Arvind Panagariya, chairman of the 16th Finance Commission, has an unenviable task. The economist has to bring order to the sharing of resources between the Centre and states and between the states themselves. He has held one meeting and one member is reported to have resigned. This resignation must have taken him by surprise, the genial soul that he is.
War has started between the states and the Centre even before Panagariya has had time to take stock. The Kerala government has gone to court against the central government on the restrictions placed on state borrowings, and their case may have merit. They argue that, under the Constitution, the central government has no power to restrict borrowing by states.
Article 293(1) of the Constitution specifically states, “Subject to the provisions of this article, the executive power of a state extends to borrowing within the territory of India upon the security of the Consolidated Fund of the state within such limits, if any, as may from time to time be fixed by the legislature of such state by law and to the giving of guarantees within such limits, if any, as may be so fixed.”
The Seventh Schedule under Article 246 reinforces this view. ‘Public debt of the Union’ comes under the Union List as item 35, while ‘Public debt of the state’ is shown as entry 43 in the State List. Thus, on the face of it, decisions relating to state debt are to be controlled by the state legislature, not the government of India.
In 2003, the Fiscal Responsibility and Budgetary Management Act restricted the overall borrowing to 60 percent of the GDP, of which the central share was to be 40 percent, thus limiting the states’ share to 20 percent. In the first two decades of the law, the states did not question this limit.
In 2018, through an amendment to the FRBM Act brought in by the Finance Act, the central government introduced the concept of ‘general debt’, the total state and central debt. The general debt was pegged at 60 percent of GDP, with 40 percent going to the central government. This concept allows the central government to restrict state borrowing legally; according to Kerala, this violates the Constitution.
In his reply, the Attorney General referred to the importance of financial prudence for the nation: “Increases in the state’s debt servicing liabilities as a consequence of higher borrowing will reduce the availability of funds for development, leading to impoverishment of people and loss of state income, and hence also loss of national income. It may also engender various social and other problems.”
Kerala pointed out that not only has the borrowing limit been restricted, the public account and off-budget borrowing by state public enterprises has been included in the definition of public debt, further reducing the states’ capacity to borrow and seriously damaging its welfare activities.
The state government later claimed the central government was willing to increase the state’s borrowing limit this year, provided the state withdrew the Supreme Court case. If true, the finance ministry probably feels that, constitutionally, it is on a weak wicket. Their assumption that Article 293(4) gives them the power to restrict market borrowings of the states may not be correct; in the context, the Article appears to relate only to borrowings from the central government.
Nor is Kerala the only aggrieved state. When the state organised a public protest in Delhi, Chief Minister Pinarayi Vijayan had Arvind Kejriwal, Bhagwant Mann and Farooq Abdullah by his side. Karnataka organised a separate protest on the same subject.
Have some states been discriminated against? The 16th Finance Commission must study this allegation and impartially make its recommendations.
When I was Vice Chairman of the Kerala State Planning Board, the 14th Finance Commission submitted its recommendations. The share of the states in the total divisible pool was increased from 32 percent to 41 percent. On the face of it, this looked like a huge jump, but it was much less.
Until the 13th Finance Commission, the mandate of the commission was restricted to non-plan finances. The 14th commission was the first to consider all resources, plan and non-plan. The plan share was 6.5 percent; hence, the state resources automatically increased to 38.5 percent. The 13th commission had also given many grants to states for specific projects. The 14th one, on the other hand, decided not to provide individual grants, except where necessary, and to pass on the amount as an allocable share; this meant an additional 1.5 percent. Thus, all that occurred was a compositional shift, not a significant actual increase in the states’ share.
However, based on the perception of the state share having increased exponentially, the Centre persuaded states to accept much lower central shares in centrally-sponsored schemes. Thus, instead of gaining from the perceived increase in states’ share in the divisible pool, the states collectively probably ended up as losers.
The divisible pool also shrank as the Centre resorted to cesses and surcharges, which do not have to be shared with the states. The RBI highlighted this issue in its ‘Study of State Finances’, which points out that due to an increase in cess and surcharge, the divisible pool has shrunk from 88.6 percent of gross tax revenue in 2011-12 to 78.9 percent in 2021-22 despite the 10 percentage point increase in tax devolution recommended by the Finance Commission.
According to a study by India Ratings, the Centre has allocated barely 35.5 percent (budgetary estimate) of the divisible tax pool with states, lower than the 15th commission’s recommendation of 41 percent. The states’ share averaged 35.4 percent of the divisible pool during 2021-2025, down from 39.8 percent during 2016-2020.
The Centre has also been borrowing more liberally than the states. Central government debt accounted for 58.3 percent of the country’s nominal GDP in Jun 2023, compared with the ratio of 57.5 percent in the previous quarter. The average debt ratio of states barely exceeds 27 percent.
The share of states has also been badly affected by the large number of centrally sponsored schemes. Some states do not require them and a few others cannot be implemented in some states. Combined with their lack of flexibility, this has resulted in a wide variation in their implementation across states.
Panagariya and his commission, therefore, have their task cut out in restoring order and fairness in government finances, keeping in view that while states account for 62 percent of public expenditure, they receive only 37 percent of the revenue.
The commission’s press release after their first meeting said, “The 16th commission acknowledged the need for wide-ranging consultations with various stakeholders, including state governments, local bodies, ministries of the government of India, and experts.” A long, acrimonious and arduous journey awaits them.
(Views are personal)
K M Chandrasekhar
Former Cabinet Secretary and author of As Good as my Word: A Memoir
(kmchandrasekhar@gmail.com)