Kerala's Fiscal Crisis: SC Refers Case to 5 judges Constitution Bench

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Kerala’s Fiscal Crisis and Dispute with the Centre

The Supreme Court of India has referred Kerala’s Case on the net borrowing cap to a five-judge Constitution Bench on 1st April, 2024. This decision comes amidst Kerala’s ongoing fiscal challenges and dispute with the central government over the state’s financial autonomy.

As Kerala struggles with high levels of debt, revenue deficits, and expenditure, this case has significant implications for federal-state financial relations and the role of the judiciary in addressing issues of fiscal federalism in India.

This article explores the context of the Supreme Court’s decision and examines the factors contributing to Kerala’s poor fiscal health, the measures taken by the kerala government, and the broader implications for Kerala’s development and welfare.

Kerala’s Fiscal Crisis: An Overview

The Reserve Bank of India (RBI) has categorized Kerala among the five most financially stressed states in India. The RBI’s debt sustainability analysis suggests that state need urgent corrective measures to improve its fiscal health.

Some key facts about Kerala’s fiscal crisis:

The RBI projects that Kerala’s debt-to-GSDP (Gross State Domestic Product) ratio will exceed 35% by the financial year 2026-27. This highlights the seriousness of Kerala’s worsening debt situation.
The crisis has caused an acute shortage of funds in Kerala for all expenditures except:
- Salaries
- Pensions
- Essential administrative expenses
Kerala’s outstanding liabilities, as a percentage of its GSDP, have risen from 31% in 2018-19 to 39% in 2021-22. This is higher than the national average.
The committed expenditure of Kerala, as a percentage of its revenue receipts, increased from 74% in 2018-19 to 82.40% in 2021-22. This limits the state’s ability to spend on productive sectors.

Causes of Kerala’s Fiscal Crisis

The Kerala state budget for the financial year 2023-24 attributes the current fiscal crisis to the following factors:

Reduction in the revenue deficit grant given by the central government
Discontinuation of the Goods and Services Tax (GST) compensation to states
Limits imposed on the state’s borrowing
Considering certain off-budget borrowings as part of the state’s overall borrowing

But Financial experts argue that Kerala’s fiscal crisis is primarily due to the state government’s poor fiscal management over the years. They point out the following issues:

Persistent failure to control expenditure and mobilize resources, as highlighted in the 2016 white paper on state finances
The substantial increase in revenue expenditure every five years due to the revision of salaries and pensions
High committed expenditure (salaries, pensions, interest payments) leaving little room for development spending
Excessive off-budget borrowings that underestimate the true extent of the state’s debt

Impact on Kerala’s Economy and Development

Kerala’s persistent fiscal crisis has adversely affected the state’s economic growth and development prospects:

The state’s capital expenditure, crucial for creating long-term assets and supporting growth, has remained low compared to other states. In 2023-24, capital expenditure allocation is expected to decrease by 2% compared to the previous year.
The high committed expenditure (70% of revenue receipts in 2023-24) leaves limited funds for development projects and welfare schemes.
The growing debt burden could put further stress on Kerala’s debt servicing ability, as revenue growth remains sluggish due to various factors.

Kerala’s Arguments

The state accused the Centre of interfering with its autonomous powers to regulate finances by imposing a net borrowing ceiling.
Kerala argued the Constitution grants states fiscal autonomy, and borrowing limits are regulated by state legislation.
It claimed Rs 26,000 crore is immediately required to avert a financial crisis.

Centre’s Response

The Attorney General submitted to the Supreme Court that Kerala’s fiscal condition is precarious due to inadequate public finance management.
Despite substantial financial support from the Centre, Kerala allegedly continues to face financial stress due to reckless borrowing and unproductive expenditure.
The Centre warned Kerala’s elevated outstanding liability ratio exacerbates fiscal deficits and could lead to a debt trap.

Supreme Court’s Stance and Referral

The Supreme Court advised the Centre and Kerala to negotiate and settle differences over the borrowing cap.
It disapproved of the Centre’s condition that Kerala must withdraw the suit before any additional funds are released.
On 1st April, 2024, the Supreme Court of India referred the larger issues in Kerala’s suit, which involve interpreting constitutional provisions on borrowing powers, to a five-judge Constitution Bench.

The outcome of this case could have significant implications for the framework of fiscal federalism and intergovernmental financial relations in India. It underscores the complexities in balancing federal governance principles with effective fiscal management of states.

Expectations from the Constitution Bench

The five-judge Constitution Bench has the responsibility to:

Provide clarity on the issues of fiscal autonomy and federalism raised by Kerala
Interpret relevant constitutional provisions, such as Article 293 on state borrowing
Determine the implications for fiscal management of states and the Centre’s role in regulating state borrowing
Offer guidance on balancing the need for fiscal discipline with the autonomy of states in managing their finances

Final Thoughts

Addressing Kerala’s fiscal crisis requires a multi-pronged approach focusing on both revenue enhancement and expenditure management:

Improve tax administration efficiency and bring more taxpayers into the tax net
Rationalize expenditure by prioritizing productive spending and reducing wasteful subsidies
Enhance non-tax revenue sources like state-owned enterprises and user charges for public services
Limit off-budget borrowings and use them only for creating revenue-generating assets
Work with the central government to resolve issues related to revenue sharing and borrowing limits within the framework of Indian fiscal federalism