Fiscal Federalism Under Scrutiny: Supreme Court Refers Kerala’s Borrowing Dispute to Larger Bench (01 April 2024)

Date of the Judgment: 01 April 2024
Citation: 2024 INSC 253
Judges: Hon’ble Mr. Justice Surya Kant and Hon’ble Mr. Justice K.V. Viswanathan
Can the Union government impose borrowing limits on states, and what is the extent of a state’s right to borrow? The Supreme Court of India recently grappled with these crucial questions of fiscal federalism in a suit filed by the State of Kerala against the Union of India. The core issue revolves around the Union’s actions to restrict Kerala’s borrowing, which the State argues violates its constitutional rights. The two-judge bench of Justices Surya Kant and K.V. Viswanathan referred these questions to a larger five-judge bench for authoritative interpretation.

Case Background

The State of Kerala initiated an Original Suit against the Union of India, challenging certain actions that restrict the State’s borrowing power. These actions include an amendment to the Fiscal Responsibility and Budget Management Act, 2003, a letter imposing a ‘Net Borrowing Ceiling’ on the State, and another letter granting consent for open market borrowing with a specified limit. The State contends that these actions exceed the Union’s powers under Article 293 of the Constitution, which governs borrowing by states.

The State of Kerala sought an interim injunction to restore the borrowing position that existed before the restrictions and to allow the State to borrow INR 26,226 crores immediately. The Union of India, on the other hand, argued that it has the power to regulate state borrowings to maintain the fiscal health of the country.

Timeline

Course of Proceedings

The Supreme Court heard arguments from both sides on the maintainability of the suit and the interim relief sought. The State of Kerala argued that the Union does not have the power to regulate all state borrowings, while the Union contended that it has the power to do so to maintain fiscal health. The Court, recognizing the substantial questions of constitutional interpretation, decided to refer the matter to a larger bench.

Legal Framework

The core of the legal dispute revolves around Article 293 of the Constitution of India, which governs borrowing by states. The provision states:

“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.”

The Court also considered the Fiscal Responsibility and Budget Management Act, 2003, and the recommendations of the 14th and 15th Finance Commissions.

Arguments

Arguments by the State of Kerala:

• The Union’s power to regulate state borrowings is limited to loans taken from the Central Government, not all borrowings.
• Liabilities arising from the Public Account and State-Owned Enterprises should not be included in the State’s borrowings.
• The State needs INR 26,226 crores to meet budgetary obligations.
• The State has under-utilized borrowing space from previous years that should be available now.
• Over-borrowing from previous years should not be adjusted against the current borrowing ceiling.
• The State’s debt is sustainable as its GSDP is rising faster than the effective interest rate.

Arguments by the Union of India:

• The Union has the power to regulate all state borrowings to maintain the fiscal health of the country.
• Liabilities from Public Accounts and State-Owned Enterprises can be included in state borrowings to prevent circumvention of borrowing ceilings.
• The State’s financial issues are due to its own mismanagement, not the Union’s regulations.
• The State’s claim of under-utilized borrowing space is factually incorrect.
• Over-borrowing in a financial year must be adjusted against the borrowing amount of the next financial year.
• Allowing the State to take on more debt would jeopardize the fiscal health of the country.

The State of Kerala argued that they had underutilized their borrowing limits in previous years, and they should be allowed to avail this space. The Union of India argued that the State had over-borrowed in the past and that the over-borrowing must be adjusted in the succeeding years.

Innovativeness of the argument: The State of Kerala’s argument that the Union’s power to regulate state borrowings is limited only to the loans that the State takes from the Union, and not all borrowings, is an innovative interpretation of Article 293 of the Constitution.

Issues Framed by the Supreme Court

The Supreme Court framed the following issues:

1. What is the true import and interpretation of the expression in Article 131 of the Constitution: “if and in so far as the dispute involves any question (whether of law or fact) on which the existence or extent of a legal right depends”?
2. Does Article 293 of the Constitution vest a State with an enforceable right to raise borrowing from the Union government and/or other sources? If yes, to what extent such right can be regulated by the Union government?
3. Can the borrowing by State-Owned Enterprises and liabilities arising out of the Public Account be included under the purview of Article 293(3) of the Constitution?
4. What is the scope and extent of Judicial Review exercisable by this Court with respect to a fiscal policy, which is purportedly in conflict with the object and spirit of Article 293 of the Constitution?

Additionally, the Court noted other important questions impacting the federal structure of governance:

• Is fiscal decentralization an aspect of Indian Federalism?
• Are the Impugned Actions violative of Article 14 of the Constitution?
• What has been the past practice regarding regulation of the Plaintiff’s borrowing by the Defendant?
• Are the restrictions imposed by the Impugned Actions in conflict with the role assigned to the Reserve Bank of India?
• Is it mandatory to have prior consultation with States for giving effect to the recommendations of Finance Commission?

Treatment of the Issue by the Court

The following table demonstrates how the Court decided the issues:

Authorities

The Court considered the following authorities:

Judgment

The Court held that the State of Kerala failed to establish a prima facie case for an interim mandatory injunction. The Court found that the State’s claim of under-utilized borrowing space was not convincing and that the Union’s argument on adjusting over-borrowings from previous years was more plausible. The Court also noted that the balance of convenience and the potential for irreparable injury favored the Union, as granting the injunction could have adverse effects on the fiscal health of the country. The Court did, however, acknowledge the State’s financial hardship and noted that the Union has offered some financial relief during the pendency of the case.

