Explained | Modi Vs Pinarayi: The battle over borrowings

In December 2023, the Kerala government approached the Supreme Court against the Centre's borrowing limits, saying that the latter was taking away the state's rights.

In its plea, Kerala alleged that the Centre was arbitrarily imposing a net borrowing ceiling, thereby limiting the amount the former could raise through all sources, leading to an urgent requirement of around Rs 26,000 crore to meet its financial obligations.

The Left Democratic Front (LDF) government has accused the Union finance ministry of imposing a Net Borrowing Ceiling in a manner that limits it from raising funds from all sources, including open market borrowings

Further, the Centre has reduced the Net Borrowing Ceiling of the state by introducing aspects into the “borrowing”, which otherwise are not considered “borrowings.” This was done in two ways:

a) By deducting liabilities arising from the public account and borrowings by state-owned enterprises where the principal and/or interest is serviced out of the budget, or where such funds are made to finance schemes announced by the state.

b) By imposing conditions on borrowings wherein a certain reform must be conducted by the state to be eligible to borrow a certain amount.

Kerala’s eligible borrowing limit is Rs 39,626 crore, but the state has been allowed to borrow only Rs 28,830 crore till now. The limit was lowered mid-fiscal without any prior notice, based on an improper calculation of the public account balance, KN Balagopal, the finance minister of the state, claimed in his Budget speech for 2024-25.

Kerala has reportedly raised a demand for an additional borrowing of Rs 24,000 crore and has flagged that the state is being allowed to raise Rs 5,000 crore only if the borrowings are linked to power sector reforms.

Union’s claim

The Centre, in its plea, stated that the Union has long relied on Article 293 (3) and 294 (4) of the Constitution to control spending and borrowing by states. The limit is recommended by the Finance Commission based on a pre-approved formula.

According to the 15th Finance Commission’s recommendations, the upper limit of states’ borrowings can be set at 3.5 percent of their GSDP for FY24 and FY25. For the current fiscal year, 0.5 percent of the ceiling was linked to power sector reforms.

In response to Kerala’s suit, the Centre, through the Attorney General of India, said in a note that the financial stress faced by Kerala was primarily due to poor financial mismanagement. The Union government further said that substantial financial resources were provided to the Southern state from 2020-21 to 2023-24, more than the amount recommended by the 15th Finance Commission, including Rs 14,505 crore as a back-to-back loan to meet the GST compensation shortfall.

Terming public finances an issue of national interest, the Centre, in its response, said that any state defaulting on debt servicing could threaten the entire country’s financial stability.

This Net Borrowing Ceiling provided to states is fixed in a non-discriminatory and transparent manner as guided by the recommendations of the Finance Commission, the Union said, adding that given that the state-level debt can affect the credit ratings of the entire country, it was important to bring off-Budget borrowings by states on the books to ensure fiscal transparency.

Legal tussle

Kerala has contended that this action of the centre is against article 293 (3), which empowers a state to borrow funds on the security or guarantee of its consolidated fund, in alignment with its fiscal autonomy.

Though the Supreme Court agreed to hear the case on March 6, it urged the parties to keep the channel for negotiations open. This confrontation between Kerala and the Union government transpired in an original suit filed by the state in the Supreme Court.

States seldom file suit in the apex court against the centre unless they apprehend a threat to their federalism. For instance, in 2021, the Punjab government filed a suit against the centre in the Supreme Court against a notification extending Border Security Force (BSF) jurisdiction within the local limits of the state. The case is currently pending in the SC. Meghalaya is pursuing a suit against the Centre over its empowering other states to ban the sale of its lottery on the ground that the lottery is important for its fiscal survival. Article 131 of the constitution empowers states to file suit against the Union.

In its suit, Kerala has alleged that the central government’s amendments to the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, gravely interfere with its financial autonomy, which is guaranteed under the Constitution. The FRBM Act was introduced by the Centre two decades ago to institutionalise financial discipline in the country.

The Centre maintains that given its generosity in allocating funds to the state, Kerala’s fiscal crisis is of its own doing. On February 19, the central government told the apex court that it had offered the state a borrowing space of Rs 13,608.57 crore, if Kerala withdrew the plea. However Kerala refused to take the offer and decided to continue with the litigation.