GOI and GIA & Contributions. A major source of Revenue receipts

has been the States Own Tax Revenue (SOTR) which constitutes almost 64 per cent of total

revenue receipts in Budget estimate 2012-13. Including the own non tax revenue, this share

increases to more than 67 per cent of revenue receipts. Thus the State substantially relies

more on its own resources rather than on devolution of central taxes or grants from Centre.

Revenue receipts on the whole are expected to increase by Rs.3423 crore over the budget

estimate for FY12-13. Due to the moderation of the growth in Central taxes, the devolution

of Central taxes in the current year may fall short of the budgeted estimate of Rs.13094

crore.

State Own Tax Revenues (SOTR):

51. SOTR comprises of the four major taxes of the State and all other taxes levied by the State.

Commercial taxes constitute the major part of own tax revenues i.e. about 60 per cent. SOTR

was estimated at Rs.51821 crore in budget estimate 12-13 which was 10 per cent more than

the actuals in 2011-12. The overall tax revenue is expected to exceed budget estimate.

23

Non Tax Revenue:

52. The major single source of non tax revenues are receipts from mining and forest

development tax. However the entire forest development tax receipts are a pass through in

the State Budget since these are transferred to Forest Development Fund maintained in the

Public Account and the same is utilized thereafter for schemes of Forest Department. Mining

receipts are basically royalty on major and minor minerals. These receipts have been a

steady source of income to the State. Since the mining receipts were conservatively

estimated at Rs.1500 crore in FY12-13, it is expected to meet this target. The other sources

of non tax revenues include interest receipts and dividends. Non Tax Revenues have not

been growing at the anticipated rate and have been identified as one area which requires

significant thrust. While the BE 11-12 target could be achieved, it was largely due to interest

receipts on account of investment in GOI treasury bills. The FMRCs advice on taking

concerted action in improving non tax revenues needs to be acted upon early.

24

Non Debt Capital Receipts (NDCR):

53. NDCR includes largely sale of assets and recoveries of loans and advances. In recent past,

State has been unable to realise the monetary potential out of the land available with it.

Also due to sluggish real estate market and various administrative hurdles, no additional

revenue from such land sale has been possible during 2012-13. Keeping this aspect in mind,

the estimate under this head for FY13-14 has been estimated conservatively.

Expenditure pattern:

54. Public expenditure indicates the quantum of government spending on social and physical

infrastructure for the development of the State. The basic broad categorization of public

expenditure is into plan and non-plan. Chart below indicates the growth of Plan and Non

Plan expenditure over the years. While the Non Plan expenditure quantum is much more

than the Plan Expenditure, the Plan expenditure of the State has also steadily increased.

Following chart shows the plan non plan expenditure comparison over the last four years.

55. While Non Plan expenditure in RE 12-13 has grown at a rate 21 per cent over the 2011-12

accounts, during the same period the Plan expenditure too has increased by over 21 per

cent. Thrust has been given to further improve the Plan expenditure while curbing the non

essential non plan expenditure. Also as detailed later in the MTFP, a large part of non plan

expenditure of State consists of development expenditure. Development expenditure is that

expenditure which is primarily spent on Social and Economic Services. The Government

25

strategy is to effectively control non-essential non developmental expenditure so as to

enhance resource allocation for development activities in various sectors.

Fiscal Indicators:

56. The two primary fiscal indicators that are carefully monitored and kept within the limits

specified in KFRA are the Revenue Balance and Fiscal Balance. The excess of revenue

receipts over revenue expenditure is available as revenue surplus to finance capital

expenditure. KFRA mandates that State should maintain adequate Revenue Surplus. State

has continuously maintained Revenue Surplus ever since 2004-05 ensuring that entire

borrowings and revenue surplus are made available for capital expenditure only and not for

meeting current expenditure. However of late, there has been an area of concern. Revenue

Surplus relative to GSDP has reduced from 1.8 per cent in 2006-07 to around 0.5 - 1 per cent

in recent time. The drop in revenue surplus has significant impact on financing of capital

expenditure which would now depend on additional borrowings.

