Borrowing Battles: Kerala’s Curious Reliance on Constitutional History

“I am writing this letter to seek your urgent intervention in an issue that threatens to seriously compromise the federal-state financial arrangements envisaged in the Constitution of India…” began Kerala Finance Minister Balagopal’s July 2022 letter to his Union counterpart Nirmala Sitharaman. The letter conveyed a palpable sense of desperation. The State was undergoing a ‘grave financial crisis.‘

Kerala was grappling with a daunting deficit of 23,000 crores to balance its current fiscal year’s budget. Minister Balagopal pinpointed various factors linked to Union fiscal policy that contributed to the situation: reduced grants-in-aid, a halt in GST compensation, and most significantly, the Union’s slashing of Kerala’s borrowing limit by nearly 4,000 crores. He warned that ‘..the safety of the socio-economic security system that the state has worked so hard to build over the last several decades will be in jeopardy…‘ 

The Union controls Kerala’s borrowing through Article 293(3) and (4) of the Constitution of India. Article 293(3) says that without the Union government’s ‘consent’, a state may not ‘…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…’ Clause 4 explains that ‘consent’ in this context “may be granted subject to such conditions, if any, as the Government of India may think fit to impose.” 

Kerala, like most Indian states, was indebted to the Union. Therefore, as per Article 293, the Union had the authority to regulate Kerala’s borrowing if deemed necessary. In 2023, the Union exercised this power by imposing a Net Borrowing Ceiling (NBC) of ₹32,442 crore on Kerala. This meant Kerala couldn’t borrow beyond this amount from any source, falling far short of its borrowing requirements. Minister Balagopal’s letter in 2022 was ignored as was Kerala’s repeated pleas for adequate borrowing in the following two years.

The predicament was dire. Borrowing was the only way for Kerala to get out of its financial crisis. An adversarial Union, backed by Article 293, was undermining this escape route. The next steps were clear: In December 2023, Kerala took the Union government to the Supreme Court.

A key argument in Kerala’s petition was the interpretation of ‘any loan’ in Article 293. Kerala contended that the phrase referred only to loans taken from the Union. So Article 293 gave the Union the power to only State’s borrowing from the Union itself, not from other sources such as capital markets. The interpretation of Article 293 remains largely uncharted within constitutional law. No precedents, analogous cases, or legal commentary on this provision exist to help us engage with and evaluate Kerala’s argument. Could constitutional history provide any relief? 

Unlike GOI Act 1935, Constitution Framers Anticipated No Conflict

Article 293 is a substantive replica of the Article 163 of the Government of India Act 1935 (‘1935 Act’) including the provision that bars the provincial government from raising ‘any loan’ without the consent of the Centre if it is indebted to the Centre. Unlike the Constitution of India, however, there was an additional sub clause of the Article that stated that the Union’s consent “shall not be unreasonably withheld.” The sub-clause also precluded the Union from refusing, “if sufficient cause is shown” to give a loan or guarantee. They were also barred from imposing “any condition which is unreasonable.” 

The sub clause anticipated potential conflict and put in systems for dispute resolution.

“…if any dispute arises whether a refusal of consent, or a refusal to make a loan or to give a guarantee, or any condition insisted upon, is or is not justifiable, the matter shall be referred to the Governor-General and the decision of the Governor-General in his discretion shall be final…” it said. 

The 1935 Act dedicated considerable attention to the arbitrary withholding of consent by the central government to a province. Notably, it vested the final decision-making authority in the highest executive figure of the time—the Governor General.

The Constituent Assembly picked up Article 163 of the 1935 Act, which would eventually become Article 293. But crucially, it dropped the sub clause that dealt with arbitrary withholding of consent. This was the case as early as B.N. Rau’s 1947 Draft. But why? 

When Article 293 was taken up debate in the Constituent Assembly on 10 August 1949, veteran civil servant and Drafting Committee member Gopalaswami Ayyangar said: 

 “..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…” 

Ayyangar’s sentiment seems to have been widely shared among other members in the Assembly. Not one member took issue with it or said anything in response. Looking back, it’s striking that Ayyangar, and evidently the Assembly as a whole, believed that the transition from British to Indian governance would eliminate conflicts between the Union and the States regarding borrowing. 

