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In what seems to be a growing friction between fragmented fiscal realities within Indian states, distinct financial realities are playing out under a single national fiscal umbrella.

National debates over what really constitutes a legitimate social safety net versus an irresponsible electoral “freebie” have shaped policy and welfare discourse in recent years and assembly polls. The debates signalled a loud, deeply polarising argument involving clashes over the fiscal health of the public exchequer i.e. for the states polling and also for the Union government supporting those where its own party is in power for a ‘double-engine’ fiscal governance push. 

To see past the noise and uncover the underlying structure of sub-national public finance, it is impertinent to analyse state budgets by applying advanced tools of assessment. One also needs to understand the growing concerns emerging from the rise in hidden debt or off-budging borrowings plaguing the macro-fiscal landscape. 

For analysing the former, we use cluster modelling based upon three core variables to analysing India’s state budgets: fiscal stress, welfare intensity, and capital investment ratios. The result of this analysis helps in going past political rhetoric, signalling the emergence of a hidden taxonomy shaped by four unique financial regimes where we see states operating in two different economies.

Source: Analysis based on data available from the Reserve Bank of India (RBI), State Finances, 2010-2024.

The first regime consists of the high-stress economic engines, the demographic heavyweights and industrial powerhouses that produce the vast majority of India’s wealth and industrial output. Economists refer to the “fly paper effect” as the structure of the economy, where the tax revenue will be allocated back to the areas it is generated from. 

The result of this effect is that all of the new tax revenues from growing manufacturing centres (such as Maharashtra, Tamil Nadu, Gujarat and Karnataka) will be fully allocated to either growing social programmes, which continue to build huge demands upon state agencies, or to meet existing demands within the social major general area. In Tamil Nadu, with its extensive welfare state system (which was first started with its world famous mid-day meal programme), social programmes operate to create stability for its industrial labour market. 

In order to expand into the future however, states such as Karnataka and Gujarat must borrow heavily in the market to finance their expansion (for example through issuance of state development loan bonds), only to see future revenues consumed by the mounting interest costs. 

Telangana and Andhra Pradesh, both have large dollar value submerged irrigation projects and cash transfer programs for farmers in agriculture, competing for the same balance sheet. In West Bengal, fixed costs of administration, pensions and interest on accumulated debts eat up about 50% of revenue receipts, entirely freezing the state’s capacity for new capital formation. 

The demographic giants in northern India find themselves in a different kind of fiscal stranglehold. Uttar Pradesh has been able to formalise its........

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