KIIFB’s Masala Bond Issue: A Derailed Debate

In the midst of hot summer and election propaganda, the state government faced a huge allegation from the opposition for accruing Rs 2,150 crore with a 9.723% rate of interest, from the international financial market, through the Kerala Infrastructure Investment Fund Board, popularly known as KIIFB.

The Canadian Company CDPQ purchased the masala bonds issued by KIIFB through the London Stock Exchange (LSE), which at present is the only global hub for the same. If we have to reap the benefits of that money, we must find the avenues to invest it sensibly through effective debates and discussions. But the present debate over masala bond issue of KIIFB seems to be a farce as it mostly beats around the bush.

What are bonds and masala bonds?

A bond is a financial instrument, which will have a set maturity period over one year, issued by the company or government that requires the funds. It is considered as a debt instrument, as we have to pay interest at an agreed rate,  that will be mentioned in the bond itself. Masala bond is a rupee dominated bond sold to overseas investors who will bear the currency risk.  It is similar to the Chinese Yuan denominated “Dim Sum Bonds" or Japan’s ‘Samurai’ bonds. In short, the name ‘masala’ was chosen to give the bonds strong Indian identity as we use a large amount of spices in our cuisines. The first Masala bond was issued by the International Financial Corporation (World Bank’s IFC) in 2014, which raised  a Rs 1,000 crore bond to fund infrastructure projects in India. The government promotes the companies to go for masala bond, as it strengthens the internationalization of Indian rupee.  In order to encourage this, from 17^th September 2018 to 31^st March, 2019,  the Central Government provided withholding tax waiver for masala bonds.  Among the states, Kerala was the first in India that used the option to accrue money through masala bond.

Formation of KIIFB

KIIFB is a government-owned financial institution constituted to mobilize funds for infrastructure development from outside the state.  Kerala is often blamed for its poor fiscal management as the state that spent the largest chunk of its exchequer for salaries and pensions.  The state's fiscal debt to GSDP ratio is over 30% and is keeping increasing.  It is not the fault of a particular government but the populist measures over the past thirty years.  To maintain fiscal discipline and the overall management of public funds, the Union Government had passed Fiscal Responsibility Budget Management Act way back in 2003.  Though none of the states or the Centre attained the targets, the Union Government still put certain restrictions on the state's borrowing.  Based on this, a state government is allowed to borrow to the extent that its fiscal deficit does not exceed the limit of 3% of its gross state domestic product (GSDP).  

However, the 14th Finance Commission provided a further flexibility of 0.5 percentage points to states, subject to rigid conditions.   The average of the last five years fiscal deficit  (5.2% in 2018-19) in Kerala stood around 3.7%,  far ahead of the targets suggested by the fourteenth Financial Commission, which legitimately prevents the state’s eligibility to borrow money.  As a panacea to this, it was Dr.Thomas Isaac, who invented the idea of accumulating money through KIIFB, which is planning to finance worth Rs.50,000 crore of plans.  Borrowings of KIIFB have been backed by sovereign guarantee of the Government of Kerala and debt servicing is supported by a statutory mandated revenue stream whereby the entire petroleum cess and fifty per cent of the motor vehicle tax collected in the state of Kerala are transferred directly to KIIFB.

The controversy

The controversy raised by the opposition is mainly on two grounds.  The first one is about the interest rate.  The interest rate of the bond is inversely related to the creditworthiness of the issuer. In simple terms, the company with AAA rating will get a lender with a low rate of interest.  Here, KIIFB has been rated as BB,  technically which is four notches less than that of AAA. This credit worthiness has been measured by global credit rating agencies like S & P or Fitch.   The rate of interest may also depend on the existing demand and supply of similar bonds at the LSE.  But it's a fact which has nothing to do with the state government's interference. As per the information, for Rs.2150 crore, we have to pay around Rs. 210 crore interest annually,  and  the total   repayable amount will add  up to Rs. 3200 crore after five years.

The second criticism is about the lender.  The Canadian company CDPQ's association with SNC Lavalin prompted the opposition to raise allegations. LSE is a much more independent body and there are arbiters and brokers in the global market as in the domestic financial market.  In theory, there are chances of collusion between these stake-holders in the market.  But in the case of masala bonds,  any proposal of borrowing by eligible entities through issuance of bonds will be examined by the Foreign Exchange Department of Reserve Bank of India (RBI).  RBI has also revised provisions for the maturity period, all-in-cost ceiling and recognized lenders (investors) of masala bonds.  Prima facie, at present we do not have evidence to blame the Government.

Masala bond: a path-breaking step in the development of Kerala?

The unexpected natural disasters during mid-2018 coupled  with fiscal indiscipline weakened Kerala’s exchequer;  so the amount received through masala bond will give an impetus to the government.   It is an undeniable fact that we need money for development, but it is not the amount of money but its utilization that matters a lot.  In order to succeed further,  we need to redefine our existing development approach with proper utilization of available resources, strengthening the existing revenue collection methods and controlling the expenditure by regulating populist reforms. Unfortunately we are far behind in all these aspects.   Many of the public infrastructure facilities of Kerala are of poor quality or unutilized or underutilized, including state highways.  The Public Works Department, which plays a pivotal role in infrastructure development of the state, is also not free from corruption. Despite these, in his past three budgets, Finance Minister Dr Isaac announced various infrastructure proposals, including a synthetic track and stadiums across the state through KIIFBs fund.  Are these important especially when the state is heading towards a financial crisis? What the prime areas to be invested in are,  is an important question to be decided.   From a rational angle, it is not the source, but the usage of funds that will be vital for future.  But unfortunately we fall short in making serious deliberations in this direction.   The proponents of KIIFB calculate  as in the case of a housing loan, i.e. the 100 crore today at its  present value will not be equal to its future value. Generally a company issues bonds to find money to invest in their business due to its capacity to regenerate.  Here, KIIFB plans to invest in infrastructure facilities, and technically they are all parts of the social overhead capital.  And  hence they are not financially remunerative.  Kerala’s Own Tax Revenue (OTR) growth is stagnated for long.  Kerala Economic Review shows that OTR growth rate since 2013-14 has been at an average of 10%,   much lower than 18% during 2006-2013.  Meanwhile, the state is not ready to curtail any of its politically motivated populist measures. Notwithstanding Kerala’s fiscal illnesses,  the present government prefers to have a liability in future in the name of development.  It casts  doubt on a myopic approach than a holistic one, as it adds fuel to fire.

The State was able to make up for it because of the rise in Central government’s grants. This was thanks to the change in procedures by which routing of the share in centrally-sponsored schemes was done through the State budgets as also  Central devolution of taxes and revenue deficit grants as per the Finance Commission’s recommendation.  In a nutshell, we are managing the show but not solving the issue. Therefore, we are forced to conclude that the present mode of development in Kerala is not only unsustainable but also suicidal.                         

(The author is faculty member at KUFOS, Kochi and can be contacted at:  mailtokrajesh@gmail.com)