That said, they were foresighted in a way because nearly 75 years have passed with almost no constitutional conflict on the scope and application of Article 293. The Kerala case is arguably the first, and won’t be the last.

The Expert Committee  

About two years before his speech, on September 4, 1947, Ayyangar proposed the appointment of an expert committee to study the financial provisions of the Constitution. The Assembly recognized the complexity involved in drafting these provisions, and following Ayyangar’s suggestion, an expert committee was indeed appointed. Its task was to review the financial provisions of the 1935 Act and recommend suitable provisions for the Constitution of India, covering aspects such as tax allocation and borrowing powers

Remarkably, this Committee was one of the rare instances where experts, rather than members of the Constituent Assembly, took the lead. It included N. R. Sarkar, a former member of the Governor-General’s Executive Council and renowned industrialist and financial expert; V. S. Sundaram, a member of the Indian Audit and Accounts Service; and M. V. Rangachari, then serving as the Budget Officer of the Government of India. 

The Committee presented its report to the President of the Constituent Assembly on December 5, 1947. Reflecting on the memorandums it received from provincial governments, which echoed the concerns of contemporary Indian states, it emphasised:

“…every province has highlighted the urgency of its social service and economic development programs, along with the limitations of its own resources, both current and potential. They have unanimously called for a substantial transfer of revenues from the Central resources….” 

Incidentally, in its written submission to the Supreme Court, Kerala attached this Expert Committee’s report and quoted the following extract, where the Committee discussed the borrowing powers of the States: 

 “…The most outstanding advantage of the freedom of borrowing is the sense of financial responsibility it creates; for, there is no more accurate, sensitive, and dependable metre of the credit of a borrowing Government than the reaction of the securities market. We do not, therefore, wish to withdraw this freedom…” 

Kerala used this to argue that the framers of the Constitution intended for financial markets to be a source of state borrowing and that ‘the open market borrowings of State Governments have become more mature as hoped for by the Expert Committee in its report 75 years ago.’ Kerala was subtly trying to convince the Court that Article 293 gave States the freedom to borrow from the markets. 

Intriguingly, Kerala’s petition omitted the preceding sentence of the extract from the report: “The present position is that the provinces have the freedom to borrow in the open market in India except when they are indebted to the Centre.” The Committee acknowledged the states’ authority to borrow from the open market, but with the condition that they are not already indebted to the Centre. The report also emphasised the need for measures to prevent borrowing governments from disrupting the capital markets. 

In light of this, Kerala’s plea to interpret Article 293 as giving the Union the power to control states’ borrowing only with respect to loans taken from the Union does not stand. Clearly, the Committee was talking about restricting states’ borrowing powers from the market, not from the Union! Additionally, the Committee report provides the rationale behind this, stating that unrestricted borrowing can have repercussions for capital markets. By invoking the Expert Committee’s Report, Kerala, known for its football credentials, seems to have scored an own goal. 

But the Supreme Court will take the final call. In the Kerala petition, the three-judge Bench noted that the Supreme Court had not extensively interpreted Article 293. They directed the case to a five-judge Constitution bench that will determine the scope of the Union government’s authority to restrict a state government’s borrowing. 

On the strength of constitutional history and the framers’ disposition towards the borrowing powers of the states, Kerala’s argument that article 293 gives States ‘unfettered’ powers to borrow from the market will not hold muster. That said, constitutional disputes are rarely decided on just constitutional history, the Constitution is a ‘living document’ as many would like to remind us. There are diverse interpretive and doctrinal techniques and strategies that can come into play.

Kerala has indeed deployed these in the petition to advance an interpretation of Article 293 that does not give the Union summary powers over a States borrowing. It might very well be the case that the Constitution framers’ view that there was no need to include provisions to adjudicate or even anticipate a dispute regarding borrowing powers, must today be discarded in light of recent developments.

Conflict between states and the Union in the realm of financial matters has been dominated by issues around taxation powers, sharing of tax proceeds, grants-in-aid etc. It appears now that borrowing is poised to be the new front in India’s fiscal federalism—and for this Kerala will, well, take the credit.

This article was first published on constitutionofindia.net on 24 April 2024.