Electoral freebies underpin growing drift in states' fiscal discipline

Bihar goes to the polls on November 6 and 11, marking the beginning of a crucial electoral cycle. Eleven more states will hold elections over the next two years. The spectacle of pre-election giveaways and populist promises will capture the headlines, as it always does. What will matter more, yet draw less attention, is the steady erosion of states’ fiscal discipline.

 

The deepening fault line of sub-national fiscal drift beneath India’s political economy is now hard to ignore. Evidence of competitive populism is mounting. Press reports put pre-election doles across eight states over the past two years at ₹67,928 crore. Significantly, women-centric schemes have become the new normal, often enabling the ruling party to defy anti-incumbency. In Madhya Pradesh, the Ladli Behna Yojana helped the Bharatiya Janata Party (BJP) overcome four-term anti-incumbency, with vote shares rising by 7.53 percentage points. In Jharkhand, the Maiya Samman Yojana proved equally decisive for the Jharkhand Mukti Morcha (JMM). A PRS report estimates that nine states cumulatively budgeted over ₹1 trillion in 2024–25 largely for unconditional cash transfers to women — an unprecedented scale of fiscal outlay tied directly to electoral cycles.

 

Arguably, these commitments have blurred the line between welfare and political patronage, embedding populism in state finances. Development economics supports well-designed conditional transfers, especially to women. The issue is not cash transfers per se. It is their current architecture — being largely unconditional, universal, and effectively permanent — that creates enduring fiscal claims without efficiency gains, shifting states’ spending from productive investment to recurrent giveaways. The spiral of competitive populism, between incumbents and the Opposition, and among states, also raises the floor of fiscal profligacy.

 

The NITI Aayog’s Fiscal Health Index (FHI) 2025, which assessed 18 major states on fiscal parameters, offers a sobering snapshot. The combined debt-to-GSDP (gross state domestic product) ratio has increased to about 30 per cent, up from 22 per cent a decade ago; while the interest-payment burden has risen to almost 21 per cent of revenue receipts. In fiscally-profligate states such as Punjab, West Bengal, Kerala, and Rajasthan, debt ratios have increased to 38-46 per cent, with more than half of revenues absorbed by debt service in several states, leaving little room for investment in physical and human capital.

 

Yet these headlines tell only part of the story. Shadow liabilities  — off-budget borrowings and guarantees — have quietly expanded. Maharashtra’s off-budget guarantees alone stand at ₹1.44 trillion. Many states like Tamil Nadu, Karnataka, West Bengal, and Kerala routinely borrow through power utilities, irrigation corporations, and transport agencies, keeping liabilities off-balance sheet. The Reserve Bank of India has repeatedly red-flagged these practices, estimating that such hidden debt could easily add 0.5 to 1 percentage points to states’ actual fiscal deficits. This silent accumulation, often fuelled by electoral populism, corrodes fiscal credibility of states and weakens the foundations of sustainable, intergenerational development.

 

Financial markets are beginning to register these strains. Banks, the main investors in state bonds, have reported limited appetite, and several auctions have seen undersubscription. With states planning to borrow ₹2.82 trillion in the October-December quarter, the supply pipeline remains heavy, while demand is thin and sentiment cautious. Market pricing remains blunt, transmitting general stress without differentiating state-specific fiscal risk.

 

In early September, the spread between 10-year state development loans (SDLs) and central government securities widened to around 80-100 basis points, the sharpest in five years. Even as overall yields have climbed, the market still struggles to tell good borrowers from bad. Punjab and West Bengal, with debt exceeding 47 per cent and 39 per cent of GSDP, respectively, continue to raise funds at rates barely higher than fiscally stronger states such as Gujarat or Maharashtra, where the ratio is closer to 19 per cent. Uniform auction formats and the RBI’s smoothing interventions have compressed spreads, while banks’ exposure caps have left little room for genuine price discovery. In such an environment, fiscal prudence earns no premium, and indiscipline no penalty, blunting states’ incentives to course-correct.

 

Restoring the fiscal credibility of states will require more than restraint. It will need institutions and the mechanisms that can resist the politics of easy promises. The Centre must credibly commit to a no-bailout rule. States breaching revised debt ceilings should face automatic reductions in discretionary grants. Fiscal responsibility legislation at the state-level must be redesigned around debt sustainability analysis, accounting for all contingent liabilities, growth projections, and interest dynamics, not just around crude deficit limits that invite creative accounting.

 

Markets, too, must play a disciplining role. SDL auctions need transparent disclosures and genuine price discovery mechanisms so that investors can differentiate, rather than subsidise, risk. The Fifteenth Finance Commission’s conditional borrowing framework should be strengthened, with explicit penalties for states that maintain persistent revenue deficits while expanding unconditional transfer schemes.

 

However, institutional reform alone will not suffice if underlying political incentives remain unchanged. The harder truth is that competitive populism will persist until voters internalise the opportunity cost of persistent fiscal profligacy. Only when electoral populism is matched by fiscal transparency and voter discernment will India’s states compete on governance rather than giveaways.

 

The author is associate professor, economics & public policy, at the Indian Institute of Management, Ranchi. The views are personal