Balancing the path to higher economic growth with fiscal discipline has its challenges, and is often fraught with missteps.
The recent Union Budget stresses on the need for higher fiscal consolidation. But the Union government’s own overall borrowing (and debt) has ballooned in recent years.
The rising hidden debt incurred by the Indian government, a result of off-budget borrowings combined with a lack of fiscal transparency makes any objective of achieving a fiscal consolidation path or a lower fiscal deficit target suspicious.
India’s current public debt stands at approximately 83% of GDP, a level that is projected to remain around 83.6% until 2027-28, according to IMF estimates.
What is happening with states?
At the heart is a basic question, how do fiscally weaker states get growth and fund welfare, infrastructure and development without incurring unsustainable debt?
A recent study suggests that some Indian states have tried to manage this by securing growth with relatively better balanced fiscal prudence, while others are caught in a downward spiral of reckless borrowing and financial short-sightedness.
This analysis comes with a caveat embedded in the political economy landscape of troubled Centre-State relations under the Modi administration. Non-BJP states have been left with little or delayed disbursed funds to manage their growth and welfare priorities, which is why some high-debt ridden states like Punjab, Rajasthan and Kerala have struggled more compared to others, and where fiscal mismanagement has reached alarming proportions.
Uttar Pradesh, the most populous state, is struggling with 27.6% debt-to-GSDP, unable to generate enough revenue and is overly dependent on central government transfers. The phrase ‘double engine sarkar’ seems to be often used in the Yogi-Modi administration, but there is a clear bias in the treatment of BJP-run states vs those where the party is not in state-power. Punjab is largely suffering the consequences of this asymmetric political bias which has clear economic and fiscal implications.
Source: RBI
The Reserve Bank of India has repeatedly flagged some of the critical risks associated growing stock of contingent liabilities, which refer to potential obligations in debt that are likely to arise in the future. Rise of such ‘contingent’ liabilities function like invisible debt (one that is difficult to actually estimate at the time but is more certainly there and accrued over a period of time). If these liabilities materialise, as estimated, they significantly strain state finances, leaving governments unable to meet essential commitments or sustain developmental initiatives. The Union government too hasn’t done much in its own effort to either assist or guide states.
Source: CSEP
Beyond the understood fiscal risks, the hidden debt issue poses cascading implications for India’s macro-social and developmental priorities. Average welfare expenditure allocations for critical schemes, economic development and social-welfare programs has suffered at the hands of higher capex and interest payments. Interest payments, themselves, consume nearly 42% of overall government revenue, diverting resources away from critical welfare schemes for better employment security, education, and healthcare.
Rising off-budget borrowings: The hidden debt issue warranting attention
While fiscal deficits and borrowings are debated in budget speeches, the real crisis is buried under off-balance-sheet borrowings, hidden liabilities, and reckless fiscal management. The numbers look bad enough on paper, but a deeper look reveals a far more disturbing reality, that threatens the financial stability of several states in the long run.
The most glaring issue is of the rising off-budget borrowings for the Union Government, which has failed to effectively address this issue despite projecting a path to fiscal consolidation one budget after another. This has also pushed states to undertake more borrowings to finance expenditure and interest-payment fiscal burden.
Source: Author Calculations from Handbook of Statistics on Indian Economy (RBI) and Union Budget Documents, 2012-24
In the absence of critical fiscal support from the Union government, predominantly because of political reasons delaying pre-existing federal fund-sharing arrangement on transfers, some opposition-rules states like Tamil Nadu, Andhra Pradesh and Punjab have used state-owned power companies, irrigation agencies and transport corporations as borrowing vehicles, keeping massive liabilities off their books. The result has been a growing mountain of debt that never officially appears in state budgets, but must still be repaid.
Tamil Nadu’s off-budget borrowings were approximately 1.55% of its GSDP in the fiscal year 2021-22. These borrowings are primarily attributed to entities such as the Tamil Nadu Generation and Distribution Corporation (TANGEDCO) and the Tamil Nadu Civil Supplies Corporation.
Source: CMIE Economic Outlook, CMIE States of India, PRS, State budget documents, NSE EPR
Closely linked to this is the issue of contingent liabilities. When states issue loan guarantees for failing public sector enterprises, they are essentially betting taxpayer money on unviable projects-raising such contingent liabilities. Power distribution companies (DISCOMs) and state transport agencies in Rajasthan, Punjab and Bihar are prime examples, accumulating losses that will eventually force governments to step in with bailouts. As of March 2021, the contingent liabilities of India’s state governments were approximately 3.7% of GDP, while those of the Union government were about 2.5% of GDP.
