The Price of Promises

Uneven growth, swelling giveaways and rising debts are testing the foundations of India’s fiscal federalism.

Income gaps, swelling welfare commitments and uneven revenue growth are reshaping India’s state finances. The country’s federal compact, once defined by shared revenues and coordinated investment, is now marked by diverging fortunes between richer and poorer states, widening rural-urban divides and a rising appetite for politically seductive cash transfers. These shifts are beginning to strain fiscal stability.

Per-capita income disparities have reached historic highs. Sikkim’s income is more than three times the national average; Bihar’s is less than two-fifths of it, an eightfold gap. Among major states, Telangana, Haryana and Delhi sit comfortably above the average, while Bihar, Uttar Pradesh and Madhya Pradesh lag far behind. Such gaps reflect unequal fiscal capacities. Maharashtra, Karnataka, Tamil Nadu and Gujarat generate buoyant tax revenues, allowing them to invest heavily in infrastructure and public services. Poorer states, constrained by thin tax bases, rely on central transfers to fund their development.

Inequality is widening within states too. Nationally, incomes of the richest ten percent in urban areas are more than twice rural incomes; in Himachal Pradesh, Bihar, Goa and Meghalaya the gulf is sharper. These disparities weaken the redistributive muscle of fiscal federalism.

Into this fragile landscape has entered a potent political instrument of unconditional cash transfers (UCTs) for women. What began modestly in 2022–23, with only two states adopting them, has become a national wave. By 2025–26, a dozen states will offer monthly stipends (typically between Rs.1,000 and Rs.2,500) to women under schemes such as Karnataka’s Gruh Lakshmi, Madhya Pradesh’s Ladli Behna and Maharashtra’s Ladki Bahin. Election-bound states have been especially enthusiastic, with Assam and West Bengal sharply expanding allocations.

Rising debt

The fiscal impact is striking. UCT outlays are projected to reach Rs.1.68 trillion in 2025–26, about 0.5 percent of GDP - more than double the level two years earlier. Six of the twelve states implementing UCTs now face revenue deficits linked directly to these schemes. Karnataka has moved from a 0.3 percent surplus to a 0.6 percent deficit; Madhya Pradesh’s surplus has more than halved. Maharashtra has already pared its Ladki Bahin benefits from Rs.1,500 to Rs.500 for overlapping beneficiaries, signalling the limits of fiscal largesse.

UCTs are politically appealing: they deliver money cleanly, empower women and avoid bureaucratic entanglement. But their rapid expansion without corresponding revenue mobilisation risks swelling debts and crowding out investment in education and health. Most schemes lack outcome-based targeting, raising concerns about long-term value.

States, to their credit, have broadly followed the 15th Finance Commission’s fiscal roadmap. Their collective deficit is budgeted at 3.2 percent of GDP in 2024–25, only slightly above the previous year’s 2.9 percent. Revenue deficits remain modest at roughly 0.2 percent. Yet the quality of financing is less reassuring. Market borrowings are expected to fund nearly four-fifths of the fiscal deficit this year. Gross market loans jumped by more than 32 percent in 2023–24 to over Rs.10 trillion. This growing reliance exposes states to interest-rate volatility and refinancing risk.

Fiscal opacity

Off-budget borrowings (loans raised by state entities but guaranteed by the exchequer) are an even murkier problem. These climbed by 38 percent in 2024–25 to nearly Rs.30,000 crore. Maharashtra, Karnataka, Telangana and Kerala rely heavily on such opaque financing. New central rules now include these borrowings within states’ debt ceilings, and Delhi has phased out its own off-budget loans. An interest-free capital-investment loan scheme designed by the Centre offers a more transparent alternative. But fiscal opacity still clouds state budgets.

Despite some consolidation after the pandemic, state debt remains high at 28.5 percent of GDP as of March 2024, far above the FRBM target of 20 percent. Only Gujarat, Maharashtra and Odisha meet that benchmark. Punjab, Kerala and West Bengal sit at the opposite end of the spectrum, burdened by generous subsidies, hefty pension liabilities and sluggish revenue growth. Rising contingent liabilities add to the strain. As the Centre seeks to reduce its own debt-to-GDP ratio to 50 percent by 2031, coordination with the states will be essential.

NITI Aayog’s Fiscal Health Index 2025 highlights this unevenness. Odisha leads the pack, thanks to disciplined borrowing and judicious capital spending. Chhattisgarh and Goa perform well. But Punjab and Kerala remain mired in fiscal stress, weighed down by high committed expenditure and limited revenue growth.

Spending patterns reveal a deeper challenge. Education accounts for 14–15 percent of state expenditure insufficient to meet the National Education Policy’s target of devoting 6 percent of GDP to the sector. Maharashtra and Gujarat commit large sums, but Tamil Nadu has reduced its share, an unsettling shift for a state long celebrated for its social investments. Health spending remains chronically low, averaging 4.5–6.2 percent of expenditure, well below the 8 percent recommended by the Finance Commission. Only Kerala allocates more than 3 percent of its GSDP to health; most others lag, leaving households vulnerable to high out-of-pocket costs.

Agriculture receives around 6 percent of expenditure, but states typically favour subsidies over productivity-enhancing investments. Police budgets average 3 percent, yet training and forensics absorb less than 2 percent. Infrastructure spending on roads and bridges stands at roughly 4 percent; maintenance is frequently ignored. Water supply and sanitation receive just 3.2 percent. Meanwhile, social-welfare programmes, especially UCTs, are consuming a rising share of budgets.

State finances thus sit at a critical crossroads. Committed expenditure and subsidies swallow 62 percent of revenue receipts, constricting the room for investment in essential sectors. For states to remain reliable stewards of India’s development ambitions, they must reform. Strengthening tax administration, widening the tax base, privatising electricity-distribution companies and monetising assets would ease dependence on Delhi. The Centre, for its part, could restore balance by sharing personal-income-tax revenues and folding cesses back into the divisible pool.

Expenditure restraint is just as vital. Rationalising subsidies, enforcing outcome-based budgeting and imposing stricter norms for new welfare schemes would help restore fiscal discipline.

Ultimately, fiscal health will depend on renewed cooperative federalism. Odisha and Chhattisgarh show that reform-minded governance can deliver resilience. Without similar resolve across the map, the ambition of a prosperous, developed India may remain elusive.

(The writer is a Chartered Accountant with a leading company in Mumbai. Views personal.)