The story so far: The Supreme Court on Monday declined any interim relief to Kerala in its suit seeking that the Union government relax its borrowing restrictions to enable the State to borrow additional funds during the current fiscal year. It also refused to stay the operation of two letters issued by the Union Finance Ministry last year and certain amendments made to the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, in 2018 that imposed borrowing cap restrictions on States.
Kerala moved the top Court last year accusing the Union government of arbitrarily imposing a Net Borrowing Ceiling (NBC) on the State, which brought it to the brink of a financial crisis as it could not no longer pay salaries and pensions or fulfil other essential financial commitments.
A bench of Justices Surya Kant and K.V. Viswanathan also referred to a Constitution Bench the larger questions of law raised in the suit, such as whether Kerala had an “enforceable right” under Article 293 of the Constitution to raise its borrowing limits from the Union government and other sources.
Net borrowing ceiling
The NBC imposes a limitation on borrowings of a State from all sources including open market borrowings. The Union government decided to deduct liabilities arising from the public account of the States to arrive at such a cap. Additionally, borrowings by State-owned enterprises, where the principal and/or interest are serviced out of the Budget or through assignment of taxes, cess or any other State revenue, are also deducted from the NBC.
The NBC for States is fixed at 3% of the Gross State Domestic Product (GSDP) or ₹8,59,988 crore in absolute terms for the Financial Year (FY) 2023-24 as recommended by the 15th Finance Commission. On December 5 last year, Finance Minister Nirmala Sitharaman, while responding to a question raised by CPI(M) MP John Brittas in the Rajya Sabha, clarified that the NBC for Kerala is pegged at ₹32,442 crore for FY 2023-24.
Kerala has opposed the inclusion of debt of State-owned enterprises as its own debt. Infrastructure projects initiated by the State government are funded primarily by the Kerala Infrastructure Investment Fund Board (KIIFB), a statutory body, through extra-budgetary borrowings. Due to the inclusion of the debt of the KIIFB in the NBC, the State has claimed that it is unable to pay salaries and meet expenses for welfare schemes. Notably, no prior Finance Commission has recommended the inclusion of the debt of State-owned enterprises in the NBC.
In November last year, Kerala Chief Secretary V. Venu apprised the Kerala High Court that the State was in a “deep financial crisis” and was finding it difficult to clear the dues of its employees. The Court was hearing a petition filed by a retired KSRTC employee claiming that his pension was on hold.
Fiscal autonomy under the Constitution
Article 293 of the Constitution permits States to borrow only from within the territory of India on a guarantee from the consolidated fund of the State and within such limits as outlined by the legislatures of each State. The subject “Public Debt of the State” finds mention in Entry 43 of the State List of the Constitution and thus the Parliament cannot legislate or administer upon such matters. If a State wishes to borrow from the Centre, then such a transaction will be regulated by the FRBM Act, 2023.
Pertinently, under Article 293(3), the State has to obtain the consent of the Centre to raise “any loan,” if “any part of the previous loan” extended by the Centre is outstanding. The NBC has been imposed by invoking the powers of the Centre under this provision.
To contend that the balances in the public account of the State should not be included in the NBC, Kerala has relied upon Article 266(2) which stipulates that the money collected by the Central or State government which does not pertain to the consolidated fund can be brought under the head of ‘public accounts.’ These include small savings, security deposits, provident funds, reserve funds and other treasury deposits. All activities pertaining to such public accounts fall squarely within the domain of the State legislature.
It has also been argued on behalf of the Kerala government that the scope of Article 293(3) and (4) is limited to the “States” as defined under Article 1(1) of the Constitution and cannot be extended to include the debt of government agencies, including companies and statutory bodies.
Kerala’s contentions
In December last year, Kerala filed a suit in the Supreme Court under Article 131 of the Constitution which empowers the Court to settle disputes between a State Government and the Union Government in the country. It alleged that the imposition of the NBC violates the principle of fiscal federalism and causes “severe damage to the economy of a small State with meagre resources.”.
The suit also challenged letters issued on March 27, 2023, and August 11, 2023, by the Ministry of Finance and the amendments made to Section 4 of the FRBM Act, 2003 through the Finance Act, 2018 that imposed the NBC, saying that they curtailed the constitutionally guaranteed fiscal autonomy of States. It further underscored that “the ability to determine the borrowing of the State in order to balance the budget and make up the fiscal deficit is exclusively within the domain of the States.”