How each authority was viewed by the Court?

• The Court referred to Article 131 of the Constitution of India* to determine whether the dispute involves a question of legal right, and decided to refer the interpretation to a larger bench.
• The Court referred to Article 293 of the Constitution of India* to determine the borrowing powers of states and the regulatory powers of the Union, and decided to refer the interpretation to a larger bench.
• The Court referred to the Fiscal Responsibility and Budget Management Act, 2003* to understand the debt limits set for the Central and State Governments.
• The Court referred to the Report of the 14th Finance Commission* to understand the mechanism of adjustment of over-borrowings by states.
• The Court referred to the Report of the 15th Finance Commission* to understand the borrowing limits and under-utilization of borrowing space.
• The Court referred to State of Haryana v. State of Punjab, (2004) 12 SCC 673* to distinguish between prohibitory and mandatory injunctions.
• The Court referred to Shepherd Homes Ltd. v. Sandham, [1970] 3 WLR 348* to differentiate between forward-looking and backward-looking injunctions.
• The Court referred to Dorab Cawasji Warden v. Coomi Sorab Warden, (1990) 2 SCC 117* to emphasize the higher standard required for granting mandatory injunctions.

What weighed in the mind of the Court?

The Court was primarily concerned with the fiscal health of the nation and the potential adverse effects of granting the interim injunction. The Court also considered the principles of fiscal responsibility and the need to maintain a balance between the borrowing powers of the states and the regulatory powers of the Union. The court was not convinced with the arguments of the State of Kerala.

Logical Reasoning:

The Court considered the arguments of both the parties and decided that the State of Kerala was not entitled to an interim mandatory injunction.

The Court stated, “At this stage, based on the contentions of the Plaintiff – State with which we are not prima facie convinced, permitting any borrowing —whether INR 24,434 crores as claimed in the written note or INR 10,722 crores as alternatively claimed —would not be tenable.”

The Court also stated, “On a comparative evaluation of the submissions, it seems to us that the mischief that is likely to ensue in the event of granting the interim relief, will be far greater than rejecting the same.”

The Court further stated, “It appears prima facie that ‘monetary damage’ is not an irreparable loss, as the Court can always balance the equities in its final outcome by ensuring that pending claims are adjusted along with resultant additional liability on the opposite party.”

Key Takeaways

• The Supreme Court has referred the interpretation of Article 293 of the Constitution to a larger bench.
• The Court has emphasized the importance of fiscal responsibility and the need to balance the borrowing powers of states with the regulatory powers of the Union.
• The Court has clarified that financial hardship is not equivalent to irreparable injury.
• The Court has indicated that over-borrowings by states in previous years can be adjusted against their borrowing limits in subsequent years.

Directions

The Court directed the Registry to place the matter before the Hon’ble Chief Justice of India for the constitution of an appropriate Bench to answer the questions framed in the order.

Development of Law

The ratio decidendi of the case is that the State of Kerala failed to establish a prima facie case for an interim mandatory injunction. The Court also indicated that over-borrowings by states in previous years can be adjusted against their borrowing limits in subsequent years. This case is important as it will clarify the scope of Article 293 of the Constitution and the extent of the Union’s power to regulate state borrowings.

Conclusion

The Supreme Court’s decision to refer the matter to a larger bench highlights the significance of the constitutional questions raised in the case. The interim order reflects the Court’s concern for maintaining fiscal stability and the need for a thorough examination of the issues related to fiscal federalism. The final outcome of this case will have a significant impact on the financial autonomy of states and the regulatory powers of the Union.

Category

• Constitutional Law
  • Article 131, Constitution of India
  • Article 293, Constitution of India
  • Fiscal Federalism
  • Interim Injunction
  • Original Suit
  • Judicial Review
• Finance Law
  • Fiscal Responsibility and Budget Management Act, 2003
  • Finance Commission
  • State Borrowings
  • Public Finance

FAQ

Q: What is the main issue in this case?
A: The main issue is whether the Union government can impose borrowing limits on states and the extent of a state’s right to borrow under Article 293 of the Constitution.

Q: What did the Supreme Court decide in this case?
A: The Supreme Court did not grant an interim mandatory injunction to the State of Kerala and referred the matter to a larger bench for a final decision.

Q: What is a mandatory injunction?
A: A mandatory injunction is a court order that compels a party to take a specific action, as opposed to a prohibitory injunction which restrains a party from doing something.

Q: What is the significance of Article 293 of the Constitution?
A: Article 293 governs the borrowing powers of states and the conditions under which they can borrow, especially when they have outstanding loans from the Union government.

Q: What is fiscal federalism?
A: Fiscal federalism refers to the division of financial powers and responsibilities between different levels of government, such as the Union and the states.

Q: What is the implication of this case for state governments?
A: This case will clarify the extent of state governments’ borrowing powers and the Union government’s regulatory authority, which will have a significant impact on their financial autonomy.

Q: What is the next step in this case?
A: The matter has been referred to a larger bench of five judges of the Supreme Court for a final decision on the constitutional questions raised.