Centre's debts, interest soar even as it deflects blame onto states

Last week's Budget debate in the Rajya Sabha erupted into fierce confrontation when Opposition members challenged the Centre over its mounting debt burden. Finance Minister Nirmala Sitharaman fired back, rejecting claims of reckless borrowing while turning the spotlight on states and their increasing appetite for funds. Her message was clear: reducing India's debt isn't Delhi's job alone—states must share the burden.

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The numbers tell a stark story. Central government debt has ballooned from ₹43.5 lakh crore in FY12 to over ₹200 lakh crore in FY25—and is projected to hit ₹218.5 lakh crore by FY27. The pandemic, which necessitated higher borrowing, can't shoulder all the blame. Official documents reveal the debt was already climbing steeply before COVID-19 struck, and has continued its upward march long after the health crisis subsided.

The following graphs maps the trend since FY12. Notice the sharp spike both before and after the pandemic fiscal of FY21.

A better measure of debt is as a percentage of GDP. The Fiscal Responsibility and Budget Management (FRBM) Act of 2003 caps it at 60 per cent of GDP for governments (Centre and states), of which the Centre’s limit is 40 per cent of GDP.

The following graph shows that the Centre has failed to adhere to its limits.

The “Statements of Fiscal Policy as required under the Fiscal Responsibility and Budget Management Act, 2003”, released with the Budget 2026 documents on February 1, says: “The Central government shall endeavour to limit the General Government Debt to 60 per cent of GDP and the Central Government Debt to 40 per cent of GDP, by 31st March, 2025.”

FRBM limit on debt

Whichever way one may look, the Centre’s debt is more than the mandated level, although it is coming down from the peak of 61.4 per cent in FY21 (the pandemic fiscal).

India adopted the FRBM limit on debt, along with fiscal deficit at 3 per cent of GDP, at the insistence of International Monetary Fund (IMF) when it sought a bailout in 1991. The IMF has imposed the fiscal austerity or consolidation conditions on all countries which have sought its bailout. The IMF’s views are changing, though.

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In the March 2022 issue of its inhouse magazine, Finance & Development, the IMD showcased several articles which said the old fiscal rules were no longer valid. It was pointed out that the IMF’s Fiscal Monitor shows average general government debt in advanced economies were at 122 per cent of GDP, far higher than 64 per cent for emerging markets. India’s general government debt is around 80 per cent of GDP.

Irrelevance of austerity rules

Among others, the irrelevance of the old fiscal austerity rules was attributed to a dramatic fall in interest rates across the world. One of the articles pointed out that it was the fiscal austerity/consolidation that delayed the European Union’s (EU) recovery from the global financial crisis of 2007-09.

It isn’t surprising, therefore, that during the pandemic, Nobel laureate Joseph Stiglitz told the US to give up fiscal austerity and borrow more to spend more, arguing that lower fiscal spending would constrain growth and cause higher debt-to-GDP ratio – the opposite of what fiscal austerity seeks. Similar pleas were made for India by Nobel laureate Abhijit Mukherjee and former RBI Governor Raghuram Rajan.

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Another way of looking at the debt level is the interest outgo. More the interest outgo, less the funds available for fiscal spending.

The graph below presents a scary picture of the Centre’s rising interest burden. It has gone up from 20.7 per cent of its total revenue receipts (tax revenue and capital receipts) in FY12 to 25.7 per cent in FY26 (RE) and estimated at 26.3 per cent in FY27 (BE).

Why states’ demand has risen

As for Sitharaman's assertion in the Rajya Sabha that the states’ demand for funds have grown, The Federal had pointed out days earlier that this is for a valid reason — the Centre has been shortchanging states in devolution of funds. This has happened in two ways:

(i) Devolution of tax as awarded by the 14th (42 per cent) and 15th Finance Commission (41 per cent) averages 33 per cent during FY18-FY26 (BE).

(ii) Total transfers to states (which include the Finance Commission tax awards and grants for local bodies and disaster management and funds from the central schemes) averages 36.7 per cent — less than even the FC awards on tax devolution alone. It is also below 50 per cent which used to be the case earlier, as the 14th Finance Commission recorded in its 2015 report.

The graph below maps these devolution trends.

But that is one part of the problem.

There are two others.

(iii) With the adoption of Goods and Services Tax (GST) in July 2017 (FY18), states gave up their rights to most indirect taxes — further choking their fiscal space.

(iv) Since the pandemic, the Centre has tightened states’ fiscal space further by closely monitoring their borrowings, linking it to specific reforms in power sector, urban bodies and steps for ease of doing business. Even routine fund transfers are linked to states following the Centre’s diktat, like rebranding their school education schemes as the PM SHRI.

Given that the Centre has near monopoly on raising financial resources (direct taxes are exclusive to it), states are left with little choice but to look at it for funds.