[This is a Guest Post by Harshil Watson.]
Recently, the Finance Minister, while declaring the final tranche of the Covid-19 economic package, acceded to the request of the States, and raised their borrowing limit to 5 per cent of Gross State Domestic Product (“GSDP”), up from 3 per cent before, fixed by the Union Government (hereinafter referred to as “Center”) under the Fiscal Responsibility and Budget Management Act, 2005. In itself, this is a welcome move. Allowing States to borrow an additional Rs 4.28 lakh crore this year will provide them with the resources to fight COVID-19 and perhaps, help them maintain their budgeted expenditure allocations. However, this increment comes with certain attached conditions.
As per the announcement, the first tranche of additional borrowings from the Center amounting to 0.5 per cent of GSDP will be unconditional. However, the next 1 per cent of borrowing will be allowed in four tranches, linked to reforms in the areas of ease of doing business, implementation of the Center’s ‘one nation one ration card’ scheme, implementation of power sector reforms to be brought in through Electricity Amendment Act, 2020, and working towards increasing revenues of urban local bodies. States will be allowed to borrow the final tranche of an additional 0.5 per cent only if they ‘completely’ achieve the targets in three of the four reform areas.
The two types of conditions imposed, out of which one is tied to specific purposes and the other is an implementation-based performance condition, form the subject matter of this post.
Concept of Borrowing under the Constitution
293. Borrowing by States
(1) 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
(2) The Government of India may, subject to such conditions as may be laid down by or under any law made by Parliament, make loans to any State or, so long as any limits fixed under Article 292 are not exceeded, give guarantees in respect of loans raised by any State, and any sums required for the purpose of making such loans shall be charged on the Consolidated Fund of India
(3) A State may not without the consent of the Government of India raise any loan if there is still outstanding any part of a loan which has been made to the State by the Government of India or by its predecessor Government, or in respect of which a guarantee has been given by the Government of India or by its predecessor Government
(4) A consent under clause ( 3 ) may be granted subject to such conditions, if any, as the Government of India may think fit to impose.”
While States have the authority to borrow under Article 293 (1) of the Constitution, the Center exercises control through Article 293 (3), which requires state governments that are indebted to the Centre to seek its consent before borrowing. While giving such consent, the centre may impose conditions as it may deem fit under Article 293(4). As all the States owe money to the Centre, in effect, today no State can raise loan without the Centre’s consent. The States are also debarred from raising any loan out of India. Foreign loans can be raised exclusively by the Centre.
The imposition of the above-mentioned performance conditions through Article 293(4) by the Government is unprecedented. On a perusal of previous reports of the Finance Commissions (e.g. here and here), one may note that the Finance Commissions, while deciding the quantum of the loans to be granted to the States, have always taken under consideration only financial factors like debt-GSDP ratio, debt to revenue ratio, fiscal deficit etc. Thus, it is only the first time that the Government, without any such recommendation of the Finance Commission, has decided to impose implementation-based performance goals.
Therefore, the unprecedented use of Article 293(4), clubbed with its widely worded language, poses various Constitutional concerns such as:
- By directing the States to implement Central schemes, whether the Center has confused its financial power under Art. 293, with its administrative power of control under Art. 256?
- By tying the borrowed funds of the State to specific purposes, whether the Center has encroached upon the financial autonomy of the States, and in effect disturbed the Federal character of the Constitution?
- By coercing States into implementing Central schemes, whether the Center has violated the inherent limitation of ‘consent’ and ‘cooperation’ in Art. 293?
Colourable Exercise of Power under Article 293(4)
With respect to the first question, I argue that power under 293(4) to impose conditions is purely a financial power of the Center, which exists by virtue of it being an existing lender, and this financial power must not be confused with its general power of control over the States under Art. 256.