57. Fiscal Deficit is the gap between the total expenditure and total non debt receipts of the

State. This financing gap is met out of budgetary borrowings and out of Public Account.

Deficit financing is one of the well acknowledged ways of financing the gap between

available receipts and anticipated expenditure. Prior to 2004-05, State used to have large

fiscal deficits and used to borrow to finance current expenditure too. Due to Fiscal

Consolidation, since 2004-05 State has maintained Fiscal Deficit within 3 per cent of GSDP,

which is the Finance Commission recommended norm.

58. State has strictly adhered to Fiscal Deficit (FD) ceiling prescribed by the 13th Finance

Commission in its Fiscal Consolidation Roadmap for Karnataka. Hence the statutory ceiling of

FD of 3 per cent of GSDP was maintained except during the years FY08-11, when special

permission was given by GOI to increase the fiscal space and borrow more to provide a fillip

to the slowing economy. As seen from the table 8 and following graph, Fiscal Deficit as a

percentage of GSDP limit has not been breached during the last three years. As against the

FD limit of 2.94 per cent fixed for BE12-13, it is expected to maintain FD as a percentage of

GSDP to within this limit.

26

Table 8

Fiscal Deficit Trends (in Percent)

Fiscal Deficit 2009-10 2010-11 2011-12 2012-13 RE KFRA Ceiling 4.00% 3.44% 3.00% 3.00% Achievement 3.24% 2.81% 2.83% 2.93%

Debt Sustainability Indicators:

59. The two primary indicators that the State Government adopts to monitor its debt stability

and sustainability are the ratios of Interest Payments to Revenue Receipts (IP/RR) and Total

Liabilities to GSDP (TL/GSDP). Both these indicators are prescribed by the 13th Finance

Commission for evaluation of debt sustainability of the State.

Interest Payments to Revenue Receipts (IP/RR):

60. Due to fiscal consolidation as well as revenue mobilisation, the Interest to Revenue Receipts

ratio has declined over the last decade to around 8 to 8.5 per cent in recent times. 13th

Finance Commission has mandated that the IP : RR ratio is kept within 15 per cent. As seen

below, due to buoyancy in revenue receipts, State has ensured that Interest Payments are

27

kept well within this ratio. Since 2009-10, this limit has not been in excess of 11 per cent. In

2012-13 it is expected to further reduce and maintain this ratio at around 8.1 per cent in

revised estimate. Reduced requirement for debt servicing ensures more resources for

investment in development programmes.

Total Liabilities to GSDP:

61. The total liabilities of the State are an important indicator of the debt position of the State.

In absolute numbers, the Total Liabilities of the State has more than doubled in the last

decade and has exceeded Rs.1 lakh crore. However as a ratio of the GSDP it is 25.5 per cent

(RE12-13), within the 13th Finance Commission norm of 25 per cent to be achieved by 2014-

15. The State includes liabilities under Off-budget borrowings under the definition of Total

Liabilities.

62. Based on the 13th Finance Commission recommendations, the Karnataka Fiscal Responsibility

(Amendment) Act, 2011 has amended Section 4 of KFRA to incorporate ceiling for

Outstanding Debt (or Total Liabilities) as seen at table 9.

28

Table 9

KFRA Ceiling on Total Liabilities

Year 2011-12 2012-13 2013-14 2014-15

OD/GSDP (%) Ceiling as provided under

KFRA

26.0 25.7 25.4 25.2

63. The above ceilings have been strictly adhered to by the State. The fresh borrowings in any

year are opted for keeping in mind the above ceilings. In view of this, State has been

ensuring that Total Liabilities are kept within the limits as seen from the following graph. In

view of the already high quantum of Total Liabilities in absolute numbers, State would have

to exercise caution and prudence on its borrowing strategy in the coming years and thereby

limit such borrowings to be requirement basis only.

