Economic Survey 2025-26: The concern is state finances

Indian states are set to raise close to Rs 5 trillion from the bond market in the January-March quarter of the current financial year, marking the largest quarterly state borrowing programme on record and sharpening concerns about yield pressures, debt sustainability, and the evolving balance of fiscal responsibility between the Centre and the states. A central empirical contribution of the Economic Survey 2025-26 is its explicit shift from assessing Union government fiscal performance in isolation to evaluating general government finances as the relevant unit of market scrutiny. While the Union government achieved a fiscal deficit of 4.8 per cent of GDP in FY25, outperforming its budgeted target of 4.9 per cent, and has committed to a further consolidation to 4.4 per cent in FY26, the Survey highlights that this credibility is increasingly being offset by the fiscal behaviour of state governments. In particular, several states are exhibiting rising revenue deficits financed through market borrowings, a compositional shift that weakens debt sustainability despite stable headline deficit ratios. The Survey provides a revealing cross-country comparison to substantiate this claim. Despite India and Indonesia sharing the same BBB sovereign credit rating, India’s 10-year government bond yield stands at approximately 6.7 per cent, compared to 6.3 per cent for Indonesia. Traditional explanations such as inflation differentials, growth prospects, or monetary policy stance are insufficient to explain this spread. Instead, the Survey argues that markets are pricing in latent fiscal risks emanating from state-level finances, including expanding unconditional cash transfers and weakening expenditure quality. According to the Reserve Bank of India’s indicative calendar for state Development Loans (SDLs), total market borrowings by states and union territories in the final quarter are estimated at Rs 4,99,821 crore, to be raised through 13 weekly auctions between January 6 and March 27. If fully realised, this would push total state market borrowing for the year to an all-time high, with the fourth quarter alone accounting for close to two-fifths of the annual total. The borrowing calendar reveals a front-loaded and persistent supply of state paper through the quarter, with weekly auction sizes rising from about Rs 30,000 crore in early January to nearly Rs 48,000 crore in the second half of March. What gives this clustering sharper significance is a point stressed in the Economic Survey 2025-26: state borrowing is no longer being absorbed passively by markets. Investors are increasingly evaluating general government borrowing pressures, making the timing and concentration of state issuance itself a driver of yield outcomes. The calendar also shows how concentrated this borrowing has become. Several of India’s largest states including Karnataka, Maharashtra, Tamil Nadu, Madhya Pradesh, Rajasthan, West Bengal and Uttar Pradesh appear repeatedly across the calendar, often tapping the market for Rs 4,000-10,000 crore in a single auction. Karnataka and Maharashtra alone are scheduled to borrow almost every week, highlighting how a small group of large states now account for a significant share of total market borrowing. This surge in state borrowing comes at a time when the Union government is expected to emphasise fiscal restraint and consolidation in the Budget. The RBI’s Financial Stability Report (December 2025) helps explain why state borrowing has risen so sharply. While the report says that India’s overall economy and financial system remain stable, it points out that state governments continue to face strong fiscal pressure, mainly because a large share of their spending is fixed and difficult to cut. These include salaries, pensions, interest payments, and subsidies, which together now account for roughly one-third of states’ revenue expenditure, leaving limited room for adjustment in times of stress. India’s general government debt-to-GDP ratio remains elevated at around 82 per cent, with state government debt forming a significant and rising component. Moreover, in the past decade, states have become the primary agents of welfare delivery running food distribution systems, cash transfers, health schemes, housing programmes, and infrastructure projects. Many of these are politically salient and difficult to scale back. Yet states’ revenue-raising powers remain limited. While GST and tax devolution have stabilised revenues, states have little control over tax rates and face constraints on non-tax revenues. The result is a mismatch between responsibilities and resources, which borrowing increasingly fills. The problem is not only rising supply. There is a shift on the demand side. Traditionally, insurance companies and pension funds absorbed large quantities of government and state bonds. But in recent years, many have begun rebalancing portfolios towards equities and higher-yielding assets, reducing their appetite for long-term government paper. This means states are issuing more debt at a time when their most reliable buyers are becoming more selective. Taken together, the Survey’s findings suggest that the forthcoming Budget will need to balance fiscal discipline with federal equity. The evidence supports stronger incentives for capex-oriented state spending, tighter scrutiny of revenue-deficit financing, and greater reliance on market-based signals such as SDL spreads. Mohan is Professor of Economics and Dean, O.P. Jindal Global University. Malhotra is a Research Analyst with Centre for New Economics Studies (CNES), O.P. Jindal Global University