State borrowing, fiscal responsibility laws and off-budget liabilities

Detail

1. Constitutional rules on borrowing

• Art. 292 (Union borrowing): the Union borrows on the security of the Consolidated Fund of India. This is the main government account, where all revenue and loans go.

• Parliament may set a limit on this borrowing by law.

• Art. 293 (state borrowing): this Article gives the Centre the power to limit how much states borrow [5].

• 293(1): a state may borrow only within India. It borrows on the security of its own Consolidated Fund of the State. A state cannot borrow abroad directly.
• 293(3): a state needs the Union's consent to borrow if any loan from the Union is still outstanding. Every state has such old loans, so in practice every state needs consent [5].

• 293(4): the Union may attach conditions to this consent.

• State borrowing limits: each year the Centre caps how much each state may borrow. The cap is usually a share of GSDP (Gross State Domestic Product, the total value of goods and services produced in a state in a year).

• Net Borrowing Ceiling (NBC): the maximum net amount a state may borrow in a year, fixed each year under Art. 293(3).
• "Net" means new borrowing minus loans repaid in that year.

2. The borrowing path and its tightening

• Fiscal deficit (definition): how much the government must borrow in a year to cover spending that its own income does not cover.
• Formula: Fiscal deficit = Total expenditure − (Revenue receipts + Non-debt capital receipts).

• Non-debt capital receipts include loan recoveries and disinvestment proceeds.

• 15th FC path for states' fiscal deficit:

• 4% of GSDP (2021-22)
• 3.5% (2022-23)

• 3% (2023-26)

• Power-sector bonus: states could borrow up to 0.5% of GSDP extra each year for four years, 2021-22 to 2024-25. The Department of Expenditure, Ministry of Finance, granted this room only when a state carried out power reforms [6].

• The actual extra room was 0.25%–0.5% of GSDP, depending on performance [6].
• Criteria [6]:
  • how much electricity use was metered, including farm connections
  • paying power subsidy through DBT (Direct Benefit Transfer, money paid straight into the consumer's bank account)
  • reducing AT&C loss (Aggregate Technical & Commercial loss, which is power lost in wires, theft and unpaid bills)
  • closing the ACS-ARR gap (the difference between what it costs a DISCOM to supply one unit of power and what it actually collects per unit)
• Result: 13 states were allowed to raise ₹1,48,361 crore of extra borrowing between 2021-22 and 2024-25 [6].

• (NCERT scaffold: "0.5% extra tied to power-sector reforms". The retrieved window ends in 2024-25.)

• Worked example: how the NBC is calculated

• Suppose a state's GSDP is ₹10 lakh crore. Its fiscal deficit cap is 3%, so ₹30,000 crore.
• If it earns the full power bonus of 0.5%, it gets ₹5,000 crore more. Its total room becomes ₹35,000 crore.
• Suppose a state SPV borrowed ₹4,000 crore that the state budget will repay. That amount is deducted.

• The state can now borrow directly only ₹31,000 crore.

• Off-budget borrowing: a state company, corporation or SPV (Special Purpose Vehicle, a separate company set up for one project) borrows money. The loan is not in the state's own accounts, but the state budget repays it.

• From March 2022, the Centre counts such borrowing (when it is serviced from the budget) inside the NBC [5].

• Off-budget borrowing done in 2021-22 is being adjusted against the NBC over 2022-23 to 2025-26, so the cut is spread out and not taken in one year [5].

• SASCI (Special Assistance to States for Capital Investment): long-term, interest-free loans from the Centre for capex (capital expenditure, which is spending on assets like roads and buildings). These loans give states extra capex room outside the ceiling (see §6 of the parent note).

• Kerala's suit:
• Background: Kerala raised ₹14,313 crore through off-budget borrowing in 2021-22, and an estimated ₹2,770 crore in 2022-23 [5].
• The CAG (Comptroller and Auditor General) found that Kerala exceeded its net borrowing limit by ₹981 crore in 2021-22 [5].
• The case: Kerala challenged the curbs under Art. 131. This Article gives the Supreme Court original jurisdiction over disputes between the Centre and states, meaning such cases go straight to the Supreme Court.
• In April 2024, the Supreme Court referred the Art. 293 questions to a Constitution Bench (at least 5 judges) (verify current).

3. Fiscal responsibility laws (FRLs)

• FRL (definition): a law that makes a government meet set fiscal targets, such as a deficit cap, a debt ceiling and regular reporting to the legislature.
• FRBM Act 2003: the Fiscal Responsibility and Budget Management Act. It binds only the Centre.
• NCERT (Class 12, Box 5.2): states' FRLs made rule-based fiscal reform "more broad based".
• Coverage: NCERT says "26 states have already enacted". Now every state had an FRL by 2010-11.

• Karnataka was the first state (2002), even before the Centre's FRBM Act.

• How the Finance Commissions pushed states:

• 12th FC: gave states debt relief only if they passed an FRL. This was a carrot, not a command.

• 13th FC: asked states to amend their FRLs to follow its deficit path.

• FRLs are amended when needed. For example, Kerala issued a Fiscal Responsibility (Amendment) Ordinance in 2021 [7].

4. Pressures on state finances

• Off-budget borrowing through SPVs:
• Examples: Kerala's KIIFB (Kerala Infrastructure Investment Fund Board) and Telangana's irrigation corporations.

