The ongoing Court battle between Kerala and the Union government on public debt raises fundamental questions in federal fiscal relations and also whether a State can take independent fiscal decisions regardless of their consequences on the national economy.

At the heart of the issue is Article 293 of the Constitution which empowers the Centre to fix a Net Borrowing Ceiling (NBC) for a State if the latter is indebted to the former, which is the case with all States.

The NBC is fixed by the Centre according to a formula governed by FRBMA and Finance Commission (FC) Recommendations, allowing an extra 0.5 per cent over the 3 per cent FRBMA limit subject to a State implementing specified power sector reforms, plus its contribution to the New Pension Scheme and loan repayments made during the previous year.

The Centre contends that this ensures sustainable borrowing while ensuring improvement in power sector efficiency, while the State contends that it is an encroachment upon its constitutional jurisdictions.

The dispute arose with the Centre also including extra budgetary borrowings (EBB) of the State raised through its public undertakings and not reflected in the budget, which reduced its borrowing limit to only ₹20,690 crore, or by more than ₹17,000 crore, creating an acute financial crisis and jeopardising budget implementation.

It has upset the State’s own FRBMA targets and taken away its exclusive constitutional rights to determine borrowing to balance the budget.

Centre’s Argument

The Centre has argued before the Supreme Court that the State is under financial stress “purely due to its own financial mismanagement”. To circumvent the borrowing limits, it has resorted to EBB of ₹42,285 crore from 2016-17 to 2021-22 through the Kerala Infrastructure Investment Fund Board (KIIFB) and Kerala Social Security Pension Limited (KSSPL) which have no revenue sources of their own; hence their debts have to be repaid only through the budget. KIIFB is a statutory body that raises loans for investment in large infrastructure projects.

Similarly, KSSPL is a government company that disburses social security pensions by raising loans from the market which are serviced by the government through the budget.

Such EBBs, undisclosed in the Budget, are non-transparent means of financing fiscal deficit (FD). If all the EBBs are considered, the debt ratio of Kerala increases to 40.88 per cent for 2021-22, as against 38.7 per cent computed otherwise, way beyond the 32.6 per cent limit prescribed by 15th FC for the year.

While underlining the need for fiscal discipline, the Centre pointed to the adverse consequences of unsustainable levels of government debt and borrowing, like lowering of the country’s sovereign credit rating with its adverse macroeconomic consequences upon the national economy.

Kerala may well be one of the most profligate States, with its FD exceeding 5 per cent in FY 2022, of which the revenue deficit accounted for more than 3 per cent. But the Centre is guilty of the same infractions it is accusing Kerala of.

Shifting goal posts

The Centre’s FRBMA (2003) itself has been amended four times through the Finance Acts — in 2004, 2012, 2015, and 2018, each time shifting the original target of achieving 3 per cent fiscal deficit and zero revenue deficit by March 2008 to farther and farther away. It has also introduced an escape clause that allows the Centre an easy route to deviate from its FRBMA targets.

As regards the EBBs, what the KIIFB does — borrowing from the market to execute infrastructure projects for government — is similar to what NHAI and other central bodies do for the Central government — raising loans through “Fully Serviced Bonds” serviced by the Centre through its Budget allocations. Another mechanism is through the National Small Savings Fund (NSSF) which is a part of the Union Government’s Public Account, withdrawal from which does not require Parliamentary approval, which enables the Centre to use as routinely to finance its FD.

In FY 2020, the Centre, through a statement in the budget, disclosed a total EBB of ₹1.48-lakh crore, but CAG calculated that another ₹1.75-lakh crore remained undisclosed. Including both these figures, the actual FD would have been 1.6 percentage points higher than 4.6 per cent calculated for the year, way above the FRBMA limits. While the Centre includes EBBs for fixing the States’ NBC, does not do so for computing its own FD, reflecting an asymmetry in approach.

The Centre and States need to agree on what constitutes EBBs and mechanism for funding these debts and criteria for their disclosure. These disputes should be resolved in a consultative body like a GST Council where the Centre and States can evolve a consensus on such issues rather than the Supreme Court, which may not be equipped to handle the economic fallout of its decisions, which will be for the governments at the Centre and in the States to handle.

The writer is a former DG at the Office of the CAG

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