Varenya Singh
Kerala government’s recent move to the Supreme Court against the borrowing limits set by the centre has brought back focus to current deficiencies in India’s statutory frameworks regulating fiscal prudence. In this context, the arbitrariness of the Fiscal Responsibility and Budget Management Act, 2003 (‘FRBM Act’) regarding the constitutional question under Article 293 is in urgent need of re-examination.
The arbitrariness in the application of the FRBM Act, 2003 (and FRBM Rules, 2004) acts as an impediment to state fiscal autonomy, in extension, corroding the structure of fiscal federalism built in the constitution.
The excessive discretion of the union government contravening the principles of fiscal federalism shall be demonstrated through the faulty design choices within the act. These include – oscillating timelines for reigning in revenue and fiscal deficit under the act, dilution of fiscal targets through escape clauses, etc.
The statutory contortions in the FRBM Act
The text of the FRBM Act, 2003 states its goal as follows:
“An Act to provide for the responsibility of the Central Government to ensure intergenerational equity in fiscal management and long-term macro-economic stability by [omitted] removing fiscal impediments”.
What merits attention is the footnote next to the word ‘Omitted’. It reads – “The words ‘achieving sufficient revenue surplus and’ omitted by sec. 210 of Act 13 of 2018 (w.e.f. 29.03.2018)”. This omission is not an isolated occurrence through the statute. The Act has undergone changes in multiple instances. The most consequential of which is the recent amendment of 2018.
The domain of monetary policy and the removal of fiscal impediments are largely the domain of the centre, where fiscal federalism and constitutional design intersect in Article 293 of the constitution concerning the limits of state borrowing. The act delineates ‘the cap of aggregate guarantees’ against the Consolidated Fund of India (CFI), hence operationalising the constitutional provision of Article 293.
The 2018 amendment set out the 3 percent Fiscal Deficit limit. Primary Deficit in the act has been set as an indicator under the Effective Revenue Deficit. Additionally, there is a differentiation of ‘General’ and ‘Central Government debt’ to 60 per cent and 40 per cent by Financial Year (FY) 2024-24, respectively.
The most important change that affects state fiscal autonomy is the inclusion of ‘Limits on securities’ against the CFI. The enactment greatly restraints state borrowing powers. The provisions of Article 293 on state borrowings are subsumed in the ‘Central government debt’, which includes the ‘total outstanding liabilities’ on the security of the CFI.
Loans under ‘Government debt’ taken against the CFI include a substantial share of State Government Borrowings. Additionally, ‘Guarantee Targets’ act as limitations on State borrowing. Loans on CFI security have been restricted to only 0.5 per cent of the GDP in a single financial year since the 2018 amendment. Therefore, state borrowing powers after the 2018 amendment are further curtailed.
Faulty design choices impinge state fiscal autonomy
These changes in the constitutional and statutory framework limit the fiscal autonomy of the state governments. Reductions on borrowing limits put fiscal pressure on the states. It limits the avenues of borrowing by making CFI the primary source of collateral security while the sites of revenue expenditure expand under the welfare programme requirements of the union. This contortion of fiscal federalism disproportionately affects a few states. Inter-state debates over the terms of reference for the 15th Finance Commission and the recent constitution of the 16th Finance Commission are illustrative of this issue.
The 2018 Amendment accords more discretion to the Union Government through Escape Clauses. Intended for exceptional circumstances, the scope of escape clauses has been widened to include not just war, national calamity, and collapse of agriculture but also vague grounds such as ‘structural reforms in the economy’.
State debt burdens have only deepened. Increasing centralisation of fiscal powers has created a resource deficiency, which has led to ‘fragility’ in the federal system. Although there has been additional borrowing space from 3 to 3.5 per cent of the GDP, state deficits have widened because of the economic crisis following the Covid-19 pandemic. Moreover, the GST compensation obligation of the Union towards the states ended in June 2022, further shrinking state revenue streams. There is a high gap between a state’s welfare expenditure and revenue receipts. This is further compounded by the lack of rationalisation of welfare schemes and higher borrowing requirements due to the ill health of power discoms.
Rather than assisting the states in addressing their fiscal shortages, the FRBM Act has solely expanded the discretionary space of the Union government in the fiscal arena. Coupled with a paucity of institutional fora for states to notify their internal fiscal priorities and discontents, the federal balance in the sphere of fiscal reforms is skewing unfavourably against the states.
Constructing fiscal federalism: The court’s view
Despite the large-scale consensus, apprehensions on the centralisation of state borrowing floated within the constituent assembly on the question of Article 293. Since Article 293 deals with borrowings against the CFI, the element of parliamentary approval is given supremacy in the final design of the Indian Constitution. This choice directly owes to the principle of democratic accountability, power-sharing, and representation. The design choice in the fiscal federalism model adopted within the FRBM Act neglects such a principle of accountability and representation. It rather showcases the disregard for the principle of power-sharing on the federal level.
