Funding States using Future Revenue

– Penned by Varnika Gupta

As the Sri Lankan Crisis unfolded, the news was doing the rounds about how some Indian states were also in a state of high debt and some relevant checks and measures need to be taken to avoid a fate similar to our neighboring island country. Recently, the government took cognizance of the situation and addressed this red-flagged issue. Read along to find more.

The banks that made loans to state government organizations based on the escrow of the state’s future revenue streams or by utilizing collectorates and courts as security have come under fire from the Center and RBI. This looks to be questionable lending from the bankers’ side. Escrow refers to giving charge of resources involved in transaction to a third party temporarily. Normally, an escrow arrangement is resorted to when funding is for a project with income streams. The future income streams are escrowed to obtain a loan from a bank based on its commercial profitability. But in this case, what is escrowed is not future streams of income from a project since there is no funding for any project commercial in nature here but future taxes of the state to obtain a loan. Earlier, in communication to the state, it has already been noted that pledging of future tax revenues was not in line with Article 266(1) of the constitution, which mandates that all taxes and loans should flow into the Consolidated Fund of the state.

With multifold increase in expenditure of the states compared to revenue, the states are finding it difficult to finance their activities, leading to motley of borrowings from various sources. Currently, every single state is indebted to the Centre and thus, all of them require the Centre’s consent in order to directly borrow. The states, instead of directly borrowing, take a different route, wherein loans are taken by a public institution which borrows on direction of the government. This method of borrowing is known as off budget borrowing.

For the state government, this looks a convenient and indigenous way of circumventing the Fiscal Policy and Budget management norms. The government can ask an implementing agency to raise the required funds from the market through loans or by issuing bonds. Since the loan is not taken directly by the govt, it does not reflect in the budget document and, hence, the numbers also do not reflect in fiscal deficit. Such financing tends to hide the actual extent of government spending, borrowings and debt and increase the interest burden, increasing the financial risk

This indiscriminate lending by the banks  to the state governments have a potential risk of creating future non performing assets(NPAs) by the state governments. As the future streams of income in terms of taxes is escrowed by the state governments, the concept of sustainable debt in long term is lost, and can have dank on the finances of the state.

Earlier, Comptroller and Auditor General of India(CAG), said that this  route of financing puts major sources of funds outside the control of Parliament and thus, suggested a policy to disclose to the parliament about the amount, rationale and objective of such funding. It was found that between 2019-20 and 2020-21 at least five states – Andhra Pradesh, UP, Punjab, MP and Himachal – escrowed future revenues.

To prevent any impending financial crisis due to unsustainable debt, the Centre has asked banks to stop such practices, especially SBI, which doled out loans on off budget borrowings. Now onwards, off-budget borrowings are now being equated with the state governments’ own debt. This measure will now shed a light on the state debt which had earlier escaped government’s vigilance.

LENS INTO ANDHRA’S FINANCIALS

The Andhra Pradesh government is existing on a hand-to-mouth basis, supported by day-to-day borrowings. As part of this, the state government has gone in for borrowings from nationalized banks by creating an escrow account and pledging future retail excise tax revenues into that account in addition to providing government guarantees for the same. A consortium of nationalized banks consisting of State Bank of India, Punjab National Bank and Indian Bank together gave an amount of Rs.13,500 crore to finance different electoral promises of the Chief Minister against a government guarantee and escrowing of the future excise revenues of the state government. Such a huge loan without ant justified flow of revenue entails high interest rates which would create a financial burden on the state in the coming years and collateral economic loss.

Due to such practices undertaken by the states, tough measures are needed to keep a check on financials of the state and prevent it from turning into Sri Lanka like situation in future. Last month, RBI was forced to seek a review of such lending practices by the bank board and report compliance by September.

References

• https://reader.magzter.com/reader/jw9132jbe2r7itdc6oxopv1018090559x17qjzav/1018090?isLib=1
• https://vajiramandravi.s3.us-east-1.amazonaws.com/media/2022/7/23/14/32/32/Banks_told_to_stop_funding_states_using_future_revenue.pdf
• https://www.tribuneindia.com/news/punjab/centre-warns-punjab-against-raising-funds-via-assets-future-revenue-415358
• https://www.rbi.org.in/scripts/FS_Overview.aspx?fn=2757
• https://www.thehindu.com/news/national/andhra-pradesh/apsdcl-loans-pac-chief-faults-state-guarantee/article35479430.ece
• https://www.thehansindia.com/telangana/bjp-dares-kcr-to-dissolve-assembly-go-for-elections-752967?infinitescroll=1

The Economics and International Business Club of IIM Indore

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