To do away with the Rs 2300 crore overdraft the state government has entered into an agreement with RBI, appointing it as sole agent for investment of government’s funds besides carrying on its general banking business. While the opposition called it ‘an enslaving mechanism’, the government said it was necessary to salvage J&K Bank. A Kashmir Life report.
Managing the finances of J&K has always remained more of a jugglery. Running a huge establishment with a narrow resource base amid the unpredictability of a place caught in a conflict is a tall order. So what do the babus in the finance ministry do? They dig a hole to fill a hole. And it was while filling one such hole that the government was caught digging a burrow that the opposition thinks is actually a grave!
Reserve Bank of India (RBI) entered into a supplementary agreement with the J&K government under which the central bank will carry on its general banking business and act as the sole agent for investment of government funds. Though RBI has remained J&K’s debt manager nominally since 1972, it was the state-owned J&K Bank that would act as an agency bank, debt manager and development bank. In immediate follow-up to the agreement, RBI agreed with J&K Bank appointing it as its agent for conducting the general banking business of the state government. Both the agreements were effected on the recommendation of the state government and the new system shall be in vogue from next fiscal.
The agreements are the outcome of efforts by Omar Abdullah’s government to reduce the resource outgo on interest on account of overdraft (OD). J&K government is enjoying an overdraft of Rs 2000 crore besides another advance for power worth Rs 200 crore. It pays an average of 10 per cent interest on the OD.
Opposition Reaction
Hell broke loose after RBI stated its supplementary agreement with the bank. Peoples’ Democratic Party (PDP), the state’s principal opposition reacted fiercely. Terming it the “most lethal nail in the coffin of state’s autonomy” and “an enslaving mechanism” for a state government already reeling under “economic deprivation and begging bowl syndrome”, party president Ms Mehbooba Mufti said the “decision removes the last fig leaf that the ruling party tried to cover its real intentions and duplicity with.”
Ms Mufti said J&K Bank is not only a flagship financial institution of the state but it represents the ability of our professionals to script great success stories. The decision, she fears, could be the first step towards its liquidation as a state-owned company. Listing intellectual capital, natural resources, fiscal stability and freedom as “essences of any self-respecting people”, Ms Mufti said the ruling National Conference (NC) “in line with its heritage” continues to uproot these cornerstones.
“The decision about J&K Bank is reminiscent of the surrender of rights over water resources in 1952 to New Delhi and the right of the state legislature to amend its constitution in July 1975 immediately after Sheikh Mohammad Abdullah came back to power as a price for it,” she decreed. Apart from compromising the state’s financial position, and restricting the growth prospects of the bank – the biggest institution that the government has built, she said the decision hurts the claims of being an ‘autonomous’ state.
Even the Hurriyat (Mirwaiz) reacted. It said the decision amounted to trifling with the sentiments of Kashmiris and an admission of embracing “financial domination”. The alliance termed the bank as the real asset of the society and threatened to mobilise public opinion against “the autonomy-demanding government from adopting hypocritical tendencies”.
FinMin Explains
The raging controversy could not prevent the state’s finance minister Abdul Rahim Rather from reacting. Addressing a crowded news conference in the civil secretariat Jammu to explain his “cash management agreement” Rather talked about the financial indiscipline in the government but took refuge in his efforts to salvage the bank.
A fourth-time finance minister Rather genuinely said the OD has become a structural deficit and the decision is to address it once and for all. He talked about the resource outgo to the bank on account of interest (now over Rs 200 crore a year) and said the liability is increasing as OD is being sourced without approval from either the legislature or the cabinet.
“This negative tendency (increasing the OD) if not checked forthwith, could have proved very disastrous for J&K Bank as RBI has many times passed strictures against the bank for exceeding the overdraft limits,” Rather said. “Reputation and credibility of J&K Bank was continuously at risk and the trust of investors would have fallen at any movement resulting in a catastrophe for J&K Bank,” he added.
