Debt Sustainability of States

Source: The post “Debt Sustainability of States” has been created, based on “Debt Sustainability of States – A Complex Issue” published in “The Hindu” on 31 October 2025. Debt Sustainability of States.

UPSC Syllabus: GS Paper -3-Indian Economy

Context: Debt sustainability of Indian States refers to their capacity to service debt without compromising developmental expenditure or resorting to excessive future borrowing. The FRBM Review Committee (2017) and the 15th Finance Commission prescribed uniform fiscal targets for both the Centre and the States. However, given wide inter-state variations in growth, income, and spending patterns, a one-size-fits-all approach may not be suitable to assess debt sustainability.

RBM and Finance Commission Targets

1. The FRBM Committee recommended limiting total public debt to 60 per cent of GDP by 2023 (40 per cent for the Centre and 20 per cent for States).
2. It emphasised that governments should not borrow for current expenditure and that fiscal deficit should act as the key operating target.
3. The 15th Finance Commission, post-COVID, set targets for States’ fiscal deficit at 2.8 per cent of GSDP and fiscal liabilities at 30.9 per cent by 2024–25, along with a revenue surplus goal.

Debt Trends across States

1. States’ overall debt increased from 22.8 per cent of GSDP in 2011–12 to 31 per cent in 2020–21, moderating to 28.8 per cent by 2024–25.
2. However, large variations exist across States — from 16.3 per cent in Odisha to over 57 per cent in Arunachal Pradesh.
3. These disparities highlight differences in economic growth, fiscal capacity, and expenditure priorities, making uniform benchmarks unrealistic.

Multi-Parameter Approach to Debt Sustainability

1. Debt sustainability depends on how productively borrowings are used and whether the return on debt exceeds its cost.
2. A higher debt–GSDP ratio may still be sustainable if debt is invested in infrastructure and productive capital formation.
3. The study proposes a composite Debt Sustainability Index based on five criteria:
   1. Domar Gap: Difference between GSDP growth and interest rate.
   2. Debt Buoyancy: Difference between GSDP growth and debt growth.
   3. Debt-to-GSDP Ratio: Traditional measure of debt stock.
   4. Debt-to-Revenue Receipt Ratio: Indicates repayment capacity.
   5. Capital Expenditure-to-Debt Ratio: Reflects productive use of borrowings.
4. The first four parameters are given 15 per cent weight each, and the fifth, reflecting asset creation, carries 40 per cent weight.

Key Findings

1. The debt-to-GSDP ratio and the sustainability index show limited correlation.
2. Only Punjab and West Bengal have index values below 0.2, while Odisha scores above 0.9, indicating strong fiscal sustainability.
3. Sixteen States with index values above 0.6 are considered fiscally prudent, showing effective debt management despite higher debt ratios.
4. During 2021–2025, GSDP growth exceeded the average interest rate by about 8 per cent, indicating solvency.
5. Debt-to-revenue receipts ratio varies from 0.8 in Arunachal Pradesh to 3.6 in Punjab, showing wide repayment differences.
6. In eleven States, including Punjab, Kerala, and Tamil Nadu, debt exceeds cumulative assets, indicating inefficient use of borrowings.

Challenges in Ensuring Debt Sustainability

1. Inter-State Variations: Diverse growth rates, income levels, and fiscal capacities make uniform debt limits unrealistic.
2. High Revenue Expenditure: States often borrow to meet current expenditure, reducing funds for capital formation.
3. Weak Debt Utilisation: In many States, borrowings are not efficiently used for asset creation.
4. Limited Revenue Base: Dependence on central transfers and low own-tax revenue restrict fiscal autonomy.
5. Interest Burden: Rising debt servicing costs reduce fiscal space for development spending.
6. Populist Policies: Competitive welfare schemes and subsidies increase fiscal stress.
7. Lack of Transparency: Off-budget borrowings and guarantees obscure the true extent of liabilities.
8. Inter-generational Equity: Borrowing for non-productive purposes shifts the debt burden to future generations.

Policy Recommendations

• The Finance Commission should adopt a multi-dimensional framework instead of a single fiscal ratio for assessing sustainability.
• Fiscal consolidation targets must be State-specific, considering economic capacity and development needs.
• Block grants should be provided with Key Performance Indicators (KPIs) for fiscal discipline and efficiency.
• States must strengthen their own revenue mobilisation and ensure borrowings are directed toward productive capital expenditure.
• Greater fiscal transparency and coordination with the Centre are essential for credible debt management.

Conclusion: Debt sustainability of States is a multi-dimensional and dynamic issue. The wide fiscal diversity among States makes a one-size-fits-all approach ineffective. A flexible, multi-criteria framework assessing solvency, repayment capacity, and productive use of debt is vital. Ensuring fiscal discipline, while allowing States autonomy to pursue growth-oriented borrowing, will promote both macroeconomic stability and equitable development across India.

Question: A one-size-fits-all approach to debt management may not be suitable for Indian States. In light of this statement, discuss the challenges of ensuring debt sustainability among Indian States and suggest suitable measures for improvement.