Context

The Supreme Court refused to grant Kerala relief in its dispute over net borrowing limits with the Centre. 

Why Supreme Court Refused Kerala Relief on Borrowing Cap Set by Centre but Referred Case to Constitution Bench

• Challenge to Centre’s Borrowing Ceiling Imposition: The state government approached the Supreme Court against the Centre imposing a ceiling on the amount it can borrow, saying it was violative of the principles of fiscal federalism.
• Acknowledgment of Union’s Argument on Excessive Borrowing: The court acknowledged the Union’s argument that if there’s excessive borrowing, it may lead to reductions in subsequent years. 
• Referral of State’s Plea to Constitution Bench: However, the court referred the plea filed by the state against the Centre over interference with the state’s powers to borrow and regulate its own finances to a Constitution Bench.
  • The bench noted that since Article 293 of the Constitution has not so far been subjected to any authoritative interpretation by this court”, therefore the questions raised in the suit “are referred for answering by a five judge bench”.

Article 292 and 293: Borrowing Power Under Indian Constitution

The Constitution makes the following provisions with regard to the borrowing powers of the Centre and the states:

• Article 292: Borrowing by the Government of India

  • It deals with the borrowing power of the Central Government.
  • The Central government can borrow either within India or outside upon the security of the Consolidated Fund of India or can give guarantees, but both within the limits fixed by the Parliament. 

• Article 293: Borrowing by the State Governments

  • It deals with the borrowing power of the states. Clauses under it includes:
    • A state government can borrow within India (and not abroad) upon the security of the Consolidated Fund of the State or can give guarantees, but both within the limits fixed by the legislature of that state.
    • The Central government can make loans to any state or give guarantees in respect of loans raised by any state. Any sums required for the purpose of making such loans are to be charged on the Consolidated Fund of India.
    • A state cannot raise any loan without the consent of the Centre, if there is still outstanding any part of a loan made to the state by the Centre or in respect of which a guarantee has been given by the Centre.

International Practice In Subnational Borrowing Regulation

• Mechanisms for Subnational Borrowing Regulation:

• • Various mechanisms employed across the world reveal four broad categories of subnational borrowing regulations. If borrowing by subnational entities has not been prohibited altogether, a country may rely on:
    • Market discipline
    • Centrally-imposed or self-imposed fiscal rules,
    • Centralised administrative regulation
    • Cooperative regulation

• Market Discipline: 

  • It relies on capital markets to send signals to subnational governments regarding the willingness of creditors to lend, with the same signals also indicating when borrowing is becoming unsustainable.

• Fiscal Rules: 

  • A regime relying on fiscal rules constrains the fiscal behaviour of subnational governments so as to ensure that there is predictability and robustness in the fiscal outcomes that emerge. 
    • Rules that have this effect can impose debt ceilings, deficit targets, expenditure rules of both quantitative and qualitative nature, Etc.

• Centralised Administrative Regulation: 

• • It gives the Central Government direct control over subnational borrowing.  This approach is more frequently used by unitary countries and less by federal countries.
    • It can go to the extent of requiring the centre to evaluate and approve each different credit transaction itself, resulting in micromanagement of state debt. 

• Cooperative Regulation: 

  • Mechanisms involving cooperative regulation facilitate the active involvement of subnational governments in determining borrowing controls, including through negotiation processes.
    • Thus, leads to arrival at overall fiscal targets for the general government as well as more specific constraints on separate governments. 
    • While combining the advantages of the other three approaches, cooperative systems promote information symmetry and dialogue between all the stakeholders who have an interest in the common pool of resources of the nation.