Summary: The piece examines the State of Kerala’s challenge against the Union of India’s borrowing constraints, analyzing the fiscal relationship, constitutional history, and the Union’s authority to regulate the States’ borrowings.

The State of Kerala filed a petition in the Supreme Court in December 2023 against the Union of India, impugning the constraints imposed on its borrowing powers by the Union. The root of the issue lies in the provisions of Article 293 of the Indian Constitution. This provision has never been the subject of judicial review in any constitutional court in the country. On April 1, 2024, after the Supreme Court’s attempt to facilitate an amicable, non-judicial solution to the dispute failed, the Court passed an order denying Kerala’s plea for interim relief of an immediate borrowing facility up to Rs.26,226 crores. It referred the matter to a 5-judge Constitution Bench. This piece will firstly, outline the current fiscal relationship between the Union and the States, secondly, canvass Kerala’s arguments in the petition, thirdly, discuss the history of Article 293, and fourthly, discuss the Union’s locus to regulate State borrowings. 

The current fiscal situation

The Union government sets Net Borrowing Ceilings (NBC) for each State based on the formula proposed by the 13th Finance Commission. The Terms of Reference of the 12th and 13th Finance Commissions (FC) specifically tasked them with addressing State finances. These references were made after States underwent a period of fiscal stress, the root of which was identified as high-interest loans taken on by the Union on behalf of the States. The 12^th FC recommended that debt relief by the Union be made contingent on the States enacting Fiscal Management Acts that outline State plans to consolidate their fiscal deficits.

The fiscal deficit is the difference between total revenue and total expenditure. When a State enjoys a positive fiscal deficit, it has a ‘revenue surplus’. The Finance Commissions’ recommendations are aimed at the Union and State governments achieving a sustainable fiscal deficit that reflects healthy economies. In 2018, the Union amended Sections 2 and 4 of the Fiscal Responsibility and Budget Management Act. The Act now defines ‘general government debt’ as the total debt of the Union and State governments in Section 2 (bb), and Section 4 (1) (b) (i) of the Act states that the Union government shall endeavour to ensure that general government debt does not exceed 60% of the Gross Domestic Product (GDP) of the nation.

Article 293 of the Constitution discusses the borrowing powers of the States. Article 293 (3) states that a State may not raise a loan without the consent of the Union government if the State is indebted to the Union by way of loan or guarantee. Article 293 (4) empowers the Union to place such conditions as it deems fit when giving its consent under Article 293 (3). Currently, all the States are indebted to the Union, and hence, all States require the Union’s consent when they wish to exercise their borrowing power. It is these conditions that the State of Kerala is challenging before the Supreme Court.

Kerala’s arguments

The State of Kerala has sought to challenge the Union government’s decision on the following lines. Firstly, that States enjoy plenary powers over borrowing, the management of their public debt, and the expenditure of monies through approved budgets. Secondly, that the Union’s decision to treat SOE borrowings and Public Account liabilities as State borrowings is bad in law. Thirdly, that the amendments to the FRMA are a colourable exercise of legislative power and hence, unconstitutional. The Government of Kerala further argues that the Union’s actions violate Article 14 since the Union regularly breaches its FRBM targets and treats its own SOE borrowings as non-state borrowings. Hence, the Union fails to apply consistent standards among the Union’s own borrowing and the States’.

The Supreme Court in its April 1 Order framed four issues, the first relating to scope of Article 131, the second regarding a State’s rights (if any) under Article 293 and scope of Union regulation under that Article. The third issue deals with the question of whether borrowings by SOEs and liabilities arising under the Public Account can be included within the scope of Article 293 (3). Fourthly, the Court referred the question of the scope and extent of judicial review with respect to fiscal policy. This piece will address the second and third issues only.

The History of Article 293

Article 293, as stated earlier, has been the subject of judicial scrutiny. It is thus expedient to consider the history of the provision, and the reasoning that led to the caveat in Article 293 (3). Article 293 traces its roots to the Government of India Act, 1935 (GoI). Section 163 of the Act was Article 293’s predecessor. The Drafters of our Constitution imported this provision with two modifications- firstly, subsection (4) of the provision was deleted. Subsection 4 provided that the Federal Government would not tie-up its consent to Provincial Borrowing with unreasonable conditions. The Assembly Debates show that Shri Ananthasayanam Ayyangar provided a justification for the change- the drafters believed that such restrictions would be inconceivable in a nation that was governed by its own people. Secondly, the GoI Act provided that Provinces could borrow from foreign markets subject to Federal approval. Under the scheme of the Constitution, only the Union can borrow from foreign markets.

