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Introduction

With nearly half of India’s major States projected to remain in revenue deficit in 2026–27, the rising debt-to-GDP ratio is weakening fiscal stability, shrinking development spending, and increasing States’ dependence on the Union, thereby straining cooperative federalism.

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Structural Causes Behind Rising State Debt

• Revenue Deficit: States spend heavily on salaries, subsidies, and interest payments while regular tax and non-tax revenues remain insufficient, forcing borrowing even for day-to-day expenses.
  Eg: Ministry of Finance MER 2026 noted 9 of 18 major States are projected to remain in revenue deficit.
• Welfare Burden: Expanding farm waivers, and populist schemes increase committed expenditure without generating productive assets, worsening fiscal sustainability.
  Eg: Rising subsidy burdens in States like Punjab and Andhra Pradesh have repeatedly raised fiscal concerns in RBI’s State Finances reports.
• Weak Tax Base: Dependence on GST compensation, limited own tax mobilisation, and weak property tax/user charges reduce States’ independent fiscal capacity.
  Eg: Post-GST compensation delays increased fiscal stress for many States during and after COVID.
• Low Capital Returns: Borrowing for projects with poor execution and weak returns fails to generate future revenue, leading to debt accumulation without growth support.
• Off-Budget Loans: State PSUs and guarantees hide actual liabilities outside budgets, creating hidden debt and weakening transparency in fiscal management.
  Eg: FRBM reviews flagged power DISCOM liabilities and guarantees as major off-budget fiscal risks.

Measures for Fiscal Consolidation

• Revenue Discipline: Borrowings should be restricted for capital creation, while routine expenditure must be financed through regular revenue to avoid persistent revenue deficits.
  Eg: FRBM framework emphasizes eliminating revenue deficit for sustainable state finances.
• Better Taxation: Improve GST compliance, strengthen property tax and expand digital tax administration to enhance own-source revenues.
  Eg: Finance Commission recommendations stress stronger municipal taxation and better tax buoyancy.
• Rational Spending: Reduce non-merit subsidies and prioritize social infrastructure spending that improves long-term growth and repayment capacity.
• Debt Transparency: RBI recommended including off-budget borrowings for realistic State debt evaluation.
• Centre-State Coordination: Strengthen fiscal councils and cooperative borrowing limits to preserve both discipline and federal trust.

Conclusion

Fiscal consolidation should not mean austerity but smarter public finance where States borrow less for survival and more for growth. Sustainable debt management is essential not only for economic resilience but also for preserving the spirit of cooperative federalism.

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