Context

• In 2023, the central government introduced a Net Borrowing Ceiling (NBC) for the State of Kerala, restricting the maximum permissible borrowing under law to 3% of the projected Gross State Domestic Product (GSDP) for the fiscal year 2023-24.
• This measure has significantly impacted Kerala’s fiscal position, making it challenging for the State to meet expenditure needs and limiting its investment in developmental and welfare projects.
• Amid these developments, it is important to explore the legal and constitutional issues surrounding the borrowing powers of Indian States under Article 293 and examine the implications of fiscal restrictions imposed by the Centre on State autonomy.

Constitutional Basis for Borrowing Powers

• Chapter II of Part XII of the Indian Constitution defines the borrowing powers of both the Centre and the States.
• Article 292 authorises the central government to borrow on the security of the Consolidated Fund of India, while Article 293 empowers State governments to borrow within India using the security of the State's consolidated fund.
• Parliament and State legislatures may adjust borrowing limits through legislation as needed.
  • Article 293(2) provides that the Centre may lend to any State, subject to conditions set by parliamentary law.
  • Article 293(3) restricts a State from borrowing without central consent if it has any outstanding loans or guarantees from the Centre.
  • Article 293 is modelled on Section 163 of the Government of India Act, 1935, which established borrowing rules for British provinces.
• However, unlike Section 163(4), which provided a safeguard against unreasonable central delays or conditions on loans, the Indian Constitution did not adopt such provisions, given that post-Independence governance was entrusted to a national government expected to act in harmony with State governments. 

The Centre's Financial Control and the FRBM Act and Its Objective

• To implement the mandates in Article 292, the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 was enacted.
• The objective was to maintain financial restraint by establishing goals such as the elimination of revenue shortfall and the reduction of fiscal deficit.
• To eliminate the revenue shortfall and the budgetary deficit, a target of 3% of GDP is established for the Centre’s yearly fiscal deficit ratio (FD).
• As in the Centre’s directives, States enacted their own pieces of legislation to control their fiscal deficit.
• The FRBM Amendment Act, 2018 required the central government to ensure that the fiscal deficit did not surpass 3% of GDP and that the total public debt did not surpass 60% of GDP.
• By 2025–26, the government expects to reduce the fiscal deficit to less than 4.5% of GDP.

The Case Before the Supreme Court and Implications for Fiscal Federalism

• Key Issues in the Supreme Court Case
  • The primary contention in Kerala’s case is that the Centre’s NBC policy has overstepped constitutional boundaries by infringing on the State's fiscal autonomy, which is protected under Article 293.
  • Kerala argues that the Constitution grants States the right to borrow on the security of their Consolidated Fund, with Article 293(3) imposing restrictions on this right only in cases where a State has outstanding central government loans or guarantees.
  • However, Kerala asserts that the Centre’s NBC policy imposes sweeping restrictions on its borrowing capacity without regard for the State’s specific financial needs or development priorities.
• The Extent of Central Power Over State Finances
  • Furthermore, Kerala’s challenge raises questions about the extent of central power over State finances.
  • Article 293(4) grants the Centre discretionary authority to attach conditions to loans and borrowings, but Kerala argues that this discretion should not allow for arbitrary limitations that undermine a State’s constitutional rights.
  • The case thus centres on whether the Centre’s actions constitute an overreach of the powers granted under Article 293(4) and if they unjustly infringe upon State fiscal autonomy.
• Interpretation of Article 293 and the Scope of State Borrowing Rights
  • Recognising the significance of the case, the Supreme Court has referred the matter to a Constitutional Bench to determine whether the Centre’s restrictions on borrowing under the NBC align with the Constitution’s intent and provisions.
  • The Bench must determine whether the Centre’s discretion under Article 293(4) allows for overarching fiscal controls like the NBC or whether this authority is limited to cases where a State’s existing central loans necessitate restrictions.
  • A restrictive interpretation could safeguard States’ fiscal autonomy, while an expansive interpretation could legitimise greater central control over State finances.
• Impact on Fiscal Federalism
  • The case brings to the forefront the ongoing debate about fiscal federalism in India.
  • Fiscal federalism implies a system where both the Centre and the States enjoy financial independence to manage their revenues and expenditures.
  • However, the NBC policy challenges this notion by imposing a uniform borrowing cap on all States, potentially disregarding the unique fiscal needs of each State.
  • The Court’s interpretation will play a crucial role in either reinforcing or weakening India’s federal structure by setting the boundaries for State fiscal independence.

Potential Outcomes and Consequences of Supreme Court’s Interpretation

• If the Court Upholds the NBC Policy
  • A decision in favour of the Centre would reinforce the central government’s authority to impose fiscal restrictions on States.
  • This outcome could set a precedent, enabling the Centre to exercise stronger financial oversight over State budgets and borrowing practices.
  • However, it might also spark dissent from other States that view this as a threat to their autonomy, potentially leading to tensions within the federal system.
• If the Court Limits the Centre’s Discretion
  • Alternatively, if the Court rules that the Centre’s discretion under Article 293 is limited and cannot override States’ borrowing rights, it would reaffirm the constitutional principle of fiscal federalism.
  • This decision would strengthen State autonomy and could encourage a more cooperative approach to fiscal management, where both levels of government work together to balance fiscal responsibility with local needs.

The Path Forward:

• Establishment of a Commission on the Lines of Financial Commission
  • A commission akin to the Finance Commission should be instituted to assess State loan requests considering both the State’s financial needs and the Centre’s goal of fiscal consolidation.
  • Such a commission would ensure that borrowing terms are set transparently and equitably.
• Transparent Decision-Making and Consultative Process
  • The Centre should make its procedures for granting or denying State borrowings publicly available.
  • Transparency in decision-making would reduce the potential for bias and enhance trust between the Centre and States.
  • The Centre should consult with State governments before imposing loan conditions or restrictions.
  • A collaborative approach would create cooperative federalism and respect for States’ fiscal needs.
• Uniform Borrowing Standards and Respect for Fiscal Autonomy
  • Any borrowing limits should be applied uniformly across States, ensuring that decisions are unbiased and do not favour any specific region.
  • Restrictions imposed under Article 293(4) should be reasonable, allowing States adequate financial independence while promoting fiscal discipline.

Conclusion

• The imposition of a Net Borrowing Ceiling on Kerala highlights the need to revisit and possibly reform Article 293 of the Indian Constitution.
• While fiscal responsibility is essential, the Centre’s overarching control over State borrowing has the potential to undermine the federal structure by limiting States’ financial autonomy.
• The establishment of clear guidelines and a financial commission to manage State borrowing would provide a more equitable and transparent approach, allowing States to manage their finances effectively within a federal framework.