In the Jindal Stainless Steels v. State of Haryana case, Justice Ramana envisages that in Indian fiscal federalism, the union and the states are “co-equal”. Justice Ramana notes – “No state, in this grand union, should be made to feel discriminated and embarrassed merely because history was not congenial to them and they have remained underdeveloped.”
Further, in the Union of India v. Mohit Minerals case, the Supreme Court noted – “ Indian federalism is a dialogue between cooperative and uncooperative federalism where the federal units are at liberty to use different means of persuasion ranging from collaboration to contestation.” However, the FRBM Act does not provide a forum for institutionalising and managing such contestation. Rather, it gives asymmetrical discretionary power to the Union government.
The incongruity between the FRBM Act and Article 293
There is a problem of lack of congruence between the design of the FRBM Act and Article 293. This leads to the constitutional question of fiscal federalism. Article 293(3) reads – “a state may not without the consent of the government of India raise any loan still outstanding any part of a loan…”. The element of consent lends discretionary power to the union government. Section 4 of Article 293 touches upon the principle of state-federal structure. States have had higher fiscal responsibilities since the COVID-19 pandemic, and with the rise in the Indian welfare programme costs, the ambit of these responsibilities has seeped into previously uncharted spheres of socio-economic policy design.
“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 logic of the design focuses on the practice of fiscal prudence. However, its implications for the domain of statutory power, specifically with the FRBM Act, impinge on state fiscal autonomy, contravening the principles of fiscal federalism built in the constitution. The consent clause is the constitutional logic extended to the FRBM Act, which creates the problem of arbitrariness. It clogs the inbuilt design choices of fiscal federalism. Therefore, the act does not promote fiscal prudence but rather ‘fiscal anxiety.’
FRBM Act encroaches on state fiscal autonomy
An emerging public debate has risen in the arena of fiscal federalism, especially relating to Article 246 and Article 293. ‘Public Debt of State’ is on the state list under the 7th schedule; however, the borrowing limits provision of Article 293 comes into friction with this entry. The State Government of Kerala contends that this is in further conflict with the FRBM Act. With the introduction of budgetary constraints on borrowings within the act, the fiscal grounds for states to act in their agency and maintain adequate liquidity are shrinking.
Moreover, the conflict between state and central budget management protocols creates a further rift. The suit by the State Government of Kerala is symptomatic of the larger problem. The FRBM Act introduces new grounds for centralisation that obscure the independent functioning of the State Fiscal apparatus. Though the constitution enumerates state-level budgetary and fund management provisions, union legislations virtually disregard their administrative capacity.
Arrears owing to structural problems, but more significantly, welfare functions of the state have a cumulative effect on the debt burdens of the state. Though constitutional, the power to impose borrowing limits under Article 293 should be a matter of exceptional circumstance as opposed to the current regime of overuse.
The diminishing of state fiscal capacities is a larger threat to the sphere of federalism. State preoccupation with pecuniary concerns and arbitrarily legislated statutory fiscal obstructions like the FRBM Act create a dependency problem. The goal of the act is to introduce long-term fiscal prudence. Since the buck stops at the ‘buck’ itself, a long-term fiscal crisis can only be averted if the federating units have the financial agency to manage their affairs.
Arbitrariness creates fiscal anxiety
The arbitrariness of the FRBM Act manifests at both the statutory and the implementation stage. The design of the act provides for contingencies based on “exceptional grounds” only to be disclosed on the occasion of a breach of targets. The CAG report on the FRBM Act highlights how the Union finance ministry was unable to “explain the deviations from the FD (fiscal deficit) target without identifying specific factors responsible for meeting the targets”.
Therefore, the Act has provisional flexibility built. However, the clauses in question are primarily used by the Union government to justify its financial frustrations. States in this circumstance are forced to contend with the effect of these frustrations and become an unplanned corollary of fiscal constraint. The provisions on state borrowings under Article 293 become the primary battlegrounds for friction between the Union and the States. It is here where the states bear the detriment of prudential norms without the gains from the policy.
These features are hindrances in state planning for welfare that the act seeks to fulfil. Arbitrary changes in the FRBM Act impede long-term fiscal planning and reflect policy adhocism. In such a structure, state legislatures have to repeatedly realign their fiscal priorities to meet the new compliance measures and avoid penalties.
The lack of predictability in the functioning of the act instigates an erosion of the legitimacy of the choices made by the Union. The maintenance of State fiscal autonomy is a substantial requirement for the principles of cooperative federalism in the Indian Constitutional design. A resolution to inter-state inequalities as the goal of governance requires cooperative federalism. Bargained financial autonomy for the state is a prerequisite for the pursuit of this goal. Multiple deferments in the FRBM Act targets, as indicated by the CAG review report, create precedents of distrust. Curtailment of borrowing powers disables not just their financial capacities but also the power-sharing consensus built in the constitutional framework.
