Trust and loan’: Fiscal Federalism

Context: In the Union budget 2022-23, Finance Minister has provided for Rs. 1 lakh crore in loans to state governments to enable them to increase their capital expenditure. These loans will be interest free and repayable after 50 years.

About Fiscal Federalism

• It refers to the division of responsibilities with regards to public expenditure and taxation between the different levels of the government.
• Fiscal federalism is the economic counterpart to political federalism.
• It assigns functions to different levels of government and also offers appropriate fiscal instruments for carrying out these functions.
• Determination of these specific fiscal instruments is a challenging task.

Why such an arrangement raises questions regarding Centre-state fiscal relations?

One, the first and foremost issue is related to Article 293 (3) of the Constitution. According to it, states may not raise any loan without the consent of the government of India as long as there is still an outstanding loan. Thus, state borrowings are restricted by the Centre’s approval.

• But, over the past decade, the Union government has done away with the loan component in the central plan assistance. States’ liabilities towards the Centre are declining as per the 15th Finance Commission. Thus, over time states will not have any obligations towards the Centre which should eventually increase their freedom.
• However, loans from multilateral agencies to states are also routed through the Centre which is not going to end in the near future. Hence, the budgetary proposal along with the constitutional provision is giving the Centre greater say over the states’ fiscal management at a time when it had been decreasing.

Two, there is another concern over the possibility of conditions being attached to these loans. Also, the amount is not being transferred to the states in the form of a grant. A grant is shown as part of revenue expenditure, while loans have been shown as capital expenditure.

• Three, the burden of execution will fall on the states. The states which are politically aligned with the Centre or those whose finances are uncertain may opt for this option. But others may not borrow, as they have rights to deny.

Four, the funds meant for capital expenditure may be shifted towards revenue expenditure due to a fall in capital spending being balanced by these loans.
Road Ahead

• There is a need to create an environment of trust between the center and states. Considering the fault lines in Centre-state relations, this arrangement can be seen as interference on states’ fiscal independence and become a political issue.