Why Indian States’ Finances Are Deteriorating: GST, Debt And Capex Stress Explained

State budgets are tightening as GST-linked revenues wobble, committed costs rise, and borrowing increases, pushing governments to trim capital spending first.

The Issue In Brief: States Feel A Fiscal Squeeze 

Indian states are finding it harder to balance budgets because a large part of spending is locked into salaries, pensions, interest and subsidies, while revenue growth remains uneven. When collections fall short, states usually protect routine expenditure and postpone capital works, which hits infrastructure creation. 

The stress is also visible in higher borrowing, with markets closely tracking state bond supply and yields. At the same time, several states argue that GST rate changes and the end of compensation have narrowed their revenue options, leaving them more dependent on transfers and GST inflows.

What Is Going Wrong In State Budgets?

A major red flag is the size of “committed” expenditure. PRS Legislative Research notes that in 2023-24, states spent 53% of revenue receipts on salaries, pensions and interest, and 9% on subsidies. This leaves limited flexibility when revenues underperform. 

The result is a familiar pattern: development works slow down, payment backlogs rise, and governments lean more on borrowing to keep routine spending steady.

Read More : Capex Loan Disbursals

Before the deeper dive, here is a quick view of the core pressure points.
 

The above numbers explain why even states with big budgets can struggle to push capex on time.

Revenue Shortfalls And Capex Cuts

The fiscal squeeze becomes visible when budget estimates do not match actual collections. A Times of India report on Telangana said that between 2015-16 and 2023-24, the state’s revenues were on average 21% below projections, the highest mismatch among states. It also noted that such gaps force spending cuts and extra borrowing within FRBM limits.

Karnataka shows how this plays out on the ground. A Times of India report (as of Jan 2026) said only 46% of the state’s ₹71,336 crore capex allocation had been utilised, while overall spending reached about 65% of the estimated outlay. The report also flagged a ₹30,000 crore gap bridged through borrowing and an interest bill of ₹45,600 crore.

Meanwhile, Reuters reported states were set to borrow a record ₹12 trillion in FY2026, with yields rising 30-60 bps, prompting concerns on borrowing calendars and maturity choices. 

How Did It Reach Here? GST Changes, Compensation End, Hidden Liabilities

Several states link fiscal strain to GST design and policy changes. Kerala’s Finance Minister K N Balagopal said states now have limited taxation powers mainly over liquor, petrol and diesel, and that GST rate reductions have cut revenue space. The same report said Kerala cited a loss of ₹21,955 crore after compensation ended, and expected a further ₹8,000-10,000 crore shortfall.

The compensation phase had a defined end-point. A NIPFP Working Paper No. 376 (dated 23 Mar 2022) discussed stress risks as the compensation regime was ending in June 2022.

A PIB release dated 31 May 2022 said after releasing ₹86,912 crore, only compensation for June 2022 remained. 

Also Read : GST 2.0: Credit Card Spends

There is also the reporting challenge of liabilities outside the main budget. PRS notes that some states do not disclose off-budget borrowings in budget documents. 

Before stakeholder voices, a state-by-state snapshot.
 

This pattern points to recurring stress across revenue accuracy, capex execution, and borrowing reliance.

Who Is Saying What?

In Karnataka, Basavaraj Rayareddi, the CM’s economic advisor, linked revenue pressures to GST-related changes and central fund flow, while indicating efforts to improve spending before year-end.

In Kerala, Finance Minister K N Balagopal said GST rate cuts were squeezing state revenues and flagged delays in grants.

A LoansJagat explainer also warned that recurring “freebie” outlays can tighten fiscal space and squeeze infrastructure spending.

Conclusion

State finances are under strain because committed spending and interest costs are rising faster than flexible revenue space. Without realistic revenue estimates and clearer liability reporting, capex remains the first casualty.