The provisions of the GoI Act were drafted with the input of multiple committee reports and Hansard debates. The Indian Statutory Commission Report shows that the drafters of the GoI Act clearly envisioned an unequal relationship between the Federal Government and the Provinces, with the former enjoying control over the other. Section 163 allowed the Federal Government to exercise control and ensure the stability of Provincial credit. The Commission Report further provides that the Central government has the power to require the Provinces to maintain their credit at a stated figure. It is imperative to remember that these provisions in the 1935 Act were accompanied by the Seventh Schedule and the Legislative Lists which outlined the spheres of legislative authority. Section 163 (4) tempers any attempt to end the investigation here- the final authority to arbitrate on a dispute between the Central and Provincial governments was the Governor-General, an agent of the British monarch, and thus while the GoI Act was the predecessor to our Constitution, the role, and power of the British empire cast its shadow over the document.

Today, the State of Kerala argues that “Public Debt of the State” is firmly situated in List II as Entry 43. Thus, the argument goes, Kerala has plenary and unfettered powers to regulate its own fiscal policy, and the debt of the State is an important aspect of such policy. The Union’s restrictions, the State says, have the effect of interfering with fiscal policy, and other policies of the State government. For example, by restricting the scope of its borrowings, the Union effectively halts the State’s initiatives under the Kerala Infrastructure Investment Board, and other departments that undertake capital investment and welfare initiatives for the people of Kerala. This reasoning drives the State’s arguments impugning the amendment to the FRBM Act also.

State Owned Enterprises and the Public Account

The Union government justified placing restrictions on SOE borrowing by arguing that States were bypassing the NBC through SOE borrowings. Since SOE borrowings are not treated as liabilities against the Consolidated Fund of the State (CFS), the States enjoy in practice, it is argued, enjoy unlimited borrowing irrespective of the NBC and their respective Fiscal Regulation Legislations (FRL). This practice is sought to be curbed by including SOE borrowing within the ambit of the NBC. This has reduced the amount that Kerala can borrow, and the State has vehemently argued before the Court that it is in a fiscally dire situation.

The Public Account of the State is established by Article 266 of the Constitution. Article 266 (3) provides that moneys from the Consolidated Funds cannot be appropriated except in accordance with law and the provisions of the Constitution. Article 283 places the custody of the CFs with the respective governments and Article 204 requires the State legislature to pass an Appropriation Bill to withdraw moneys from the CFS. The State government does not require legislative approval to appropriate funds from the Public Account.

The Public Account holds funds with respect to which the Government acts as a banker or a trustee. These funds include pension schemes, Small Savings, Provident Funds, et al. These funds technically do not belong to the government unlike the funds in the CF, which are raised through taxation and other revenues. Hence, the government is liable to disperse the amounts in the Public Account when those liabilities mature. Some of these liabilities are interest bearing, which means that the government is required to pay interest on them, and such interest may be sourced from the Consolidated Fund. The different accounts in the custody of the government often interact, and the CF is not aloof from the others, and liabilities arising from other accounts can be funded through the CF. The State of Kerala argues that the Public Account is beyond the scope of Article 293, and that only the Consolidated Fund is within the purview of the provision.

Each State has its unique fiscal policy and liabilities and its own relationship with the Union government, on the basis of which it receives monetary support through grants or loans. The question before the Supreme Court will clarify the role and status of Finance Commission recommendations, the scope of Article 293, and the words ‘raise any loan’, and the nature of public debt.

Kerala also argues that SOEs are not State, that is, they are not the government and cannot be treated as such. The provisions of Article 12 are confined to Part III of the Constitution, and hence SOEs’ debt cannot be treated as a claim on the Consolidated Fund of the State. Although the arguments appear to be counter-intuitive at first blush, they are worth one’s consideration. SOEs may or may not have their own revenue streams, and even if they do not, their source of funds is earmarked in State budgets as expenditure. SOE liabilities do not automatically translate into claims on the State’s CF, and it would also be difficult to prove that lenders view these SOEs as an extension of the Consolidated Fund.

On the other hand, the Supreme Court in Hindustan Construction Company Limited v Union of India held that NHAI is a statutory body that functions as an extended limb of the government and cannot be wound up under the provisions of the Insolvency Bankruptcy Code. The Court looked at the character, functions and nature of NHAI’s functions and concluded that the entity was undertaking government functions and that the provisions of the IBC, including the takeover of the entity by a Resolution Professional, for example, are not applicable to it. In such a scenario, it is evident that the liabilities of ‘government entities’ are a claim against the Consolidated Fund, and hence affect the credit of the government. When this reasoning is applied on a State level, it can be concluded that SOEs which perform ‘government functions’ cannot be excluded from the purview of Article 293 of the Constitution.  

Conclusion

This piece has outlined the most recent dispute to be referred to a constitution bench of the Supreme Court. Since it is a subject-matter that is res integra, the Supreme Court’s decision will affect the nation’s understanding of federalism and define the Court’s own powers of judicial review with respect to fiscal policy. This piece has canvassed the arguments made by the government of Kerala, and the technicalities that are disputed by the two governments. The author has undertaken an investigation into the history of Article 293, and its effect on States’ understanding and practice of fiscal policy today.

Aditya Panuganti is a second-year student at NLSIU, Bangalore, and an analyst for LAOT. 

[Ed Note: This article has been edited by Sohina Pawah and published by Harshitha Adari from the Student Editorial Board.]