Rising state debt: Several Indian states are grappling with rising debt which has become a perpetual problem. The government think tank NITI Aayog has urged state governments to adhere to fiscal deficit norms under the FRBM Act to tame their debt situation. In its latest Fiscal Health Index (FHI) for 2023-24, the Delhi-based agency has warned that rising debt and widening revenue deficits could bog down the states’ ability to respond to economic shocks. The world is already facing the headwinds from global and domestic uncertainties and the index argued that fiscally prudent states will be better positioned to maintain development spending while managing their debt burdens.
What is FHI?
The Fiscal Health Index assesses the fiscal performance of states. It measures them across five broad parameters viz expenditure quality, revenue mobilisation, fiscal prudence, debt levels and debt sustainability. In the latest ranking, Odisha has once again emerged as the most fiscally prudent state, followed by Goa, Jharkhand, Gujarat and Maharashtra. The other states in the top ten list are Chhattisgarh, Telangana, Uttar Pradesh, Karnataka and Madhya Pradesh. Among smaller Himalayan and north-eastern states, Arunachal Pradesh leads the list, followed by Uttarakhand, Tripura, Meghalaya, Assam and Mizoram.
READ | State debt worries deepen amid rising borrowings
However, there are several states which are at the other end of the spectrum. Punjab, West Bengal and Kerala continue to rank among the weakest states in fiscal management. While Bihar, Karnataka and Telangana have shown signs of mild improvement, their overall fiscal positions remain fragile. The question is – why do some states consistently manage their finances well while others struggle with mounting debt and persistent deficits?
The case of India’s most heavily indebted states
Punjab, Kerala and West Bengal are India’s most heavily indebted states where the debt-to-Gross State Domestic Product (GSDP) ratio has climbed well above the recommended thresholds of the FRBM framework. In Punjab, debt is estimated to exceed 45% of GSDP. The northern state has large subsidy commitments, especially for electricity and agriculture. On the other hand, Kerala’s debt burden is due to expansive welfare spending and relatively modest revenue growth. West Bengal faces similar pressures, where a large share of revenue receipts is consumed by interest payments and salaries.
HIgh debt levels and revenue deficits are a vicious cycle. A revenue deficit arises when a government’s revenue expenditure viz salaries, pensions, subsidies and interest payments exceeds its revenue receipts. In such situations, states are effectively borrowing not to build infrastructure but to finance day-to-day administrative expenses. This reduces fiscal flexibility and limits the capacity to invest in long-term development projects.
Why are states forced to borrow so heavily in the first place? One reason is the growing mismatch between expenditure responsibilities and revenue powers in India’s federal structure. States are responsible for large social sector commitments including health, education, welfare programmes, farm support and infrastructure but their ability to raise resources independently has narrowed over time. Rising expectations for public services and competitive welfare politics have further pushed up spending commitments.
READ | Old pension scheme unsustainable, NPS makes sense for debt-laden states
Rising state debt: The GST conundrum
The transformation of India’s indirect tax system following the introduction of the Goods and Services Tax (GST) in 2017 has also led to woes of several states. While GST created a unified national market and improved tax compliance, it also significantly reduced states’ fiscal autonomy. Before GST, states had considerable control over taxes such as sales tax, value added tax and entry tax. These taxes provided a revenue base that could be adjusted depending on fiscal needs.
With GST, most indirect taxes were subsumed into a single national system administered jointly by the Centre and the states through the GST Council. Although states were guaranteed compensation for revenue losses for five years, that compensation period ended in 2022. Since then, many states have struggled to maintain revenue growth at earlier levels. The inability to independently raise tax rates has constrained their fiscal manoeuvrability. The fallback option simply became borrowing.
While states are raising less capital, their share of committed expenditure is rising. Salaries, pensions and interest payments now consume a large portion of many state budgets. In several states, these obligations account for over half of total revenue receipts. When such fixed commitments expand, governments are left with little room for productive capital expenditure on roads, irrigation, energy and urban infrastructure.
Interestingly, the Fiscal Health Index also reveals an uncomfortable paradox. Many of the states that perform well in fiscal management still lag behind on several socio-economic indicators. States such as Odisha, Jharkhand and Chhattisgarh rank relatively high in fiscal prudence but continue to face challenges in health, education and poverty reduction. The message is that simply because a state is fiscally prudent does not mean it is also stronger on social outcomes.
READ | Rising debt of state governments threatens to derail troubled Indian economy
Many fiscally prudent states are resource-rich but historically underdeveloped. Mineral-based revenues or relatively cautious spending patterns may improve their fiscal metrics without necessarily transforming social indicators. In contrast, some highly indebted states have achieved better human development outcomes because they invested heavily in welfare programmes, healthcare and education. The standout example is Kerala. Despite its weak fiscal ranking, it consistently performs well on indicators such as literacy, life expectancy and human development. Social investment bears dividends but at fiscal trade-offs.
The point of the Fiscal Health Index is not simply identifying good and bad depending on how they spend. Rather, it is in figuring out policy models that can be emulated. The key is to strike a balance as is done by Gujarat and Maharashtra where a diversified economic structure can strengthen fiscal resilience but social welfare is also taken care of.
The Fiscal Health Index has emphasised on reforms such as subsidies rationalisation, strengthening tax administration and improving the composition of capital expenditure. India’s federal architecture is also worth scrutinising. As economic responsibilities are increasingly shifting to the states, their fiscal autonomy must be restored as well. Without greater flexibility in revenue mobilisation, states will continue to face pressure between rising expenditure demands and limited resources.