States Borrowing Power

In India, the states borrowing power is governed by the Constitution, under Articles 292 and 293, and further detailed in various legal and regulatory frameworks. Read further to learn more.

The fiscal autonomy of states in India refers to the degree of independence state governments have in managing their finances, including revenue generation, expenditure, and borrowing.

While the Indian Constitution provides a federal structure, allowing states a certain level of autonomy, the actual fiscal autonomy is nuanced, influenced by constitutional provisions, central legislation, and policies governing financial relations between the central and state governments.

These provisions outline the conditions under which the states can borrow and the limitations on such borrowing.

Understanding the borrowing powers of states in India requires a look into these constitutional provisions and the interplay between the central and state governments regarding fiscal matters.

Fiscal Autonomy of States

The Indian Constitution lays down a framework for fiscal federalism, dividing financial powers and responsibilities between the centre and the states. This division is primarily encapsulated in:

• Union List: Items on which only the central government can legislate and collect taxes.
• State List: Items on which states have the exclusive right to legislate and collect taxes.
• Concurrent List: Items on which both the Centre and states can legislate, but the central law prevails in case of conflict.

Revenue Generation:

• States have the authority to generate revenue from sources that are exclusively under their jurisdiction, such as land revenue, stamp duty, taxes on vehicles, and taxes on alcohol.
• However, major tax revenues, especially those from Goods and Services Tax (GST), Income Tax, and Corporate Tax, fall under the central government’s purview or are shared between the centre and states.

Expenditure and Financial Responsibilities:

• States have the autonomy to spend their resources on subjects listed in the State List and have to contribute to those in the Concurrent List.
• However, the financial capacity to meet these responsibilities varies greatly among states, leading to disparities in the quality of governance and public services.

Grants and Transfers:

The central government provides financial assistance to states through various mechanisms, including:

• Statutory Grants: Based on recommendations from the Finance Commission, a constitutional body that determines the distribution of tax revenues between the Centre and states, and among the states themselves.
• Central Sponsored Schemes: For specific projects or objectives, which require states to contribute a portion of the funding.
• Special Grants: For states that may need additional assistance due to natural disasters, a lack of resources, or other factors.

Constitutional Provisions for States Borrowing Power

• Article 292: This article pertains to the borrowing powers of the Union government but sets a precedent for similar structures at the state level. It allows the Union government to borrow upon the security of the Consolidated Fund of India.
• Article 293: This article specifically deals with the borrowing powers of states. Key points include:
  • State Governments’ Borrowing Powers: States are allowed to borrow within the territory of India upon the security of the Consolidated Fund of the State. This power is subject to any limitations that Parliament might decide to impose.
  • Restrictions on Borrowing by States Already Indebted to the Centre: If a state owes any money to the central government, it cannot raise any loan without the consent of the Government of India. This consent can be conditional, and the Centre has the power to impose specific conditions as it deems necessary.
  • Borrowing from Foreign Sources: States are not allowed to raise any loan or give any guarantee outside India without the consent of the Government of India.

Fiscal Responsibility and Budget Management (FRBM) Act

• The FRBM Act, enacted by the Parliament of India in 2003 and amended several times since further regulates the fiscal management practices of the central and state governments. It sets targets for the government to ensure fiscal discipline, reduce fiscal deficits, and manage public funds more efficiently.
• The Act also places limits on the deficits that states can incur and their total outstanding liabilities. However, the central government can relax these limits, considering specific circumstances or state-specific fiscal reform measures.

Role of the Central Government

• The central government, through the Ministry of Finance and its associated bodies, monitors and regulates the borrowing activities of the states to ensure that their fiscal operations do not negatively impact the overall economic stability and fiscal policy of the country.
• It also provides guidelines and, in some cases, financial assistance to states to encourage fiscal responsibility and efficient debt management.

Impact of the Goods and Services Tax (GST)

• The introduction of the GST in 2017, which subsumed a majority of state and central indirect taxes into a single tax, had implications for the fiscal autonomy of states, including aspects of their borrowing powers.
• The central government promised to compensate states for any loss of revenue resulting from the implementation of GST. This factor also plays into the fiscal and borrowing dynamics between the central and state governments.

Why in the news?

The Supreme Court on April 3 2024 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 keep operating two letters issued by the Union Finance Ministry in 2023 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 in 2023 accusing the Union government of arbitrarily imposing a Net Borrowing Ceiling (NBC) on the State.
• This NBC brought the state to the brink of a financial crisis as it could not no longer pay salaries and pensions or fulfil other essential financial commitments.

Net borrowing Ceiling (NBC)

The net borrowing ceiling of states in India refers to the limit imposed on the amount of money that state governments can borrow in a financial year.

• This ceiling is crucial for maintaining fiscal discipline and ensuring that states do not accumulate unsustainable levels of debt.
• The framework for these ceilings is influenced by several factors, including recommendations from the Finance Commission, the Fiscal Responsibility and Budget Management (FRBM) Act, and specific guidelines issued by the central government, particularly the Ministry of Finance.

Basis of the Net Borrowing Ceiling:

• Fiscal Responsibility Legislation: Both the central and state governments in India are guided by the FRBM Act, which sets targets for fiscal deficits to ensure fiscal discipline. For states, the FRBM mandates a fiscal deficit limit of 3% of the Gross State Domestic Product (GSDP).
• Finance Commission Recommendations: The Finance Commission, which is constituted every five years, recommends how the central taxes are to be divided between the centre and the states and suggests measures to maintain fiscal stability. It also provides recommendations regarding the borrowing limits of states.
• Central Government Guidelines: The central government, through the Department of Expenditure in the Ministry of Finance, sets the annual borrowing limits for each state based on a formula that considers the state’s GSDP, existing debt levels, fiscal discipline, and other relevant factors. These limits can be revised in response to special circumstances, such as natural disasters or significant economic downturns.

Adjustments and Flexibility:

The net borrowing ceiling can be adjusted to provide states with additional borrowing capacity under certain conditions:

• Performance-Based Incentives: States demonstrating good fiscal performance, such as maintaining expenditure discipline while increasing revenue collection, can be allowed additional borrowing room. This is designed to incentivize states to improve their fiscal health.
• Specific Conditions: During times of economic stress or for financing specific projects, the central government may relax the borrowing limits. For example, in response to the COVID-19 pandemic, the central government temporarily increased the borrowing limit for states.
• Linkage to Reforms: The central government has also linked additional borrowing permissions to the implementation of specific reforms, such as improvements in power sector performance, increasing urban local body revenues, or implementing business reform action plans.

Conclusion

The borrowing powers of states in India are primarily defined by the Constitution and further regulated by legislative acts such as the FRBM Act.

While states can borrow within the framework set by these laws, their borrowing is subject to limitations and conditions, especially concerning debts owed to the central government and borrowing from external sources.

This structure ensures a balance between state autonomy in fiscal matters and the maintenance of national fiscal discipline and stability.

Related articles:

• Fiscal federalism in India
• Devolution of powers and finances up to local levels
• Functions and responsibilities of the Union and the states

-Article by Swathi Satish