64. As required under KFRA, the Fiscal Performance in the previous four financial years vis--vis

the Budget Estimates (in Absolute terms and as a percentage of GSDP) is presented in the

following Table A.

29

Table - A Fiscal Performance 2009-10 to 2012-13 (` in Crore)

Particulars 2009-10 BE 2009-10

A/c 2010-11

BE 2010-11

A/c 2011-12

BE 2011-12

A/c 2012-13

BE 2012-13

RE

1 Revenue Receipts 48389 49156 53638 58206 66313 69806 81461 84884

of which

(i) State Own Tax Revenues 32721 30579 36228 38473 43817 46476 51821 53492 (ii) Non Tax Revenues 2130 3334 2820 3358 3675 4087 3193 3796

(iii) Resources from the centre

of which

- Devolution 7645 7360 9060 9506 10419 11075 13094 12500 - Grants 5893 7883 5530 6869 8402 8168 13354 15095

2 Revenue Expenditure 47238 47537 53138 54034 65034 65115 80530 83941

of which

(i) Interest 5578 5213 6316 5641 6950 6062 7500 6852 (ii) Salaries 11305 10396 12577 11086 13854 11870 18299 17120 (iii) Pensions 4001 3408 4500 4070 5500 5436 6980 7500

(iv) Subsidies(Food, Transport 1704 1806 1723 1885 1956 2120 2484 4029

Housing, Industry & Others)

(v) Power Subsidy 2402 2341 2826 4442 4301 5303 5100 6350 (vi) Devolution to ULBs 2720 2474 2885 2978 4343 4344 5237 5011

(vii) O & M

of which

- Major O&M (Roads, Buildings & Irrigation) 763 676 676 712 700 681 556 581

- Other O&M (Edn,Health, RD,WS,Agr, Forest) 7805 8088 9989 5818 7534 7292 10621 10715

(viii) Administrative Expenditure 828 892 908 914 1010 1011 1251 1331

(ix) Other Revenue Expenditure 10132 12243 10738 16488 18886 20996 22502 24452

3 Revenue Surplus 1151 1619 500 4172 1279 4691 931 943

4 Capital Receipt (Non Debt) 1977 625 2903 233 2062 330 299 257

5 Capital Expenditure 11622 13118 13112 15093 15822 17321 16542 16439

6 Fiscal Deficit 8493 10874 9708 10688 12482 12300 15312 15239 7 Outstanding Debt 77797 83482 89607 91943 101196 103030 114745 114401 8 Debt Services 7782 7521 8779 8448 10062 9382 11170 10496 9 Off Budget Borrowings 2589 3249 3249 3249 3249 3249 3249 3249

10 Guarantee Stock 7203 7203 8200 6618 9200 6640 9500 9500 11 Total Liabilites 80386 86731 92856 95192 104445 106279 117994 117650 12 GSDP at current prices 294952 335747 328312 380871 434270 434270 520766 520766 13 Annual Inflation 4% 4% 5% 5% 6% 5.0% 6.5% 8% 14 GSDP Real Growth Rate 6% 6% 8% 8% 8% 8.0% 7.5% 6%

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Table - A Fiscal Performance 2009-10 to 2012-13 ( in percentage)

Particulars 2009-10 BE

2009-10 A/c

2010-11 BE

2010-11 A/c

2011-12 BE

2011-12 A/c

2012-13 BE

2012-13 RE

ALL THE ITEMS AS PERCENTAGE OF GSDP 1 Revenue Receipts 16.41 14.64 16.34 15.28 15.27 16.07 15.64 16.30

of which (i) State Own Tax Revenues 11.09 9.11 11.03 10.10 10.09 10.70 9.95 10.27 (ii) Non Tax Revenues 0.72 0.99 0.86 0.88 0.85 0.94 0.61 0.73 (iii) Resources from the centre of which - Devolution 2.59 2.19 2.76 2.50 2.40 2.55 2.51 2.40 - Grants 2.00 2.35 1.68 1.80 1.93 1.88 2.56 2.90

