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The FRBM Review Committee, in 2017, suggested adoption of a rule based fiscal policy by limiting government debt, fiscal deficit and revenue deficits to defined targets with an escape clause. It recommended Govt debt/GDP ratio be brought down to 60 per cent by 2023 (40 per cent for the Centre and 20 per cent for States). The Committee advised governments not to borrow for current expenditure; advocated fiscal deficit as the operating target to bring down public debt. The 15th Finance Commission, after reviewing the finances of the Union and the States during Covid and thereafter, set targets for fiscal consolidation with fiscal deficit and fiscal liabilities of the States to reach 2.8 per cent and 30.9 per cent of GSDP by 2024-25 with a revenue surplus. The outcome of debt/GDP ratio on economic growth is viewed diversely. Economists feel that accumulation of public debt hinders economic agents to make optimal decisions regarding future investments leading to policy uncertainty. The positive effect of public debt on economic growth arises via Keynesian multiplier effect. Increase in public debt induces high levels of public spending, on physical and social infrastructure, and crowds in private investment. Government borrowing from domestic debt market strengthens domestic financial market, stimulates private saving and investments and hence growth. Excessive debt, however, is growth dampening, increases uncertainty and cost for private investment. States have to follow a Constitutionally mandated fiscal management path indicated by the 15th FC. Overall public debt of the States increased from 22.8 per cent of their aggregated GSDP in 2011-12 to 31 per cent in 2020-21, moderating to 28.8 per cent in 2024-25, lower than the threshold suggested by the 15th FC. However, there are significant variations in debt/GSDP ratio across the States from a low of 16.3 per cent for Odisha to over 57 per cent for Arunachal Pradesh. The debt sustainability of a State does depend on debt/GSDP; it could not be a single parameter for all States. A higher debt/GSDP ratio may be perfectly sustainable for some States based on return on debt relative to the cost, its GSDP growth, purpose for which the debt is incurred and its external effects. Various studies have used a variety of parameters to understand debt sustainability at State level. Borrowings are needed but the question is how much is too much. Five criteria We adopt the following five criteria to assess a debt sustainability level across the 28 States. These criteria are: (i) difference between the rate of growth of GSDP (proxy for return on investment) and the rate of interest (the cost of debt), which is the classic debt sustainability parameter or the Domar gap (ii) difference between rate of growth of GSDP and the rate of growth of Debt, the debt buoyancy (iii) Stock of Debt to GSDP, the traditional debt stock variable (iv) the ratio of Debt to Revenue Receipt, the actual repayment capacity and (v) the ratio of cumulative capital expenditure to debt or the collateral. An attempt has been made to have a composite index with a 15 per cent weight each to the first four criteria and a 40 per cent weight to the ratio of assets (cumulative capex) to debt. The higher weight to the ratio of assets to debt is on account of use to which the debt has been put to. The first two criteria, which indicate the Domar gap have together a weight of 0.3, equally divided; the other two criteria which link debt stock to repayment capacity perceived and actual have again a weight of 0.3, equally divided and residual weight is allocated to the fifth criteria. A ratio greater than 1 in this case suggests that on cumulative basis, State has no revenue deficit. Number greater than one indicates ability to repay debt from revenue earnings instead depending on use of debt to repay debt. The debt/GSDP ratio and the debt sustainability index of the States for the average of post Covid period (2021-22 to 2024-25 (BE)) are indicated in the accompanying graphic. The fine print The overall debt/GSDP ratio and the debt sustainability index has a limited correlation. There are only two States with a debt sustainability index below 0.2 (Punjab and West Bengal), 10 States with index value between 0.2 and 0.6, 15 States with debt sustainability index between 0.6 and 0.8 and only 1 State (Odisha with a sustainability index above 0.9. These 16 States with an index exceeding 0.6 could be considered fiscally prudent with better debt serviceability and debt use, notwithstanding a high debt/GSDP ratio in some cases. Instead of single parameter approach, this multiple variable index captures solvency together with the capacity for repayment and the quality of use of resources. The weighted interest rate for outstanding debt stock for States move in a narrow range and any variation is largely due to the maturity profile and the time of contracting debt. For a debt contracted in a particular year, inter-State variations are limited as Reserve Bank of India acts as the agency floating debt on behalf of States. The rate of growth of GSDP, except during the pandemic, has been higher than the rate of interest indicating a positive gap required for meeting solvency criteria. Notwithstanding the inter-State differences, GSDP growth has exceeded the interest rate during 2021-2025 by a huge 8 per cent. Debt/revenue receipt ratio has also varied from 0.8 (Arunachal Pradesh, where outstanding debt is below the revenue receipt) to 3.6 for Punjab, with other States falling between these two values. The ratio of debt to assets (cumulative capital expenditure and investment) varies from 0.39 (the outstanding debt exceeds the assets raising the concern on resource use in West Bengal, Punjab and Kerala) to 2.9 for Arunachal Pradesh. For 11 States (West Bengal, Punjab, Kerala, Haryana, Rajasthan, Tamil Nadu, Andhra Pradesh, Telangana, Himachal Pradesh, Karnataka and Maharashtra), debt exceeds assets. The above analysis indicates that the one size fits all approach as suggested by FC or other Committees may not be appropriate for debt sustainability including inter generational equity. Different States at different levels of growth and income may require additional resources. The consideration should not be exclusively on stock, but other parameters, and including raising and use of funds. As States know what is the best for them, it is necessary that FC allocates in block and set KPIs for the States to achieve. Gopalan is former Secretary, Economic Affairs, and Singhi is former Senior Economic Adviser, Ministry of Finance. Views expressed are personal Published on October 30, 2025
