Rising deficit and debt puts Indian states under fiscal strain: NSE Report

Fiscal consolidation measures such as managing contingent liabilities, improving fiscal transparency, and enhancing the fiscal credibility of SDLs needed to address states' financial challenges

The fiscal health of Indian states continues to be under pressure, with fiscal deficits exceeding recommended limits and a rising debt-to-GDP (gross domestic product) ratio, revealed the NSE’s latest State of States report reviewing state budget for financial year 2024-25. 

To address these challenges, there is a critical need for fiscal consolidation, especially in the fiscally-strained states. This includes reducing contingent liabilities, improving fiscal transparency, and enhancing the fiscal credibility of state development loans (SDLs) to ensure the long-term financial sustainability of these states.

21 states represent 95 per cent of India’s GDP

The report analyses the financial plans of 21 Indian states for FY25. Collectively, these states represent over 95 per cent of India’s GDP, projected at Rs 326 trillion for FY25.

 

States sampled include: Andhra Pradesh, Assam, Bihar, Chhattisgarh, Gujarat, Haryana, Himachal Pradesh, Jharkhand, Karnataka, Kerala, Madhya Pradesh, Maharashtra, Meghalaya, Mizoram, Odisha, Punjab, Rajasthan, Tamil Nadu, Telangana, Uttar Pradesh, and West Bengal.

The average GDP growth for these states is expected to reach 11.2 per cent. This is a decline from 11.8 per cent in the revised estimates for FY24. There is also notable variation among states, with Madhya Pradesh anticipating a growth rate as low as 0.6 per cent, while Mizoram is projected to achieve 22.1 per cent. This overall growth estimate surpasses India’s budgeted growth rate of 10.5 per cent.

The report findings also indicate a projected fiscal deficit of 3.2 per cent of gross state domestic product (GSDP) for FY25, surpassing the 3 per cent threshold recommended by the 15th Finance Commission.

Decline in capital spending

Following three consecutive years of robust growth, capital expenditure by states is anticipated to slow down in FY25. This slowdown is attributed to a decline in the growth of revenue receipts. An analysis of FY24 revised estimates (RE) showed that the overall fiscal deficit exceeded budget estimates by 30 basis points, reaching 3.5 per cent of GSDP. This discrepancy was attributed to a combination of lower-than-expected non-tax revenues and higher-than-expected revenue expenditure.

For FY25, total receipts for the states are budgeted to increase by 10.2 per cent to Rs 43.4 trillion, a decline from the 16.7 per cent growth recorded in FY24. Meanwhile, revenue receipts, which make up over 99 per cent of total receipts, are expected to rise by 10.6 per cent. The increase is driven by a significant growth in states’ own revenues. Despite this, overall transfers from the Centre, through tax devolution and grants-in-aid, are expected to rise by a modest 4.5 per cent.

Among the revenue streams, the state goods and services tax (SGST) is projected to see a significant growth of 16.7 per cent in FY25. FY24 saw a 21.3 per cent increase.

Moderating expenditure growth

As the growth in receipts slows, both revenue and capital expenditure are expected to witness moderate growth in FY25. Revenue expenditure is budgeted to increase by 8.9 per cent, compared to 17.2 per cent in FY24, while committed expenditure remains stable at 10.2 per cent.

Capital expenditure is projected to grow at 6.5 per cent, a decline from the previous year’s 39.3 per cent growth. Additionally, the capital-to-revenue expenditure ratio, an indicator of expenditure quality, is expected to decline from a seven-year high of 21.2 per cent in FY24 to 20.7 per cent in FY25.

It must be noted that there is considerable variation among states. For instance, Gujarat, Rajasthan, and Tamil Nadu are planning capital expenditure growth rates of between 24-30 per cent, while states like Bihar, Madhya Pradesh, and Maharashtra anticipate declines.

Markets loans to finance state fiscal deficit in FY25

For FY25, market loans are expected to finance 79 per cent of the fiscal deficit, with gross borrowings for these states projected to rise by 7 per cent to Rs 10.8 trillion. The total gross borrowings across the sampled states are projected to increase at a compound annual growth rate (CAGR) of 11.8 per cent from FY20 to FY25, with states like Madhya Pradesh and Kerala leading this trend.

Clear roadmap for fiscal consolidation needed

States contribute only 30 per cent of the total tax revenues while accounting for 60 per cent of combined expenditures. Therefore, establishing a clear roadmap for fiscal consolidation is crucial, especially for heavily indebted states such as Punjab, Bihar, and West Bengal, the report said.

Some of these states have debt-to-GDP ratios exceeding 40 per cent, with significant portions of their revenue receipts allocated to committed expenditures, limiting funds available for development. Debt-to-GDP ratio is the measure of a state’s capability to pay debts.

The report suggests that states could benefit from risk-based pricing for state development loans (SDLs) based on their financial conditions. This approach could motivate financially weaker states to adopt consolidation strategies. Additionally, states should manage their contingent liabilities. These liabilities are tied to guarantees given to state public sector enterprises (SPSEs). Addressing this issue would improve transparency and strengthen overall fiscal stability.

Finally, there is a persistent gap between budgeted estimates and actual figures in state finances. Addressing this discrepancy is vital for improving fiscal credibility. This would also ensure a more accurate assessment of financial health across states.