In a recent legal showdown, the Kerala government finds itself in a disagreement with the Central government over the imposed limits on the state's borrowing capacity. The Attorney General, R Venkataramani, submitted a note to the Supreme Court highlighting the potential repercussions of uncontrolled borrowing by states on the country's credit rating and fiscal stability.

According to Venkataramani, if a state engages in reckless borrowing for unproductive expenditures or poorly targeted subsidies, it could squeeze out private borrowing from the market. The debt of states doesn't just impact the individual state's credit rating but has wider consequences for the entire country. A default by any state in servicing its debt could lead to reputational issues and pose a threat to the overall financial stability of India.

The note emphasizes that uncontrolled borrowing would drive up borrowing costs for private industries, affecting the production and supply of goods and services in the market. This, in turn, could lead to a reduction in funds available for development, potentially causing economic hardships and loss of income at both state and national levels.

To maintain some control over borrowing activities, all states are required to seek permission from the Union government before borrowing from any source. The Union government, in granting permission, considers the macroeconomic stability of the entire country and sets borrowing limits for the states, as outlined in Article 293(4).

Venkataramani stresses that these borrowing limits are established in a non-discriminatory and transparent manner, guided by the recommendations of the Finance Commission. However, the Kerala government argues that the Centre's interference infringes upon the state's fiscal autonomy, which is protected by various articles of the Constitution.

In response to the legal challenge, the Central government has been asked by the Supreme Court to clarify its position within two weeks. The Kerala government, in its original suit, claims that the Centre's actions violate the federal structure of the Constitution and encroach upon the state's exclusive powers to regulate its finances.

The crux of the matter lies in the disagreement over the Centre's imposition of a net borrowing ceiling on Kerala. The state argues that such interference hampers its ability to balance the budget and address fiscal deficits, powers it believes are exclusively within the domain of the states.