Net Borrowing Ceiling on States by Centre

Context: Kerala has raised a challenge against the Centre’s imposition of a Net Borrowing Ceiling (NBC) in the Supreme Court, arguing that it infringes on fiscal independence and state sovereignty. The Court will examine whether the Centre’s borrowing limits potentially conflict with federal principles and the fiscal autonomy of States, and whether this interferes with the RBI’s role as public debt manager.

Net Borrowing Ceiling (NBC)

• Objective: Limits the borrowing capabilities of States from all sources, including open market borrowings, loans from financial institutions, and public account liabilities.
• Expanded Scope: Includes debt accrued by state-owned enterprises if it is covered by the State’s budget.
• Authority: The Centre enforces the NBC under Article 293(3) of the Indian Constitution, with the power to impose conditions on state loans.

Borrowing Powers under the Constitution

• Centre’s Power (Article 292): Allows the Centre to borrow upon the security of the Consolidated Fund of India.
• State’s Power (Article 293): Permits States to borrow on the security of the Consolidated Fund of the State, with conditions that require Centre’s consent if the State has outstanding loans or guarantees from the Centre.

The Kerala Case

• Imposition of NBC: The Centre restricted Kerala’s borrowing to 3% of its projected Gross State Domestic Product (GSDP) for FY2023-24, encompassing open market loans, financial institution loans, and liabilities from the State’s public account.
• Extended Coverage: To prevent circumventing borrowing limits via state-owned enterprises (like Kerala Infrastructure Investment Fund Board), the NBC includes borrowings by these entities.
• State Concerns: Kerala argues that the NBC imposes severe constraints on its borrowing capacity, impacting expenditures on essentials like pensions and welfare programs.
• Constitutional Issue: Kerala contends that including public account balances, such as provident funds and small savings under Article 266(2), in the NBC breaches constitutional rights and that the Centre cannot legislate on ‘public debt’ of States under the State List’s Entry 43.

Central Government’s Justification

• Legal Basis (Article 293(3)): States require Centre’s consent to borrow if any past loans from the Centre remain unpaid.
• Fiscal Discipline (15th Finance Commission): Emphasized fiscal discipline and cautioned against off-budget borrowing, supporting the Centre’s limitations.
• Transparency Objective: The NBC aims to ensure clear, accountable borrowing practices to prevent hidden liabilities.

Impact of NBC on States

• Challenges to Fiscal Decentralization: The NBC’s restrictions may undermine fiscal decentralization, limiting States’ financial freedom necessary for equitable development.
• Constrained Development Spending: The cap restricts State capacity to finance critical social and economic initiatives, affecting overall development.
• Limited Revenue Sources: States have constrained tax powers, with additional revenues like Cess and Surcharge not shared, further curtailing fiscal flexibility.

Steps Toward Cooperative Federalism

• Historical Perspective: The Government of India Act 1935 had loan grant safeguards that might provide a framework for current times.
• Risk to Cooperative Federalism: Strict borrowing limits may hinder cooperative federalism by limiting States’ financial management capabilities.
• Recommendation for a Commission: Based on Ananthasayanam Ayyangar’s advice, establishing a body similar to the Finance Commission could help balance fiscal discipline with State autonomy.
• Fiscal Responsibility & Budget Management (FRBM): Kerala’s commitment to reducing its fiscal deficit to 3% of GSDP by 2025-26 underlines its fiscal discipline; however, external fiscal restrictions may impede this goal.

Guidelines for Centre’s Role in Borrowing Controls:

1. Transparency: Borrowing-related decisions should be openly communicated.
2. Consultative Process: Dialogue with States should occur before implementing borrowing limits.
3. Equity: Borrowing terms should apply uniformly across all States.
4. Autonomy Respect: Fiscal restrictions should not obstruct a State’s financial management or development goals.
5. Balanced Fiscal Management: Transparent and fair borrowing guidelines will strengthen cooperative federalism and encourage sound fiscal practices.