As freebies debate rages, a look at states' contingent liabilities

In the recent Monsoon Session of Parliament, Finance Minister Nirmala Sitharaman informed Lok Sabha that borrowings by public sector undertakings and special purpose vehicles of states, where the principal and/or interest is being serviced by the state, will come under borrowings of that state.

Many such instances had come to the Finance Ministry’s notice, Sitharaman said and added the Ministry’s expenditure department had communicated to the states in March 2022 that “borrowings by state PSUs, SPVs and other equivalent instruments, where principal and/or interest are to be serviced out of the state budgets and/or by assignment of taxes/cess or any other State's revenue, shall be considered as borrowings made by the state.

Against the backdrop of the recent public debate on freebies and populist schemes, Sitharaman’s comments have gained more relevance. States are bound by borrowing ceilings as a result of their Fiscal Responsibility and Budget Management (FRBM) laws. And by making their PSUs, SPVs, cooperatives and other agencies borrow from the markets, they bypass these laws.

The general view among officials who have served in both centre and states is that a political executive can announce any scheme as long as it is funded in the centre or state’s budget, and as long as vendors or implementing agencies are paid. For example, a state can announce free electricity, but it must ensure that the dues of the state power distribution company are cleared.

“There are a number of states which fund some of their schemes through borrowings by agencies,” said an official. What these states are indulging in (and what the centre also did till recently), is off-budget borrowing, considered an unhealthy practice in public finance and fiscal policymaking.

Though no one in the central government is willing to name the errant states on record, in informal conversations, names like Telangana, Andhra Pradesh, Punjab and Uttar Pradesh, among others have come up.

One way is to measure off-budget borrowings of states is to look at their contingent liabilities. And this is best shown in the audit reports of their budgets by the Comptroller and Auditor General (CAG).

 

Contingent liabilities essentially mean that guarantees, in case of defaults by borrowers for whom the guarantees have been extended, are liabilities contingent on the consolidated fund of the state. A state will guarantee borrowings undertaken by entities it owns, like state PSUs, SPVS, cooperatives, societies and other such agencies.

A look at the audit reports of some of India’s biggest states throws some interesting numbers. The latest AG audits for most states are till 2020-21 and for some states till 2019-20. There are two kinds of contingent liabilities.

In absolute terms, the highest contingent liabilities in 2020-21 were for Uttar Pradesh and Rajasthan (2019-20). However, while Rajasthan’s contingent liabilities were above Rs 1 trillion from FY18 to FY20, that of Uttar Pradesh has grown by 136 per cent from FY17 to FY21. The biggest increase has been for Telangana from FY18 to FY21, more than 150 per cent.

The net borrowing ceiling of states is mandated by the FRBM Act. However, the upper limit of what their contingent liabilities can be is set by states’ own legislative bodies. In rare cases, like that of Maharashtra, there is no limit on contingent liabilities.

For Andhra Pradesh, the liability ceiling is 90 per cent of revenue receipts for the previous year. For Karnataka, the limit stands at 80 per cent. For Gujarat, the ceiling limit on government guarantees is a fixed Rs 20,000 crore under the Gujarat State Guarantees Act, 1963.

For Telangana, the limit was 90 per cent as well but was increased to 200 per cent in September 2020. This explains the massive jump in its liabilities.

These contingent liabilities are sure to form a significant part of the discussion around freebies and populist schemes. Especially as there is no fixed definition of what a ‘freebie’ is and how much a state spends on such schemes. Could contingent liabilities be a measure for such a definition, if any committee, as recommended by the Supreme Court, is formed?

When the 15th Finance Commission (FC) was formed, one of the terms of reference given to it was to recommend performance-based incentives to states based on “control or lack of it in incurring expenditure on populist measures.”

In its report for 2021-26, the 15th FC stated: “Many States stressed that the categorisation of schemes into populist and non-populist cannot be done objectively, as development requirements differ from State to State. Further, they argued that elected sovereign governments are accountable to the people of the State and they, rather than the Finance Commission, should have the prerogative of deciding the welfare schemes.”

15th FC Chairman N K Singh had said earlier that the body will come up with a definition of populist schemes. In the end, the 15th FC did not define freebies or populist schemes.