To make matters worse, the RBI’s bond market intervention ensures that all states borrow at nearly the same interest rate, regardless of their financial health. This means fiscally responsible states like Gujarat and Maharashtra are subsidizing inefficient borrowers like Punjab and Rajasthan, removing any incentive for reckless states to reform their finances. In a well-functioning market, high-debt states should face higher borrowing costs, forcing them to adopt better fiscal discipline. Instead, the current system rewards fiscal mismanagement.
The 15th Finance Commission has only worsened the problem, by allocating more funds to states with higher revenue deficits. The logic was to assist struggling states, but in practice, it has encouraged states to keep expenses off-budget to qualify for more central transfers. Instead of promoting efficiency, the system incentivises states to remain dependent on central funds. This is particularly visible in states like Bihar and West Bengal, where budget estimates consistently overinflate revenue projections while understating expenses, setting them up for perpetual deficits.
Meanwhile, the real development agenda suffers. Many states are spending disproportionately on salaries and pensions while neglecting capital investment. Uttar Pradesh and Bihar, despite their desperate need for infrastructure, allocate lesser percentage of their budgets to capital expenditure, diverting most resources to administrative costs and recurring expenses.
Worse still, many states are borrowing money just to roll over old debt, locking themselves in a vicious cycle where they take fresh loans simply to pay off previous ones. This is not fiscal management rather it is financial survival on borrowed time. It is also important to analyse the welfare performance of different students in relation to their overall macro-fisc position.
Welfare performance of states in terms of ‘access equality’ measures
Our Centre for New Economics Studies (CNES’) Access (In)Equality Index (AEI) in 2024 observed how states like Delhi (despite its unique multi-party governance architecture), West Bengal, Kerala (or even Goa and Sikkim) perform better compared to states like UP, Bihar, Madhya Pradesh, when it comes to being measured for securing access to basic social, economic services.
Securing easier access to basic socio-economic goods i.e. education, healthcare, social security, financial security, basic amenities is essentially part of an elected state government’s core responsibility to its citizenry.
While every state government may have different fiscal capabilities to meet the social, economic needs of its residential population at the time, what cannot be discounted is the fact that the ‘fiscal priority mapping’ of any state government (a BJP or non-BJP one) must be closely linked to welfare enhancing measures.
For context to AEI, in the methodological design of the multidimensional Access (In)Equality Index (AEI), we measured overall access, using geometric mean in order to ensure partial compensability, i.e. poor performance in one sub-index is not fully compensated by good performance in another.
Based on the score range of 0.67-0.23, states are grouped into three categories – ‘Aspirants’ (below 0.33), ‘Achievers’ (0.42-0.33) and ‘Front Runners’ (above 0.42). Bihar, Uttar Pradesh, Jharkhand, Assam, Odisha and Madhya Pradesh fall under ‘Aspirants’, requiring sustained efforts to improve ‘access’ to basic socio-economic opportunities (across all identified pillars).
States like Maharashtra, Arunachal Pradesh, Gujarat, Uttarakhand, Chhattisgarh, Rajasthan, Tripura, West Bengal, Manipur and Meghalaya are categorised as ‘Achievers’. These states have good provisions of access to (socio-economic) opportunities and must sustain their efforts to advance to the next category.
Lastly, states such as Goa, Sikkim, Tamil Nadu, Kerala, Himachal Pradesh, Telangana, Punjab, Mizoram and Karnataka are observed as ‘Front Runners’ in ensuring better access to basic socio-economic opportunities for their respective state-populations.
It is worth (re)iterating the close, correlative link drawn between state-debt levels and their AEI performance for welfare-based comparison.
States like Kerala, Punjab, Telangana, despite their high public debt have ensured better access to basic social and economic services to their state populations and have done well across most AEI pillars consistently. This has helped their respective state populations to also do well in creating high productivity across the nation. At the same time, states like Bihar, Uttar Pradesh, Madhya Pradesh, Assam, and Jharkhand (note how 4 of these 5 are BJP run states) perform the lowest across most AEI pillars-and are ranked the lowest in most ‘access’ measuring indicators.