Additionally, there are other design problems in the act. For example, food subsidies are accounted for under the ‘Extra Budgetary Funding’ category. Fiscal Deficit and Revenue Deficit are used as a recourse to avoid targets. There is also a problem of understatement. National Small Saving Fund (NSSF) loans were used to fund food subsidies in 2017-18. Therefore, liabilities on the balance sheet are rolled over. Similar examples of NABARD and NRIDA exist. Here, revenue funds were routed against these funds, and distinct institutional entities were technically formed.
The problem of frequent amendments in the FRBM Act is a symptom of vacillating legislative decision-making by the Union. The CAG report showcases the replete instances where the parameters of fiscal discipline have undergone recurrent alterations. The frequent amendments are indicative of lacunae plaguing the design choices of the FRBM Act. First, they showcase the inherent lack of consensus of the Union legislature on matters of fiscal discipline. Second, they shift the goalposts set for state fiscal conduct, hence impairing their fiscal autonomy. Finally, this precarity casts aspersions on the principles of fiscal federalism read into the constitution through landmark judgements such as the Union of India v. M/s. Mohit Minerals Through Director.
Reckoning Fiscal Responsibility and Sub-national Fiscal Autonomy
The argument in favour of a constitutional design structure of state-level fiscal autonomy runs into two main criticisms. The first is the ‘bailout argument’ as enumerated by the European experience. It is assumed that sub-national units avoid negative externalities of their fiscal negligence due to the protection of the union. The second is the disproportionate sharing of the fiscal burden, with the union bearing the costs of state-level improvidence.
The Indian scenario shows a converse trend. The FRBM review committee report 2017, constituted under NK Singh, notes – “..in our view, the states as a whole seem to have a prudent approach to their finances..”. The report goes on to highlight – “Collectively, the states managed to successfully consolidate their fiscal position after the crisis, unlike the Centre.”
Despite the regional and spatial heterogeneities of the federal units in the Indian Union, the states have not lagged in the macro-fiscal parameters laid out in the FRBM Act. Even with the restrictive design of the act, especially regarding borrowing limits and medium-term economic framework, the states have demonstrated a prudent financial approach. Hence, the logic of centralisation only lends to the consolidation of power and not the consolidation of finances.
There is an additional argument to be made about the fiduciary duty of the centre to the state under the federal framework. From the fiduciary lens, Article 293 is a protective provision to rescue states from indebtedness. However, revisions within the FRBM Act since 2018 have been operating on contrarian logic. Instead of fulfilling this fiduciary function, the pecuniary limits in the act are becoming a reason for state indebtedness. The case of Karnataka’s rising revenue deficit despite adhering to the compliance norms stipulated in the FRBM Act is illustrative of this claim.
Building it bottom-up
In conclusion, the FRBM Act of 2003, rather than fostering fiscal prudence, has become a source of fiscal anxiety, especially for state governments. Its arbitrary design has hindered state fiscal autonomy and weakened the principles of fiscal federalism in the Indian Constitution. The Union government’s excessive discretion, seen in the Act’s fluctuating timelines, escape clauses, and borrowing limits, has undermined state financial independence. The 2018 amendments further restricted state borrowing, intensifying the centralisation of fiscal authority.
The Act, meant to promote fiscal discipline, has instead pressured states to constantly adjust their fiscal priorities, often due to Union government fiscal frustrations. The disconnect between the FRBM Act and Article 293 of the Constitution raises concerns about the erosion of state fiscal autonomy and the undermining of cooperative federalism. Judicial perspectives emphasise the co-equal status of the Union and states, but the FRBM Act fails to provide a framework for managing fiscal disputes, skewing power in favour of the Union.
Frequent amendments to the Act reflect legislative indecision, deepening mistrust between Union and state governments and hindering long-term fiscal planning. While the Union government claims centralisation is necessary for fiscal prudence, states have often managed their finances more prudently, outperforming the Union in macro-fiscal metrics despite the FRBM Act’s restrictions.
Ultimately, the FRBM Act’s arbitrary nature has fostered fiscal anxiety instead of stability, burdening states with its shortcomings. Its misalignment with fiscal federalism principles has created a precarious fiscal environment where states struggle to maintain financial autonomy and meet welfare obligations. To achieve true fiscal prudence, a recalibration of the balance between Union and state fiscal powers is essential, ensuring states have the financial agency needed for their responsibilities and the nation’s economic stability.
The Author is a second-year student of National Law School of India University, Bengaluru.
Image Credit: Gokulam SeekIAS
Constitutional Law Society 
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