Economic Survey: State cash transfers threaten public investment and sovereign borrowing costs

Between, FY24 and FY25, the revenue deficit increased by 40 basis points across all states.

• Unconditional cash transfers cause rising state revenue deficits, posing fiscal risks.
• Govt achieves fiscal consolidation with higher public investment
• Fiscal stress may raise India's borrowing costs and affect long-term growth

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While the Centre has achieved fiscal consolidation alongside record public investment, rising revenue deficits and unconditional cash transfers in several States pose emerging risks by crowding out growth-enhancing spending, the Economic Survey for 2025-26 said.

"The expansion of unconditional cash transfers across several States has contributed to rising revenue expenditure, with implications for fiscal space and public investment at the state level," the Survey said.

In the post-Survey press-conference, Chief Economic Adviser V Anantha Nageswaran, said that the unconditional fiscal transfers that many states are pursuing are very useful as a short-term loan. "They put cash in the hands of the public, raises disposable income and increases spending power, no doubt. However, sustaining growth will require a careful re-prioritization, so that short term income support doesn't erode the very investments on which inclusive medium-term prosperity ultimately rests."

According to the Survey, the combined fiscal deficit of State Governments, as a proportion of GDP, has, on average, remained broadly stable at around 2.8 per cent in the post-pandemic period, similar to pre-pandemic levels. However, after the sharp correction from the pandemic induced spike of around 3.9 per cent, State deficits have gradually edged up again over the past three years to 3.2 per cent, reflecting emerging pressures on State finances.

Between FY19 and FY25, 18 States saw a deterioration in their revenue balances, of which 10 slipped into revenue deficit from revenue surplus, 5 worsened their revenue deficit and 3 managed to stay in revenue surplus despite a deterioration, the Survey highlighted.

Between, FY24 and FY25, the revenue deficit increased by 40 basis points across all states. "A key driver of this renewed fiscal stress has been lagging revenue growth relative to nominal GDP growth, compounded by the incurring of expenditures such as discretionary unconditional cash transfers," the Survey said.

On bond yields, the Survey said that with Indian government bonds now globally indexed and investors increasingly assessing general-government finances, weak fiscal discipline at the State level can no longer be treated as "locally contained"—it increasingly affects the cost of sovereign borrowing.

India’s 10-year bond yield is 6.7%, while Indonesia’s is 6.3%, even though both countries have the same credit rating of BBB. "States’ fiscal priorities, perhaps, are casting a shadow on the sovereign’s borrowing cost, as investors focus on the fiscal parameters of the general government rather than just those of the Union government," the Survey said.

More importantly, the economic costs of the insidious impact that unconditional fiscal transfers have on the incentives for self-improvement, upskilling, and employability may be more significant in the long term, it added.

On the central government’s fiscal health, the Survey said that its trajectory stands out for combining consolidation with sustained public investment, earning three sovereign rating upgrades this year Between FY20 and FY25, the share of capital spending in total central government expenditure increased from about 12.5 per cent to 22.6 per cent, while effective capex as a share of GDP rose from roughly 2.6 per cent to 4.0 per cent.

"Based on the broad trends observed during the year, the central government remains well on track to achieve its envisaged fiscal consolidation path, aiming to attain a fiscal deficit target of 4.4 per cent of GDP by FY26. As of November 2025, the union government’s fiscal deficit stood at 62.3 per cent of the Budget Estimates," the Survey said.