2 Revenue Expenditure 16.02 14.16 16.19 14.19 14.98 14.99 15.46 16.12 of which (i) Interest 1.89 1.55 1.92 1.48 1.60 1.40 1.44 1.32 (ii) Salaries 3.83 3.10 3.83 2.91 3.19 2.73 3.51 3.29 (iii) Pensions 1.36 1.02 1.37 1.07 1.27 1.25 1.34 1.44 (iv) Subsidies(Food, Transport 0.58 0.54 0.52 0.49 0.45 0.49 0.48 0.77

Housing,Industry & Others)

(v) Power Subsidy 0.81 0.70 0.86 1.17 0.99 1.22 0.98 1.22 (vi) Devolution to ULBs 0.92 0.74 0.88 0.78 1.00 1.00 1.01 0.96 (vii) O & M of which

- Major O&M (Roads, Buildings & Irrigation) 0.26 0.20 0.21 0.19 0.16 0.16 0.11 0.11

- Other O&M (Edn,Health, RD,WS,Agr, Forest) 2.65 2.41 3.04 1.53 1.73 1.68 2.04 2.06

(viii) Administrative Expenditure 0.28 0.27 0.28 0.24 0.23 0.23 0.24 0.26

(ix) Other Revenue Expenditure 3.44 3.65 3.27 4.33 4.35 4.83 4.32 4.70

3 Revenue Surplus 0.39 0.48 0.15 1.10 0.29 1.08 0.18 0.18 4 Capital Receipt (Non Debt) 0.67 0.19 0.88 0.06 0.47 0.08 0.06 0.05 5 Capital Expenditure 3.94 3.91 3.99 3.96 3.64 3.99 3.18 3.16 6 Fiscal Deficit 2.88 3.24 2.96 2.81 2.87 2.83 2.94 2.93 7 Outstanding Debt 26.38 24.86 27.29 24.14 23.30 23.72 22.03 21.97 8 Debt Services 2.64 2.24 2.67 2.22 2.32 2.16 2.14 2.02 9 Off Budget Borrowings 0.88 0.97 0.99 0.85 0.75 0.75 0.62 0.62

10 Guarantee Stock 2.44 2.15 2.50 1.74 2.12 1.53 1.82 1.82 11 Total Liabilites 27.25 25.83 28.28 24.99 24.05 24.47 22.66 22.59

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Chapter 4

Revenue Performance & Reforms

a) Tax Policy and Strategy:

65. The taxation policy of the State continuously aims at streamlining the tax structure and

administration for better tax compliance with least effort. In these times of economic

slowdown, taxation policy become all the more important not purely as a tool for revenue

generation but also as a medium and long term measure to propel the economy back to a

high growth trajectory.

66. In recent times the State has been trying to simplify and rationalize its tax structure along

with simplification of process of filing tax returns to ensure effective mobilization of

resources. The reforms carried out in the tax departments like E-payment of taxes in

Commercial Tax Department and Anywhere registration in Stamps & Registration

Department have benefitted the tax payer at large.

67. MTFP 12-16 onwards State has been disclosing the compliance costs associated with

different types of taxes it imposes. While Government spends money on tax collection

activities, some of the costs like filling out forms, keeping records and other such tax related

chores are borne by individual or entity paying the tax. These are collectively called costs of

compliance i.e. the cost incurred by the tax payer in complying with the tax payment

process. More complex tax systems tend to have higher compliance costs and as a corollary,

lower compliance cost is an indication of tax simplification.