Offering details of his achievement, Rather said the government had approached the 13th Finance Commission for help in liquidating the surging OD that usually goes to Rs 2300 crore level. The commission recommended a Rs 1000 crore grant on this account if the government agrees to the Ways and Means of the RBI to manage its finances. The government will borrow interest-free (he said the interest liability will not be the state’s responsibility) Rs 1300 crore from the market to manage the OD.
J&K Bank will continue to be the state’s banker and there will not be any change in the relationship. Under the RBI-approved Ways and Means Advance (WMA) the government will have to pay six per cent to a level of Rs 315 crore, eight per cent above Rs 315 crore and 11 per cent for an OD crossing Rs 630 crore limit. This, he said, is a breather against the existing system of paying 10 per cent for an OD of Rs 950 to Rs 1500 crore and 17.25 per cent for an amount above Rs 2000 crore.
“The new cash management system is beneficial for all the three stakeholders – state government, J&K Bank and the people of the state,” Rather ruled while terming the criticism of the decision as a malicious campaign by a class that lacks “understanding” of the new structural and fiscal reforms.
Only Success Story
J&K Bank is not only the state’s only success story. It is the state’s only listed company as well. Though the state government owns over 53 per cent of its stocks, 23 per cent of shares are with foreign institutional investors (no Indian FI has ever invested in J&K Bank). Any adverse publicity to any listed company is a serious problem and J&K Bank can not be an exception.
For no reason of its making, J&K Bank is caught between its majority owners (the government) and the regulator (RBI) – a real devil and deep sea situation. It can not tilt either way. But grudgingly it issued a long statement, revealing what was already on the newspaper front pages but adding that the agreement has added to its role and responsibilities in the state.
In the short term, the bank does not lose much. “The government is just a client who returns the money that it had taken,” explained a senior executive. “Money belongs to the public and its presence in our vaults is a liability so we have already chalked out a contingency plan to deploy these funds which will take place as and when we get the cash.” Any financial institution having a loan book of over Rs 23000 crore knows where to park Rs 2300 crore.
However, if the bank takes the finance minister’s suggestion seriously then it must lend Rs 2300 crore to the agriculture sector. Presuming that one loan account in agriculture will have a ticket size of Rs 100 thousand each, the amount the government will return will help the bank create 230000 loan accounts. Mark the difference:
Overdraft Evolution
There is no point or justification for playing the OD issue against the bank. It essentially is a problem in the state government that is using or misusing its ownership rights to lift public money at a cost that is, by an average, 3 to 5 per cent less than the rate at which a common man uses it. OD is a malfunction of a system that evolved as a strength of successive regimes.
OD is nothing new. Against Rs 57.41 crore in 1988-89, the OD had crossed Rs 200 crore when Dr Farooq Abdullah led the NC-Congress regime and resigned in 1990 after militancy broke out. It was over Rs 600 crore when Dr Abdullah returned to power in October 1996. The figure crossed Rs 1200 crore when a fractured verdict offered a hung house that even brought the state to a brief spell of governor’s rule in 2002. Now when Omar Abdullah took over, the OD is hovering over Rs 2000 crore.
NC and PDP are habitually accusing each other of this structural deficit to secure brownie points. They ignore the reality that OD existed always but it retained a pattern: it increased strictly as per the total spending of the state in any financial year – the more overall expenditure meant a good dose of OD as well. Post-1990, however, it has more reasons for spiralling up.
Rather explained the position on the floor of the house on March 9, 2002. Attributing the fiscal imbalance in public finance to the mounting pressure on security-related expenditure (SRE) – Rs 1,658.58 crore incurred ending 1997-98 of which Rs 774 crore was outstanding with the centre; salary to migrant employees worth Rs 420 crore; budgetary support to corporations at Rs 239 crore and Rs 82 crore for the India Reserve Police battalions, Rather said: “Withholding this amount led to an uncovered gap of Rs 1,129 crore spent on security items and this is reflected in overdraft and resources shortage of the state.”
