Does Centre have unfettered powers to impose conditions on states borrowing money?

On May 17, the Centre decided to increase state borrowing limits to 5% of the Gross State Domestic Product or GSDP from 3%, in light of the Covid-19 pandemic. However, the concession came with some strings attached – in order to avail the full 2% of the extended limit, states were asked to undertake several reforms. These included joining the “One Nation One Ration Card” scheme, taking steps to increase urban local body revenues, implementing certain ease-of-doing-business measures, and carrying out power sector reforms.

This decision has been criticised by some states such as Kerala, Tamil Nadu and West Bengal, and is the latest in a series of federal tensions that have emerged in India’s Covid-19 response. But apart from the political implications or merits of this particular reform agenda, the legal questions that it raises deserve scrutiny.

The constitutional framework

Article 293(3) of the Constitution requires states to obtain the Centre’s consent in order to borrow in case the state is indebted to the Centre over a previous loan. Every single state is currently indebted to the Centre and thus, all of them require the Centre’s consent in order to borrow. In practice, the Centre has been exercising this power in accordance with the recommendations of the Finance Commission. This consent can also be granted subject to certain conditions by virtue of Article 293(4). This is the source of the power exercised by the Centre in the present instance.

A natural question arises at this stage: does the Centre have unfettered power to impose conditions under this provision? For instance, can it use this power to make states implement police reforms, even though “police” falls under the exclusive domain of the states?

Neither does the provision itself offer any guidance on this, nor is there any judicial precedent that one could rely on. Interestingly, even though this question formed part of the terms of reference of the 15th Finance Commission, it was not addressed in its interim report.

When researching on this question for a Vidhi Centre for Legal Policy report submitted to the 15th Finance Commission, I looked into the historical background of this provision. The origin of Article 293 in its current form can be traced to Section 163 of the Government of India Act, 1935. However, the colonial law expressly stated that the Centre shall not seek to impose “any condition which is unreasonable”.

Not just that, if a dispute were to arise regarding any condition, the matter had to be referred to the Governor-General, who would take a final decision. Congress leader Ananthasayanam Ayyangar had explained in the Constituent Assembly that since a national government was going to replace a foreign one, there was no need to retain these safeguards.

Interestingly, an expert committee of the Constituent Assembly had earlier suggested constituting a “Loan Council” for this purpose. This makes for very interesting reading today in light of the recent creation of the Goods and Services Tax Council. An institutional arrangement of this nature would certainly have been closer to the spirit of cooperative federalism.

The Centre’s limitations

In the absence of any guidance on this provision, one could argue in favour of multiple interpretations. On plain reading, it could be said that since Article 293(4) does not include any expressly-stated limitation, the Centre may impose any type of condition. However, some implied limitations may also be read into this provision through a purposive interpretation in the following manner.

The Centre can impose conditions only when it gives consent for state borrowing, and it can only give such consent when the state is indebted to the Centre. This suggests that one possible purpose behind conferring this power upon the Centre was to protect its interests in the capacity of a creditor. A broader purpose of ensuring macroeconomic stability is also discernible, since state indebtedness negatively affects the fiscal health of the nation as a whole. Seen in this light, the Centre should only impose conditions that have a direct bearing on a state’s indebtedness or on macroeconomic stability.

It is also well established in case law that where a constitutional provision has the potential of affecting the federal character of the Constitution, it must be interpreted narrowly. In other words, the powers that have been expressly reserved to the states cannot be whittled down through an expansive and unfettered interpretation of the Centre’s powers.

This means that in the present case, the Centre was not justified in requiring states to join the One Nation One Ration Card scheme by exercising its power under Article 293(4). After all, this has no direct bearing on a state’s fiscal health or on macroeconomic stability, and encroaches upon the legitimate domain of states.

On the other hand, the conditions relating to urban local body revenues, power sector reforms, and ease-of-doing-business measures evidently satisfy the necessary criteria – even if otherwise undesirable. Given these limitations, if the Centre desired to extend its One Nation One Ration scheme throughout the country, it should have opted for building consensus with reluctant states instead of compelling them through this route.

Kevin James is a Research Fellow at Vidhi Centre for Legal Policy and an Honorary Fellow at the Centre for Multilevel Federalism. His Twitter handle is @kevin_james9595.

Views expressed are personal.