THE SEVERE EROSION OF FISCAL FEDERALISM

THE CONTEXT: The debate surrounding Kerala’s protest of the Centre’s imposition of a Net Borrowing Ceiling (NBC) underscores a growing concern over the erosion of fiscal federalism in India. This brings into the limelight the conflict between the constitutional autonomy of states to manage their finances and the Centre’s regulatory mechanisms intended to ensure fiscal discipline and transparency.

THE ISSUES:

• Net Borrowing Ceiling (NBC): The NBC is a limit set by the Centre on the total amount that states can borrow from all sources, including open market operations and loans from state-owned enterprises. Specific to Kerala, the NBC now includes debts incurred by the Kerala Infrastructure Investment Fund Board (KIIFB), which funds infrastructure projects through extra-budgetary routes. Including KIIFB’s debts under the NBC restricts Kerala’s financial autonomy, directly impacting its ability to fund welfare schemes and pensions.
• Constitutional Limits and Fiscal Federalism: Article 293(3) requires states to seek the Centre’s permission to borrow if they have any outstanding federal loans. The imposition of the NBC by the Centre is under this article, which Kerala contends is a violation. Kerala’s legal stance to move to the Supreme Court suggests that the Centre’s decision infringes on the state’s constitutional rights to manage its public debt (Entry 43, State List) and public accounts (Article 266(2)).
• State Fiscal Responsibility and Transparency: Kerala Fiscal Responsibility Act, 2003 mandates reducing the fiscal deficit to 3% of Kerala’s Gross State Domestic Product (GSDP) by 2025-26. Kerala’s fiscal deficit has been reported at 2.44% and the revenue deficit at 0.88% of the GSDP, indicating a responsible fiscal approach compared to the Centre’s fiscal deficit, pegged at 5.8% for 2023-24.
• Impact on Governance and Welfare Implications: The restricted borrowing capacity directly impacts the state’s social obligations, such as funding pensions and welfare programs essential for balanced socio-economic development. The KIIFB’s innovative financial strategy for infrastructure development in Kerala is a model of how state autonomy can be effectively utilized for the public good, which NBC hinders.
• Assessment of Federal Dynamics: The shift in Federal Structure by transitioning from cooperative federalism towards a more ‘annihilative federalism,’ where the Centre’s stringent controls over state finances limit the states’ operational independence. Examination of this shift in India’s federal structure reflects on the long-term implications on centre-state relations and the principle of subsidiarity.
• Borrowing Restrictions: The 15th Finance Commission recommended that 41% of the net proceeds of Union taxes be shared with the states. However, the Centre’s decision to include off-budget borrowings done by states while deciding their borrowing limits led to a sharp decrease in such borrowings. This has been seen as a restriction on states’ ability to borrow and manage their finances, with Kerala particularly affected due to the inclusion of the debt of KIIFB in the NBC.

THE WAY FORWARD:

• Seek Judicial Clarification: Given that Kerala has moved the Supreme Court on the matter, one solution is a judicial review of the constitutional validity of the NBC with respect to Article 293(3) and Article 266(2). The Court’s interpretation could resolve disputes regarding the constitutional limits of the Centre’s authority over state borrowing.
• Review of 15th Finance Commission Recommendations: The issues stemming from interpreting the 15th Finance Commission’s recommendations could be re-examined. States can engage with the Finance Commission or the Union Finance Ministry to advocate their concerns and seek a more nuanced approach that doesn’t infringe on states’ fiscal autonomy while upholding fiscal sustainability.
• Legislative Action: Parliament could consider enacting legislation or amending existing laws (subject to constitutional limits) to clarify the scope of central oversight on state borrowings. This should respect the balance of fiscal federalism and be designed after extensive consultations with states.
• Strengthen Cooperative Federalism: Regular high-level meetings between the Centre and States, through forums like the GST Council or a specially convened fiscal policy council, could help facilitate dialogue. These meetings would aim to negotiate borrowing limits and ensure that states have enough financial leeway to meet their obligations.
• Promote Fiscal Responsibility at the State Level: States can take proactive steps to strengthen their fiscal management, as Kerala has done through the Kerala Fiscal Responsibility Act. By setting clear deficit targets and budget management practices, states can demonstrate their commitment to fiscal prudence, potentially increasing their negotiating power with the Centre.
• Build a Consensus on Public Account Handling: The issue of including public account withdrawals within the NBC could be addressed by building a broader consensus among all states, which can then be presented to the Centre in a united front to exclude such transactions from the borrowing limits.
• Economic Reforms and Growth Promotion: Widening the tax base through economic reforms, boosting the investment climate, and promoting growth in the state’s own-source revenue can be sustainable ways of ensuring sufficient funds for state spending without reliance on borrowings.

THE CONCLUSION:

Kerala’s challenge against the Centre’s Net Borrowing Ceiling (NBC) imposition highlights a significant constitutional dispute over fiscal federalism and state autonomy in financial management. The state argues that the Centre’s restrictions on borrowing, including debts of state-owned enterprises and public account balances, infringe upon its constitutional rights. This legal battle underscores the tension between central oversight and state fiscal independence, potentially reshaping the dynamics of federal-state financial relations in India.

UPSC PAST YEAR QUESTION:

Q.1 Though the federal principle is dominant in our Constitution and that principle is one of its basic features, but it is equally true that federalism under the Indian Constitution leans in favour of a strong Centre, a feature that militates against the concept of strong federalism. Discuss. (2014)

Q.2 The concept of cooperative federalism has been increasingly emphasized in recent years. Highlight the drawbacks in the existing structure and the extent to which cooperative federalism would answer the shortcomings. (2015)

Q.3 How far do you think cooperation, competition, and confrontation have shaped the nature of federation in India? Cite some recent examples to validate your answer. (2020)

Q.4 Public expenditure management was a challenge to India’s government in the context of budget-making during the post-liberalization period. Clarify it. (2019)

Q.5 What are the reasons for introducing the Fiscal Responsibility and Budget Management (FRBM) Act, 2003? Discuss its salient features and their effectiveness critically. (2013)

MAINS PRACTICE QUESTION:

Q.1 Critically examine the contention between the State of Kerala and the Centre over the imposition of a Net Borrowing Ceiling (NBC) concerning Article 293(3) of the Indian Constitution. Analyze the implications of such a ceiling on fiscal federalism and state autonomy, along with its potential impact on state welfare schemes and infrastructure projects.

SOURCE:

https://www.thehindu.com/opinion/op-ed/the-severe-erosion-of-fiscal-federalism/article67818283.ece