The Reserve Bank of India has raised concerns over the increasing spending on subsidies by state governments, labelling it as an incipient stress. RBI’s latest report, State Finances: A Study of Budgets of 2024-25, emphasises the urgent need to rationalise subsidies to prevent them from crowding out more productive investments. This warning gains significance as 23 states and Union territories reported rising fiscal deficits in FY24, reveals the RBI’s Handbook of Statistics.
States have earmarked Rs 9.2 lakh crore for capital expenditure in 2024-25, which accounts for 2.8% of the GDP — an increase from Rs 7.6 lakh crore (2.6% of the GDP) in FY24. However, high fiscal deficits are already slowing capital expenditure growth. After a robust 39.3% increase in FY24, capital expenditure by states is projected to grow by a modest 6.5% in FY25. This reduction in infrastructure, health, and education investments directly impacts economic growth and public service delivery.
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Spending by state governments
A significant portion of state budgets is being consumed by subsidies. These include farm loan waivers, free or subsidised electricity for agriculture and households, transport, gas cylinders, and cash transfers to targeted groups. An Axis Bank report highlights that 14 states have implemented income transfer schemes for women alone, with an annual outlay of Rs 2 lakh crore, equivalent to 0.6% of India’s GDP.
Excessive spending on welfare programmes risks constraining resources for essential infrastructure and development. Given the high debt-to-GDP ratios, mounting guarantees, and rising subsidy burdens, the RBI has called for fiscal consolidation while prioritising developmental and capital expenditure.
Revenue Expenditure
Regional fiscal pressures
States like Punjab, Kerala, and Karnataka face significant fiscal challenges. Punjab’s debt crisis, aggravated by extensive welfare spending and limited revenue-generating capacity, is a case in point. Kerala and Karnataka also struggle with high debt-to-GDP ratios, driven by extensive social welfare programmes. Rajasthan, Uttar Pradesh, and West Bengal grapple with similar issues, fuelled by growing subsidy burdens and substantial infrastructure investments.
Among South Indian states, Tamil Nadu has the highest fiscal deficit, stemming from heavy investments in public health, welfare schemes, and infrastructure. While these investments are crucial for development, states must strike a balance between growth and fiscal sustainability.
Rationalising subsidies
The RBI has stressed on the need to redirect funds currently allocated to subsidies towards more impactful areas such as health, education, agriculture, research and development (R&D), and rural infrastructure. Investments in these sectors can generate employment and reduce poverty more sustainably than short-term subsidies.
Some states have made strides in fiscal consolidation, maintaining their aggregate gross fiscal deficit within 3% of GDP for three consecutive years (2021-22 to 2023-24). Revenue deficits were also restricted to 0.2% of GDP during 2022-23 and 2023-24. The early 2000s introduction of Fiscal Responsibility Legislations (FRLs) led to improved fiscal indicators, with overall state debt declining from 31.8% of GDP in March 2004 to 28.5% in March 2024. However, this level remains above the 20% threshold recommended by the Fiscal Responsibility and Budget Management (FRBM) Review Committee (2017).
Towards fiscal sustainability
States with high debt levels, such as Punjab, Bihar, Kerala, and West Bengal, must establish transparent and time-bound debt consolidation plans. The RBI advocates for next-generation fiscal rules that offer flexibility to manage shocks, such as the pandemic, while ensuring medium-term fiscal sustainability.
Leveraging technology can also enhance fiscal health. States can use data analytics, machine learning, and artificial intelligence to refine tax systems and boost revenue. Non-tax revenue can be increased through timely revisions of user charges for services like power, water, and transport.
In 2024-25, many states have already taken steps to bolster revenue. Gujarat, for example, has set up GST Seva Kendras to simplify registration and prevent document misuse. Haryana is considering facilitation cells to assist start-ups and MSMEs with GST compliance, alongside a QR code-based system to prevent alcohol diversion. Amnesty schemes in Kerala and Rajasthan aim to ease businesses’ transition to GST by waiving penalties on tax arrears.
If states continue to prioritise subsidies, augmenting their own revenues is essential. Such measures can ensure fiscal space for welfare without compromising developmental priorities.
State governments have historically relied on subsidies to address immediate economic challenges. While these initiatives serve short-term needs, it is imperative for governments to adopt a long-term perspective. By shifting focus to investments that drive sustainable growth, states can avoid the pitfalls of short-term populism and create a resilient economic foundation.
The time has come for states to balance grassroots welfare with fiscal prudence. Rationalising subsidies and prioritising investments in critical sectors will ensure sustainable development and long-term economic prosperity.