The Economic Survey had a prescient warning on worsening state government finances potentially increasing sovereign borrowing costs. State government fiscal deficits have risen over the last few years from 2.7% of GDP in FY23 to 3.2% in FY25.
The deterioration in fiscal metrics is led by slowdown in revenue growth, both tax collections and non-tax collections such as grants from the Centre. As per the survey, only 11 state governments had a revenue surplus in FY25 against 19 in FY29. A revenue deficit essentially means that the states are borrowing to meet daily operational costs such as salaries, interest, subsidies, pensions, etc.
In FY26, as per our estimates, the fiscal metrics of state governments would have worsened further with fiscal deficit estimated at 3.3% to 3.4% of GSDP. Revenue deficit has widened to 0.9% of GDP in FY26 from 0.1% in FY19.
The deterioration in fiscal metrics hasn't resulted in state governments reducing their focus on capital expenditure. This is thanks to the Scheme for Special Assistance to states for capital investment. Under the scheme, the Centre provides 50-year, interest-free loans to state governments exclusively for capital expenditure.
In FY25, state governments' capital expenditure had sustained at 2.4% of GDP, out of which 0.4% of GDP was financed via these loans. In FY26, the Centre has earmarked ₹1.5 lakh crore under this scheme, out of which ₹83,600 crore has been released till date. The positive assessment by the survey indicates continuation of capex loans to state governments in FY27 and possible enhancement.
The rising popularity of unconditional cash transfers among state governments has been flagged as a risk to expenditure quality by the survey. These cash transfers are mostly targeted at women and are estimated at ₹1.7 lakh crore in FY26 (0.5% of GDP). The range among state governments is from 0.2% of GSDP to as high as 1.25% of GSDP. The cash transfers provide immediate income support to meet health and personal needs. However, it erodes dwindling fiscal space among state governments to undertake vital investments. The survey highlighted that these schemes are not associated with a sun-set clause, adding to the burden of committed expenditure.
It argues that investment expenditure is the most consistent and statistically important driver of per capita income growth. States which devote a larger share of resources to investment see durable gains in per capita income, rather than short-term transfer-led cash schemes.
Another aspect of state finances that the survey touched upon was the rising level of debt to GDP for state governments, as well as higher interest payments to revenue receipts ratio. In FY25, state government debt to GDP stood at 28.1% and interest payments to revenue receipts at 12.6%. Among state governments, there is considerable variation with debt levels ranging from 55% of GSDP to less than 20% of GSDP. However, the yields on state government bonds doesn't reflect the differentiated fiscal performance among states. Or in other words, states which are fiscally prudent are not rewarded with lower borrowing costs.
To ensure better risk assessment by the market and more accountability for state governments, the survey recommends timely, granular and standardised dissemination of state-level fiscal data, including off-budget liabilities and guarantees.
State government finances don't get the attention they deserve due to difficulty in tracking data. However, over the years, the share of state governments in overall government expenditure has steadily increased, accounting for nearly 60% of total general government expenditure. The difficulty in garnering revenues has resulted in higher state government borrowings, competing for resources with not just the Centre but the private sector as well.
(The author is chief economist at IDFC First Bank)
The deterioration in fiscal metrics is led by slowdown in revenue growth, both tax collections and non-tax collections such as grants from the Centre. As per the survey, only 11 state governments had a revenue surplus in FY25 against 19 in FY29. A revenue deficit essentially means that the states are borrowing to meet daily operational costs such as salaries, interest, subsidies, pensions, etc.
In FY26, as per our estimates, the fiscal metrics of state governments would have worsened further with fiscal deficit estimated at 3.3% to 3.4% of GSDP. Revenue deficit has widened to 0.9% of GDP in FY26 from 0.1% in FY19.
The deterioration in fiscal metrics hasn't resulted in state governments reducing their focus on capital expenditure. This is thanks to the Scheme for Special Assistance to states for capital investment. Under the scheme, the Centre provides 50-year, interest-free loans to state governments exclusively for capital expenditure.
In FY25, state governments' capital expenditure had sustained at 2.4% of GDP, out of which 0.4% of GDP was financed via these loans. In FY26, the Centre has earmarked ₹1.5 lakh crore under this scheme, out of which ₹83,600 crore has been released till date. The positive assessment by the survey indicates continuation of capex loans to state governments in FY27 and possible enhancement.
The rising popularity of unconditional cash transfers among state governments has been flagged as a risk to expenditure quality by the survey. These cash transfers are mostly targeted at women and are estimated at ₹1.7 lakh crore in FY26 (0.5% of GDP). The range among state governments is from 0.2% of GSDP to as high as 1.25% of GSDP. The cash transfers provide immediate income support to meet health and personal needs. However, it erodes dwindling fiscal space among state governments to undertake vital investments. The survey highlighted that these schemes are not associated with a sun-set clause, adding to the burden of committed expenditure.
It argues that investment expenditure is the most consistent and statistically important driver of per capita income growth. States which devote a larger share of resources to investment see durable gains in per capita income, rather than short-term transfer-led cash schemes.
Another aspect of state finances that the survey touched upon was the rising level of debt to GDP for state governments, as well as higher interest payments to revenue receipts ratio. In FY25, state government debt to GDP stood at 28.1% and interest payments to revenue receipts at 12.6%. Among state governments, there is considerable variation with debt levels ranging from 55% of GSDP to less than 20% of GSDP. However, the yields on state government bonds doesn't reflect the differentiated fiscal performance among states. Or in other words, states which are fiscally prudent are not rewarded with lower borrowing costs.
To ensure better risk assessment by the market and more accountability for state governments, the survey recommends timely, granular and standardised dissemination of state-level fiscal data, including off-budget liabilities and guarantees.
State government finances don't get the attention they deserve due to difficulty in tracking data. However, over the years, the share of state governments in overall government expenditure has steadily increased, accounting for nearly 60% of total general government expenditure. The difficulty in garnering revenues has resulted in higher state government borrowings, competing for resources with not just the Centre but the private sector as well.
(The author is chief economist at IDFC First Bank)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
