Loan as lever

Published : Nov 19, 2004 00:00 IST

For a relatively small loan the Karnataka government has allowed the World Bank to exercise considerable leverage on economic policy and this has had adverse impact on the people.

in Bangalore

THE World Bank-aided economic reform programme in Karnataka, put in place by the S.M. Krishna government soon after taking office in December 1999, received its first performance evaluation in the May 2004 elections, when the Congress lost a substantial block of its electoral base in both the Lok Sabha and the State Assembly elections. It won just 68 seats in the 224-seat Assembly and was forced to form a coalition government with the Janata Dal (Secular). This verdict contained a clear message about economics and the poor. It was the popular rejection of a party that had come to power with a big mandate in the November 1999 elections (132 out of 224 seats) but failed to deliver on the promise that Krishna made when he announced the reform agenda in 2000, namely, "the eradication of poverty through economic growth tempered with equity".

The years between 2000 and 2004 saw the consolidation of Karnataka's reputation as an Information Technology hub and an investment friendly State. These were also years when a comprehensive reform programme was implemented. The reform agenda included much-needed initiatives in providing transparency and efficiency in the government sector. It also had the expansion of primary education as one of its more laudable objectives.

However, its core goal was that of contracting the fiscal deficit, primarily through cutbacks in public expenditure. This meant rolling back subsidies in areas such as the public distribution system, power, transport, irrigation, water supply and support to small-scale industry. Alongside, there also took place a privatisation drive, notably in Karnataka's large and once robust state sector, and also in public utilities such as power and transport.

The World Bank provided a loan of $250 million (roughly Rs.1,300 crores) in two tranches in 2001 and 2002 to support these cross-cutting reforms. The loan instalments were linked to fairly rigid performance milestones. When the Bank, for example, perceived the reform momentum to have slipped in 2003, it withheld the third tranche of the loan, of $200 million (around Rs.900 crores). In its Country Strategy Report 2004 (CAS 2004), the Bank is firm on the necessity of taking such action. "The Bank seems to have done well in sending a consistent signal on the link between adjustment lending and progress in reforms," the Report notes, citing Uttar Pradesh, Andhra Pradesh, Orissa, Tamil Nadu and Karnataka as States where loans/credits were withheld when reforms went "off-track".

The four "activating triggers" of the reform programme, or its core objectives, identified by the World Bank, relate to the areas of: a) fiscal control (withdrawal of subsidies and other public expenditure cutbacks); b) administrative reforms (cutbacks in government employment, reducing pensions and wage structures); c) private sector development (disinvestment of public sector and creating a better environment for private investment); and d) poverty monitoring.

The principal objective of the reform package, namely that of cutting public expenditure, appears to have hit low-income groups in both the agrarian and the urban sectors, with the poor bearing the brunt of the burden of reform. There has been a steep and perceptible increase in agrarian distress between 2000 and 2004 in Karnataka. Debts and crop losses led thousands of farmers to suicide over this period, leaving their families even more impoverished than they had been (see box).

Many of those who committed suicide did so because they were unable to pay the arrears in power costs that were suddenly slapped on them on account of power tariff hikes. The withdrawal of subsidies for agriculture led to a sharp rise in the costs of cultivation. Food subsidies were reduced.

There were escalations in the costs of public services, which hit low-income consumers. User charges were increased for irrigation, transport and water and in public hospitals. There was a collapse of employment in the rural areas, resulting in large-scale migration of agricultural labour and poor peasants to cities.

With the closure/privatisation of the public sector, a little short of two lakh permanent employees were forced to take Voluntary Retirement Scheme (VRS) payments. The majority of them joined the army of the unemployed, as they were too old to be re-employed, or did not have the requisite skills for jobs in other sectors of the economy. Of the contract workers in the state sector who lost employment, there is not even a count.

The previous government often blamed the three-year drought for the agrarian distress, particularly for farmers' suicides. But reforms continued despite the drought, and drought exacerbated the impact of reform-driven government policies.

Through these years, the voluminous documentation on reform and its impact, generated by the State government and its primary external funders for the reform programme, the World Bank, made no reference to the growing distress in rural Karnataka, which sections of the media, independent researchers and some political parties had started taking serious note of. The slogan of poverty mitigation was ever part of the rhetoric of reform but in real fact it appeared as if economic reform and the real lives of the poor had separate trajectories.

