State Finances and Budgets in India:

State finances play a crucial role in shaping India's broader economic landscape. With India’s federal structure, states not only drive local governance priorities but also contribute significantly to the nation's fiscal health, infrastructure, healthcare, and employment initiatives.

Key Fiscal Trends in FY2025

1. Rising Fiscal Deficit:

   • Combined fiscal deficit of 17 major Indian states rose to ₹9.5 trillion (3.2% of GSDP) in FY2025 from ₹7.8 trillion (2.9% of GSDP) in FY2024. This increase signifies a widening fiscal gap.

   • The rise in fiscal deficit is driven mainly by capital spending (up by ₹678 billion or 0.2% of GSDP).

   • Capital expenditure (Capex) has risen significantly, reflecting increased investments in infrastructure and development, but there’s still a need for better fiscal quality.

2. Revenue Trends:

   • Revenue receipts growth slowed to 6.3% in FY2025 from 7.9% in FY2024. The slowdown in revenue growth limits the states' ability to fund essential services.

   • Revenue expenditure continued to grow steadily at 9%, which compressed the fiscal space and increased the revenue deficit, worsening the overall fiscal health.

3. Capital Expenditure Patterns:

   • Capex by 17 states reached ₹7.4 trillion, marking a growth of ₹678 billion from FY2024. However, it fell short of the Revised Estimates (RE) by ₹1.1 trillion.

   • States like Uttar Pradesh, Andhra Pradesh, Madhya Pradesh, Maharashtra, Tamil Nadu, and Karnataka saw a 42% YoY spike in Capex, reaching ₹2.2 trillion.

   • March spike in capital spending: Over 30% of annual capex was executed in March, which is higher than FY2024, indicating back-ended spending trends often aligned with March borrowing spikes.

4. Centre vs States:

   • The Centre managed to reduce its revenue deficit, while states witnessed a surge in theirs. This discrepancy highlights sub-optimal fiscal management at the state level.

   • A higher revenue deficit means less borrowing room for capital expenditure, which limits the growth potential for infrastructure investments.

Challenges in State Finances

1. Vertical Fiscal Imbalance:

   • The Centre collects the majority of tax revenues, while states bear the lion’s share of core expenditures (health, education, infrastructure). This creates dependency on central transfers and limits the autonomy of state governments.

2. Delayed Transfers and GST Compensation:

   • States often face delays in receiving transfers, particularly GST compensation, impacting their ability to plan and execute budgets effectively. Disputes within the GST Council further add to uncertainties.

3. Borrowing Constraints:

   • The Fiscal Responsibility and Budget Management (FRBM) Act places limits on the state borrowing, constraining their ability to invest in high-impact sectors like education, healthcare, and infrastructure.

   • States are often forced to take market borrowings or engage in off-budget borrowing, which reduces financial transparency.

4. Populist Spending vs. Productive Investment:

   • Election cycles often see a shift in focus toward freebies and subsidies. While these measures may cater to immediate needs, they often leave little room for long-term investments in productive infrastructure.

5. Weak Revenue Mobilization:

   • Many states struggle with revenue generation, relying heavily on central transfers and grants. States also underperform in areas like property tax collection and largely untaxed agricultural income.

Government Initiatives to Strengthen State Finances

1. Finance Commission Recommendations:

   • Vertical and Horizontal Devolution: Periodic recommendations on tax sharing and grants-in-aid aim to ensure equity and efficiency across states.

   • Performance-Based Incentives: States are incentivized for improvements in sectors like sanitation, education, and fiscal management (e.g., 15th Finance Commission).

2. Fiscal Responsibility and Budget Management (FRBM) Act:

   • Many states have adopted FRBM laws to cap fiscal deficits and improve financial transparency. These laws encourage medium-term fiscal planning and accountability.

3. Atmanirbhar Bharat Borrowing Incentives:

   • States that implement reforms in areas like One Nation One Ration Card, Ease of Doing Business, and Power Sector Reforms are allowed additional borrowing up to 2% of GSDP.

4. GST Compensation Mechanism:

   • After the GST rollout, the Centre provided compensation for revenue shortfalls, enabling states to transition smoothly to the new tax regime.

5. Digital Public Financial Management Systems:

   • Platforms like PFMS and e-Kuber streamline fund transfers and expenditure tracking, enhancing transparency and reducing leakages.

6. Debt Consolidation and Sinking Funds:

   • States are encouraged to create Consolidated Sinking Funds to manage debt repayment efficiently, following RBI guidelines on prudent debt management.

Reform Pathways for Strengthening State Finances

1. Revenue Mobilization:

   • Property Tax Reforms: States need to digitize and rationalize property tax collection, improving revenue while enhancing compliance.

   • Agricultural Income Tax: There’s an ongoing debate on taxing high-income farmers to boost state revenue, especially in states with large agricultural economies.

   • User Charges and Non-Tax Revenue: States must explore better pricing for public services like water, sanitation, and healthcare to cover operational costs.

2. Expenditure Efficiency:

   • Outcome-Based Budgeting: Linking expenditure to measurable outcomes ensures better accountability.

   • Rationalization of Subsidies: Shifting to Direct Benefit Transfers (DBT) for targeted subsidies can reduce the fiscal burden.

3. Borrowing and Debt Management:

   • Market-Based Borrowing: States should explore issuing bonds with credit ratings to attract private investors, especially for infrastructure projects.

   • Off-Budget Borrowings: States need to be transparent about loans taken via public sector enterprises (PSUs) and special purpose vehicles (SPVs).

4. Institutional Capacity Building:

   • State Fiscal Research Units: Establishing dedicated units for evidence-based policy formulation can help states better understand fiscal dynamics.

   • Training Programs: Local officials should undergo regular training on budgeting, forecasting, and compliance.

5. Cooperative Federalism:

   • GST Council Reforms: Giving states more say in rate-setting and dispute resolution could lead to more efficient tax policies.

   • Flexibility in Centrally Sponsored Schemes: States should be allowed to adapt central schemes to local needs, fostering better policy implementation.

Conclusion

Tracking the fiscal patterns of Indian states is crucial for understanding broader economic health and ensuring long-term stability. While states continue to face challenges like vertical fiscal imbalances, delayed transfers, and borrowing constraints, ongoing government reforms and initiatives offer a path toward better fiscal management. By focusing on revenue mobilization, expenditure efficiency, and debt management, states can enhance their financial autonomy and drive more productive investments in critical sectors like infrastructure, healthcare, and education.