State market borrowings: India’s states have a persistent finance problem. Many of them are heavily indebted. They are now leaning more on market borrowings to finance their fiscal deficits, reshaping India’s subnational debt market.
The Reserve Bank of India’s Annual Report for 2025-26 shows that market borrowings financed 76.3% of states’ gross fiscal deficit in the 2025-26 Budget Estimates, up from 71.8% in the 2024-25 Revised Estimates. States are funding expenditure amid slower transfers, welfare commitments and infrastructure ambitions.
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This matters because both the Centre and the states are under pressure to maintain fiscal discipline while supporting growth through public spending. States have become major drivers of public capital expenditure. Their budgets fund roads, urban infrastructure, power distribution, irrigation, health, education and welfare. That spending push has raised borrowing requirements. States are turning more to the market rather than relying mainly on central transfers or small savings.
In absolute terms, states raised Rs 12.76 trillion through state government securities in 2025-26, against Rs 10.73 trillion in the previous year. Gross market borrowings were 95.1% of the amount indicated in quarterly borrowing calendars. There were 1,055 issuances during the year, including 217 re-issuances. The amount raised as a share of total sanctions rose to 93.6% from 91.4% a year earlier.
State debt costs are rising
The greater reliance on market borrowing has come at a cost. The weighted average cut-off yield on state government securities rose to 7.32% in 2025-26 from 7.2% in the previous year. The weighted average spread over comparable central government securities widened to 50 basis points from 30 basis points. Investors are demanding a higher risk premium for holding state debt, even though state securities still carry implicit sovereign comfort.
As states borrow more, the demand-supply balance shifts and yields move up. Investors are also becoming more selective. They are looking more closely at each state’s finances, debt levels and governance record. The average inter-state spread on fresh 10-year state bonds doubled to 8 basis points from 4 basis points a year ago. Markets are beginning to charge weaker states more and reward stronger states with lower borrowing costs.
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Earlier, most state bonds were priced almost similarly, irrespective of the strength of a state’s finances. Investors treated state government securities as safe because of implicit sovereign backing and low default risk. That assumption is weakening. Rising debt, salaries, pensions, subsidies, welfare schemes and off-budget liabilities are forcing markets to distinguish between states.
Several states are already under fiscal stress. Punjab, Rajasthan, Kerala and West Bengal remain among the more vulnerable large states. Interest payments consume a large share of their revenue receipts. Welfare guarantees and subsidy commitments have made consolidation harder.
The visible debt stock understates the risk. Guarantees to state-owned enterprises, off-budget borrowings and liabilities of power distribution companies can migrate to state budgets when cash flows fail. PRS has noted that some states do not disclose off-budget borrowings in their budget documents. State guarantees are also material. Telangana, Andhra Pradesh, Sikkim, Rajasthan and Uttar Pradesh have been flagged for large guarantee exposure, with power and infrastructure entities accounting for much of the risk.
State fiscal deficit and welfare pressure
India’s general government debt, covering both the Centre and states, remains elevated by emerging-market standards. The Centre has set out a medium-term consolidation path, and the Union government’s fiscal deficit for 2025-26 was reported at 4.4% of GDP, in line with the revised estimate. State finances are more uneven.
Populism has intensified in recent years. Political parties promise cash transfers, free electricity, farm waivers and subsidised services. These measures may offer short-term political returns. They also raise revenue expenditure and reduce space for productive capital spending.
The power sector remains the largest hidden pressure point. Free or cheap electricity, delayed subsidy payments and weak discom finances repeatedly push liabilities back to state governments. Guarantees to power entities accounted for a large share of state guarantees, averaging 47% across states. This weakens the distinction between commercial borrowing by state entities and fiscal borrowing by the state itself.
Fiscal rules have also become more elastic. The 3% of GSDP deficit norm remains the anchor for states under the Fifteenth Finance Commission framework. States were also allowed additional borrowing space of 0.5% of GSDP if they met power-sector reform conditions. This flexibility is useful when it finances assets. It becomes dangerous when it accommodates subsidies, salaries or election promises.
The real test is not debt alone, but the gap between growth and interest cost. A state that grows fast can carry debt more easily. A slow-growing state with high committed expenditure cannot. This is why markets are beginning to price state debt differently.
The RBI has flagged the need for greater transparency in state borrowings. It has been encouraging states to adopt a Benchmark Issuance Strategy. Under this system, states would issue bonds of fixed maturities according to a pre-announced schedule, closer to the Centre’s borrowing programme. This should give investors better visibility and improve price discovery.
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The strategy is expected to be introduced on a pilot basis in 2026-27 for Andhra Pradesh, Bihar, Chhattisgarh, Kerala, Madhya Pradesh, Maharashtra, Rajasthan, Telangana and Uttar Pradesh. If implemented well, benchmark issuances can deepen the state government securities market, improve liquidity and reduce uncertainty for investors.
State market borrowings test cooperative federalism
The RBI report also records the use of liquidity support mechanisms by states during the year. Nineteen states and Union Territories used the special drawing facility. Eleven resorted to ways and means advances. Ten used overdrafts on a few occasions. These instruments help governments manage temporary mismatches between receipts and expenditure. Repeated use, however, points to cash-flow stress.
This is where cooperative federalism will be tested. States account for a large share of public spending on health, education, agriculture, welfare and infrastructure. They are also expected to drive capital expenditure and job creation at the local level. Their revenue-raising powers remain constrained after the introduction of GST. The Centre’s tax base is larger and more flexible.
Greater support from the Centre is therefore important. Timely tax devolution, higher capital grants and a predictable transfer mechanism can help states manage their finances without excessive dependence on market borrowings. India needs a stronger fiscal partnership to sustain growth while keeping debt under control.