Fiscal Debt Sustainability in Indian States 2025 Review

Recent fiscal reviews show the complexity of managing public debt across Indian States. The 15th Finance Commission and earlier committees have set targets to reduce debt relative to the economy. However, diverse economic conditions and debt uses among States challenge a uniform approach. A multi-criteria analysis offers deeper insight into fiscal health beyond simple debt ratios.

Background and Fiscal Targets

The Fiscal Responsibility and Budget Management (FRBM) Review Committee in 2017 proposed rule-based fiscal policy. It aimed to limit government debt to 60% of GDP by 2023, split as 40% for the Centre and 20% for States. The Committee advised avoiding borrowing for current expenditure and recommended fiscal deficit as the main target to reduce debt. The 15th Finance Commission later set State-level targets – fiscal deficit at 2.8% of GSDP and fiscal liabilities at 30.9% by 2024-25, with an expected revenue surplus.

Debt and Economic Growth Relationship

Public debt impacts growth in complex ways. Excessive debt can deter investment and increase uncertainty. Yet, moderate debt can stimulate growth via Keynesian effects by funding infrastructure and social services. Government borrowing can also deepen domestic financial markets and encourage private savings. The balance between beneficial and harmful debt levels depends on how debt is managed and utilised.

State-Level Debt Trends and Variations

State debt rose from 22.8% of GSDP in 2011-12 to 31% in 2020-21, then eased to 28.8% in 2024-25, below the 15th Finance Commission’s threshold. However, debt levels vary widely – Odisha has 16.3% debt/GSDP while Arunachal Pradesh exceeds 57%. This shows debt sustainability cannot rely on a single ratio. States differ in economic growth, debt purpose, and repayment capacity.

Five Criteria for Debt Sustainability

Debt sustainability is assessed using five criteria – (i) Domar gap – difference between GSDP growth and interest rate on debt; (ii) Debt buoyancy – difference between GSDP growth and debt growth rates; (iii) Debt to GSDP ratio; (iv) Debt to revenue receipt ratio, indicating repayment capacity; (v) Ratio of cumulative capital expenditure (assets) to debt, reflecting collateral value. A composite index weights these criteria, with 40% weight on assets to debt ratio. A value above 1 indicates a State can repay debt from revenue rather than borrowing further.

Composite Debt Sustainability Index Findings

The index shows limited correlation with simple debt/GSDP ratios. Punjab and West Bengal score below 0.2, indicating poor sustainability. Ten States score between 0.2 and 0.6, while 15 States exceed 0.6, showing fiscal prudence. Odisha tops with over 0.9. This index reflects solvency, repayment ability, and quality of debt use more accurately than single metrics.

Interest Rates and Growth Dynamics

Weighted interest rates on State debt vary slightly due to maturity profiles. RBI manages debt issuance, limiting rate differences. Except during the pandemic, GSDP growth has outpaced interest rates by about 8% from 2021 to 2025, supporting debt sustainability. However, debt to revenue receipt ratios range widely, from 0.8 in Arunachal Pradesh to 3.6 in Punjab.

Asset Coverage and Debt Use Concerns

Debt to asset ratios vary from 0.39 to 2.9. Eleven States, including West Bengal, Punjab, and Kerala, have debt exceeding their cumulative capital assets, raising concerns about resource utilisation and fiscal health. This marks the importance of debt purpose and investment quality in assessing sustainability.

Policy Implications and Flexibility

A uniform debt target for all States is inadequate. States differ in growth, income, and investment needs. Debt assessment should consider multiple parameters, including debt use and repayment capacity. Finance Commissions should allocate resources with flexibility and set key performance indicators tailored to State conditions.

Questions for UPSC:

1. Critically discuss the impact of public debt on economic growth and investment in developing economies.
2. Analyse the role of the Finance Commission in maintaining fiscal discipline among Indian States and its challenges.
3. Examine the concept of debt sustainability and its relevance in the context of federal fiscal management in India.
4. Estimate the implications of varying debt-to-GDP ratios on inter-state fiscal equity and economic development in India.

Answer Hints:

1. Critically discuss the impact of public debt on economic growth and investment in developing economies.

1. Moderate public debt can stimulate growth via Keynesian multiplier by funding infrastructure and social services.
2. Excessive debt increases uncertainty, raises borrowing costs, and crowds out private investment.
3. Public debt deepens domestic financial markets, encouraging private savings and investments.
4. High debt may lead to policy uncertainty, reducing optimal future investment decisions.
5. Debt use quality (productive vs. unproductive spending) determines its impact on growth.
6. Developing economies face trade-offs between growth needs and debt sustainability constraints.

2. Analyse the role of the Finance Commission in maintaining fiscal discipline among Indian States and its challenges.

1. Finance Commission sets fiscal deficit and debt targets for States to ensure fiscal consolidation.
2. It recommends fiscal responsibility frameworks and incentivizes revenue surpluses.
3. Challenges include diverse economic conditions and growth rates across States.
4. One-size-fits-all targets often fail to reflect State-specific debt sustainability and investment needs.
5. Monitoring and enforcement mechanisms are limited; States have autonomy in fiscal management.
6. Need for flexible allocations and KPIs tailored to State realities to improve fiscal discipline.

3. Examine the concept of debt sustainability and its relevance in the context of federal fiscal management in India.

1. Debt sustainability means ability to service debt without compromising fiscal stability or growth.
2. Single metrics like debt/GSDP ratio are insufficient; multi-criteria indices better capture sustainability.
3. Factors include Domar gap (growth vs interest rate), debt buoyancy, repayment capacity, and asset coverage.
4. States differ widely in economic growth, debt purpose, and repayment ability, requiring nuanced assessment.
5. Federal fiscal management demands balancing autonomy with fiscal prudence and intergenerational equity.
6. Composite sustainability indices guide more tailored and effective fiscal policies for States.

4. Estimate the implications of varying debt-to-GDP ratios on inter-state fiscal equity and economic development in India.

1. Wide variation in debt/GSDP ratios (16.3% Odisha to 57% Arunachal Pradesh) reflects uneven fiscal capacities.
2. Higher debt ratios may be sustainable if matched by higher growth and productive asset creation.
3. Uniform debt targets may disadvantage States with different growth rates and investment needs.
4. Debt disparities can affect inter-state equity, with some States facing higher borrowing costs or fiscal stress.
5. Quality of debt use (capital expenditure vs revenue borrowing) influences long-term development outcomes.
6. Policy must balance fiscal discipline with flexibility to support equitable economic development across States.