Editorial 2 : State Spending Capacity
Context
Enhanced borrowing flexibility and Centre-supported loans have expanded states’ fiscal space in recent years, but future capital spending will depend on borrowing limits and Finance Commission decisions.
Introduction
In recent years, questions have arisen regarding how states breached the 3% fiscal deficit limit and whether expanding welfare schemes have constrained capital expenditure. The editorial explains that higher deficits were largely enabled by additional borrowing relaxations granted by the Centre and the Finance Commission, while capital expenditure has remained resilient despite rising social welfare spending.
Borrowing Flexibility and Higher Fiscal Deficits
- States were allowed borrowing beyond their base limit of 3–4% of GSDP during FY2021–FY2025. Additional borrowing of 0.5–1.1% of GSDP was permitted to support growth during economic stress.
- This flexibility explains why several states recorded fiscal deficits above 3%. The relaxation was policy-driven rather than a result of fiscal indiscipline.
Role of Central Loans in Expanding Fiscal Space
- The Centre extended GST compensation loans worth ₹2.6 trillion in FY2021–FY2022. These loans helped states manage revenue shortfalls caused by GST implementation and the pandemic.
- States also received ₹3.7 trillion under 50-year interest-free capex loans during FY2021–FY2025. These loans were over and above normal borrowing limits and directly supported capital spending.
Reform-Linked Borrowings and Power Sector Reforms
- Several states availed additional borrowings by completing Centre-prescribed reforms.
Total reform-linked borrowings amounted to ₹1.1 trillion during FY2021–FY2025.
- Power sector reforms alone enabled states to borrow an additional ₹1.3 trillion.
This incentive-based approach linked fiscal flexibility with structural improvements.
Carry-Forward of Unutilised Borrowings
- States were allowed to carry forward unused borrowing limits from FY2021 to FY2022. This provision helped sustain spending amid fragile post-pandemic recovery conditions.
- The 15th Finance Commission further allowed carry-forward within its award period. This softened fiscal constraints and widened spending space in recent years.
Welfare Spending and Revenue Deficit Management
- States have significantly increased social welfare spending, including cash transfers.
Cash transfers to women across 11 states rose to ₹1.5 trillion in FY2026 from ₹120 billion in FY2023.
- Despite this rise, revenue deficits widened only marginally.
States adjusted spending under other heads or rationalised older schemes to manage fiscal pressure.
Capital Expenditure Remains Resilient
- Contrary to concerns, welfare spending has not crowded out capital expenditure.
States’ combined capital expenditure and loans grew at a strong CAGR of 18.5%.
- Capital spending by 28 states doubled to ₹8.4 trillion during FY2021–FY2025.
This reflects continued emphasis on growth-supporting expenditure.
Future Fiscal Space and the 16th Finance Commission
- States’ future spending capacity will depend heavily on the 16th Finance Commission’s recommendations.
Decisions on resource sharing, borrowing limits, and carry-forward provisions will be crucial.
- The continuation or withdrawal of borrowing flexibility will shape state-led growth.
Reduced fiscal space could constrain capital expenditure despite development needs.
Conclusion
States’ fiscal expansion in recent years has been enabled by exceptional borrowing flexibility and Centre support, allowing them to balance welfare spending with capital investment. Going forward, the ability of states to sustain growth-oriented expenditure will largely depend on the framework laid down by the 16th Finance Commission, making its recommendations critical for India’s medium-term economic trajectory.