CAG Report on States Fiscal Health: Decadal Surge in Public Debt

A Decade of Rising State Debts: Fiscal Caution or Collapse?

₹59.60 lakh crore. That is the staggering level of states' combined public debt in 2022-23, as revealed by the Comptroller and Auditor General (CAG) in its latest analysis. This figure marks a threefold increase from ₹17.57 lakh crore in 2013-14, with debt now accounting for 22.17% of India’s GDP. The report highlights glaring debt-to-GSDP imbalances, where Punjab leads the pack at 40.35%, followed closely by Nagaland (37.15%) and West Bengal (33.70%). In stark contrast, states like Odisha (8.45%), Maharashtra (14.64%), and Gujarat (16.37%) remain fiscally conservative. But behind these numbers lie deeper institutional fractures and a troubling shift in fiscal priorities.

The Fiscal Instrument: Borrowings to Fund Current Expenditure

Central to this discussion is the breach of the ‘golden rule’ of borrowing, which mandates that debt should fund investment—not day-to-day costs. Alarmingly, CAG found that in 11 states, including Punjab, Tamil Nadu, Andhra Pradesh, and West Bengal, more than half of net borrowings have been utilized for operational expenses such as salaries, pensions, and subsidies. For instance, Punjab—a state grappling with fiscal insolvency—spends nearly a quarter of its revenue receipts on interest payments alone.

This debt surge is underpinned by policy decisions such as farm loan waivers, power subsidies, and the revival of the old pension scheme, fueling what CAG calls ‘competitive populism.’ The cessation of GST compensation in June 2022 exacerbated these pressures, stripping states of fiscal autonomy without providing adequate compensatory frameworks. Over-reliance on State Development Loans (SDLs) further burdens states with market-determined interest rates, contributing to inflationary pressures and reducing private sector borrowing capacity.

The Case for Rising State Debt

To steel-man the argument, some level of debt escalation is inevitable when states are tasked with welfare obligations alongside developmental mandates. COVID-19 intensified states' fiscal strain, forcing them to borrow amidst falling revenues and contracting GSDP. Borrowing during crises is not only legitimate but often necessary to sustain essential social services.

There are historical precedents to highlight how debt-backed public spending can deliver dividends, such as Kerala’s approach to social investments. The state’s borrowing-supported healthcare model drew significant global praise during the pandemic, showcasing how targeted expenditure can foster long-term resilience. Similarly, borrowing in education and infrastructure—if managed effectively—has multiplier effects on the economy, raising productivity and fostering equitable growth.

States also argue that their fiscal space has been squeezed post-GST. While the GST regime unified taxation, it eliminated independent revenue streams like octroi and entry tax. Without adequate autonomy, states have limited scope for revenue mobilization, leaving borrowing as the only feasible option for maintaining both welfare and development spending.

The Case Against Debt-Driven Fiscal Policies

Yet, the CAG's findings reveal a disquieting pattern that undermines the case for debt proliferation. One central critique lies in the quality of expenditure. If borrowing merely funds consumption subsidies or recurring expenses, the debt provides no future returns. For example, reviving the old pension scheme—a measure adopted by Rajasthan and Himachal Pradesh—imposes significant future liabilities without generating tangible economic value.

A second concern is inefficiency in fiscal management. Interest payments alone consume 20–25% of revenue receipts in many debt-heavy states, leaving negligible room for developmental spending. This trend could permanently entrench states in a cycle of fiscal dependency, unable to mobilize resources for transformative capital investments.

More troubling is the inflationary impact of consumption-oriented public spending. Large-scale SDL borrowings not only crowd out private sector investments but also elevate borrowing costs across the board. Moreover, India's general government debt—standing at ~80% of GDP including the Centre’s debt—far exceeds the 60% cap recommended by the FRBM Review Committee, pushing macroeconomic stability into a vulnerable zone.

Lessons from International Comparison: Germany’s Debt Brake

Germany offers an instructive counterpoint, having adopted a constitutional “debt brake” (Schuldenbremse) in 2009. The initiative imposes a stringent cap on structural deficits, limiting them to 0.35% of GDP. Importantly, the law mandates balanced budgets for state governments, with exceptions permitted only under exceptional circumstances like pandemics or crises.

The policy has largely been credited with significantly moderating Germany’s public debt trajectory, especially when contrasted with other European economies facing debt crises. However, critics argue that the debt brake can constrain fiscal space for necessary infrastructure investments. Even so, Germany’s model underscores the utility of legally codified borrowing limits in addressing fiscal profligacy—an approach Indian states could adapt in principle.

Where Things Stand: The Road Ahead

The debate is far from settled. While borrowing is unavoidable for welfare and emergency interventions, the real risk is not debt itself but its misallocation. States like Tamil Nadu and Punjab demonstrate troubling signs of unproductive spending, which could entrench systemic fiscal imbalance. On the other hand, encouraging debt-funded capital investments remains an unexplored opportunity that could address underfunding in critical areas like water management and public transport.

State-level fiscal discipline must align with long-term sustainability benchmarks, particularly under the FRBM framework. Conditional borrowings linked to fiscal reforms and transparent debt management could help improve fiscal prudence. Adopting hard caps on borrowings for non-productive expenditures might also be unavoidable.

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