Recent analyses by the Comptroller and Auditor General of India (CAG), Crisil, and Morgan Stanley reveal a worrying trend in Indian state finances. Despite the central government's focus on capital expenditure and fiscal discipline, many states are struggling to balance their budgets, marked by high revenue expenditure, declining capital outlay, and escalating debt burdens.
CAG Flags Fiscal Imbalances Across States
The CAG has consistently raised red flags in numerous audit reports concerning state finances. These issues are not limited to economically weaker states. For instance, the Tamil Nadu audit report for 2024-25, tabled on September 10, highlighted persistent fiscal stress despite a favorable macroeconomic environment. The report noted weak revenue buoyancy, high committed expenditure, increasing subsidy dependence, and inefficient use of borrowings. Tamil Nadu's capital expenditure, while growing in absolute terms, constituted only 12.14% of total expenditure and 1.51% of GSDP, below the national average. Its outstanding public debt surged by 309% between 2015-16 and 2024-25, from ₹1,94,096 crore to ₹7,94,107 crore.
Similar concerns were voiced for Kerala in its FY25 CAG report, which showed total expenditure growing by 8.97%, primarily driven by a 9.32% increase in revenue expenditure. Despite a decadal high in capital expenditure at ₹17,886.78 crore, Kerala continues to rely on significant off-budget borrowings through entities like the Kerala Infrastructure Investment Fund Board and Kerala Social Security Pension Ltd, which are serviced from the state's Consolidated Fund but remain undisclosed in its official budget. Audit reports for states including Haryana, Himachal Pradesh, Rajasthan, and Jharkhand also echo these issues of falling capital expenditure amidst rising borrowings, jeopardizing fiscal consolidation.
Analysts Warn of Weakening Fiscal Health
Reports from financial analysts reinforce these concerns. Crisil noted that the fiscal deficit of 17 major states remained elevated at 3.2% of GSDP in FY26. The revenue deficit also increased to 0.8% of GSDP, with more states falling into deficit due to moderating revenue growth. Capital expenditure moderated across these states, with only three achieving their targets, while market borrowing rose sharply. Crisil emphasized that capital expenditure, crucial for long-term growth, lost momentum, standing at 2.2% of GSDP for the 17 states, lower than both FY25 and budgeted FY26 levels.
Morgan Stanley's recent analysis also pointed out that while the aggregate fiscal position of states has stabilized post-pandemic, structural challenges persist, causing state finances to plateau. States account for approximately 53% of total government spending, significantly impacting the economy. The report highlighted a weakening in the quality of expenditure, with total spending moderating to 15.2% of GSDP in FY26. A growing portion of state expenditure is now directed towards redistributive spending like cash transfers and welfare schemes. Morgan Stanley projects the aggregate state fiscal deficit to remain at 3.2% of GSDP in FY27, advocating for states to prioritize fiscal prudence, achieve sustained revenue growth through stronger tax buoyancy, and improve expenditure quality with a greater emphasis on productive capital expenditure.