After three years of strong growth, capital spending by states is expected to moderate in FY25, growing by a modest 6.5% to Rs 6.5 lakh crore, down from a strong 39.3% growth in FY24RE. The capital-to-revenue expenditure ratio, a measure of expenditure quality, is set at 20.7% for FY25BE, declining from 21.2% in FY24RE. Punjab has the lowest ratio at 6.2%, while Gujarat leads at 36.2%. Revenue expenditure is also budgeted to increase by a four-year low of 8.9% to Rs 44.2 lakh crore. Committed expenditure (interest payments and pensions), on the other hand, remains high, comprising about 24% of total revenue expenditure and consuming nearly a quarter of revenue receipts. Punjab, Kerala, Himachal Pradesh, and Tamil Nadu have allocated over 35% of their revenue receipts to committed expenditure in FY25.

The overall fiscal deficit of these 21 states is pegged at Rs 10 lakh crore or 3.2% of their GSDP in FY25BE vs. 3.5% in FY24RE, above the recommended 3.0% by the 15th Finance Commission. Eight of these 21 states have budgeted for a sub-3% fisc, led by Jharkhand (2%), Gujarat (2.5%) and Maharashtra (2.6%). Nearly 79% of this deficit is expected to be funded through market loans, with gross borrowings rising by 7% to Rs 10.8 lakh crore. States’ reliance on market loans has dropped in the recent years, thanks to higher loans from the Centre. Outstanding liabilities to GDP ratio at 29% in FY22 for our sample states may rise to ~33% after accounting for contingent liabilities (states’ guarantees to SPSEs). In our sample, UP accounts for over 19% of the overall contingent liabilities, followed by Telangana at 15% and Andhra Pradesh at 13%.

With states contributing only 30% of total tax revenues but accounting for over 60% of total general government expenditure, improving their financial positions has become increasingly critical. Our analysis highlights the need for a clear fiscal consolidation roadmap for fiscally strained states, a gradual reduction in contingent liabilities to enhance transparency, improved fiscal credibility, and risk-based pricing for State Development Loans (SDLs). These measures are essential for the long-term fiscal health of states, ensuring they are adequately equipped to address exigencies and emerging priorities in an ever-changing landscape.