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The Centre has told the Supreme Court that Kerala was “one of the most financially unhealthy States” and debts run by States affect the credit rating of the whole country. The Centre said the poor financial indicators of Kerala point to a “lack of proper management of its public finances”.

• The state of Kerala filed a suit against the Centre for-
  • Violating the federal structure of governance 
  • causing “severe damage to the economy of a small State with meagre resources”
• The State urged the court to protect the federal system of governance in which the State has the exclusive power to regulate its finances through the preparation and management of its budget and borrowings.
• Kerala said recent actions, like imposing a Net Borrowing Ceiling in an arbitrary manner, were calculated to reduce it to a “state of penury”.

What is Centre’s response?

• In response, the Centre referred to three Finance Commission reports which had highlighted the deteriorating debt situation of the State.
• The Reserve Bank of India has also categorised Kerala among the five highly stressed States with high indebtedness requiring urgent corrective measures.
  • Kerala, Rajasthan and West Bengal are projected to exceed the debt-GSDP (Gross State Domestic Product) ratio of 35% by 2026-27.
• The Centre said the poor financial indicators of Kerala point to a “lack of proper management of its public finances”.
  • “Substantial financial resources” were provided to the Kerala government from 2020-21 to 2023-24 over and above the amount recommended by the 15th Finance Commission.
  • One of these was the payment of Rs 14,505 crore as “back-to-back loan to meet GST compensation shortfall”.
  • The state has been breaching its FRBM targets with unhealthy levels of Revenue Deficit-Fiscal Deficit ratio (65% in 2018-19). This implicitly explains why the state has resorted to borrowing to finance its Revenue Deficit

How are Centre-State Financial Relations?

• In federal structure (Indian political governance system), the power to raise money as well as the power to spend is distributed across the Union Government, State Governments and Local Governments.
• Articles 268 to 293 in Part XII of the Constitution deal with Centre–state financial relations.
• Finance Commission (Article 280) recommends to the President on the distribution of net proceeds of taxes between the centre and states.
• Constitution divides the taxing powers between the Central and states in following way:
  • Parliament has an exclusive power to levy taxes enumerated in the Union List.
  • State Legislature has exclusive power to levy the taxes enumerated in the state list. Both the Parliament and the state legislature can levy the taxes enumerated in the Concurrent List.
  • The residuary power of taxation (that is, the power to impose the taxes not enumerated in any of the three lists) is vested in the Parliament. Under this provision, the parliament has imposed gift tax, wealth tax and expenditure tax.

• Parliament can provide for grants-in-aid to states by the Centre. Such sums are charged on the Consolidated Fund of India (Article 275).
• The Union can make public purpose grants to states and to any institution within the states (Article 282).
• Grants-in-Aid to the States - Besides sharing of taxes between the Centre and the states, the Constitution provides for grants-in-aid to the states from the Central resources. There are two types of grants-in-aid, viz, statutory grants and discretionary grants:
  • Statutory Grants - Article 275 empowers the Parliament to make grants to the states which are in need of financial assistance and not to every state. These sums are charged on the Consolidate Fund of India every year.
• Apart from this general provision, the Constitution also provides for specific for specific grants for promoting the welfare of the scheduled tribes in a state or for raising the level of administration of the scheduled areas in a state including the State of Assam.
• The statutory grants under Article 275 (both general and specific) are given to the states on the recommendation of the Finance Commission.
  • Discretionary Grants - Article 282 empowers both the Centre and the states to make any grants for any public purpose, even if it is not within their respective legislative competence. Under this provision, the Centre makes grants to the states.
  • Other Grants - The Constitution also provided for a third type of grants-in-aid, but for a temporary period.
• Borrowing by the Centre and the States
  • The centre can grant loans to states and also give guarantee in respect of loans raised by them (Article 293).
  • The Central government can borrow either within India or outside upon the security of the Consolidated Fund of India or can give guarantees, but both within the limits fixed give the Parliament.
  • Similarly, a state government can borrow within India (and not abroad) upon the security of the Consolidated Fund of the State or can give guarantees, but both within the limits fixed by the legislature of that state.
  • The Central government can make loans to any state or give guarantees in respect of loans raised by any state. Any sums required for the purpose of making such loans are to be charged on the Consolidated Fund of India.
  • A state cannot raise any loan without the consent of the Centre, if there is still outstanding any part of a loan made to the state by the Centre or in respect of which a guarantee has been given by the Centre.
• Parliament can impose restrictions on Inter-state trade and commerce in the public interest (Article 302).
• The accounts of the states shall be kept in such from as prescribed by the president on the advice of the Comptroller and Auditor-General of India (Article 150).