Recent news highlights that the Enforcement Directorate (ED) has initiated a preliminary inquiry into the overseas borrowings by the Kerala Infrastructure Investment Fund Board (KIIFB). The probe is to determine whether these borrowings breach the Foreign Exchange Management Act (FEMA) provisions of 1999. KIIFB, a body established to manage the Kerala Infrastructure Investment Fund under the KIIF Act 1999, saw its role evolve in 2016. From being an entity managing investment bonds, it morphed into a resource-mobilizing body for developmental projects above and beyond the budget.
Key Findings
The Comptroller and Auditor General (CAG) underscored that in 2019, the KIIFB raised Rs. 2,150 crore from the international market without the Central government’s consent. This action breaches regulations as any state government must seek the Government of India’s approval before loan raising. Moreover, the KIIFB exceeded its legal capacity by issuing masala bonds to source funds from foreign markets, thereby violating Article 293 (1) of the Constitution.
Article 293 (1) specifies that a State’s executive power includes borrowing within India upon the security of the State’s Consolidated Fund within certain limits.
Investigation by Enforcement Directorate
The ED sought information from the Reserve Bank of India (RBI) regarding the ‘no objection certificate’ allegedly issued to the KIIFB. This certificate would have enabled the agency to take out substantial loans from the foreign financial market.
Potential Consequences of the Inquiry
This investigation could cause a significant drop in KIIFB’s revenues and impact the loans extended to KIIFB by the International Finance Corporation, an arm of the World Bank group. Investors may be hesitant to invest in its masala bonds due to the ongoing inquiry, leading to additional revenue loss.
The audit could also lead to administrative paralysis, potentially halting all infrastructure development projects in which KIIFB invested.
Kerala Government’s Stand
The Kerala government disagrees with the CAG’s findings, stating that KIIFB, being a corporate entity, is not subject to the same regulations as the state government. According to FEMA provisions, corporate entities are free to issue masala bonds to procure funds from foreign markets.
Masala Bonds and their Regulations
Masala bonds are rupee-denominated bonds that Indian companies use to source funds from overseas markets in Indian rupees. As per RBI regulations, any corporate body or Indian bank can issue these bonds overseas. These bonds can be subscribed by residents of countries that are members of the financial action task force (FATF) and whose securities market regulator is an International Organisation of Securities Commission (IOSCO) member.
Constraints on Using Funds Raised from Masala Bonds
According to RBI regulations, funds raised through these bonds cannot be used for real estate activities, except for developing integrated townships or affordable housing projects. Nor can these funds be used for capital market investment, land purchases, or lending to other entities for such activities.
