From UPSC perspective, the following things are important :
Prelims level: Finance Commission; State Government; FRBM Act;
Mains level: Fiscal Federalism and its challenges
Why in the News?
Recently, the SC rejected Kerala’s plea for immediate relief in its case urging the Union government to ease borrowing constraints, allowing the state to secure extra funds in the ongoing fiscal year.
State governments receive funds from three sources:
- Own revenues (tax and non-tax)
- Transfers from the Union government as shares of taxes and as grants
- Market borrowings
Fiscal Demands for Extra Funds:
- Increased Expenditure: In 2020-21, the Kerala government sharply increased its spending to 18% of its GSDP, to provide economic relief in the wake of the COVID-19 pandemic, aided by the relaxation in borrowing norms then
- Central Gov transfers to Kerala declined: As ratios of GSDP, the Union government’s transfers to Kerala declined to 2.8% in 2023-24, significantly lower than previous years, even as the State’s revenues remained at around 8.0%.
- This meant that, in 2023-24, the State government could meet its modest budget expenditure, equivalent to 14.2% of GSDP, only by raising the borrowing to 3.4% of the GSDP
Socio-Economic for Extra Funds:
- Aging Population: Kerala, like many other states, faces the challenge of an aging population, which puts pressure on pension funds and healthcare systems, necessitating long-term financial planning and investment.
- Pension Liabilities: The substantial outgo for pensions poses a financial burden on the state’s budget, requiring strategies for sustainable pension management to ensure fiscal stability.
- Youth Outmigration: Kerala experiences significant outmigration of its youth, leading to a loss of productive workforce and potential tax revenues, highlighting the need for policies to retain skilled workers and stimulate economic growth
About Net Borrowing Ceiling (NBC):
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Basis of the Net Borrowing Ceiling:
- Fiscal Responsibility Legislation: Both the central and state governments in India adhere to the FRBM Act, which establishes fiscal deficit goals to uphold fiscal discipline. Under the FRBM, states are required to maintain a fiscal deficit limit of 3% of the Gross State Domestic Product (GSDP).
- Central Government Guidelines: The central government, through the Department of Expenditure in the Ministry of Finance, sets the annual borrowing limits for each state based on a formula that considers the state’s GSDP, existing debt levels, fiscal discipline, and other relevant factors. These limits can be revised in response to special circumstances, such as natural disasters or significant economic downturns.
- Finance Commission Recommendations: The Finance Commission, which is constituted every five years, recommends how the central taxes are to be divided between the centre and the states and suggests measures to maintain fiscal stability. It also provides recommendations regarding the borrowing limits of states.
Conclusion: States need to put in place an effective forecasting and monitoring mechanism for cash inflows and outflows so that a need-based approach is followed for market borrowings and the interest cost of cash surpluses is minimized.
Mains PYQ
Q What were the reasons for the introduction of Fiscal Responsibility and Budget Management (FRBM) Act, 2013? Discuss critically its salient features and their effectiveness. (UPSC IAS/2013)
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