Opinion | State Of States: Fiscal Ill-Health Threatens India’s ‘Viksit Bharat’ Dream

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Last Updated:January 31, 2025, 12:35 IST

As states account for approximately two-thirds of public spending and one-third of total revenue, their fiscal performance is crucial for the country’s overall economic stability

Rising expenditure over the years has increased pressure on state governments to borrow more, leading to a weakening of their fiscal health. (Getty)

Today, V. Anantha Nageswaran, the Chief Economic Adviser (CEA) of India, will present the Economic Survey 2024–25 before Parliament. Based on past trends, apart from evaluating macroeconomic indicators such as fiscal performance, growth projections, and external factors affecting the economy, the survey will also examine socio-economic issues, including education, employment, poverty, climate change, and sectoral policy recommendations.

ALL EYES SET ON THE BUDGET

A perceptible slowdown in India’s GDP growth amid a continued spike in food inflation.
Private investment as well as private consumption failing to show healthy growth.
Disruption, uncertainty, and turmoil on the external front due to the return of the transactional Trump to the Oval Office.
Last but not least, the culture of freebies (revdis) has become the “new normal".

HIGH EXPECTATIONS

India’s budgetary reforms began in 1991 when Manmohan Singh dismantled the Nehruvian legacy of the Licence-Permit Raj through his LPG (Liberalisation, Privatisation, and Globalisation) policies. Since then, every finance minister, including Sitharaman, has contributed to India’s economic trajectory, positioning Bharat as a nation poised to become the world’s third-largest economy during Modi’s current term.

However, Sitharaman today faces an unprecedented challenge—one that no finance minister before her has encountered: how to transform the nation into Viksit Bharat by 2047.

ALSO READ | Economic Survey 2024-25 Live Updates: FM Sitharaman To Table Survey Shortly As President Concludes Joint Address

THE HEADWIND: DETERIORATING FISCAL HEALTH OF STATES

Like everyone else, I too have high expectations from Sitharaman’s upcoming budget. But I clearly see a fault line, a major headwind facing her, which she can’t control and without countering which, Bharat cannot become viksit.

And that fault line is the strained and deteriorating fiscal health of state governments. This piece primarily examines the ‘state of states: fiscal health of states’, which takes centre stage for three critically important reasons:

States account for more than two-thirds of total public spending in the country and over one-third of total revenue.
The Indian Constitution assigns states significant responsibilities in development and infrastructure, making their fiscal performance crucial to national development and stability.
The fiscal health of states has gained significant prominence, as their financial well-being is essential for achieving long-term fiscal sustainability and overall economic growth.

ALL STATES ARE NOT EQUAL

Indian states are heterogeneous in terms of geography, population, area, natural resource endowments, and socio-economic characteristics. They also vary significantly in expenditure, revenue generation, and dependence on central transfers. Moreover, when it comes to expenditure and resource allocation, the efficiency of state governments differs—some utilise their funds effectively, channelling resources towards productive growth, while others do not.

However, rising expenditure over the years has increased pressure on state governments to borrow more, leading to a weakening of their fiscal health.

THE GOLDEN RULE

The fiscal rules applicable to both the Centre and states stipulate the elimination of the revenue deficit—often referred to as the golden rule of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003. This rule states that the stability of revenue receipts should form the basis for designing revenue expenditure so that all borrowing can be directed towards capital expenditure, which is productive in nature.

This raises an existential question: Are states following the Golden Rule of the FRBM Act, 2003? And if not, what is the main culprit?

Before proceeding further, I posit that the growing culture of freebies—now having reached a monstrous proportion—is placing an unprecedented strain on the fiscal health of states.

GROWING UNCONTROLLED FREEBIES – THE NEW NORMAL

Irrespective of which state first adopted the freebies route and when, the stark reality today is that all states of Bharat—regardless of the political spectrum they belong to—find themselves trapped in a vicious cycle of freebies, freebies, and more freebies. It would not be an overstatement to say that freebies, or revdis—whatever name one chooses to give them—have become the new normal.

The list of freebies is expanding by the day. Beyond free education and free healthcare, it now includes free electricity, free water, free ration, free transport, free LPG cylinders, free mobile phones, free laptops, free bicycles, state support for marriage and elderly pilgrimage, loan waivers, and indiscriminate cash transfers. It is as absurd as it gets.

I agree that in a country like Bharat, where absolute poverty and destitution remain persistent and the income disparity between the haves and have-nots is widening rapidly, some form of targeted direct transfers to the destitute and poor is inevitable.

But the real travesty is that instead of diminishing over time, freebies have become a genie out of the bottle—an unstoppable force and an irreversible trend. Worse, with elections now a year-round phenomenon in the country, every election season sees both the size of the freebie kitty and the list of recipients expanding exponentially.

The Election Commission has shown an unwillingness to regulate it, calling it a policy matter, while the Supreme Court, despite being seized of the issue for the past four years, has done little beyond discussing the formation of an expert panel and suggesting all-party meetings.

THE DANGER LURKS

If the populist, competitive freebies culture is not curbed at the state level, then no matter how transformative Nirmala Sitharaman’s budget may be, make no mistake—the dream of India becoming Viksit Bharat by 2047 will remain a pipe dream.

The choice before Indian states is unmistakably clear: abjure and roll back freebies or perish. I cite two recent reports to substantiate this assertion.