Politics inhibiting fair treatment of opposition-ruled states
Recent cases of letters and points of contention raised/exchanged between state finance ministers of Kerala, West Bengal, Telangana, Tamil Nadu and Union Finance Ministry show how the Modi Government is arbitrarily squeezing non-BJP states from exercising their fiscal autonomy.
In managing the swelling fiscal deficit and public debt levels (including of fiscally weak states), the public expenditure composition and fiscal priorities must be more clearly understood, due to differed constitutional assignment of functions for the Union and State governments. Most redistributive expenditures -critical for welfare outcomes- are in functional domain of States.
Any contraction of such expenditure at the State level, due to coercive actions of the Union Government or due to high state accrued public debt levels, can have adverse distributional consequences, with a regression that can already be observed in performance outcomes state-level performance on access to education, healthcare, social security, particularly for the vulnerable and marginalized sections.
The importance of maintaining fiscal prudence mustn’t come at the cost of low welfare priorities for any national government, particularly in aiding states that need more assistance. The Prime Minister may also need to recognize how welfare driven expenditure needs aren’t part of ‘revdi’ politics but more about securing a government’s basic responsibility to its people and the larger citizenry.
State governments (irrespective of their party affiliation) need all the support they can get at this point to either borrow ‘more freely’ under a mutually agreed fiscal roadmap for their developmental needs or be otherwise supported to manage their finances on their own, or through borrowing financed support offered by the Union/Centre.
In either of the scenarios, balancing growth with fiscal prudence, ensuring fiscal cooperation and transparent functioning for a secured, fraternally placed federal policy is vital for protecting the Union-State fiscal space and enhancing macroeconomic stability to the economy. There is no room for an ‘ad hoc’ ‘arbitrary’ decision making mechanism by the Union government, nor selective partisan constitutional interpretations for partisan gains, which might trigger more direct confrontations between State governments and the Union Ministry of Finance, having severe economic implications.
What does this mean?
India’s macro-fiscal health management is faced with substantial structural issues, as both the Union and State governments grapple with reconciling between needs of securing higher economic growth and exercising fiscal restraint. The Union government, despite promoting fiscal consolidation, has increased its overall borrowings and off-budget liabilities, combined with a lack of transparency, creating issues of rising hidden debt. Public debt which has reached to 83% of GDP with reports suggesting it will remain at 83.6% until 2027-28. Simultaneously, States are experiencing budgetary constraints, as high-debt states such as Punjab, Rajasthan, and Kerala grapple with delayed fund transfers and political partialities in fiscal distributions from the Unio Government. Uttar Pradesh, the most populous state, also exhibits a debt-to-GSDP ratio of 27.6% and has a deeper reliance on central transfers. The off-budget borrowings of Tamil Nadu, constituting 1.55% of its GSDP in 2021-22, underscore the larger concern of states employing state-owned firms to evade borrowing limitations, particularly in the absence of assistance from the Union government. Moreover, interest payments account for around 42% of total government revenue, reallocating resources from critical social programs.
The Centre for New Economics Studies (CNES) Access (In)Equality Index (AEI) 2024 indicates that states such as Kerala, Punjab, and Telangana, despite substantial debt, achieve better welfare outcomes, whereas states like Bihar, Uttar Pradesh, and Madhya Pradesh rank lowest in access to social and economic services. Political difficulties between opposition-led states and the Union Finance Ministry intensify fiscal inequities, limiting states’ autonomy and development.
A more transparent and inclusive fiscal framework respective constitutional principles of a federal polity and economic relationship is crucial to tackle India’s escalating debt crisis. It requires the Union government to take centre stage in ensuring this, while abandoning politically motivated economic measures and concentrate on more equitable, rules-based fund distributions, particularly helping out weaker, higher debt-ridden states. States, irrespective of their political leadership and party in power also need the financial autonomy and support necessary to manage their spending and borrowing news responsibly while prioritizing welfare and infrastructure development. Without fundamental reforms in its growing debt-position triggered by off budget borrowings, and in its macro fiscal-deficit management, Indian government risks long-term economic stagnation, increased regional inequities, and weaker state capacities to offer key public services (a scenario that is already visible).
With contributions from Ankur Singh, CNES.
Deepanshu Mohan is a Professor of Economics, Dean, IDEAS, and Director, Centre for New Economics Studies. He is a Visiting Professor at London School of Economics and an Academic Visiting Fellow to AMES, University of Oxford.
