After more than two years of what looked like an intense showdown, the Center appears to have finally brought states like Kerala to their knees on off-budget borrowing. The Center has been pushing for states like Kerala to include their off-budget borrowing using special purpose vehicles like KIIFB in their annual borrowing limit.
Kerala is still in resistance mode and is paying the price. The Union government has not approved Kerala’s borrowing schedule for the first quarter (April-June) of the financial year 2022-23. By May 10, Kerala is expected to have raised Rs 4,000 crore from the open market. He could not.
This tightening of funds has already led to some Treasury restrictions. If this center-state conflict persists, Kerala’s fiscal situation could become precarious.
Convenience of off-budget loans
Kerala has always objected to the inclusion of the Kerala Infrastructure Investment Fund Board (KIIFB) and other off-budget borrowing in its budget deficit calculations.
In fact, the very reason for creating SPVs like the KIIFB was to circumvent the borrowing limit set for the states. The logic was that most free market borrowing was used to fund committed expenses such as salaries, pensions, and interest, leaving virtually nothing for development spending. Tax-free off-budget loans were the solution.
If loans from KIIFB and other government-funded bodies like Kerala Social Security Pension Limited (KSSPL) had been taken into account, Kerala’s budget deficit would have looked even more inflated. The latest CAG report states that the KIIFB and KSSPL had borrowed Rs 1,930.04 crore and Rs 6,843.65 crore respectively in the financial year 2019-20, neither of which was reflected in the calculations. of the deficit for this financial year.
Closure of a busy ring road
The Center has now moved to permanently close the route that states usually resort to to evade constitutionally mandated tax audits. States are legally entitled to borrow 3% of their GSDP on the open market; from this financial year, it is 3.5% of GDP.
They made full use of it, and on top of that they encouraged their PSUs and SPVs to borrow heavily. According to a CRISIL Ratings study of 11 states, including Kerala, off-balance sheet borrowing by states had reached a ten-year high of 4.5% of state gross domestic product (GSDP), or Rs 7.9 lakh crore, in 2022.
These huge amounts are not reflected in the annual financial statements (budgets) of these states, but are funded by state budgets. The KIIFB, for example, is supported by the annual transfer of 50% of Kerala’s motor vehicle tax revenue and the full tax on petrol.
A double whammy for the States
But from now on, the Center wishes that the loans contracted by the SPV are also included in the ceiling of borrowing of the States. This will lead to a decrease in net annual government borrowing. The KIIFB, for example, will first need to consider routine and more urgent borrowing needs in the open market of Kerala before programming its loans. In such a situation, the very existence of the KIIFB could be called into question as the body was formed to operate outside of these restrictive constitutional and fiscal concerns.
During this exercise, states will experience additional deprivation. The decision to transfer PSU and SPV borrowings to the budget will be implemented retrospectively, starting in FY 2020-21. This means that excess borrowing incurred by states using off-budget mechanisms in the past two fiscal years – 2020-21 and 2021-22 – would be deducted from their borrowing limit for that fiscal year 2022-23.
Will the payment of wages suffer?
The Center has already requested States to provide revised borrowing figures for the past two fiscal years. Top sources said Onmanorama that Kerala had still not provided these figures. Hence, the Center refused to endorse Kerala’s borrowing schedule.
Kerala was unable to mop up Rs 4000 cr in three auctions scheduled by the RBI: April 19 (Rs 1000 cr), May 2 (Rs 2000 cr), May 10 (Rs 1000 cr). This caused a slight budget squeeze, threatening to derail the payment of salaries and pensions in May.
Finance Minister KN Balagopal, while conceding that the Center had not sanctioned Kerala free market borrowing, said the situation would not affect salaries and pensions. “I hope the Center will not behave vindictively,” he said.
Why the Center and CAG despise the KIIFB
The Centre’s logic was set out in the March Monthly Summary Report issued by the Expenditure Department. “These off-budget borrowings from the states have the effect of circumventing the net state borrowing ceiling by channeling the loans out of the state budget through public or statutory bodies despite being responsible for the repayment of these loans.These borrowings have an impact on fiscal revenues and deficits and thus have the effect of exceeding the targets set for fiscal indicators under the Fiscal Responsibility and Fiscal Management (FRBM) Act.”
The latest report of the Comptroller and Auditor General on Kerala Finances has also flagged the issue. “Even though the repayment of the amount borrowed and its interest (by the KIIFB) are funded from government revenue, the government’s financial records do not reflect these borrowings,” the CAG report said. “KIIFB’s liabilities are a direct charge on the government’s own resources and are therefore a direct responsibility of the state government,” he added.