June 11, 2023

Centre Imposes Economic Sanction on Kerala

TM Thomas Isaac

THE central government's decision to reduce the annual public borrowing of the state government is an assault on the state's public finances. According to the prevailing FRBM Act, state governments have the right to borrow up to 3 per cent of the Gross State Domestic Product (GSDP) from the market. Additionally, due to the state's compliance with certain electricity sector conditions imposed by the central government, the state is entitled to an additional borrowing of 0.5 per cent of the GSDP. However, the recent communication from the central government indicates that the state's borrowing limit has been lowered to 2 per cent. This follows a reduction in the state's borrowing ceiling from 3.5 per cent to 2.2 per cent in the previous year. This year, the borrowing limit has been further reduced to 2 per cent.

The expected GSDP of the state is Rs 11 lakh crores. With a borrowing limit of 3.5 per cent, the state would be able to borrow Rs 38,000 crores. Even at a borrowing limit of 3 per cent, the state could borrow around Rs 33,000 crores. However, the central government has issued an order allowing only Rs 15,390 crores of permissible public borrowing for the first nine months of the financial year. For the remaining three months, a borrowing limit of Rs 5,131 crores will be permitted. Consequently, the total public borrowing for the fiscal year 2023-24 will amount to only Rs 20,690 crores. This shortfall of Rs 17,310 crores will create a huge deficit in the budget approved by the assembly, leading to a great deal of uncertainty regarding the implementation of the budget.

What the central government has done is simple. They have essentially altered the definition of public borrowing. To understand this manoeuvre, it is necessary to delve into the various categories of government borrowings, which can be broadly classified into five types.

(1) Public borrowings into the Consolidated Fund: State governments borrow by issuing bonds in the market. They can borrow directly from domestic financial institutions or seek external borrowing through the central government. The central government can also lend to state governments. All these borrowings come into the Consolidated Fund and are considered as capital receipts.

(2) Public Account Borrowings: In addition to the Consolidated Fund Account, state governments also have a Public Account. Deposits such as security deposits, provident funds, and other treasury deposits are not considered government receipts. These deposits are entrusted to the government temporarily for safekeeping. Only the net increase in the Public Account is recognised as capital receipts for the government.

(3) Off-Budget Borrowing: In certain cases, certain schemes included in the budget may lack adequate provisions in the budget. Or it may also be the case that there is a temporary shortage of funds in the treasury. To address these situations, the government may resort to borrowing through a public sector unit or agency associated with the scheme to fulfill the expenditure requirements. For instance, it is a common practice for the Food Corporation of India to borrow funds to meet the expenditure for procurement. The government subsequently reimburses the public sector unit or agency. These types of borrowings are referred to as Off-Budget Borrowing.

An example of Off-Budget Borrowing by the Kerala government is the borrowing by its Pension Payment Company. In the state, over 50 lakh elderly, disabled, and widowed persons, receive a monthly pension of Rs 1600. The company was established to ensure that the payments are made regularly every month whatever be the situation of the treasury. The state government periodically reimburses the company for any additional temporary borrowing it had to undertake, along with interest. Thus, all welfare pensions are regularly provided in monthly installments, with over half of them being distributed directly to the beneficiaries' doorsteps through cooperative banks.

(4) Extra Budgetary Borrowing: Extra Budgetary Borrowings refer to loans obtained by public sector units or agencies for their own schemes that are not included in the budget. The government provides a guarantee for these borrowings and funds the expenditure partially or entirely based on a mutually agreed pattern. An example of Extra Budgetary Borrowing would be the loans acquired by the National Highway Authority of India to finance its projects.

Kerala has established a special purpose vehicle known as the Kerala Infrastructure Investment Fund Board (KIIFB), which secures loans from the market to undertake important and large-scale infrastructure projects. These projects, along with their associated expenditures, are not included in the budget accounts. The government has entrusted KIIFB with the responsibility of implementing specific projects, for which the government provides it an annuity equivalent to half of the motor vehicle tax.

(5) Direct Borrowings of Public Sector: Public sector units and agencies may borrow for their projects without any government guarantee or financial assistance. In the event that they are unable to repay the loan, the financial liability does not fall on the government. This sets apart direct borrowings from off-budgetary or extra-budgetary borrowings.