68. Taxation reforms in 2013-14 would continue to strive for improving tax compliance and

increasing tax base. MTFP 13-17 continues to disclose the compliance cost of four major

taxes of State Government from the tax payers perspective.

b) Tax Effort:

69. Karnataka has over the years consistently achieved the highest own tax revenue to GSDP

ratio (tax effort) amongst all other States. The graph below highlights the effort in the last

four years.

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70. Tax Effort during FY 2008 to 2010 declined slightly due to the global economic crisis. Tax

effort of Government of India too was affected during this period. During the period 2004-05

to 2009-10, when the CAGR of GSDP was 15.1 per cent, the CAGR of States own tax revenue

was only 13.7 percent. Thereafter, however, the economy rebounded to the high growth

path in the latter half of 2009-10. As seen above from 2010-11 onwards the tax effort has

increased to above 10 per cent. The enhanced tax receipts are attributed to the factors like

different tax rates, widening tax base and institutional efficiency in collection all of which

improves tax compliance.

71. Though the State taxes have largely remained unaffected from the overall global economic

slowdown, there could be some moderation in tax effort in the coming years due to base

effect. Any more substantial increase in the tax growth cannot be expected in the near

future due to the tough economic climate. The challenge for the State would be to ensure

maintaining a high tax effort in future to garner adequate resources to meet expenditure

requirements of critical sectors through the 12th FYP period.

72. The composition of major taxes as a percentage of GSDP since 2008-09 is shown in the

graphs below.

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73. With the economy gaining steady momentum slowly from 2009-10 onwards, commercial

taxes and motor vehicle taxes have exceeded their pre-economic slowdown share and stand

at 6.1 percent and 0.7 percent respectively. Stamps and registration revenues which used to

comprise 1.4 per cent of GSDP in 2006-07 is at 1 per cent in 2011-12 RE. This is largely due to

the weak sentiments in the real estate market and the reduction of stamp duty to 5 per cent

under JnNURM reforms. Hence there is further scope to improve the tax collection here.

Growth in share of taxes in GSDP has been good in Excise as this has continuously increased

from 1.8 per cent in 2008-09 to over 2.2 per cent of GSDP in 2012-13 RE. It is estimated that

revenues should go up on account of upward correction of guidance values during 2013.

74. With incipient signs of slow easing of inflation in the coming days, it is expected that

investment activity too would ideally pick up slowly and steadily. The annual growth rates

and buoyancy of these taxes, individually for a 7 year period have been shown in the table

below. Tax buoyancy is a measure of the responsiveness of tax receipts to economic growth

or GSDP growth. A tax which is buoyant is one whose revenues increase by more than one

percent for a one percent increase in national income or GSDP. Buoyancy however reflects

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both discretionary changes in the tax rates and the normal revenue growth. Table 10 lists

out the buoyancy of State taxes.

Table - 10 Buoyancy in States Own Taxes (Rs. in Crore)

Commercial Tax Excise Duty Year Actuals Growth Rate Buoyancy Actuals Growth Rate Buoyancy

2006-07 13714 19% 1.2 4495 32% 2.0 2007-08 15552 13% 0.7 4767 6% 0.3 2008-09 16645 7% 0.6 5750 21% 1.8 2009-10 17960 8% 0.7 6946 21% 1.9 2010-11 23266 30% 2.2 8285 19% 1.4 2011-12 28000 20% 1.5 9775 18% 1.3

2012-13 RE 32000 14% 3.0 11300 16% 3.3 CAGR 15.17% 1.16* 16.60% 1.18*

Motor Vehicle Tax Stamps & Registration Duty

Year Actuals Growth Rate Buoyancy Actuals Growth Rate Buoyancy 2006-07 1374 24% 1.5 3206 45% 2.7

2007-08 1650 20% 1.1 3409 6% 0.3

2008-09 1681 2% 0.2 2927 -14% -1.2

2009-10 1962 17% 1.5 2628 -10% -0.9 2010-11 2550 30% 2.2 3531 34% 2.6 2011-12 2957 16% 1.1 4623 31% 2.2