Kerala further argued that the Union government cannot, under the pretext of “sound public financial management” violate or encroach upon the plenary powers of the States since “Public Debt of the State” is a subject exclusively reserved in the State List of the Seventh Schedule of the Constitution.
Highlighting that the Union government has a “dismal record of reining in its own debt,” the State contended that the Centre accounts for approximately 60% of the total debt or outstanding liabilities of India whereas all the States put together account for the remaining (approximately) 40% of the total debt of the country.”
Pointing out that it has been unable to fulfil the commitments in its Annual Budgets and pay pending dues to its employees and pensioners, the State demanded a sum of ₹26,000 crore from the Centre on an immediate basis to avert an impending financial crisis. It further stated that the net negative impact or loss sustained by the State’s economy over the next 5 years could be as high as ₹2 -3 lakhs crore.
The Centre’s stand
Responding to Kerala’s plea, the Attorney General for India R. Venkataramani submitted a written note to the Supreme Court claiming that the State’s financial woes can be attributed to its “fiscal mismanagement” over the last 20 years instead of the Centre’s actions. It asserted that the the setting of borrowing limits was done based on the recommendations of the Finance Commissions, and applied to all States equally.
It further added that the Finance Commissions make their recommendations keeping in mind the spirit of the FRBM Acts passed by the Centre and all of the States. One of the stated objectives of the Acts is to achieve a fiscal deficit target not exceeding 3% of the GDSP of a State, the note said. Each State has its own version of the FRBM Act along the lines of the central legislation and is used to regulate its fiscal deficit.
Referring to data sourced from the Reserve Bank of India (RBI), the Attorney General pointed out that Kerala’s outstanding liabilities as a percentage of its GSDP rose from 31 % in 2018-19 to 39% by 2021-22 while the average for all States was 29.8% in 2021-22.
“One of the major consequences of having a high outstanding liability ratio is enhanced outflow in terms of interest payments which in turn increases the deficit of the State and may result in a debt trap,” the note said, adding that Kerala’s interest payments as a percentage of its revenue receipts have climbed to nearly 20% as against the 14th Finance Commission’s recommended level of 10%.
The Court was further apprised that the 15th Finance Commission designated Kerala to be a “highly debt stressed” State and observed that it had “largely failed” to limit its fiscal deficit to 3% of GSDP for almost all of the past decade. Quoting the Commission’s report, the Attorney General pointed out, “The State has been breaching its FRBM targets with unhealthy levels of Revenue Deficit-Fiscal Deficit ratio (65% in 2018-19)....This implicitly explains why the State has resorted to borrowing to finance its revenue deficit.”
Supreme Court’s ruling
Highlighting that a “prima facie case” and the “balance of convenience” lay in favour of the Union government, the Supreme Court refused to pass any interim order to lift the net borrowing ceiling for Kerala or enable the State to borrow ₹26,226 crore on an immediate basis.
Also read | Kerala’s public debt comes down to ₹2.38 lakh crore
“If the State has essentially created financial hardship because of its own financial mismanagement, such hardship cannot be held to be an irreparable injury that would necessitate an interim relief against the Union… it might set a bad precedent in law that would enable the States to flout fiscal policies and still successfully claim additional borrowings,” the Court noted.
It also pointed out that the Centre had already allowed a “substantial relief” of ₹13,608 crore for the State to tide over the immediate crisis. However, the Court expressed disapproval of the condition imposed by the Centre that the State should withdraw the suit in return for financial help.
Noting that there exists a vacuum in the law concerning Article 293 of the Constitution, which deals with financial borrowings by States, the Bench referred the matter to a five-judge Constitution Bench which the Chief Justice of India would constitute later. Some of the questions of law framed for adjudication by the larger Bench include —
- What is the true import and interpretation of the following expression contained in Article 131 of the Constitution: “if and in so far as the dispute involves any question (whether of law or fact) on which the existence or extent of a legal right depends”?
- Does Article 293 of the Constitution vest a State with an enforceable right to raise borrowing from the Union government and/or other sources? If yes, to what extent can such right be regulated by the Union government?
- Can the borrowing by State-owned enterprises and liabilities arising out of the Public Account be included under the purview of Article 293(3) of the Constitution?
- What is the scope and extent of Judicial Review exercisable by the Supreme Court with respect to a fiscal policy, which is purportedly in conflict with the object and spirit of Article 293 of the Constitution?
