Finance Commission suggests 3% borrowing cap for states, flags risks from off-budget loans

The share of state government borrowings in total government borrowings has risen significantly since 2015‑16.

• States' fiscal deficits capped at 3 percent of GSDP for 2026–31 award period
• Finance Commission urges states to stop off-budget borrowings and enhance reporting
• Govt keeps states' tax share at 41% as recommended

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The Finance Commission has recommended that States’ fiscal deficits remain capped at 3 percent of GSDP during the award period 2026–27 to 2030–31, while discouraging the use of off-budget borrowings, warning that such practices could weaken their financial stability in the future.

“States should completely discontinue the practice of incurring off‑budget borrowings and bring all such borrowings onto their budgets. If, for any reason, off‑budget borrowings are undertaken, there should be a framework for their regular annual reporting, preferably as part of the budget,” the 16th Finance Commission said in its report.

It also recommended that the Comptroller and Auditor General (CAG) include disclosures on off-budget borrowings in State Finance Accounts.

Highlighting inconsistencies in State-level Fiscal Responsibility Legislations (FRLs), the Commission has urged states to amend their FRBM laws to align with the recommended consolidation path and to expand the definition of deficit and debt to include off-budget liabilities.

In its report, covering 2026–31, the Commission said the 3 percent ceiling on state borrowing should be strictly enforced under Article 293(3) of the Constitution to ensure debt sustainability.

It clarified that interest-free on-lending by the Centre to States under the Special Assistance to States for Capital Investment (SASCI) would continue to be outside this limit, as is the current practice.

In recent years, states have increasingly relied on market borrowings to finance their deficits.

The share of state government borrowings in total government borrowings has risen significantly since 2015‑16, accounting for about 33 per cent of total government securities issued in 2015‑16, which increased to 43 percent in 2024‑25.

Consequently, states hold around 36 percent of outstanding securities in 2025‑26, compared to 24 percent in 2015‑16.

Higher market borrowings by the states also arises from the fact that they do not avail National Small Savings Fund (NSSF)

The Union government on February 1 accepted the recommendations of the 16th Finance Commission and decided to retain the share of states in a common pool of taxes for the 2026-31 period at 41 percent.

Fiscal roadmap

The Commission has laid out a fiscal framework under which the Union government’s fiscal deficit is targeted at 3.5 percent of GDP by 2031, while states remain at 3 percent, resulting in a combined fiscal deficit of 6.5 percent of GDP.

This includes 0.5 percent of GDP that the Centre borrows to give interest-free loans to States for capital expenditure under SASCI.

The roadmap assumes that states maintain revenue balance while sustaining high levels of capital expenditure to support infrastructure development over the next decade.

Under this framework, combined Union-State debt is projected to rise to 73.1 percent of GDP by the end of the award period, before stabilising and declining over the long term, supported by economic growth.