OD has always remained an expensive business. For a varied set of reasons, the interest rates remained harsh. Till 1997-98, according to the Comptroller & Auditor General (CAG) J&K Bank charged the state government 16 per cent for a temporary loan of Rs 550 crore and 20.75 per cent for any amount exceeding this limit. In 1998-99 the rate for interest for the two categories was changed to 15.81 percent and 21.42 percent, respectively.
In 1999-2000, it changed to 14.03 per cent and 21.42 per cent and in 2000-01 to a further 13.75 per cent and 19.5 per cent, respectively. Since October 2001, it further changed to 13 and 15 percent. Besides, the bank would charge it another five per cent if the OD level dropped below Rs 600 crore. This was done to evade any losses by keeping money on call – not investing that much money anywhere where it would have better yields.
In January 2003, the new rate regime took over – 12 per cent to Rs 1000 crore and 13.50 per cent of the loans exceeded that limit. The committed charges on unavailed portion were finally waived. This was perhaps why when Muzaffar Hussain Beig took over as the finance minister he said they are availing OD at “killing rates”. In December 2003 he renegotiated the interest rate and reduced it further. “The state government has paid an amount of Rs 861.06 crore as interest from April 1996 to October 2003 to the bank,” he said.
Baig’s Interventions
Successive regimes did talk about managing the OD menace. Initially, it was the lip service but as the public kitty bled, there was an element of seriousness also. The first major effort was that of Muzaffar Hussain Beig who was shocked that his first two hours in office surged the OD from Rs 1123 crore to Rs 1150 crore. Later, he shocked people in his maiden vote on account speech in March 2003. “We began to live in a fiscal sin and the budgets that we produced as an annual ritual, were illegitimate,” Beig said while announcing that the government is working to adopt the RBI Ways and Means system to come out of the OD trap.
Well before Beig came with his regular budget for fiscal 2003-04 in June 2003, he had sent a detailed proposal to the union finance ministry and the RBI. The focus was to manage acceptance of his idea that various Financial Institutions (FI) would subscribe to the low-cost bonds that his government would float and the amount would go to liquidate the OD, then slightly over Rs 1200 crore. RBI offered them two options. Once the OD gets adjusted RBI would implement the ways and means directly or operationalise it through J&K Bank.
Beig offered an idea. “For this (transition from OD to RBI ways and means) the OD would be either taken over by union government or by other device of financial engineering in such a way that its servicing burden on the state budget is correspondingly reduced,” Beig said in his budget speech. J&K proposes to write off the existing stock of debt and transition from the present OD system to RBI ways and means and the advances would be made in three years. To facilitate this move, the union finance ministry has agreed to take over the outstanding debt in phases, he said.
As Beig’s team started working on the next budget, the central government rejected their vision of the system they wanted to adopt. The government submitted a new proposal under which it offered it would privately place government securities worth Rs 800 crore with the JK Bank. The tenure of these securities would be 10, 11 and 13 years bearing a coupon of 50 to 80 basis points above the prevailing market rate. These will be tradable and JK Bank can off-load these in the market as and when there is appetite for the paper.
The union finance ministry had conveyed it would provide a grant of Rs 400 crore as an “incentive to move to a fiscally more prudent system”. Together, the two systems would clear almost the entire OD and help the state government to accept RBI ways and means in future. Besides, the state government was seeking approval for additional market borrowing of Rs 300 crore.
Barring the exchange of papers there was no progress. The central government was pushing the idea but the delay in Srinagar led the babus in Delhi to pull the strings and delay devolutions. Finally came the budget of finance minister P Chidambaram for 2004-05 in which he announced releasing Rs 300 crore to J&K government for managing its overdraft with the JK Bank after it adopts the RBI Ways and Means.
Within two days after this announcement Beig deferred his plans of adopting RBI ways and means. The major reason for rejecting the idea was the new system was reducing the OD facility to a “useless extent” thus devouring the government’s capacity to manage smooth governance. Six years later when his successor signed the agreement Beig termed it “a brazen sell out of state interests”.
