By R Surya Murthy
When governments begin borrowing not to build roads but to pay salaries, something has gone very wrong.
That is where most of India’s states now stand. Behind the glitter of welfare promises and populist giveaways lies a stark fiscal truth — India’s subnational governments are running out of money, freedom, and foresight.
The latest State of State Finances 2025 report by PRS Legislative Research reads like a quiet obituary for prudence. It shows that states are spending 62% of their total revenue receipts on salaries, pensions, interest payments, and subsidies. Together, these items now swallow almost two-thirds of every rupee earned. What remains is barely enough to run essential services, let alone invest in growth.
This is not an accounting glitch. It is the predictable outcome of a political system that values handouts over hard choices.
In election after election, states are competing to announce new cash transfers, subsidies, and freebies — each more generous than the last. In 2025-26 alone, twelve states will collectively spend ₹1.68 lakh crore on unconditional cash transfers to women, roughly 0.5% of India’s GDP.
The beneficiaries are real and the intentions are noble. But the arithmetic is brutal.
Six of those twelve states already run revenue deficits — meaning they spend more than they earn even before these schemes kick in. The money for welfare is being borrowed. And borrowed money always comes due.
When states must pay old loans with new ones, when interest consumes more than development, welfare becomes unsustainable. It turns from a safety net into a fiscal trap.
This kind of populism is not compassion — it is a deferred crisis.
The façade of fiscal health is maintained by loans, not revenue.
States’ combined debt now stands at 27.5% of GDP, far above the 20% ceiling recommended by the Fiscal Responsibility and Budget Management (FRBM) Review Committee. Interest payments alone consume 13% of all state revenues.
Punjab spends more than it earns — a staggering 107% of its revenue receipts go into committed expenses. Himachal Pradesh, Kerala and Tamil Nadu are not far behind. These are not outliers anymore; they are indicators of a wider contagion.
This means states are financing yesterday’s bills with tomorrow’s money. The future — children’s education, healthcare, public infrastructure — is being quietly mortgaged to maintain political credibility today.
The rot is not only political; it is structural. The Goods and Services Tax (GST), introduced as a grand unifying reform in 2017, has slowly become a fiscal straitjacket for states.
In 2015-16, taxes that are now under GST yielded 6.5% of GDP. By 2023-24, that figure had fallen to 5.5%.
The system was supposed to expand the tax base. Instead, rate rationalisation, exemptions, and economic slowdown have shrunk it. Worse, the Centre holds the upper hand in the GST Council, effectively controlling the tap of state revenues.
The result: states have lost both revenue and autonomy. They no longer control the largest portion of their tax base, yet they must answer to voters for the promises they make.
This is the quietest erosion of fiscal federalism in independent India — one that has happened not through confrontation, but through consensus and compulsion.
Fiscal centralisation is also visible in how the Centre funds the states. The share of untied transfers — money states can use freely — has dropped from 68% under the 14th Finance Commission to 64% under the 15th. Instead, conditional grants and centrally sponsored schemes dominate.
The Union government’s Special Assistance Scheme for Capital Investment (SASCI), launched in 2020-21, gives states interest-free 50-year loans for capital works. On paper, it looks generous: ₹4.01 lakh crore has been disbursed. But only 38% of those loans in 2025-26 are unconditional, down from 80% three years ago.
This shift matters. It turns investment into dependency. States can no longer plan freely — they must align with Delhi’s checklists to get funds. The same Centre that lectures them on discipline also dictates their priorities.
What we are witnessing is not cooperative federalism, but conditional federalism — one loan at a time.
The obsession with quick cash has quietly displaced long-term public investment. In state after state, budgets show rising subsidy lines and falling capital outlays.
The visible consequence is stalled infrastructure, weak social services, and a generation growing up in the shadow of debt. Rural roads remain unpaved, irrigation canals unfinished, power networks unmodernised. These are not accidents; they are opportunity costs.
The irony is cruel: welfare meant to empower ends up shrinking opportunity. When states cut capital spending to fund cash schemes, they erode the very base on which empowerment stands — jobs, productivity, and self-reliance.
India’s fiscal federalism now mirrors its economic divide. Richer states like Maharashtra and Karnataka collect and spend more per person than poorer ones such as Bihar or Jharkhand. The gap is widening.
This unevenness carries real consequences. Richer states can afford welfare without breaking the bank. Poorer ones cannot, yet are under electoral pressure to match giveaways. The outcome is predictable — debt spirals, payment delays, and growing dependence on the Centre.
Federalism, once designed to empower diversity, is becoming a mechanism for fiscal conformity. The poorest states are left waiting for conditional grants; the richest quietly pull ahead. The political map looks united, but the fiscal map is splitting down the middle.
By March 2025, the collective liabilities of all states had reached 27.5% of GDP. Interest payments are rising by 10% a year, faster than the 9% growth in revenues. The Standing Committee on Finance, in its August 2025 report, warned that states must sustain discipline to ensure macroeconomic stability.
But the incentives point the other way. Election cycles are shorter than loan tenures. Politicians find it easier to distribute benefits than to explain deficits. Fiscal responsibility laws exist, but they are bent each time politics demands.
The result is predictable: states are borrowing against a future that may never arrive.
The storm has not yet peaked. The Eighth Central Pay Commission, expected in 2026, will raise salary and pension costs sharply. For many states, it will wipe out whatever fiscal space remains. Once again, they will borrow to pay, not to build.
The implications go far beyond balance sheets.
Chronic state debt will eventually force higher interest rates and tighter credit conditions. It will deter private investment in infrastructure, slow job creation, and limit funds for public health and education. The Centre may step in with bailouts, further centralising power and weakening the autonomy the Constitution intended.
In short, fiscal stress at the state level is not just an economic issue — it is a democratic one. When states lose the capacity to act independently, federalism becomes form without function.
India needs a reset in how it thinks about welfare and finance. Welfare is essential — but it must be built on sustainable revenue, not recurring debt. States must learn to distinguish between compassion and recklessness, between empowerment and entitlement.
Each new subsidy should come with a clear financing plan and sunset clause. Every pay commission award should be accompanied by structural reform in public employment. And the Centre must restore genuine fiscal autonomy — not through rhetoric, but by restoring untied transfers and letting states raise and retain more of their own revenue.
The alternative is bleak. If states continue to live beyond their means while surrendering their powers, India will drift into a model where Delhi collects, decides, and directs — and states merely distribute.
That is not federalism. It is dependency dressed as democracy.
For too long, both state and central governments have dodged the real question: who will pay for India’s politics of plenty?
The PRS report answers it in silence — through numbers that don’t lie. States are financing their ambitions by mortgaging their future.
Unless the political class accepts that fiscal discipline is not austerity but self-preservation, India’s next crisis will not be in its markets or banks. It will begin in its budgets. (IPA Service)
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