Finance Commission – Issues related to devolution of resources

The severe erosion of fiscal federalism


From UPSC perspective, the following things are important :

Prelims level : Fiscal deficit

Mains level : Net Borrowing Ceiling (NBC)

Fiscal federalism in dire straits?

Central Idea:

The article discusses Kerala’s protest against the imposition of a Net Borrowing Ceiling (NBC) by the Central Government, which restricts the state’s ability to borrow funds. It argues that this imposition undermines fiscal federalism and challenges the constitutional authority of the state legislature over financial matters.

Key Highlights:

  • Kerala Chief Minister Pinarayi Vijayan leads a protest against the Central Government’s imposition of a financial embargo on Kerala.
  • The NBC limits states’ borrowings, including those from state-owned enterprises like the Kerala Infrastructure Investment Fund Board (KIIFB), leading to a severe financial crisis in Kerala.
  • The article questions the constitutionality of including state-owned enterprises’ debt in the state’s total debt, arguing that it encroaches on the state legislature’s authority over financial matters.
  • Kerala’s Fiscal Responsibility Act, 2003, aims to reduce fiscal deficit, demonstrating the state’s commitment to fiscal discipline.
  • The article criticizes the move towards “annihilative federalism,” where the central government’s actions detrimentally affect states’ ability to meet welfare obligations.

Key Challenges:

  • Balancing fiscal discipline with the need for states to fund development projects and welfare schemes.
  • Addressing the erosion of fiscal federalism and the encroachment of central authority over state finances.
  • Resolving the conflict between the powers of the central government and state legislatures regarding financial matters.
  • Mitigating the impact of borrowing restrictions on states’ ability to fulfill their financial obligations.

Key Terms:

  • Net Borrowing Ceiling (NBC): Limit imposed on states’ borrowings from all sources.
  • Kerala Infrastructure Investment Fund Board (KIIFB): State-owned body responsible for funding infrastructure projects.
  • Fiscal Responsibility Act: Legislation aimed at reducing fiscal deficit and promoting financial discipline.
  • Fiscal Federalism: Distribution of financial powers and responsibilities between the central government and states.
  • Annihilative Federalism: Central government actions that undermine states’ financial autonomy and welfare obligations.

Key Quotes:

  • “The wide array of constitutional issues…point at the severe erosion of fiscal federalism in the country.”
  • “The borrowing restrictions are an example of ‘annihilative federalism’ at play.”

Key Examples and References:

  • Kerala’s protest led by Chief Minister Pinarayi Vijayan against the financial embargo imposed by the Central Government.
  • The inclusion of KIIFB’s debt in Kerala’s total debt, leading to funding constraints for welfare schemes.
  • Comparison of Kerala’s fiscal deficit reduction efforts with the central government’s fiscal deficit estimates.

Key Facts and Data:

  • Kerala’s fiscal deficit reported to have reduced to 2.44% of the GSDP.
  • Central government’s fiscal deficit estimated to be 5.8% for 2023-2024.

Critical Analysis:

The article underscores the tension between central authority and state autonomy in financial matters, highlighting the constitutional ambiguity surrounding the imposition of borrowing restrictions. It argues for a balanced approach that acknowledges states’ fiscal responsibilities while ensuring fiscal discipline.

Way Forward:

  • Reevaluate the imposition of borrowing restrictions to ensure they do not unduly impede states’ ability to meet financial obligations.
  • Enhance dialogue and cooperation between the central government and states to address fiscal challenges while respecting constitutional principles.
  • Clarify the division of financial powers between the central government and state legislatures to mitigate conflicts and promote fiscal federalism.

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