• The problem:

  • the reported deficit looks small
  • the real debt is hidden
  • lenders and voters cannot see the true burden

• Guarantees and contingent liabilities:

• Guarantee: the state promises a lender that it will repay if its own company cannot.
• Contingent liability: a debt that becomes the state's only if something happens, such as a default.

• Scale: guarantees given by states were 4.2% of their total GSDP at the end of 2020-21 [4].

• DISCOM losses: state power distribution companies sell power below cost and collect bills poorly.

• Losses build up → the state takes over DISCOM debt or pays bailouts → the state's own debt rises.

• Reversion to the Old Pension Scheme (OPS), 2022-23: Rajasthan, Chhattisgarh, Punjab and Himachal Pradesh went back to OPS.

• OPS is a defined-benefit pension, fully paid from the budget. NPS is contributory: the employee and the government both pay into a fund.

• OPS keeps pension costs low today, but raises them sharply in future years.

• Freebies and unconditional cash transfers: these are revenue expenditure (day-to-day spending that creates no asset). They squeeze the money left for capex.

• The 16th FC flagged concern about untargeted cash transfer schemes [2].

5. 16th FC fiscal roadmap (2026-31)

• States' fiscal deficit limit: 3% of GSDP every year [2].
• End off-budget borrowing: "strictly" discontinue it and bring all such borrowing onto the budget [2].

• Widen the definitions of fiscal deficit and debt so they uniformly include all off-budget borrowing [2].

• Rationalise subsidies:

• clear exclusion criteria (who does not qualify)
• rigorous reviews

• no off-budget financing of subsidies [2]

• Privatise DISCOMs [2].

• Create a debt-warehousing SPV: a separate company that holds the old DISCOM debt, so the new private owner does not carry it [2].

• This debt may be repaid early or later using SASCI funds [2].

• State PSEs (public sector enterprises owned by state governments):

• Close 308 inactive state PSEs [2].

• If a PSE makes losses in 3 of 4 years in a row, the state Cabinet should decide whether to close it, privatise it or keep it for strategic reasons [2].

• Debt path: combined Centre + states debt is projected to fall from 77.3% of GDP (2026-27) to 73.1% (2030-31) [2].

• The 16th FC also recommended a Centre fiscal deficit of 3.5% of GDP by 2030-31 [2]. The Union's own targets are covered in the government-budget-fiscal-policy topic.

• States' debt: total outstanding debt of states was 27.5% of GDP at the end of March 2025 [3]. (Scaffold: "about 28% of GDP", RBI State Finances.)

• Worked example: debt-GSDP ratio
• Formula: Debt-GSDP ratio = (Outstanding debt ÷ GSDP) × 100.
• Suppose a state has ₹2.8 lakh crore of debt and ₹10 lakh crore of GSDP. Its ratio is 28%.
• Suppose the state also has ₹40,000 crore of off-budget loans repaid from its budget. Counting those, the true ratio is 32%. This is why the 16th FC wants the definition widened.

Prelims Hooks

• Art. 293(1): a state may borrow only within India, on the security of its Consolidated Fund. States cannot borrow abroad directly.
• Art. 293(3): the Centre's consent is needed only while a Union loan is outstanding. In practice this covers every state.
• Art. 131 (original jurisdiction) was used by Kerala to challenge the borrowing curbs. This is not Art. 32, and it is not an appeal.
• The Net Borrowing Ceiling has included budget-serviced off-budget borrowing of state PSUs and SPVs from March 2022 [5].
• The power-sector bonus was up to 0.5% of GSDP a year for 2021-22 to 2024-25. 13 states got ₹1,48,361 crore [6].
• Trap: the FRBM Act 2003 binds only the Centre. States have their own FRLs, and Karnataka (2002) was first.
• The 12th FC tied debt relief to states passing FRLs.
• 16th FC: states' FD 3%; 308 inactive state PSEs to close; combined debt 77.3% → 73.1% of GDP (2026-27 → 2030-31) [2].
• AT&C loss = technical loss + commercial loss (theft and unpaid bills). The ACS-ARR gap = cost of supplying one unit minus revenue earned per unit [6].

Mains Points

• Fiscal autonomy vs. fiscal discipline (GS-II): Art. 293(3) turns a historical debt into lasting control by the Centre.
• States' view (Kerala's Art. 131 suit): counting off-budget borrowing inside the NBC, and doing it after the fact, cuts into their autonomy.
• Centre's view: hidden debt threatens macro stability, and the national debt is shared by all.

• The Constitution Bench's ruling will settle how far Art. 293(4) conditions can go.

• Transparency is the core fix (GS-III): off-budget borrowing and guarantees (4.2% of GSDP, 2020-21 [4]) hide the real debt.

• The 16th FC's widened definitions of deficit and debt [2] follow the IMF-style "general government" idea: count every liability the budget will finally repay.

• Incentives beat commands: the 12th FC's debt relief for FRLs, the 0.5% power-sector bonus [6] and SASCI all show that conditional borrowing room can push reforms like DISCOM metering and DBT.

• The risk is that reforms stay shallow once the incentive ends.

• Quality of spending: OPS reversion and untargeted cash transfers raise committed revenue spending.

• This leaves less room for capex, and capex has a higher multiplier (each rupee of capex adds more to GDP than a rupee of revenue spending).
• Link to the 16th FC's call for subsidy rationalisation and PSE closure [2].