In CAS 2004, there is no mention of the agrarian crisis in Karnataka or Andhra Pradesh, States that saw the highest numbers of despairing, poverty-stricken farmers who had lost the will to live commit suicide during the very years that the CAS alludes to. In fact, in respect of the "focus States" (Andhra Pradesh, Uttar Pradesh and Karnataka) the CAS 2004 noted: "In terms of the outcomes achieved with Bank support... the performance of the focus States, in terms of various economic and social indicators, was encouraging. Growth prospects had improved, poverty levels had declined and key social indicators critical to India's attainment of the Millennium Development Goals had either improved or their deterioration has been arrested in all three States."

WHAT has been the impact of economic reforms in Karnataka, and what is the role and stake of the World Bank in the State's reform agenda towards which it has committed just below $1.2 billion to be disbursed in five instalments?

Karnataka approached the World Bank through the Government of India for financial support for its reform programme in 1999. According to Bank documents of mid-2001, Karnataka had performed well in respect of the four "activating triggers" that would make it eligible for the first Karnataka Economic Restructuring Loan (KERL). The Bank already had an ongoing programme in the State of support through technical advice and sectoral lending. Thus, although the Bank was not directly responsible for the State's reform package, its engagement with the State had laid the foundation for such a programme and the direction it should take.

More specifically, the Bank upheld the State's efforts to control the fiscal deficit as steps in the correct direction. By 2000, the State had taken steps to control off-budget borrowing; it had put the brakes on the power sector deficit; and most importantly, from the Bank's perception, it was cutting public expenditure. A Medium Term Fiscal Plan (MTFP) was formulated to guide yearly budgets.

In the area of power reform, the State had enacted the Karnataka Electricity Reform Act (1999), and had introduced a power policy based on future privatisation of distribution. It had also established the Karnataka Electricity Regulatory Commission (KERC) in 2000, which in the same year awarded Karnataka's first power tariff increase since 1998.

The State, the Bank noted, was keen to control the government wage bill (which had increased substantially owing to the Fifth Pay Commission recommendations) by abolishing 20,000 vacant posts in 1999-2000 and another 55,000 vacant posts in 2001. It had capped the food subsidy, the second largest after power, at Rs.300 crores by reducing the numbers eligible for subsidised foodgrains. The government withdrew support for small industries "which had led to the accumulation of some Rs.3.4 billion in liabilities". (This, at a time when the small-scale sector had already been affected by the closure of the public sector that it serviced, and on which it survived.)

The State government also "started to rid itself of the burden of state-owned commercial enterprises", the Bank noted. In March 1999, Karnataka had 81 public enterprises (including five public utilities) with a total of 1,62,000 employees. Excluding state utilities, the sector reportedly made a loss of Rs.110 crores in 1998-99. A Policy Paper on Public Sector Reforms and Privatisation recommended the withdrawal of the state from all commercial activities through the sale or closure of these units.

The Bank commended the poverty reduction initiatives the government had taken - the focus on improving agricultural productivity, the emphasis on directing investments to the more backward regions of northern Karnataka, and the fiscal and governance reforms, which, the Bank said, had "various potential benefits for the poor". Karnataka was also the second State in India to publish a Human Development Report (1999).

Financing reforms - particularly in respect of underwriting the power sector deficit and payments towards VRS while protecting "high-priority spending" - was estimated by the State government to cost about Rs.5,000 crores for the period between 2001 and 2004. It therefore requested the Bank in 2001 for a preliminary loan to meet a financing gap of Rs.1,200 crores. The World Bank sanctioned the first tranche of the KERL comprising $150 million (around Rs.800 crores) in June 2001, followed by the second tranche of $100 million (around Rs.500 crores) in March 2002. This was given as 30 per cent grant and 70 per cent loan, with the Government of India bearing the foreign exchange risk. The total credit line for reform was negotiated for just under $1.2 billion to be released in five annual tranches.

