Decode Politics: Kerala’s financial crisis and why it has gone to SC against Centre

What are the rules and statutes that govern borrowing and lending between states and the Centre?

Fiscal autonomy and fiscal responsibility

Article 293 of the Constitution grants fiscal autonomy to states and mandates them to borrow only from within the territory of India on guarantee from the Consolidated Fund of the State. For the states, the extent of borrowing is defined in the fiscal responsibility Acts of each state.

All transactions between the Centre and the state governments are carried out under the Fiscal Responsibility and Budget Management Act, 2003, which was enforced “to provide for the responsibility of the Central Government to ensure intergenerational equity in fiscal management and long-term macro-economic stability … greater transparency in fiscal operations of the Central Government and conducting fiscal policy in a medium-term framework and for matters connected therewith or incidental thereto”.

Kerala’s contention

The Kerala government, in its Supreme Court petition, contends that the Centre is infringing upon its fiscal autonomy by amending the Fiscal Responsibility and Budget Management Act (FRBM), 2003, to curtail its borrowing limit. The Centre last amended the Act in 2022 to “reduce the fiscal deficit to below 4.5% of GDP by 2025-26”.

The state also contends that the Centre’s move, first in May this year and then again in August, has cut its borrowing limit from Rs 32,422 crore to Rs 15,390 crore, and Rs 26,000 crore is immediately required to avert the impending financial crisis.

“The Defendant (Centre) through the Impugned Amendments has encroached into the legislative domain of the Plaintiff (Kerala) State as ‘Public Debt of the State’ is an item exclusively in the State List in the Seventh Schedule under Article 246 of the Constitution. The Impugned Amendments, which are ultra vires the Constitution would potentially be used to thwart the powers of the Plaintiff State. The Plaintiff State has a reasonable fear that the Defendant will use the Impugned Amendments to legitimise and legalise the executive actions of the Defendant in issuing the Impugned Orders, which are ultra vires the Constitution… If the damage is not prevented, the Plaintiff (Kerala) State, with its meagre resources, will not be able to recover from this for decades,” the plea states.

What is the net borrowing limit for Kerala?

On December 5, John Brittas, the CPI(M) Rajya Sabha MP belonging to Kerala, asked Finance Minister Nirmala Sitharaman about “the quantum and details of net borrowing limit fixed for Kerala for Financial Year 2023-24”.

In reply, the minister clarified that “Based on the recommendation of the 15th Finance Commission, the normal Net Borrowing Ceiling (NBC) of the States including Kerala have been fixed at 3 per cent of the Gross State Domestic Product for the financial year 2023-24. Accordingly, the normal NBC of the State of Kerala has been arrived at Rs 32,442 crore for the Financial Year (FY) 2023-24”.

What were the recommendations of the 15th Finance Commission?

Historically, the FRBM Act 2003 required states to limit their fiscal deficit to 3% of the GSDP. However, the Covid pandemic and the ensuing lockdowns required both state and Central governments to stretch their borrowings in order to meet the gap between falling revenues and rising expenditures.

“Responding to the demands by the states for an increase in the borrowing limit from 3 per cent in 2020-21 in view of the unusual fiscal pressures, the Government of India stepped up the borrowing limits of states from 3 per cent to 5 per cent for the year,” states the 15th Finance Commission main report, that makes recommendations for 2021-2026.

For the remainder of the period, it laid down the following recommendations for the normal net borrowing limit of states:

2021-22 > 4% of GSDP

2022-23 > 3.5% of GSDP

2023-24 to 2025-26 > 3% of GSDP

What has been Kerala’s record on fiscal health?

The 15th Finance Commission designated Kerala to be a “highly debt stressed” state. Data revealed that Kerala had largely failed to limit its fiscal deficit to 3% of GSDP for almost all of the past decade.

“The state has been breaching its FRBM targets with unhealthy levels of Revenue Deficit-Fiscal Deficit ratio (65% in 2018-19). This implicitly explains why the state has resorted to borrowing to finance its Revenue Deficit,” noted the commission.

A high RD-FD ratio implies that the state government is borrowing not to invest in productive schemes but to meet its day to day expenses such as salaries and pensions.

The commission noted that Kerala had the second highest levels of salaries (as a percentage of total revenue expenditure), and worse, the trend growth of salaries was the highest — suggesting that this burden was continuing to rise.

Not surprisingly, the capital expenditure has suffered and is “very low compared to its class both as a percentage of total expenditure as well as GSDP”.

Kerala’s fiscal situation has not improved in the wake of the Covid pandemic with the fiscal deficit continuing to stay outside the mandated limits

How bad is Kerala’s situation?

In November, Kerala Chief Secretary V Venu told the Kerala High Court that the state was in a “deep financial crisis” and finding it difficult to garner funds for its daily operations. The court was hearing a petition filed by a retired Kerala State Road Transport Corporation (KSRTC) employee claiming that his pension was on hold.

Earlier this month, many transactions in the treasury were reportedly put on hold due to the paucity of funds. The director of the treasury department issued orders not to process bills exceeding Rs 1 lakh, except those pertaining to pensions and salaries.

Centre’s stand

The Union government earlier this year rejected the Kerala government’s request for Rs 8,000 crore of additional funds saying it violates the fiscal responsibility Act. Kerala Finance Minister K N Balagopal’s trip to the capital in November to meet Sitharaman on the issue also yielded no results.

Is Kerala alone?

The Centre has also slashed the borrowing limits of Punjab from Rs 39,000 crore to Rs 21,000 crore. It has reduced Himachal Pradesh’s limit from Rs 14,000 crore to Rs 9,000 crore while in Telangana, the state’s borrowing limit was cut by Rs 15,000 crore.

Kerala politics

The tug-of-war between the Centre and the Kerala government is not just restricted to borrowing limits but extends to many other fiscal issues such as GST collection and allocation of Central funds. Key figures in the Kerala government have accused the Centre of targeting states with non-BJP governments over fiscal matters.