How precarious is the financial health of Indian states?

The Covid-19 pandemic brought India’s economy to a grinding halt, and, although the centre was overstretched financially, so were the states, with many reeling under increasing debt. 

The matter again picked up heat, when Finance Minister of Kerala KN Balagopal wrote a letter to Union Finance Minister, Nirmala Sitharaman to not count the liabilities of the state government, like statutory bodies and companies, as the state debt. Balagopal highlighted the precarious financial situation Kerala is in. He added in the letter that “the financial health of the state has been seriously affected by a reduction in the revenue deficit grant to the tune of around Rs 7,000 crore this year and loss due to stoppage of GST compensation of around Rs 12,000 crore.” 

This is not just a story of Kerala. Many other states too are treading the same path, suffering from precarious financial health, thanks to the Covid-19 and some inappropriate policy measures that have added fuel to the fire. Some states even have debt above the sustainable levels. According to the RBI’s report titled 'States Finances - A Risk Analysis', the average GFD-GDP ratio of the states before the pandemic stood at a 2.5 per cent (2011-12 to 2019-20), which was lower than the Fiscal Responsibility Legislation (FRL) ceiling of 3 per cent.

However, there were variations: while Andhra Pradesh, Kerala, Punjab and Rajasthan incurred average GFD of above 3.5 per cent of GSDP, Assam, Gujarat, Maharashtra, Odisha and Delhi ran ratios less than 2 per cent. According to the report, states’ fiscal positions deteriorated sharply in 2020 with a sharp decline in revenue, increase in spending and a sharp rise in debt to GSDP ratios. The report went on to add that in terms of debt to GSDP ratio, Bihar, Kerala, Punjab, Rajasthan and West Bengal were highly stressed states. 

Similarly, the State of State Finances Report by PRS Legislative attributed the choice of the centre to raise money through cess and surcharge as one of the reasons for poor financial health of states, as cess and surcharges reduce the tax devolution to states. The centre’s cess and surcharge revenue, which is not shared with states, is estimated to increase by 77 per cent to Rs 4.5 lakh crore in 2020-21; two-thirds of it will come from petrol and diesel. Due to cesses and surcharges, states’ share in the centre’s gross tax revenue was around 29 per cent in 2020-21. This is lower than the 41 per cent share in central taxes recommended by the 15th Finance Commission. 

The tax revenue of some, like Madhya Pradesh, Punjab and Kerala, has been declining over time, making them fiscally more vulnerable.

For most of these states, non-tax revenue has remained volatile, dropping significantly in recent years. The declining tax revenue and non-tax revenue are affecting the states’ expenditure planning and also increasing their dependence on market borrowing. According to the RBI report, the decline in non-tax revenue is under general services, interest receipts and economic services.  

According to the RBI, staff estimates, forecast of debt to GDP ratio for the period of 2026-2027 for some states are as follows: Bihar 31.2 per cent, Punjab 46.8 per cent, Kerala 38.2 per cent, Rajasthan 39.4 per cent, West Bengal 37 per cent. The analysis by the RBI shows that most of the other states are likely to exceed the debt-GSDP ratio of 30 per cent in 2026-27. Punjab is expected to be the worst performer with its debt-GSDP ratio projected to exceed 45 per cent in 2026-27. Rajasthan, Kerala and West Bengal are projected to exceed the debt-GSDP ratio of 35 per cent by 2026-27.  

Another factor that is deteriorating the financial health of the states is high expenditure on subsidies, as per the latest available data from the Comptroller and Auditor General of India (CAG). The state governments’ expenditure on subsidies has grown at 12.9 per cent and 11.2 per cent during 2020-21 and 2021-22, respectively, after contracting in 2019-20. According to the CAG report, the share of subsidies in total revenue expenditure by states has also risen from 7.8 per cent in 2019-20 to 8.2 per cent in 2021-22.  According to the RBI report, Jharkhand, Kerala, Odisha, Telangana and Uttar Pradesh are the top five states that have seen the largest rise in subsidies in the last three years.

However, taking cognizance of the seriousness of situation for some states, the RBI report went on to add that some states will need to undertake significant corrective steps to stabilise their debt levels.