The message from both reports is loud and clear—unless states, particularly the frontline ones, get their act together and do so urgently, Bharat will have to stop dreaming about becoming a developed nation by 2047.

RBI REPORT – THE RED FLAG

This year’s RBI report, State Finances: A Study of Budgets of 2024-25, covers the period from 2022-23 (actuals) to 2024-25 (budget estimates) and includes a focus on fiscal reforms by states.

While the report acknowledges the progress made by state governments in fiscal consolidation—such as keeping the aggregate gross fiscal deficit within 3 per cent of GDP for three consecutive years (2021-22 to 2023-24) and restricting the revenue deficit to 0.2 per cent of GDP in 2022-23 and 2023-24—it simultaneously raises a red flag: “Several states have announced sops pertaining to farm loan waivers, free electricity for agriculture and households, free transport, allowances for unemployed youth, and monetary assistance to women in their Budget for 2024-25… Such spending could crowd out the resources available to them and hamper their capacity to build critical social and economic infrastructure."

Furthermore, the report warns: “An area of incipient stress is the sharp rise in expenditure on subsidies, driven by farm loan waivers, free/subsidised services (such as electricity for agriculture and households, transport, and gas cylinders), and cash transfers to farmers, youth, and women."

It also cautions: “States need to contain and rationalise their subsidy outgoes so that such spending does not crowd out more productive expenditure."

According to the RBI report, the high debt-to-GDP ratio, outstanding guarantees, and the increasing subsidy burden necessitate that states persist with fiscal consolidation while placing greater emphasis on developmental and capital spending.

NITI AAYOG STATE FISCAL INDEX

The Fiscal Health Index (FHI) initiative by NITI Aayog aims to develop a comprehensive understanding of the fiscal health of Indian states. The FHI analysis covers eighteen major states that drive the Indian economy in terms of their contribution to GDP, demography, total public expenditure, revenues, and overall fiscal stability. Needless to say, as states account for approximately two-thirds of public spending and one-third of total revenue, their fiscal performance is crucial for the country’s overall economic stability.

The composite FHI has been developed based on five sub-indices: Quality of Expenditure, Revenue Mobilisation, Fiscal Prudence, Debt Index, and Debt Sustainability. Notably, this maiden exercise is based on trends in major fiscal indicators from 2014-15 to 2022-23, making it two years outdated—a period in which the freebie culture has escalated dramatically.

ANALYSIS OF THE NITI AAYOG INDEX

The analysis clearly underscores that strong revenue mobilisation, effective expenditure management, and prudent fiscal practices are critical determinants of a state’s fiscal success.

Here is the big picture:

Frontline states lagging – None of the frontline or large states feature in the top three of the composite index. Instead, the top four positions are occupied, in order, by Odisha, Chhattisgarh, Goa, and Jharkhand. The first frontline state to make an appearance is Gujarat, at fifth position.
The bottom five states offer a stark warning – The five states ranked lowest on the composite index are Haryana, Kerala, West Bengal, Andhra Pradesh, and Punjab. Intriguingly, at the absolute rock bottom is Punjab—once the granary of India—while even Bihar, often labelled ‘bimaru’, ranks higher at 14th. Punjab languishes in 18th and last place.
Trapped in the ‘muddle of the middle’ – Excluding the top five and bottom five, eight states are stuck in the middle, with a composite index score of 50 or below (compared to Odisha’s leading score of 67.8). And what a roll call of states these are: Maharashtra, Uttar Pradesh, Telangana, Madhya Pradesh, Karnataka, Tamil Nadu, Rajasthan, and Bihar, ranked in descending order.

With this index providing data only up to FY2023, and the freebie culture worsening over the past two years, the fiscal condition of states caught in the middle would have further deteriorated.

ODISHA TOP RANKED VERSUS BOTTOM RANKING STATES

Here’s how Odisha, the top state, compares to the bottom five, with Punjab at the very bottom:

Odisha – Odisha excels in fiscal health, securing the highest overall index score of 67.8. It tops the Debt Index (99.0) and Debt Sustainability (64.0) rankings while maintaining above-average scores in Quality of Expenditure and Revenue Mobilisation. The state has consistently maintained low fiscal deficits, a strong debt profile, and an above-average capital outlay-to-GSDP ratio, ensuring fiscal stability and sustainable growth.

Bottom Five Ranked States – Haryana, Punjab, Andhra Pradesh, West Bengal, and Kerala are all at the bottom, each facing significant fiscal challenges. Kerala and Punjab struggle with low-quality expenditure and debt sustainability; West Bengal faces revenue mobilisation and debt index issues; Andhra Pradesh has high fiscal deficits; and Haryana has a poor debt profile.

Debt growth and rising interest payments exacerbate these challenges, and it’s unclear how these regions will achieve fiscal sustainability.

THE BOTTOM LINE

Karnataka’s ranking has declined significantly, falling from 3rd in 2014–15 to 10th in 2022–23. This is mainly due to weak performance in quality of expenditure and debt sustainability. Punjab, Kerala, and West Bengal have consistently faced fiscal challenges over the past nine years, grappling with high debt, substantial interest payments, weak revenue generation, and inefficient capital expenditure. Their reliance on non-tax revenue further impacts their fiscal health and rankings.

The bottom line is that states must step up and get their act together. It is a wake-up call for all states. As the experiences of Maharashtra, Karnataka, and Punjab show, if proactive measures are not taken, the fall in the snakes and ladders game will be a freefall.