The underlying premise of the power under Art. 293(4) is the outstanding debts of the State. This suggests that a possible purpose of this provision is to protect the rights of the Centre in its capacity as a creditor. Apart from this, a broader purpose of creating a mechanism to facilitate macroeconomic stability may also be discernible, as State indebtedness negatively affects general government debt, i.e. the fiscal health of the nation as a whole. Since clause (4) enables the Central Government to impose conditions only when granting consent under clause (3), reading these two clauses together suggests that such conditions should also be limited to questions of State indebtedness and macroeconomic stability. In other words, conditions which do not pertain to State indebtedness and which have no fiscal stabilising effect would be beyond the ambit of clause (4).
Article 256: Obligation of States and the Union
The executive power of every State shall be so exercised as to ensure compliance with the laws made by Parliament and any existing laws which apply in that State, and the executive power of the Union shall extend to the giving of such directions to a State as may appear to the Government of India to be necessary for that purpose.
If we were to also assume power under Art. 293(4) to mean an administrative power of control, it couldn’t have been the intention of the makers of the Constitution to restrict this power only to States with outstanding loans. This would lead to an absurd conclusion that only the States with outstanding loans are to implement the central schemes and not the others who have no pending debts. There exists no rational connection between outstanding debts and implementation of central schemes. It is only because all the States today are indebted to the Union, that the Centre has misunderstood this limited power of a lender with its administrative power of control under Art. 256.
Federalism and Financial Autonomy of the States
By now, it has been held by numerous judgements that the Courts should not adopt an approach which has the effect of or tends to have the effect of whittling down the powers reserved to the States. In light of this, it may be possible to argue that conditions imposed under clause (4) of Article 293 should not impinge on the federal character of the Constitution, beyond what is strictly required for the purposes of this provision.
I argue that the Center, by directing state spending towards specific central projects, has encroached upon the financial autonomy of the States and has used this power to get a backdoor entry into domains exclusively reserved for the States. Under Art. 266, money received through loans by Central Government, until it is repaid, forms part of the State Consolidated Fund and the States have the autonomy to determine their spending priority. Along with loans, Central assistance also flows to the States through grants under Art. 282.
Art. 282: Expenditure defrayable by the Union or a State out of its revenues The Union or a State may make any grants for any public purpose, notwithstanding that the purpose is not one with respect to which Parliament or the Legislature of the State, as the case may be, may make laws
As these are ‘grants’ by the centre to the States, the States are under no obligation to return these sums. Therefore, essentially being the Center’s money, these are also linked to specific purposes and often used to incentivize States to implement central schemes. However, this is not the case with loans under Art. 293. Because it is borrowed based on State’s needs and because it forms part of the State Consolidated Fund, States have significant autonomy over its spending and any law/exercise of any executive power of the Center, which takes away this autonomy of the State, is antithetical to the principle of Federalism.
For instance, one of the conditions imposed in the current scenario is the reforms to be undertaken in the domain of ease of doing business. Ease of doing business is an ideological condition – what if Kerala, as a communist-run State, does not want to prioritise business? Can the centre essentially impose an economic model under the guise of Article 293? Indeed, the Kerala government may have different priorities for allocating resources. Such conditions, then, conflict with the principle that States have the freedom to determine their spending priorities.
Demarche from Cooperative Federalism to Coercive Federalism
While the Center has, through its powers under Art. 293(4), encroached upon the domain exclusively reserved for the States, the fact that the Center has chosen to practically coerce States in implementing the Central schemes is a greater problem in the Indian Federal landscape. ‘Cooperative Federalism’ may not be a Constitutionally enforceable obligation, but is certainly a principle inherent in the Federal idea and also fundamental to the successful operation of the federation in practice, particularly where the vertical fiscal imbalance is such a dominating feature of that landscape.
The idea of ‘cooperative federalism’ is something which has also now been acknowledged by the Indian Courts in various judgements. (See Jindal Stainless). More so, the Court in the State of Rajasthan, notes the observation of Granville Austin wherein he is of the view that “the Constitution of India was perhaps the first constituent body to embrace from the start what A.H. Birch and others have called “cooperative federalism”.
