Funding of states

The Centre and RBI have pulled up banks for lending to state government entities based on the escrow of the state’s future revenue streams or using collectorates and courts as security. An Escrow is an arrangement for a third party to hold the assets of a transaction temporarily. It refers to giving charge of resources to a third party or banks till a loan or a liability is cleared.

Details –

• The Centre has expressed concern over state governments securing loans by mortgaging sovereign assets or escrowing their future revenues.
• State assets such as municipal parks, collector’s office, taluk office, courts and hospitals have been used as security to raise loans from banks.
• The finance ministry has asked to end this practice as it found that most of such loans were given by PSU banks, including SBI.

Borrowing by states –

• Article 293 of Indian constitution deals with the borrowing by States (Article 292 regulates borrowing by Central Government)
• Under Article 293 (3), state governments are required to take the Centre’s permission for fresh borrowing, if they are indebted to the Government of India.
• Every single state is currently indebted to the Centre and thus, all of them require the Centre’s consent in order to borrow.

What are ‘off-budget’ borrowings?

Off-budget borrowings by a state government refer to loans taken by its entities, special purpose vehicles, that are expected to be repaid by the state government’s own budget rather than the borrowing entity’s cash flows or income.

Key highlights –

• Funds raised by escrowing future revenues —
  • • Between 2019-20 and 2020-21 at least five states – Andhra Pradesh, Uttar Pradesh, Punjab, Madhya Pradesh and Himachal Pradesh – escrowed future revenues.
    • More states may have resorted to such means, but data was not immediately available.
    • Escrowing future revenue is worrisome as states are offering securities to raise loans when they do not have revenue streams.
• Resorting to off-budget borrowings — With spending on the rise, states are increasingly resorting to off-Budget borrowings and pledging their revenue streams or sovereign assets.

Central government’s response –

• On pledging of future tax revenues —
  • The Union finance ministry had written to the States that pledging of future tax revenues was not in line with Article 266 (1) of the Constitution.
    • This article mandates that all taxes and loans should flow into the Consolidated Fund of the state.
  • Also, Article 293 (3) mandates that states cannot borrow without the Centre’s permission. Such borrowings are against this principle.
• Banks are being asked to stop such lending —
  • Recently, SBI was the first to be asked to stop such lending.
  • Many experts believe that such borrowing will ultimately create strain on Banks, particularly the PSU banks.
  • For instance, in case of default on such loans, banks will not be able to sell sovereign asset of states such as municipal parks, collector’s office etc.
• Such borrowings to be equated with the state governments’ own debt —
  • From 2022, off-budget borrowings are now being equated with the state governments’ own debt.
    • The incremental off-budget borrowings that state governments have undertaken in the last two years (2020-21 and 2021-22) will need to be adjusted out of the borrowing ceiling this year.
    • This will shed light on a segment of state debt that has escaped Centre’s oversight in the past.