by While national GDP and central budgets tend to dominate the headlines, a closer look at state (or provincial) finances often reveals the real vulnerabilities—or strengths—of an economy. In India, state governments now together account for roughly 60% of general government expenditure, yet collect only about 37% of total tax revenue. States also shoulder a huge share of public investment, social welfare spending, and rising debt burdens. As such, the health of state finances is not just a fiscal measure—it’s a vital macro‑economic barometer.
The Core Issue: Rising Deficits, Debt and Distorted Spending
Even as India’s national fiscal deficit has declined post‑pandemic, the aggregate gross fiscal deficit (GFD) of the states was budgeted at 3.2% of GSDP in 2024‑25, slightly above the 3% ceiling recommended by the 15th Finance Commission. Alarmingly, 15 states—including Andhra Pradesh (4.2%), Sikkim (5.4%) and Himachal Pradesh (4.7%)—projected deficits beyond that limit. This reflects persistent revenue shortfalls and fast-growing expenditure driven by subsidies, salaries, and interest payments.
The Reserve Bank of India (RBI) has repeatedly urged Indian states to adopt time‑bound debt consolidation plans, pointing out that although total liabilities fell to 28.5% of GDP by March 2024 (from 31% in 2021), this level remains elevated and unsustainable without reforms. A mounting interest burden is crowding out space for capital investment; in many states, interest payments alone now consume a significant share of annual revenue.
Data Speaks: Where State Deficits Reflect Economic Malaise
- States’ capital spending has increased markedly in recent years—Republic-to-state capital capex rose by 2.1 times between FY21 and FY24, highlighting concerted infrastructure push by sub‑national governments. Yet, revenue collection has not kept pace. For instance, Uttar Pradesh and Chhattisgarh have higher own‑tax‑to‑GSDP ratios (~8.8%), while many special‑category states languish below 6%.
- The CRISIL estimate that 18 major states expect their revenue receipts to grow 7‑9% in FY26 underscores that tax buoyancy and central transfers remain the key levers behind state capability to invest without excessive debt.
- The Comptroller and Auditor General (CAG) recently flagged financial strain in Telangana, with rising deficit and weaker-than-expected revenue collections—an early warning sign of weakening sub‑national health. Similarly, Punjab saw its borrowing limit slashed by the Centre in mid‑2025 due to power sector arrears and sputtering revenues, forcing liquidity crunches mid‑year.
- Andhra Pradesh and Madhya Pradesh boast large public sector enterprises, but many state‑level PSUs in MP reported losses, with ₹40 crore in misappropriation and idle treasury funds exposed by the CAG report. These inefficiencies add to fiscal stress and reduce space for productive investment.
- Perhaps most worrying, rising off‑budget borrowing and contingent liabilities—such as unpaid guarantees and specialty fund obligations—are not always captured in headline deficit numbers, masking deeper fiscal fragility.
Together, such trends show that when state budgets become unsustainable, it results in reduced public capital, slower growth, higher inflationary risk, and increased default vulnerability.
What This Means for the Broader Economy
A financially stressed state cannot deliver adequate infrastructure, health, and education. States with high debt and interest commitments often cut back on capital expenditure and defer reforms. This leads to a fragile growth dynamic—where GDP slows, credit costs rise, states resist further borrowing, and the fiscal space shrinks. Conversely, states that maintain fiscal discipline—such as Kerala (debt‑GSDP ~33.9%, below FRBM ceilings) or Tamil Nadu—find it easier to invest in human capital, attract private investment, and fund welfare programs sustainably.
Way Forward: Principles, Reforms, and Policy Pathways
- Strengthen State-Level FRBM Acts and Fiscal Rules
Every state should legislate clear ceilings on fiscal, revenue, and debt ratios (as envisaged under the Fiscal Responsibility & Budget Management framework) with automatic corrective action if standards are breached. - Transparency on Off-Budget Liabilities
Liabilities such as NPS contributions, guarantee redundancies or infrastructure bonds need to be reported and capped—through an independent fiscal responsibility council at the national level. - Rationalise Non-merit Subsidies and Social Schemes
Subsidy spending (e.g. farm waivers, freebies, public C-seats) should be calibrated, welfare payments made conditional, and replaced with direct benefit transfers that don’t distort states’ revenue-reserve balance. - Boost Own Revenue Mobilisation
States with low share of SGST, excise or property tax should invest in digital compliance, widen tax base and rationalise stamp duties to reduce overreliance on centre‑to‑state devolution. - Tie Borrowing to Structural Reform
The 0.5% extra borrowing window granted by the Finance Commission should be conditioned on reform in power sectors, public sector governance, and climate-proofed capital programs—for both fiscal discipline and productivity impact. - Promote Peer Learning and Expert Review
States should share best practices through a platform akin to the RBI’s “state finance forum”, enabling regular joint reviews, peer-to-peer audits, and advisory support for capacity building.
Conclusion
State finances reflect subtle truths about an economy’s strengths and weaknesses—much more than headline GDP figures can ever tell. When states borrow prudently, invest wisely, and diversify revenue bases, they lay the groundwork for sustained national growth. But where budgets are unbalanced, liabilities hidden, or investment crowded out by subsidy commitments, the economy becomes fragile. For India—or any federal economy—to thrive in a volatile global environment, state fiscal health must become an integral part of macroeconomic strategy. A country can only grow as strong as its weakest sub‑national budget; strengthening that requires not only reform, but recognition that state finance is national economic infrastructure
