State finances are turning into a matter of concern. Here’s why

The Centre may be focussing on capital expenditure and fiscal discipline, but several Indian states are finding it difficult to balance their books and are facing a problem of high revenue expenditure, falling capex, and rising debt and deficit. These, in turn, have raised red flags over the sustainability of state finances in the coming years.
Revenue expenditure has been on the rise as higher spending on salaries, interest and debt repayment, subsidies and welfare transfers have increased.

The problem has been raised by the Comptroller and Auditor General of India (CAG) in numerous audit reports of state finances in recent months, and this is not just a challenge for the economically weaker or less developed states. Take for instance, the state finances audit report of Tamil Nadu for 2024-25 that was tabled in the state assembly on September 10.

MUST READ | Insolvency regulator sounds alarm over misuse of bankruptcy law; tells professionals to dig deeper

The CAG reported highlighted that despite favourable macroeconomic environment, Tamil Nadu’s fiscal position remained under stress. “While deficit levels and debt ratios remain within prescribed limits, the underlying fiscal structure is characterised by weak revenue buoyancy, high committed expenditure, increasing subsidy dependence, and suboptimal utilisation of borrowings,” it noted.

The state’s capex increased in absolute terms, but constituted only 12.14% of total expenditure and 1.51% of GSDP, which is lower than the all-States average. Growth in revenue receipts lagged behind GSDP reflecting low revenue buoyancy and only 33% of public debt receipts translated into capex. Outstanding public debt increased by 309% during the decade from 2015-16 to 2024-25, rising from ₹1,94,096 crore to ₹7,94,107 crore.

Numerous other reports of the CA have flagged a similar trend across states. Take another instance—Kerala. A recent CAG report on the state’s finances for FY25 noted that total expenditure grew by 8.97% during FY25, mainly driven by a 9.32% (₹13,294.44 crore) increase in revenue expenditure.

Significantly, capex was at a decadal high of ₹17,886.78 crore in FY25.

DON'T MISS | 10 districts with largest non-farm informal firms are in WB, Gujarat, Telangana, UP

But the report flagged that Kerala continues to resort to significant off-budget borrowings through two state public sector enterprises—Kerala Infrastructure Investment Fund Board and Kerala Social Security Pension Ltd—which are serviced from the Consolidated Fund of the state but are not disclosed in its budget.

Similarly, audit reports of states including Haryana, Himachal Pradesh, Rajasthan and Jharkhand have also highlighted similar issues around falling capex even as borrowings are rising and fiscal consolidation is at risk.
Even in more recent years of FY26 and FY27, analysts have flagged weakening fiscal health of states.

A recent report by Crisil noted that the fiscal deficit of 17 major states remained elevated at 3.2% of GSDP in FY26, though performance varied significantly across states. Revenue deficit increased to 0.8% of GSDP from 0.7% a year earlier amid moderating revenue growth, with more states slipping into deficit, it further said, adding that capital expenditure (capex) moderated, with only three states achieving their capex targets, while market borrowing rose sharply.

“Capex, which is critical for long-term growth, lost some momentum in fiscal 2026,” it said. For the 17 states in the analysis, state capex stood at 2.2% of GSDP, lower than both 2.3% in fiscal 2025 and the budgeted 2.9% for fiscal 2026.

MUST READ | GDP is not enough: UN expert group proposes 31 indicators to measure a nation's progress

A recent report by Morgan Stanley also pointed out that while the aggregate fiscal position of states has stabilised from pandemic-era stress, several structural challenges continue to weigh on fiscal balances, causing aggregate state finances to plateau.  States account for about 53% of total government spending (Centre plus state) and thus have a meaningful impact on the economy, it said but noted that at the aggregate level, the quality of expenditure has weakened at the margin, with total spending moderating to 15.2% of GSDP in F2026.

Over the last couple of years, the expenditure mix has been increasingly directed towards redistributive spending in the form of cash transfers and welfare schemes, to support the vulnerable and marginalised sections of the community. It expects the aggregate state fiscal deficit to be at 3.2% of GSDP in F2027, in line with the past two years.

“Over the medium term, we believe that the states will need to prioritize fiscal prudence to achieve meaningful debt consolidation,” it said, adding that the sustainability of state finances will require sustained revenue growth through stronger tax buoyancy, alongside improved expenditure quality with greater emphasis on productive capex.