Freebie fallout

Bihar is a case in point. Populist welfare schemes announced during the recent poll campaign, including a ₹10,000 grant to women, could cost the state over ₹41,000 crore, Emkay Global estimates. That's nearly 4% of the gross state domestic product (GSDP), and exceeds even the planned capital expenditure for 2025-26.

Bihar already relies heavily on New Delhi for funds, with over 70% of its revenue coming from central transfers, including tax devolution and grants. This makes the state's finances inherently volatile, as any fluctuation in central support can immediately strain fiscal stability, pointed out Paras Jasrai, associate director at India Ratings and Research.

The state's fiscal deficit in 2024-25 is estimated to have been 6% of GSDP, while the budget for 2025-26 targets 3%, based on an ambitious 22% nominal economic growth. But data until September shows the fiscal deficit is already at 7.8% of the estimated GSDP.

What this means is that the new Bihar government will begin its term with far less fiscal room than its welfare promises require.

Poll pressures

A similar strain is visible across several states that saw polls in the past two years. Fiscal deficits are steadily rising in election years, and staying elevated thereafter, suggesting that welfare-linked spending can lead to chronic fiscal pressure, rather than one-time costs.

Chhattisgarh offers one of the sharpest examples, with its deficit rising from 1.0% of GSDP in the pre-election year (2022-23) to 5.3% in the election year. It is estimated to have stayed there in 2024-25. Maharashtra's fiscal deficit rose by roughly 40 basis points (bps) after the Ladki Bahin scheme aimed at women was introduced. Odisha's is estimated to have risen by 100 bps, and its 2025-26 budget pegs the fiscal deficit-to-GSDP ratio above 3%, compared with 1.7% in 2023-24.

The 15th Finance Commission had set a 3% limit for 2025-26, but several states have already overshot the target. Hence, that 3% ceiling could now become the floor, said the Emkay Global report. With Tamil Nadu, Kerala and West Bengal headed to polls next year, this upward drift is unlikely to ease: their fiscal deficits in recent years have been around the 3%-mark. However, Assam and West Bengal estimate their fiscal deficits to rise up to 5.75% and 4.02% in 2024-25, respectively.

Crowded commitments

Even outside election cycles, state finances are under pressure from a more structural source: the "committed" expense needs such as salaries, pensions, interest payments and subsidies. According to a report by PRS Legislative Research, in 2023-24, states spent 62% of their revenues on such expenses. These obligations cannot be scaled down easily, and when they consume such a large share of revenue, development spending loses out. This squeeze is already showing up in headline numbers, with states recording a 0.4% revenue deficit in 2023-24, meaning they had to borrow simply to meet recurring expenses, the report said. For 2025-26, states have estimated about 50% of revenue receipts to go on these expenses.

This curtails the space available for capital expenditure, which is the kind of spending that can power longer-term growth. States' capex amounted to just 2.7% of GSDP in 2023-24. "Consistent welfare expenditures cause debt to balloon, which further leads to increase in committed interest payments. States must boost capital expenditure, as a one-percentage-point increase in their own capex results in 80 bps of GDP growth," Jasrai said.

Revenue gap

Meanwhile, goods and services tax (GST) has yet to become the revenue source it was expected to be. In the four years before it was launched in 2017, states earned an average of 2.8% of GSDP from the taxes that were later subsumed under GST, but this dropped to 2.6% in the GST era, the PRS Legislative Research report said. With states no longer getting compensated for any revenue loss since mid-2022, this gap has become more visible.

The Centre has also seen a decline in the share of revenue that comes from the taxes that got subsumed under GST in 2017, the report said. But the story of states is more worrying, as their fiscal space can be directly influenced by state GST (SGST) mop-ups. The trajectory since 2017 has been uneven. Some north-eastern states have benefited from GST's destination-based structure, seeing an improvement in their tax-to-GSDP ratios, the report said. But several bigger states—including Punjab, Chhattisgarh, Karnataka, Madhya Pradesh and Odisha—have experienced a clear decline relative to the pre-GST years.

Capex status

The Centre's capital spending has picked up well this year, clocking ₹5.8 trillion in April-September, about 40% higher year-on-year (though last year's base was low, given muted expenditure during the general elections). But central investment, while important, has a limited growth multiplier when weighed against state-level capex, which typically delivers a stronger impulse because it feeds directly into local infrastructure, procurement and employment.

A review of capital spending by 23 states for H1 2025-26 shows several large states have increased capital investment, with Punjab, Gujarat and Madhya Pradesh each seeing over 30% growth. But this still points to slower-than-planned progress. For several of the largest state economies—including Maharashtra, Tamil Nadu, Uttar Pradesh, Karnataka and West Bengal—capex utilization has been below that seen in the same period last year.

However, Jasrai noted that states tend to go slow on capex in the first half because they cannot avoid revenue expenditure, and they want to first see how much revenue they are able to earn. They can catch up in the second half, he added.