Why in News?
- RBI’s October 2025 Review and a Business Line article highlighted rising concerns over the debt sustainability of Indian States.
- States’ aggregate debt-to-GSDP ratio stands at ~28.8% (2024–25 BE) — below the 15th Finance Commission’s ceiling (30.9%), yet with wide inter-State disparities.
- Experts caution that a “one-size-fits-all” fiscal target by Finance Commissions may not ensure true debt sustainability given differing State growth rates and fiscal capacities.
Relevance
- GS Paper 3 – Economy: Fiscal federalism, debt sustainability, Finance Commission targets, and macroeconomic stability.
- GS Paper 2 – Polity & Governance: Centre–State fiscal relations, role of RBI and Finance Commission in debt management.
Conceptual Basics
What is State Debt?
- Borrowings by State governments to finance fiscal deficits — through market loans, National Small Savings Fund (NSSF) loans, and institutional borrowings.
- Represents outstanding liabilities on State finances.
Key Measures:
- Debt-to-GSDP ratio: Indicator of fiscal health; ratio of total outstanding debt to the State’s Gross State Domestic Product.
- Fiscal Deficit: Excess of total expenditure over total revenue and non-debt receipts.
- Revenue Deficit: When revenue expenditure exceeds revenue receipts.
Legal and Policy Framework
| Provision / Committee | Key Recommendations / Provisions |
| FRBM Act, 2003 (and Amendments) | Mandates fiscal discipline and debt targets for Centre & States. |
| N.K. Singh FRBM Review Committee (2017) | Recommended overall public debt ≤ 60% of GDP by 2023 (Centre 40%, States 20%). Advocated fiscal deficit as key operating target. |
| 15th Finance Commission (2020) | Set State fiscal deficit ≤ 2.8% of GSDP and debt ≤ 30.9% by 2024–25. Targeted revenue surplus. Included escape clause for emergencies. |
| Article 293(3), Constitution | States must obtain Central consent to raise loans if they owe any outstanding loan to the Centre. |
Data Overview
| Indicator | 2011–12 | 2020–21 | 2024–25 (BE) |
| States’ Debt-to-GSDP (%) | 22.8 | 31.0 | 28.8 |
| 15th FC Threshold (%) | — | — | 30.9 |
| Range Across States (%) | 16.3 (Odisha) – 57 (Arunachal Pradesh) | — | — |
Interpretation:
- Aggregate State debt appears manageable, but fiscal stress varies sharply across States.
- Odisha, Maharashtra, Karnataka show prudent fiscal management.
- Punjab, West Bengal, Kerala, Rajasthan, and Andhra Pradesh exhibit high and potentially unsustainable debt ratios.
Why the Variation?
- Economic Structure: Industrialized States have broader tax bases → higher repayment capacity.
- Fiscal Management Quality: Revenue vs capital expenditure discipline.
- Borrowing Purpose: Productive (infrastructure) vs unproductive (revenue spending).
- Growth Differential: States with higher GSDP growth can sustain higher debt (positive Domar gap).
- Interest Rate Structure: RBI facilitates borrowings; hence variation mainly from growth differentials.
Five Criteria for Debt Sustainability (As per Authors)
| Criterion | Meaning / Indicator | Relevance |
| 1. Domar Gap: (GSDP Growth – Interest Rate) | Positive gap = solvency; negative = rising debt stress. | Measures sustainability in dynamic sense. |
| 2. Debt Buoyancy: (Growth of GSDP – Growth of Debt) | If GSDP grows faster → improving fiscal health. | Reflects debt absorption capacity. |
| 3. Debt-to-GSDP Ratio | Stock variable showing overall debt burden. | Traditional measure used by Finance Commissions. |
| 4. Debt-to-Revenue Receipts Ratio | Indicates actual repayment capacity. | High ratio = poor serviceability. |
| 5. Capital Expenditure-to-Debt Ratio | Shows productivity of borrowings. | Captures “quality of debt use.” |
Weightage in Composite Index:
- Criteria (1) + (2): 30% (Domar & buoyancy)
- Criteria (3) + (4): 30% (repayment capacity)
- Criterion (5): 40% (asset quality)
Key Empirical Findings (2021–25)
- Positive Domar Gap: GSDP growth exceeded interest rate by ~8 percentage points, indicating overall solvency.
- Debt/Revenue Receipt Ratio:
- 0.8 for Arunachal Pradesh (healthy)
- 3.6 for Punjab (critical stress)
- Debt/Asset Ratio (Cumulative Capex):
- 0.39 (assets < debt) in West Bengal, Punjab, Kerala — poor resource use.
- 2.9 in Arunachal Pradesh — high asset creation relative to debt.
- Fiscal Sustainability Index (2021–25 avg):
- <0.2: Punjab, West Bengal (very weak)
- 0.2–0.6: 10 States (moderate)
- 0.6–0.8: 15 States (good)
- 0.9: Odisha (excellent fiscal prudence)
Economic Implications
Positive Effects of Moderate Debt
- Stimulates Keynesian multiplier through higher public investment.
- Crowds in private investment via infrastructure development.
- Deepens domestic debt markets and enhances financial inclusion.
Negative Effects of Excessive Debt
- Crowds out private investment (higher interest rates).
- Creates policy uncertainty and reduces fiscal flexibility.
- Increases interest burden → lowers capital expenditure.
- Impacts intergenerational equity by shifting repayment burden.
Policy Concerns
- One-size-fits-all FC targets ignore structural and income differences.
- High-debt States risk fiscal dominance → reduced policy autonomy.
- Off-budget borrowings by States (e.g., guarantees, special purpose vehicles) often underreported, masking true debt levels.
- Revenue expenditure bias: Large share of borrowings used for populist schemes rather than productive assets.
Way Forward
| Focus Area | Recommended Approach |
| Differentiated Debt Targets | Calibrate limits based on GSDP growth, revenue base, and asset use efficiency. |
| Performance-linked Transfers | Finance Commission to allocate block grants with KPIs for fiscal discipline. |
| Debt Transparency | Mandate full disclosure of contingent liabilities and guarantees. |
| Quality of Expenditure | Prioritize capital over revenue spending. |
| Fiscal Risk Management | Institutionalize State Fiscal Councils for oversight (as per NK Singh Committee). |
| Borrowing Reforms | Link borrowing ceilings to capital formation outcomes. |
Conclusion
- Aggregate State debt appears stable, but hidden stress exists in several fiscally weaker States.
- Debt sustainability cannot be judged solely by debt/GSDP ratio — requires a multi-parameter, State-specific approach.
- Policy must shift focus from “how much is borrowed” to “how debt is used and serviced.”
- A fiscally responsible yet flexible framework is essential for long-term macroeconomic stability and intergenerational equity.
