Why in the News?

• The Union Government imposed a Net Borrowing Ceiling (NBC) on Kerala in 2023 to limit its market borrowing to 3% of Gross State Domestic Product (GSDP) for fiscal year 2023-24. 
• Recently, the ceiling expanded to include all borrowing sources, such as open market loans, financial institution loans, and State public account liabilities.
• It also applies to certain borrowings made by state-owned enterprises to prevent them from exceeding the borrowing limit.

How will it affect Kerala?

• The Net Borrowing Ceiling (NBC) has restricted borrowing capacity, creating difficulties for the state to meet its spending requirements, it also hampered the state's ability to invest in development and welfare activities.

State Borrowing under Indian Constitution

• Article 293 of the Constitution empowers state governments to borrow within India with the security of the state's Consolidated Fund. 
• The state's borrowing power can be limited by laws enacted by Parliament or the State Legislature, and the central government can impose conditions if the state has outstanding loans guaranteed by the Centre.

How FRBM Act impacts state borrowing?

• The Fiscal Responsibility and Budget Management (FRBM) 2003 Act sets targets for fiscal discipline to reduce fiscal deficits and revenue shortfalls. It requires both the central government and the states to follow a fiscal deficit of less than 3% of GDP.   

Supreme Court’s interim ruling on the NBC

• In April 2024, the Supreme Court denied Kerala's request for interim relief from the NBC, declaring that Kerala's financial problems cannot be solely blamed on the NBC. 

Concern

• The imposition of borrowing limits on States without considering their financial condition is considered as a violation of the States' autonomy to manage their own finances.

Way Forward

• The Union Government should establish a commission similar to the Finance Commission to resolve disputes over borrowing powers, the commission must consider the financial condition of the States and the Centre's fiscal goals, and establish a balance between both. 
• Clear guidelines must be developed by discussing with states to guarantee transparency, unbiased treatment, and fiscal autonomy. The comprehensive policies designed with the states can contribute to a balanced fiscal framework and also promote cooperative federalism.

PRACTICE QUESTION

Q.Which of the following will be the possible consequences of increasing Government borrowing? 

1. Crowding out effect

2. Higher interest rates

3. Lower economic growth

Select the correct answer using the codes given below:

A) 1 and 2 only

B) 2 and 3 only

C) 1 and 3 only

D) 1, 2 and 3

Answer: D

Explanation:

Statement 1 is correct:

When the government increases its spending, it can reduce or eliminate private sector spending. This is because the government requires more revenue to spend, which can be obtained by increasing taxes or borrowing money. Higher taxes have the potential to reduce individual and business income and spending. 

Statement 2 is correct:

When the government borrows more to meet its expenditure, it creates a Crowding out effect, which increases the borrowing interest rates. Higher interest rates may reduce private investment and output growth.

Statement 3 is correct:

When the government borrows a large sum of money for an extended period, the amount of financial capital available to private sector firms decreases. A prolonged period of budget deficits can reduce economic growth.