The Exit
When Omar Abdullah’s government decided to avail the exit – available for the last many years – it somehow skipped going into the records. It directly links the decision to the 13th Finance Commission while the fact is that earlier FCs also talked about it in their meetings with the state government and the issue was on the agenda of all the finance ministers from NDA days.
When the 13th Finance Commission visited the state, the cabinet discussed the issue and a memorandum was handed over to it. It requested a one-time grant of Rs 750 crore to help the state manage the OD. Later, when Chief Minister Omar Abdullah had an interaction with the commission led by its chairman Dr Vijay L Kelker, he pleaded for a one-time Rs 1500 crore grant. The OD, he said, has become a structural reality rather than an interim necessity.
Finance Minister Pranab Mukherjee tabled Kelkar’s report in the parliament on Feb 25, 2010. It tackled many issues related to J&K including the state government’s fiscal reform proposal wherein it has pledged to invoke RBI ways and means regime. The Commission recommended a conditional fiscal reform grant of Rs 1000 crore suggesting the state government shall meet the balance amount (Rs 1300 crore) of overdraft through market borrowings, duly permitted by the finance ministry, over and above the annual borrowing ceiling of the state government.
Admitting the new system will mean J&K’s allowable fiscal deficit would be greater than the fiscal deficit consistent with fiscal responsibility laws (FRL), Kelkar said the one-off incentivisation measure will have long-term benefits for fiscal consolidation. He suggested that this amount should not be taken into account when calculating the state’s consistent fiscal deficit. Commission had sought the system to be implemented in 2010-11 (during which it did not take place) insisting that the grant may not be available to the state after 2011-12.
Interestingly, the state government will have to liquidate half of OD to become eligible for the Rs 1000 crore grant. “In case the market borrowing is raised in tranches, the grant shall be released in equal proportions,” the report said. The commission has clearly said that if at any stage, the J&K government violates ways and means advance or overdraft limits as applicable (under the new system to be supervised by RBI), fiscal reform grant to that extent shall be considered as National Plan for Regional Development (NPRD) grant and deducted from devolutions under NPRD. It is this regime that will take over now.
Flexibility Over
Tons of newsprint were consumed in the last week to debate the merits and demerits of the agreement. Parties and individuals are invariably targeting the government for losing “the apparently last fig leaf of its autonomy”. The political dimension of the deal is clear.
But the deal could increase the risks involved in governing J&K, a highly unpredictable and equally sensitive state. Plan devolutions and in certain cases, non-plan funds take its own time to reach Srinagar. But the requirement of any government for funds on the ground rarely waits. There lies the tip of the crisis. This could eventually lead the government to use its score odd corporations to borrow from the bank adding to the mess and indiscipline in the public finances. The agreement has added a new dose of formality to the relationship between the state government and J&K Bank.
The two have all along supplemented each other and that yielded good results. The new tripartite relationship could upset that equation as RBI has power to pull the strings from both sides. Earlier RBI as the regulator was “advising” the bank to walk out of some of the initiatives of the government, now as custodian of the state’s cash management system it will influence the policy-making at the secretariat level.
As the new system is still more than 60 days away, experts say, the government can negotiate the deal afresh. If a Congress-governed centre wishes to get its ally’s government out of the fiscal mess, it can still release a Rs 1000 crore grant. For the balance sum, the state government can place private securities with J&K Bank with a staggered payment schedule. No bank in India can be prevented from lending 40 per cent of its net worth to one customer and in this case,e the government can avail Rs 1100 crore at any time. Interest rates could always be negotiated.
The debate over the agreement has given the impression that the state government is desperate to save just over Rs 200 crore of OD interest and divert it for larger developmental causes. The fact is that an average nine per cent of state’s overall expenditure in any financial year goes as interest payment. For the current fiscal that means a resource outgo of Rs 2338.56 crore.