2012-13 RE 3500 18% 3.9 5300 15% 3.1 CAGR 16.86% 1.17* 8.74% 1.09*

* Buoyancy over 7 year period is based on Logarithmic Regression

c) Performance of Major Own Taxes:

i. Commercial Taxes

75. The last decade has seen landmark taxation reform of introduction of Value Added Tax with

effect from 1.4.2005 replacing the Sales Tax. VAT is applicable to all commodities except

petrol, Aviation Turbine Fuel, diesel and sugarcane on which the earlier Karnataka Sales Tax

Act is still applicable. State has made smooth transition from Sales Tax to VAT.

76. Commercial Taxes constitute more than 60 per cent of the States own tax revenues. Being a

major contributor to the SOTR, collections here have a bearing over the overall resources

available. For the FY12-13, BE 12-13 of Commercial Taxes is Rs.31100 crore. In order to meet

35

a part of the expenditure on account of cooperative crop loan waiver, VAT was increased by

0.5 per cent for one year i.e. from 01.08.2012 to 31.07.2013. During the year, the quarterly

collections and quarterly growth over corresponding period in previous year for Commercial

taxes is as shown in Table 11.

77. During the first quarter of FY 2012-13, the commercial taxes grew at the rate of almost 27

per cent and thereafter moderated to around 14 per cent in the second quarter. By the third

quarter, the growth had slowed down to 11 per cent. A part of the decline in quarterly

growth rate of taxes could be attributed to slowdown in general economic activity.

78. However despite the slowdown in growth of taxes, the budget estimate would have been

met. The good growth in tax revenue over the last few years is primarily attributable to the

positive response of the tax payers to the extensive computerization programme embarked

upon by the Commercial Taxes Department. All the dealers are now filing returns online and

more than 80% of the revenue is coming through the electronic mode. A large number of

services are being provided electronically at the doorsteps of the tax payer. As a result the

tax compliance is much better.

Goods and Services Tax (GST) Issues

79. The State is at the threshold of transition to Goods and Services Tax (GST). GST would enable

the State to tax even services while Centre can tax trade within the State. Like Value Added

Tax, there is no cascading of taxes at any stage and tax is only on value addition. Karnataka

being a high consuming State would benefit as GST is a consumption based tax.

State has all along supported introduction of Goods and Services Tax which aims at creation

of a common market in the country, making exports competitive by total removal of

Table - 11

Commercial Tax Trends during FY12-13 (Rs. in Crore)

Taxes Q1 Growth Q2 Growth Q3 Growth Q4 estimate RE

12-13

Overall growth

over previous

year Commercial

Taxes 8011 27% 7434 14% 7796 11% 8759 32000 14%

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domestic indirect taxes and making compliance simpler and easier. At the same time, State

has endeavored to ensure that the fiscal autonomy of the States in mobilizing revenue is not

compromised in the proposed GST scheme. GST regime requires a robust IT system to

ensure that the seamless input tax rebate scheme is not misused especially on inter-State

transactions. Karnataka has developed a fairly sophisticated IT infrastructure which can

operate effectively even under the new tax regime with some modifications and can be

easily integrated with the proposed GST network that would be put in place to administer

GST at State and Central level. The early introduction of this tax reform would be contingent

on early resolution of outstanding issues in the Empowered Committee constituted for GST.

ii. State Excise

80. State Excise revenue has shown a steady increase since 2008-09. It is the second largest

contributor amongst States own tax revenues. The budget estimate for FY12-13 for State

Excise is Rs.10775 crore. The quarterly collections and quarterly growth over corresponding

period in previous year for State Excise is as shown in Table 12.

81. As seen in table 12, there has been a steady growth in excise revenues for each of the three

quarters at around 22 to 23 per cent. The quarterly growth in excise has picked up in the last

two quarters. Going by this trend it is expected that excise revenues would have exceeded

the budget estimate by the end of the 4th quarter.