Consistent with its policy of pegging adjustment lending to concrete progress in reforms, the World Bank withheld the third tranche of the loan of $200 million (around Rs.900 crores) to be released in March 2003, because it was not satisfied that the reform milestones had been reached, particularly in the power sector. In the year 2002-2003 the drought in the State was perhaps at its worst, and suicide by farmers had reached alarming proportions. The "reform milestones", however, did not include intervention to address a human crisis: that would have only increased public expenditure. The Bank finally cleared the third tranche in October 2003, but then the Finance Ministry of the National Democratic Alliance government withheld it saying that the State had not achieved the targets under the Government of India's Medium-Term Fiscal Reform Facility. This decision was widely perceived in government circles in Karnataka as politically motivated. Despite the change in government, the third tranche of the loan is yet to be released.

Reform intensified - as did rural distress - through 2002, 2003 and 2004. (There was a brief phase of financial profligacy in March 2004, when the last government, sensing a hostile electoral current, spent around Rs.500 crores just before the elections on various government sops.) Reform continued to be monitored down to its minutiae by the World Bank. A reform performance matrix prepared by the government in August 2003 showed a few noteworthy achievements. One was that the number of out-of-school children fell from 10 lakhs in 2000-2001 to four lakhs in 2002-2003, largely owing to a successful midday meal scheme that was extended over the entire State. The school education budget increased by 20 per cent between 1999-2000 and 2003-2004.

However, several reform measures, which the government counted as "achievements", impacted adversely on livelihoods, particularly in the agrarian sector and at a time when drought had compounded poverty. As a result of successful measures of fiscal control there occurred: An increase in bus charges by 30 per cent since 1999; an increase in power tariffs by 34 per cent since end-2000; an increase in urban water charges for Bangalore by 45 per cent in 2001; a doubling of irrigation charges between 2000-2001 and 2002-2003; an increase in higher education charges by 20 per cent, which would be further increased by 10 per cent; the retention of user charges introduced for hospitals and rural water supply; the capping of food subsidy at Rs.300 crores, with the promise to bring down the number of green card holders from 65 lakhs to 30 lakhs by cancelling "bogus" ration cards; the closure of 14 Public Sector Units in two phases, the privatisation of three of them, and the identification of another 16 for closure/privatisation.

In respect of privatisation, the Karnataka Power Transmission Company Ltd was unbundled into four distribution companies in preparation for privatisation; private mining was invited into the mining sector; the sandalwood sector was liberalised, private operators were invited into the transport sector; an "increased flexibility for conversion of agricultural to non-agricultural land" was ensured (referring perhaps to amendments to the land reform legislation) and private sector management was brought into the water sector on a trial basis. These were the `achievements' presented by the State to strengthen its claim for the release of the third tranche of the loan.

The "main risk" to Bank support in India, the CAS 2004 noted, "was a reform derailment, which would also translate to slower growth and progress in reducing poverty". This did not happen in the 2002-2004 period, nor did the Bank become "less relevant". "The Bank group has continued to play a strong supporting role in India's reform process, particularly at the State level," CAS 2004 noted.

For the new coalition government in Karnataka, the agenda of reform, which it hopes the Bank will continue to finance, is certainly relevant. However, this government has been more flexible in its approach to reform, willing to deviate from it with respect to its social commitments. The message of the elections has obviously not been lost on it.

In a recent interview to Frontline, Chief Minister N. Dharam Singh acknowledged that there was a perception that the previous Congress government only served the urban areas and sectors such as IT and Biotechnology. "You are not doing anything for the rural areas. But you are now coming and asking for votes," was the response that Congress candidates often received during the election campaign, Dharam Singh said.

In this year's budget the government announced a scheme of subsidised rice and wheat at Rs.3 a kg for below poverty line cardholders, a move somewhat offset by the drastic reduction in the total number of cardholders. The government has also announced that it would make agricultural credit through cooperative banks available to the farmer at 6 per cent interest.

At $1 billion, the Bank's financial assistance to the State for its reform programme is not large. Over a five-year period, this would average around Rs.900 crores a year. (In comparison, the total allocation for agriculture alone in this year's budget amounts to Rs.840 crores.) For a relatively small loan, the Bank's leverage on government policy in respect of the direction that economic reform should take is, however, considerable. This suggests that the Bank's presence in the reform agenda will continue to be important, as a key lending agency for reform, as an investor in sectoral development and as a provider of technical assistance.

With a normal monsoon this year, the agricultural sector is showing some signs of recovery for the present. But of the "eradication of poverty through economic growth tempered with equity", within the matrix of reform, one is still to see evidence.

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