Debt-to-GDP ratio of Indian states in 2024

Why do states see an increase in the debt-to-GDP ratio?

The debt-to-GDP ratio of Indian states can increase due to several reasons, such as:

1. Spending on infrastructure development, social welfare programs, and public services.
2. Budget deficits when revenue generation is less than expenditure.
3. Economic shocks and unforeseen circumstances.
4. Political pressures lead to populist spending.
5. Limited revenue-raising powers of the state government.

Due to these circumstances, debt accumulation arises to bridge fiscal gaps, stimulate growth, and address the diverse demands of India's vast population.

Factors affecting variation in debt-to-GDP ratios of Indian states

Overall, the state-wise debt in India varies due to the following reasons-

1. Economic Disparities: States with higher GDPs tend to have lower debt-to-GDP ratios.
2. Fiscal Policies: Prudent fiscal practices can lead to lower debt burdens.
3. Demographic Factors: Population size and growth influence revenue generation and social spending, affecting the ratio.
4. External Shocks: Natural disasters and economic shocks may lead to increased borrowing.
5. Political Decisions: Governance quality impacts responsible debt management.
6. Regional Disparities: Variations in regional economic conditions and historical debt burdens add complexity to these ratios

As we saw in the table above, Indian states with a high debt-to-GDP ratio include Arunachal Pradesh at the top, followed by Punjab, Nagaland, Manipur and Meghalaya.

This is because of factors such as:

1. In Arunachal Pradesh and other North-Eastern states, economic disparities, limited industrialisation, rugged terrain and sparse population.
2. The agricultural sector struggles in Punjab, coupled with a history of populist policies.

Conversely, the states in India that have better debt-to-GDP ratios include Chhattisgarh at the top, followed by Karnataka, Maharashtra, Gujarat, and Odisha. This is because of factors such as:

1. Chhattisgarh's robust economic growth is driven by mining and agriculture.
2. Karnataka's growth is driven by its thriving information technology and industrial sectors.
3. Maharashtra's diverse and dynamic economy is centred around Mumbai.
4. Gujarat's industrialisation and efficient tax collection mechanisms.
5. Odisha’s mineral resources and a growing manufacturing sector.

Implications of High Debt-to-GDP Ratios of Indian States

A high debt-to-GDP ratio signifies a state's debt burden is substantial compared to its economic output. This indicates financial vulnerability and reduced fiscal flexibility. High debt levels can increase interest payments, crowding out other critical expenditures like healthcare and education. It may also raise concerns among investors and credit rating agencies, resulting in higher borrowing costs.

States with elevated debt levels face several challenges:

1. Budget constraints: High-interest payments on debt reduce funds for critical services like education and healthcare.
2. Reduced fiscal flexibility: Elevated debt levels hinder the ability to respond to economic downturns or emergencies.
3. Investor confidence: High debt erodes investor confidence, raising borrowing costs and hindering economic growth.
4. Credit rating impact: It leads to credit rating downgrades, indicating higher credit risk and intensifying financial pressures.

States must implement austerity measures, fiscal reforms, and debt reduction strategies to address these challenges effectively.

State Case Studies

In the past, how have states with increasing debt-to-GDP ratios dealt with arising issues? Let’s look at some examples:

Kerala

Despite Kerala’s commendable social and human development indicators, Kerala has one of the highest debt-to-GDP ratios among Indian states, mainly due to heavy spending on social welfare programs and infrastructure investments. This elevated debt level has increased interest payments, constraining budget allocations for critical services. Kerala implemented policy measures such as fiscal consolidation, revenue enhancement through taxes and non-tax revenue sources, and austerity measures to tackle this issue.

Punjab

After Arunachal Pradesh, Punjab has the highest state-wise debt in India.  The reasons include excessive spending on agriculture subsidies, pension obligations, and infrastructure development. This put immense pressure on the state's finances, reducing education and healthcare funds. Punjab initiated policy measures to address this challenge, including the Punjab Fiscal Responsibility and Budget Management Act, to curb fiscal deficits and limit debt accumulation. The state also sought to diversify its revenue sources, enhance tax collection, and rationalise subsidies.

Debt Sustainability and Management

Debt sustainability refers to a government's ability to meet debt obligations without risking a financial crisis. Effective debt management means lowering the debt-to-GDP ratio of Indian states and involves controlling borrowing, optimising debt structure, and ensuring funds are used efficiently.

Strategies to improve the high debt-to-GDP ratio of Indian states include:

1. Fiscal Discipline: Reduce budget deficits to curtail debt accumulation.
2. Revenue Enhancement: Boost revenue through effective taxation policies.
3. Prudent Borrowing: Implement responsible borrowing practices.
4. Debt Restructuring: Refinance existing debt to secure lower interest rates.
5. Economic Growth: Invest in productive sectors to stimulate GDP growth.
6. Enhanced Creditworthiness: These strategies can improve credit ratings.
7. Lower Borrowing Costs: Resulting in reduced interest payments.
8. Sustainable Finances: Ensuring long-term fiscal stability.