As per the accepted accounting norms thus far, the government's liabilities are categorised into two types: type one (Public Borrowing) and type two (Public Account Borrowing). Even now as far as the central government accounts are concerned, only these two types are recognised as the government's liabilities and are taken into calculation of the fiscal deficit.

However, in the case of state governments, the central government is now aiming to incorporate type three (Off Budgetary Borrowing) and type four (Extra Budgetary Borrowing) as components of the state government's public borrowing. By modifying the definition of public borrowing, their subsequent step is to proportionately reduce the annual permissible borrowing ceiling of 3 percent.


Not only is the fiscal deficit of the central government above the FRBM limit, but they have also been undertaking huge off-budgetary borrowing. After Nirmala Sitaraman became the finance minister, she introduced the practice of including off-budgetary borrowing as an annexure to the budget speech. In the fiscal year 2019-20, this amounted to Rs 1.48 lakh crore. However, the CAG report highlighted that an additional Rs 1.69 lakh crore was borrowed without being included in the annexure. Consequently, the total off-budgetary borrowing by the central government in 2019-20 stood at Rs 3.27 lakh crore.
The CAG, which has criticised Kerala and advocates for the inclusion of Kerala's off-budgetary borrowing within the permissible public borrowing limit, does not make similar recommendations for the central government. Furthermore, the off-budgetary borrowing of the central government is not accounted for in its fiscal deficit. What double standards! Moreover, when calculating the off-budgetary borrowing of the Kerala Pension Company, the gross borrowing instead of net borrowing has been taken.

The central government considers the KIIFB not as an off budgetary borrowing even though none of its projects are part of the budget and not a rupee borrowed by KIIFB even enters the government treasury. Center’s counter argument has been that the entire repayment of KIIFB is met from government grants. This argument is false. 30 per cent of KIIFB projects are self-financing revenue model projects.
KIIFB is an annuity scheme, which is a common practice employed by both the central and state governments. Under this scheme, the contractor obtains a loan to construct the infrastructure, and the government makes payments in the form of annuities over a period of 15-20 years. The interest payment for the annuity period is factored into the contractor's bid. However, no one has suggested that this procedure is off-budgetary borrowing.

As of the end of 2019, the central government had 93 annuity projects with a total outlay exceeding Rs 1 lakh crore. Thus far, no CAG audit has raised any objections or concerns regarding these projects.
KIIFB is also an annuity scheme. The government has entrusted KIIFB with the implementation of projects worth Rs 70,000 crores, with an annuity payment equivalent to half of the motor vehicle tax. Therefore, KIIFB can be considered an increasing annuity scheme. It is important to note that this arrangement does not constitute off-budgetary borrowing or a violation of the FRBM Act.
It is worth mentioning that in any annuity scheme, there is a direct liability on the government for future payments. However, such liabilities are typically not included in the calculation of the fiscal deficit or considered part of the current public borrowing.
A lingering question remains: how can one be sure that the annuity payments and repayments from revenue-earning projects would be adequate for the debt and interest repayment?

The comprehensive database of KIIFB encompasses all the details of the inflows such as budgetary allocations, funds raised from the market, revenue generated from projects, as well as outflows such as project pay-outs and debt servicing. KIIFB has developed its Asset Liability Management Model (ALM), which utilises predictive analytics and relies on artificial intelligence/machine learning. This ALM model enables KIIFB to predict, among other things, how assets and liabilities will match at any point in time within the project horizon. At no point in time, will the liabilities exceed the assets. The projects would be takem up within this self-imposed constraint. Therefore, there is no possibility of KIIFB's liabilities rebounding to the government as direct liabilities if the government fulfils its legal obligation to pay the annuity.

When it comes to calculating the central government's public borrowing or fiscal deficit, both budgetary and extra-budgetary borrowings continue to be excluded. This fundamental asymmetry between the rules for the central government and the state governments is widespread. According to the FRBM Act, both the central and state governments are not allowed to borrow more than 3 per cent of the GDP, with the fiscal deficit limited to 3 per cent. Additionally, the borrowed funds should not be utilised for revenue expenditure, and the revenue deficit should be maintained at zero.
However, till date, the central government has not adhered to these regulations, and consistently maintained a fiscal deficit of 4-6 per cent. In contrast, state governments have largely complied with the provisions. It is this central government that is taking up cudgels against the state governments by arbitrarily changing the rules and applying them retrospectively.