Analysing Indian States’ Macro-Fiscal Health

Revenue Surplus or Dependency Trap? Decoding Indian States’ Macro-Fiscal Health

Uttar Pradesh's ₹37,000 crore revenue surplus in 2025, more than double Gujarat’s, might sound like a fiscal triumph. Yet, a deeper look reveals troubling dependence: only 42% of UP's revenue came from its own sources, with the rest driven by central transfers. This glaring reliance on devolved funds raises pressing questions about fiscal autonomy and sustainable growth, especially as poorer States across India grapple with similar structural imbalances.

The Comptroller and Auditor General (CAG)’s decadal analysis exposes the uneven terrain of macro-fiscal health among Indian States — a concept that goes far beyond budget books to assess revenue generation, spending priorities, and debt sustainability. Why this report matters is clear: India's federal fiscal architecture, with States handling key sectors like health and education, increasingly faces the strain of inequitable resource distribution, debt pressures, and unbalanced expenditure priorities.

The Institutional Framework Governing State Finances

Fiscal responsibility at the State level is deeply tied to the Fiscal Responsibility and Budget Management (FRBM) Act. Under this framework, States are expected to limit their fiscal deficit to 3% of Gross State Domestic Product (GSDP), barring exceptional circumstances. Additionally, devolution mechanisms through the 15th Finance Commission allocate central taxes to States based on factors like population, income distance, and forest cover. Of the total divisible tax pool, 41% is earmarked for States.

The NITI Aayog’s Fiscal Health Index (FHI) 2025 ranks 18 major States on critical metrics like contribution to GDP and public expenditure. Odisha and Chhattisgarh shine as top performers with balanced budgets and manageable debt profiles. Struggling States such as Punjab and Kerala display chronic inefficiencies, driven by excessive subsidies, bloated revenue deficits, and burgeoning debt-to-GSDP ratios that exceed 30% in some cases.

Where the Numbers Tell a Different Story

A recurring narrative among poorer States is the mismatch between headline fiscal indicators and ground realities. Uttar Pradesh’s surplus, for instance, stems largely from central grants and tax devolution rather than internal revenue mobilization. By contrast, Maharashtra generates nearly 70% of its revenue internally, enabling a broader scope for independent fiscal planning. Such imbalances exacerbate what economists term vertical fiscal imbalance, giving wealthier States a disproportionate strategic advantage.

Yet, reliance on central funds is only half the story. Deficit financing methods have shifted dramatically over the last decade. While States once leaned more on loans from the Centre, the CAG highlights that market borrowing now dominates — through bonds and loans from financial institutions. This change exposes States to higher interest rates and repayment obligations, which may eventually crowd out development spending.

On expenditure, the evidence remains glaring: capital spending — critical for long-term growth through investments in roads, schools, and hospitals — consistently falls short. Kerala, for instance, spends nearly 80% of its budget on revenue expenditure, including salaries and pensions, leaving little for infrastructure development. Odisha, conversely, has allocated nearly 30% of its budget to capital expenditure, enabling sustained improvement in health and rural infrastructure.

Structural Tensions in Federal Fiscal Arrangements

One critical tension lies in the inherent trade-offs between devolution equity and performance-based incentives. While poorer States understandably need more resources, the current model often penalizes high-performing States economically. Maharashtra and Karnataka, which generate significant internal revenue, see a smaller proportion of devolved grants, limiting their ability to innovate fiscally.

Equally concerning is the tenuous debt trajectory. Punjab, for example, has breached both fiscal and revenue deficit limits repeatedly over the last decade. This raises questions about enforcement mechanisms under the FRBM framework — does the Centre have enough leverage to ensure compliance? The CAG’s observations suggest otherwise, noting that penalties for breaching deficit ceilings are rarely applied effectively.

Political economy pressures compound these institutional challenges. Welfare-heavy budgets in States like Andhra Pradesh and West Bengal prioritize short-term electoral gains over fiscal sustainability. For instance, massive farm loan waivers or electricity subsidies, while politically expedient, tend to push States further into deficit financing without structural reform or targeted relief.

Lessons from Australia: A Different Fiscal Compact

Australia provides an instructive comparison. Its vertical fiscal equalisation model reallocates financial resources based on States’ needs and fiscal capacity while ensuring strong accountability measures. The Commonwealth Grants Commission, an independent body, evaluates States’ performance annually, tying conditional grants to tangible developmental outcomes. Unlike India’s opaque and politically influenced transfer system, Australia’s framework assures transparency and predictability, empowering both wealthy and poorer States to plan robustly.

What Does Success Look Like in India?

For Indian States to achieve genuine macro-fiscal health, success cannot merely be defined by balanced books or headline surpluses. Key metrics to track include sustained capital expenditure growth, debt-to-GSDP ratios below 20%, and reductions in revenue dependence on the Centre for poorer States. Robust fiscal discipline must be complemented by reforms in tax mobilization and better utilization of revenue via targeted, high-impact spending in development sectors.

Much, however, hinges on political will. The 15th Finance Commission’s call for higher local body grants represents a step forward, but without better enforcement under the FRBM Act and transparent monitoring mechanisms, systemic inefficiencies will persist. Whether the NITI Aayog’s FHI can add pressure for reform or simply provide another annual ranking remains an open question.

Exam-Style Integration

• Prelims MCQ 1: Under the Fiscal Responsibility and Budget Management (FRBM) Act for States, what is the permissible limit for fiscal deficit with respect to GSDP?
  • A) 2%
  • B) 3%
  • C) 4%
  • D) 5%
• Prelims MCQ 2: Which State generated nearly 70% of its revenue internally, according to the CAG’s decadal analysis?
  • A) Uttar Pradesh
  • B) Maharashtra
  • C) Kerala
  • D) Odisha

Mains Question: Assess the structural limitations of India's fiscal federalism in ensuring equitable resource allocation among States. How far have existing mechanisms like Finance Commission devolution and FRBM mandates succeeded in addressing these challenges?

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