‘Cooperative Federalism’, as the Constituent Assembly debates suggest, becomes more important particularly in the context of Art. 293. Article 293 was picked up from Section 163 of the Government of India Act, 1935. Interestingly, that section under the Act had a protective clause, which went as:
(4) A consent required by the last preceding subsection shall not be unreasonably withheld, nor shall the Federation refuse, if sufficient cause is shown, to make a loan to, or to give a guarantee in respect of a loan raised by, a Province, or seek to impose in respect of any of the matters aforesaid any condition which is unreasonable.
While the whole section was picked as it is, this particular subsection was dropped. The only reason that could be gathered on a reading of the Constituent Assembly Debates on Draft Article 269, is, that the adoption of a Constitution brought with itself a paradigm shift from coercive Federalism to cooperative Federalism. On one will notice a sense of security amongst the members and a great trust in the concept of cooperative Federalism. M. Ananthasayanam Ayyangar, in regards to draft Article 268 and 269 remarked:
In the present Government of India Act, there is a clause that this consent ought not to be delayed or unreasonably delayed. There is no such provision in this article, because it is thought such a provision is not necessary. Under the Government of India Act, it was thought there will be a different agency who will not be, a national of this country, in charge of the administration. But now with national governments in the provinces and a national government at the Centre, it is felt that such a provision is not necessary. I hope articles 268 and 269 will meet the situation.
Similarly, Granville Austin in his book “Constitution of India – Cornerstone of a Nation” (9th ed. 2005 at p.233), has stated thus: —
When this Article was under consideration, seven out of the nine provinces had outstanding loans. Yet, the provincial governments evidently did not believe that this put them unduly in the grip of the Union and did not oppose either the Article or the proviso. Nor, it seems, has the working of this Article during the last decades been detrimental to the interests of the States.
A structuralist reading of the Article suggests that the decision of the members to not include a saving provision like S. 163(4) in the present-day Article 293, on the basis of the coming into being of a cooperative federalist structure, must be taken into account while interpreting the provisions of this Article. The fact that the States were denied foreign borrowing, making the Center their only resort, was accompanied by an inherent expectation that such a dominant position of the Center will not be used to coerce States into implementing Central reforms.
In light of this historical trajectory, the inherent limitation of cooperative federalism must be taken into account in reaching the conclusion that the Center cannot legally compel the States into prioritising their spending to Central reforms, as this would amount to practical coercion.
Unlike Art. 275, wherein the Central Government shall make grants-in-aid to States as per Finance Commission’s recommendations, there is no statutory duty under Art. 293 to consult any specialized body before granting loans or imposing conditions. Conventionally, on the discretion of the Union, the quantum of borrowing and the conditions to be imposed forms part of the Terms of Reference (ToR) to the Finance Commission. However, as this happens only on the discretion of the Union, in the present case, the conditions imposed are without any recommendations from the Finance Commission. Thus, this must pave way for establishment of something on lines of Loan Council, like in foreign jurisdictions.
In this regard, Australia’s efforts in adopting a cooperative fiscal mechanism by establishing an Australian Loan Council are worth noting. The Council meets once a year and consists of the Prime Ministers of the Centre and the States. Each State has one vote, but the Centre has two and a casting vote. All loans are arranged by the Centre and then distributed among the various governments in accordance with an agreed formula. This arrangement has reduced competition among the governments for funds and thus loans can now be arranged on more advantageous terms than was possible before
Hence, based on the above arguments, reading of Article 293 suggests that the conditions imposed by the Centre will not fit into the limited ambit of Article 293(4).
Whether or not the Supreme Court ever gets an opportunity to visit the interpretation of powers under Article 293(4) is yet to be seen. In the event that it does, there may be cause to speculate that the Court may uphold the older regime of strong financial intergovernmental relations between the Center and the States in the light of the robust federal structure – we claim to possess.