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States across India are facing increasing pressure to curb spending on populist measures, as rising revenue deficits and unconditional cash transfers threaten to stifle crucial capital investments, according to a recent economic assessment.
The assessment emphasizes the need for states to reassess their budgetary priorities.
“Prioritizing fiscal space for capital formation and investments in human capital delivers stronger and more lasting improvements in household incomes, labor productivity, and overall well-being than continually expanding open-ended unconditional cash transfers,” the assessment stated.
The assessment cautioned about the potential long-term negative effects of unconditional fiscal transfers on individuals’ motivation for self-improvement, skill development, and employment prospects, while suggesting that more targeted approaches, regular evaluations, and results-oriented designs could help address fiscal constraints.
With global investors increasingly scrutinizing government bonds on a consolidated basis, the assessment warns that “weak fiscal discipline at the state level” is no longer simply a local issue, but a potential risk to the nation’s borrowing costs.
Currently, the yield on the 10-year bond stands at 6.7 percent, exceeding Indonesia’s 6.3 percent despite both countries holding BBB ratings. The assessment suggests that ongoing revenue deficits or increased committed expenditures at the state level could negatively impact sovereign bond yields.
“This highlights the importance of coordinated fiscal discipline across all levels of government, with fiscal policy focused on expanding productive capacity and income growth rather than creating ongoing expenditure commitments,” it emphasized.
The assessment noted that in fiscal years 2024 and 2025, the revenue deficit increased by 40 basis points across all states, driven by slower revenue growth compared to nominal growth in gross domestic product (GDP) and the implementation of unconditional cash transfers.
While incentives like the Special Assistance to States for Capital Expenditure (Sasci) have encouraged states to maintain capital expenditure at 2.4 percent of GDP in fiscal year 2025, this masks a concerning trend.Revenue spending is increasingly directed toward open-ended unconditional cash transfers, which lack defined end dates or review mechanisms, creating rigidity and diverting funds from investments in infrastructure and human capital.
Across 28 states, the combined debt-to-GDP ratio is 28.1, and the interest payments-to-revenue receipts ratio is approximately 12.6 for fiscal year 2025. However, there is significant variation among states on both fronts.
“These differences are not yet fully reflected in state borrowing costs,” the assessment stated, adding that state development loans are primarily held by domestic institutions, with limited trading in the secondary market.
the assessment calls for improved disclosure of off-budget liabilities and guarantees to allow markets to accurately assess credit risk, broaden investor bases, and extend maturities.
“Expanding the investor base and increasing secondary market liquidity would lead to better pricing of state development loans
