Funding Matters: Inside The State Versus Union Conundrum

In a Country the Central Government may have the choice of handling excessive spending tackled by either printing more money, raising from markets, or rationalising the expenditure a gap. However, to a state there is the onus of paying staff, infrastructure investments, supporting new development activities, and sustaining economic growth. Not having sufficient revenue to meet expenses therefore ensues a nightmare for economists and policymakers alike.

Recent cases highlight a tale of squeezing wallets and some states have questioned constitutional provisions. Finance ministers and Chief Ministers from states such as Tamil Nadu, Kerala and Maharashtra have recently highlighted how delays in pending dues from the Union have worsened their financial conditions. And, with the drying up of revenue avenues such as Octroi, and State Central Value Added Tax post the implementation of GST, the deficit between revenue and earnings has consistently widened. The bigger question is how do we empower our states with better fiscal agility? How do we tackle the problem of fiscal deficit?

WHAT DOES RBI SAY?

The RBI in its recent paper encouragingly notes that states’ gross fiscal deficit (GFD) (is) budgeted to decline from 4.1 per cent of gross domestic product (GDP) in 2020-21 to 3.4 per cent in 2022-23. The paper also notes a healthy increment of gross sanctions under Article 293 (3) increasing from Rs 5.50 lakh crores in 2018-19 to Rs 9.69 lakh crores in 2021-21.

However, in the same paper, the RBI also adds that state' debt is budgeted to ease to 29.5 percent of GDP in 2022-23 as against 31.1 percent in 2020-21. The paper estimates that this was still higher than what a 2018 FRBM Review Committee budgeted – 20%. On the flip-side though, it can also be observed that the amount states raised during a year to the total sanctions has consistently dipped from 89% in 2019-20 to 71% in 2022-23. Does this indicate that the total sanctions were observed a drop and thereby led states to fiscal dehydration?

In the current scheme of procedures, evaluation of the state’s requirements gets evaluated by the CAG, a parliamentary committee as well as the RBI before the Union’s consent. There is a likelihood of state governments complaining of high-handedness and bias in the process since some decisions may be linked to political affiliations. One need not introspect deeply to examine cases where a demand for loan or permission to approach the markets is seen through the prism of political bias. Such an observation not only strains financial condition for states, but also raises a question on the Constitutional tenet of federalism.

Article 293 (3) & Tenets:

Constitutional provisions confer upon states to borrow within the tenets of Article 293 (3). While defining the article, the architects of our constitution envisioned subnational borrowing as an unfettered act. Article 293(4) of the Constitution also allowed the Union to impose conditions on state borrowing during the course of granting consent. With this, the Union has executive powers to stipulate conditions to such loans.

However. there are several interpretations to the sub-articles that deserve a lengthy discussion. For instance, while sub clause (3) is likely to be seen as the state's ability to borrow, sub-clause (4) may be perceived as the Union's mechanism to protecting previously disbursed loans. Several states are also likely to perceive the conditions within subclause 4 as unsustainable. Moreover, neither of the clauses provide clarity the degree of extent of the conditions.

The recent correspondence between Kerala Finance Minister and Union Finance Minister Nirmala Sitharaman reveals the state’s perspective on article 293 (4). In his letter, state finance minister, KN Balagopal blames an incorrect interpretation of the two articles that provides the Union with untenable attempt to control financial operations of the state. He also brings to the notice of the finance minister how the addition of Article 293 (3) by the Government of India was wrong and “unconstitutionally administered to constrain financial freedom for states. He deems that article 293 (3) impinges on the federal-state financial architecture and calls it “ultra-vires”.

The fourteenth commission critically envisioned the likelihood of states no longer being indebted to the Centre and also the possibility of the Union being unable to exercise its powers regarding consent and conditions. The Fifteenth finance commission in addition to suggesting fiscal measures has also clarified states to have additional short-term borrowing measures than advances and the overdraft facility with the Reserve Bank of India. FC-XV also stipulates alignment between the state and Union to ensure consistent fiscal discipline. There is no mention of the provisions under article 293 in the recent commission report.

When it comes to subnational lending, countries such as Canada, Mexico and Brazil have learnt immensely from their debt crises and these learnings should serve a lesson for us too. Subnational debt in Brazil, for instance, reportedly ballooned from 1% to 20% within 20 years to 1990. Implementing effective controls and tackling transparency concerns helped the South American economy recover in recent times.

An optimal equation is needed between the Central and the State Governments to solve the fiscal deficit conundrum. The role of institutions like the Reserve Bank of India is underrated given the institution’s experience and legal status as a financial advisor to both Union and the states. Since India follows a federal system of governance, empowered states will lead to an empowered nation, leading to the benefits of growth percolating down to the person on the street.

With the global economy projected to weaken in 2023, there is a need for the Union and states to introspect on ways to achieve fiscal prudence. The need of the hour is to strike a balance between state autonomy and fiscal responsibility.

is a distinguished corporate and legal advisor. (Twitter @akshat_khetan). Views are personal.