82. Excise department being a major tax source of revenue for State, the enforcement of excise

law has to be strict to ensure compliance. The department has increased its intensive

patrolling and surveillance on manufacturing and selling units. As a result of these

measures, there is healthy growth in revenue from sale of IMFL. The department proposes

to take up reform measures like Computerisation up to the range level offices, provision of

Table - 12 Excise Trends during FY12-13 (Rs. in Crore)

Taxes Q1 Growth Q2 Growth Q3 Growth Q4 estimate RE

12-13

Overall growth

over previous

year State Excise 3101 23% 2457 22% 2741 22% 3001 11300 16%

37

wireless, GPS sets, fire arms and modern vehicles to the departmental officers for effective

enforcement.

iii. Stamps and Registration:

83. Revenue from Stamps and Registration has been budgeted at Rs.5200 crore in FY12-13.

These receipts have shown less than anticipated quarterly growth as compared to the

previous year. Under the JnNURM reforms, there was a commitment by the State to

decrease stamp duty to 5 per cent. The decreased revenue on account of this move was

expected to be made up by increased compliance in registering documents and also by the

upward revision of guidance values in November 2011. However the impact of higher

registrations translating into better revenues may be seen only in the medium to long term.

The other reason for the slow growth in taxes could be attributed to the still recovering real

estate sector. The Department has proposed another round of upward revision of guidance

values in 2013.

84. During the year, the quarterly collections and quarterly growth over corresponding period in

previous year for Stamps and Registration is as shown below. Since growth rate has been

less this year, it is anticipated that the receipts may almost reach the budget estimates.

Table - 13

Stamps and Registration Fees Trends during FY12-13 (Rs. in Crore)

Taxes Q1 Growth Q2 Growth Q3 Growth Q4 estimate RE

12-13

Overall growth

over previous

year Stamps & Registration Fees

1246 12% 1297 3% 1355 9% 1402 5300 15%

85. The Department has recently introduced the anywhere registration where a citizen can

register his document with any Sub Registrar Office within a district. In the future too,

efforts need to be made to better align the guidance value and the market value of the

properties to increase tax realization. The Department would be provided with better

staffing. A dedicated cell on the lines existing in Maharashtra is proposed to be created

within the Department to advise regularly on guidance value revision. A system of periodic

and automatic revision of guidance values indexed to average market rates is desirable.

38

iv. Motor Vehicle Taxes

86. Budget Estimates for Motor Vehicle Taxes in FY12-13 is estimated at Rs.3350 crore. The rate

of growth of taxes in the first two quarters has been very good. The major share of tax is

collected from cars and two wheelers which constitute more than 75 per cent of the total

strength of motor vehicles in the State. While growth in the 3rd quarter has slowed down a

bit, the overall growth is expected to be around 18 per cent. Commensurate with the growth

of the vehicles, the tax revenue too has grown significantly and it is expected that during

2012-13 the revenue collection would have been more than even the revised estimate

indicated. During the year, the quarterly collections and quarterly growth over

corresponding period in previous year for Motor Vehicles taxes is as shown below

87. Computerization and issue of smart card driving licenses and registration certificate has

been implemented in all RTO/ARTOs offices in the State through PPP model. The Collection

of fees and tax, issue of driving licenses, vehicle registration, issue of permits have all been

computerized. The department is considering the collection of tax and fees also through e-

payment for better compliance of tax payments and transparency.

d) Cess Receipts:

88. A Cess is a tax on tax which is appropriated towards a specific purpose as opposed to tax

which is a general purpose levy. Levy and collection of a cess by the State creates an

obligation on its part to use the cess receipts for the specific purpose for which it is levied.

The two main cesses that the State imposes are:

a. Infrastructure Cess

b. State Urban Transport Cess

89. Infrastructur