RBI calls on states to follow Centre, frame ‘clear glide path’ to reduce debt

Starting 2026-27, the Central government will start targeting its debt-to-GDP ratio instead of the fiscal deficit, with the aim to bring it down to 50% by 2030-31 from 56.1% this year as per 2025-26 Budget estimates. Referring to this framework, the RBI said on Friday that “highly leveraged States may also frame a clear glide path for debt consolidation”.

Elevated debt levels at the Central and state levels – often referred together as general government debt – has repeatedly been cited by global ratings agencies as a key weakness of India’s public finances. While debt spiked during the peak pandemic year of 2020-21 when the economy contracted and public expenditure jumped, interest on the borrowed money must be paid. This, the RBI said, puts pressure on states’ finances as higher interest payments are often met by reducing productive expenditures, which affects medium term growth prospects.

“It is observed that the States with a debt-service ratio (interest payments to revenue receipts) higher than 15% have capital expenditure of less than 2% of GSDP as against the all-India average of 2.7%. This calls for fiscal reforms in the concerned States with emphasis on improvement in expenditure quality,” the central bank said.

For 2025-26, the RBI said states’ budgets estimates point to a gross fiscal deficit of 3.3% of GDP, unchanged from 2024-25. Crucially, as many as 16 states have budgeted for a fiscal deficit of more than 3% of their GSDP for the current fiscal, with 13 of them projecting it to be higher than 3.5%.

States need to keep their annual fiscal deficit within 3% of their GSDP, with a leeway of up to 3.5% given to those undertaking power sector reforms. The RBI noted that the increase in states’ fiscal deficit in 2024-25 was primarily due to the 50-year interest-free loans provided by the Centre for capital expenditure purposes. These loans are provided over and above the normal borrowing ceiling of states.

On their borrowings – states have budgeted to borrow Rs 12.45 lakh crore from the markets in 2025-26 on a gross basis – the RBI again sounded a warning, saying they had risen significantly in the last two decades. In the first half of the current fiscal, states borrowed 21% more compared to the same period of 2024-25 and are slated to borrow Rs 5 lakh crore in just the current quarter than ends on March 31.

Market demand for long-term government bonds has, at the same time, has reduced. “Thus, fiscally profligate States may review their market borrowings through fiscal consolidation, exploring alternative financing options and better cash management practices,” the RBI said.

Without using the word ‘freebies’, the central bank said several states had introduced measures such as free electricity and direct cash transfers to women in their budgets this year. “While social welfare programmes are essential in a country where economic disparities remain stark, these welfare expenditures run the risk of crowding out critical investments in physical and social infrastructure. Thus, it is important to carry out impact assessment to evaluate the effectiveness of welfare schemes in achieving the intended outcomes,” it said.

On the whole, the central bank said that states’ fiscal outlook for the second half of 2025-26 “remains positive”. “The temporary revenue loss on account of GST rate rationalisation may be offset by higher private consumption in the coming months,” it added.