Bharat’s States Need A Public Financial Management Reset

Bharat’s macroeconomic stability and fiscal position is often debated in the context of the central government. But the real fiscal story lies in the states. They account for nearly two-thirds of public expenditure and drive delivery in health, education, agriculture, urban development, and infrastructure. If Bharat’s next decade of growth is to be sustainable, reforming Public Financial Management (PFM) systems at the state level is no longer optional — it is foundational.

Recent evidence shows a widening divergence in fiscal performance across states. The Fiscal Health Index (2025) released by NITI Aayog ranks states on five pillars: quality of expenditure, revenue mobilisation, fiscal prudence, debt index and debt sustainability. States such as Odisha, Chhattisgarh and Gujarat perform relatively well on debt sustainability and capital expenditure quality. Others — including Punjab, Kerala, Andhra Pradesh and West Bengal — face sustained revenue deficits and elevated debt burdens (NITI Aayog, Fiscal Health Index 2025).

The broader macro picture confirms the stress. The Reserve Bank of India in its State Finances: A Study of Budgets 2024–25 notes that while aggregate gross fiscal deficits have moderated from pandemic peaks, they remain close to 3 per cent of GSDP for many states. Outstanding liabilities hover around 28–30 per cent of GSDP in several cases — well above the 20 per cent benchmark originally envisaged under Fiscal Responsibility and Budget Management (FRBM) norms (RBI, 2024).

But headline deficit numbers conceal a more structural concern: the composition of spending. Revenue deficits — borrowing to finance consumption rather than asset creation — remain persistent in some states. Audit reports by the Comptroller and Auditor General of India have flagged recurring revenue deficits and rising interest burdens in fiscally stressed states. When interest payments consume a growing share of revenue receipts, fiscal space for capital formation shrinks.

This is where Public Financial Management becomes central.

PFM encompasses the entire architecture of budgeting, revenue forecasting, expenditure control, accounting, reporting and audit. Weak PFM systems manifest as optimistic revenue projections, mid-year expenditure compression, opaque off-budget borrowings and rising contingent liabilities. The RBI has repeatedly warned about the growth of guarantees extended to state public sector enterprises and the risks posed by off-budget debt (RBI, 2024).

The problem is not merely fiscal profligacy. It is institutional fragility.

First, budgeting practices in several states remain incremental rather than outcome-oriented. Without credible medium-term fiscal frameworks, spending commitments expand faster than sustainable revenue bases. Election cycles amplify this tendency.

Second, capital expenditure is often treated as a balancing item. When revenues underperform, infrastructure outlays are cut to protect politically sensitive subsidies and committed expenditures. This undermines long-term growth multipliers.

Third, transparency gaps persist. Comprehensive reporting of contingent liabilities, power sector losses and state-guaranteed debt is uneven. Markets increasingly price fiscal credibility; opacity carries a cost.

The growth implications are significant. Empirical work cited by the RBI shows that capital outlay by states has one of the highest fiscal multipliers. States that protect infrastructure spending tend to crowd in private investment and sustain higher GSDP growth. Fiscal prudence, therefore, is not antithetical to growth — it is its precondition.

The Fifteenth Finance Commission recognised this link. Its 2021–26 report recommended performance-linked incentives for states undertaking power sector reforms and improving fiscal transparency. The Commission explicitly argued that sustainable debt trajectories are essential for intergenerational equity. So what really is the way forward?

First, states must institutionalise credible Medium-Term Fiscal Plans aligned with realistic revenue forecasts. Overestimation of GST buoyancy or non-tax receipts erodes credibility and forces disruptive mid-year adjustments. These should be completed by independent state-level fiscal councils that could enhance credibility by providing non-partisan assessments of budget assumptions and debt sustainability.

Second, transparency must be non-negotiable. Comprehensive disclosure of guarantees, off-budget borrowings and public sector enterprise liabilities should be standardised across states ensuring that there is a competitive spirit in transparency among the states especially when the information is public.

Third, revenue mobilisation needs administrative modernisation. Data analytics in GST enforcement, rationalisation of property tax systems and plugging leakages in excise can expand own-tax revenue without raising statutory rates. Revenue effort remains a key determinant of fiscal strength.

Fourth, capital expenditure at the state level should be aligned to the medium-term fiscal plans or rules that have been adopted. Borrowing for asset creation is defensible; borrowing for consumption is not beyond the norms laid out in the fiscal plans. There must be focus on this.

Bharat’s growth story will increasingly be written in state capitals. Competitive federalism cannot rest solely on ease-of-doing-business rankings or investment summits. It must be anchored in sound fiscal institutions. None of this is politically effortless. PFM reform constrains discretion and demands discipline. Yet the alternative is gradual fiscal erosion — rising interest burdens, shrinking developmental space and vulnerability to macro shocks. With PFM reform, states can convert fiscal prudence into sustained growth — and ensure that today’s development is not financed at tomorrow’s expense.