Himachal's fiscal condition is a lesson for states in what not to do

Rising competitive populism among states could seriously undermine India's long-term potential

Himachal Pradesh is facing significant financial difficulties, which not only expose the state’s ailing fiscal health but have also triggered a political slugfest between the Congress-ruled state government and the key Opposition party — the Bharatiya Janata Party. The economic distress in the state can be attributed largely to heavy borrowing, rising pension and salary budgets, the provision of freebies, and insufficient revenue generation. At Rs 1.17 lakh, Himachal Pradesh has the highest per capita debt in the country after Arunachal Pradesh. In fact, the state’s outstanding debt has ballooned from 37 per cent of gross state domestic product (GSDP) in 2021-22 to an estimated 42.5 per cent in 2024-25.

The fiscal deficit jumped more than 1.5 times from 4.05 per cent of GSDP in 2021-22 to 6.4 per cent in 2022-23. Even in 2023-24, the fiscal deficit, according to the Revised Estimate, was pegged at 5.9 per cent, a 130-basis-point increase over the Budget Estimate. The revenue deficit was also higher at 2.6 per cent of GSDP in the Revised Estimate compared to 2.2 per cent in the Budget Estimate. The state’s revenue expenditure as a proportion of its total expenditure is among the highest in the country, at around 90 per cent. Notably, the state government is now reported to be contemplating rolling back a few subsidy schemes such as subsidised power for hotel owners, free water supply in rural areas, and subsidised bus fares for women in an attempt to improve its finances.

According to the Reserve Bank of India’s report on state finances, the states finance only 58 per cent of their revenue expenditure from their own sources, suggesting the need to improve fiscal capacity. Recent studies have pointed out that state finances were less impacted by the pandemic, and despite improvements in goods and services tax collection in recent years, some states need significant fiscal reorientation. The Fiscal Responsibility and Budget Management Review Committee in 2018, for instance, had recommended a ceiling of 20 per cent debt to GSDP for states. The data, however, suggests that 12 states had debt to GSDP in excess of 35 per cent in 2023-24, while around 24 states had debt stocks worth over 20 per cent of GSDP.

The proliferation of subsidies for electoral gains is one of the reasons for rising debt levels in states. In the short run, this may not affect their capacity to borrow because the market doesn’t differentiate much among states based on their fiscal capacity primarily due to the belief that the Centre will ultimately step in to provide support. However, sustained higher deficits in states will create risks. Continued high borrowing will keep pushing up the interest burden and with large committed expenditure states will find it difficult to undertake developmental work, affecting India’s overall growth and development in the long run. It is thus important that expenditure is significantly rationalised by making state Budgets more balanced. Some states, including Himachal Pradesh, have decided to go back to the old pension scheme for state government employees. This will further increase pressure on state finances, which could have been easily avoided. Given the high general government debt and deficit, India requires a broader debate on its finances. Rising competitive populism could seriously undermine the country’s long-term potential.