Masala bonds: ED tightens noose around ex-Kerala FM Thomas Isaac

Considered a brainchild of the then finance minister, masala bonds have backfired against the Pinarayi Vijayan government

On May 17, 2019, when Chief Minister Pinarayi Vijayan rang the bells at the London Stock Exchange, Kerala was creating history by becoming the first state to tap Masala bonds to raise money for development.

The state-owned Kerala Infrastructure Investment Fund Board (KIIFB) also became the first sub-sovereign entity in India to tap the offshore rupee international bond market. The proceeds of the bonds were used for part-financing infrastructure rebuilding in Kerala, which was hit by floods in 2018. Considered a brainchild of then finance minister Thomas Isaac, it is the Masala bonds that have backfired against the Vijayan government and Isaac, as the Enforcement Directorate (ED) and the Comptroller and Auditor General (CAG) have objected to the modus operandi.

Masala bonds are rupee-denominated bonds issued outside India by Indian entities.

Through its debut Masala bond, the KIIFB had raised Rs 2,150 crore, which was part of its larger road map to mobilise Rs 50,000 crore to fund major infrastructure projects. Earlier this month, the ED had registered a case against the KIIFB and served notice to Isaac and KIIFB officials, for allegedly violating guidelines of the Foreign Exchange Management Act (FEMA). According to Isaac, the agency issued summons to him, asking for details on his role in the KIIFB’s fund raising. Isaac had approached the Kerala High Court, challenging the proceedings initiated against him but the court refused to stay the summons issued by the ED. On August 17, the court adjourned the matter to September 2.

Regarding the ED action, Isaac and the party, the CPI(M), are of the opinion that it is the Reserve Bank of India (RBI) that should raise the issue of FEMA violation and the ED has no authority to register a case on the issue. He told the media that this was a political move by the BJP government using Central agencies.

“This is a clear-cut case of harassment,” Isaac told the media.

Isaac is getting support from unlikely corners like the Congress on the matter. The leader of the Opposition in the Assembly, V D Satheesan, said the ED could not probe foreign financial transactions like Masala bonds and hence its notice to Isaac had no validity.“Here the issue is that a loan was taken from abroad at a higher interest rate. I believe that it will not come within the ED purview,” he said.

How does it affect the state?

According to the BJP, there is no politics involved in the case, but it has some substance. “Masala bonds are something that resulted in a huge loss to Kerala. We could have raised debt at lower interest rates but because of Isaac, the state had to suffer higher interest rates. He approached it with vested interests and Masala bonds became a financial liability for the state,” BJP state President K Surendran told Business Standard.

“Isaac should understand that he is not above the law of the land,” Surendran added.

The KIIFB came into existence in November 1999 as an agency to handle investment bonds of the state government. It was only in 2016 that the first Vijayan government converted it into an entity to mobilise resources for developmental projects beyond the Budget. It was announced by Isaac in his 2016-17 Budget.

The CAG had been criticising the government for off-Budget borrowing made through the KIIFB. The auditor stated that borrowing through the KIIFB and Kerala Social Security Pension Ltd might result in a huge debt trap for the state. As against the stipulation that the debt should be 29.67 per cent of gross state domestic product (GSDP), the state’s debt has touched 39.87 per cent. Adding off-Budget borrowing, which is not within the purview of the Assembly, this debt figure will increase to 42.80 per cent, the CAG cited in its report this year. The state’s debt had increased to Rs 3.24 trillion in the last five years, as compared to Rs 1.9 trillion, of which off-Budget borrowing, including that of the KIIFB, stood at around Rs  16,496 crore.

“The Centre is using investigating agencies against the state governments belonging to other parties. This holds good not just for Kerala but other states as well. At the same time, we cannot overlook the fact that there are questionable things being done by the state government, such as financial transactions outside the budgetary system,” said B R P Bhaskar, a political analyst.