Rethinking India’s Fiscal Sustainability | 31 Jan 2026

India’s fiscal health is increasingly being judged through the lens of public debt sustainability rather than annual fiscal deficits, especially after the pandemic. General Government Debt to GDP ratio increased from 75.7% at the end-March 2020 to 89.6% at the end of the pandemic year FY21, before moderating gradually with recovery. With State governments accounting for nearly one-third of total public debt, the shift recommended by the N K Singh Committee from deficit targets to a debt anchor highlights that state-level fiscal discipline and growth are now central to India’s medium-term fiscal sustainability. 

What is the Current Fiscal Regulatory Framework in India?  

• Constitutional Pillar: The Finance Commission 
  • Established under Article 280 of the Constitution, the Finance Commission (FC) acts as the "balancing wheel" of fiscal federalism. 
    • Resource Allocation: It recommends the Vertical Devolution (share of central taxes going to states) and Horizontal Devolution (allocation among states based on criteria like population, income distance, and forest cover). 
    • Grants-in-Aid: It determines the principles for providing grants to states that face revenue deficits or need funds for local bodies and disaster management. 
• Legislative Pillar: The FRBM Act (2003) 
  • The Fiscal Responsibility and Budget Management (FRBM) Act is the primary legal tool for ensuring fiscal discipline. 
  • Core Targets: It mandates the government to limit the Fiscal Deficit and reduce the Debt-to-GDP ratio (the NK Singh Committee recommended a target of 60% for General Government debt, 40% for Centre and 20% for States). 
  • Transparency: The Act requires the government to lay three policy statements before Parliament along with budget annually: 
    • Medium-term Fiscal Policy Statement. 
    • Fiscal Policy Strategy Statement. 
    • Macroeconomic Framework Statement. 
  • The Escape Clause: Under Section 4(2), the government can deviate from targets by up to 0.5% of GDP during "extraordinary circumstances". 
• Revenue Pillar: The GST Council 
  • The 101st Constitutional Amendment created the GST Council, a joint forum of the Centre and States. 
    • It harmonizes indirect taxation, which is crucial for revenue buoyancy. 
    • By bringing most indirect taxes under one umbrella, it aims to reduce tax leakage and improve the Tax-to-GDP ratio, a vital indicator of fiscal health. 
• Institutional Monitoring: NITI Aayog & CAG 
  • NITI Aayog: Recently, NITI Aayog introduced the Fiscal Health Index (FHI). The FHI analysis examines 18 major states that are pivotal to India’s economy, based on their contributions to GDP, population, public expenditure, revenues, and overall fiscal stability. 
  • Comptroller and Auditor General (CAG): CAG audits the accounts of the Union and States, ensuring that public spending adheres to the law and that there is no "off-budget borrowing" that masks the true fiscal deficit. 

How has India’s Approach to Fiscal Consolidation Evolved Recently? 

• Strategic Shift-From Deficit Targeting to Debt Anchoring: The government has announced to formally transition its primary fiscal anchor from the annual fiscal deficit to a medium-term Debt-to-GDP ratio, aiming to ensure intergenerational equity and secure sovereign rating upgrades.  
  • This structural reform prioritizes long-term solvency over short-term accounting adjustments, signaling a mature fiscal framework that aligns with global best practices. 
  • For instance, reflecting a calibrated consolidation strategy, the Centre has outlined a medium-term objective of lowering central government debt to about  50±1 % of GDP by FY2030-31, with outstanding liabilities budgeted at 56.1% of GDP in FY2025-26 (BE) declined from 57.1 in FY 2024-25. 
• Adherence to the 'Glide Path' Amid Global Headwinds: Despite global geopolitical volatility and election-year pressures, the Centre has strictly adhered to its fiscal glide path, demonstrating counter-cyclical fiscal discipline to build market credibility.  
  • This resistance to populist expansionism ensures that private investment is not "crowded out" by excessive government borrowing, keeping bond yields stable. 
  • For instance, signalling a clear consolidation intent, the fiscal deficit has been budgeted at 4.4% of GDP in FY2025–26, marking a decisive improvement from the Revised Estimate of 4.8% in FY2024–25, and aligning closely with the medium-term objective of bringing the deficit below 4.5% of GDP. 
• 'Capex-Led' Consolidation- Focusing Quality of Expenditure: There is a deliberate multidimensional strategy to improve the "Quality of Deficit" by slashing consumption spending (revenue deficit) while aggressively hiking Capital Expenditure (Capex).  
  • This ensures that borrowing is used for asset creation (roads, defense, railways) which has a high fiscal multiplier effect, rather than servicing salaries or subsidies. 
  • For example, the revenue deficit has been reduced to 1.5% of GDP in FY2025–26 from 1.9% in FY2024–25, while effective capital expenditure has been stepped up to about 4% of GDP in FY25 (Economic Survey 2025-26) , signalling a clear shift from consumption-led spending to growth-augmenting investment. 
• Digitization-Driven Revenue Buoyancy: Fiscal consolidation is now being driven by revenue augmentation via technology (AI & Data Analytics) rather than just tax rate hikes, leading to the formalization of the economy.  
  • The strategy focuses on widening the tax net and plugging GST leakages, resulting in a tax buoyancy greater than 1, which acts as a natural fiscal stabilizer. 
  • For instance, reflecting improved tax buoyancy and compliance, Income Tax Return filings rose sharply to about 9.2 crore in FY2024–25 from 6.9 crore in FY2021–22, while the share of direct taxes in total tax revenue climbed to nearly 58.8% (Economic Survey 2025-26), significantly strengthening revenue capacity and easing fiscal deficit pressures. 
• 'Carrot and Stick' Federal Fiscal Discipline: The Centre has operationalized a cooperative yet conditional fiscal framework, linking state borrowing limits to specific power and urban sector reforms.  
  • This prevents state-level fiscal profligacy from derailing national consolidation, treating General Government Debt (Centre + States) as the true metric of health. 
  • For example, while incentivising sub-national consolidation, the Centre has earmarked ₹1.5 lakh crore as 50-year interest-free loans to states in FY2025–26, with disbursements linked to reforms and compliance conditions, even as aggregate state government debt remains elevated at around 27.5% of GDP. (as of 2024-25) 
• Rationalization of Subsidy Bill: A critical analytical development is the structural reduction of the non-merit subsidy burden, shifting from universal subsidies to targeted direct benefit transfers (DBT).  
  • By weaning the budget off heavy fuel and fertilizer subsidies through efficiency measures (like Nano-urea), the government has created fiscal space for developmental goals without blowing the deficit. 
  • For instance, the total subsidy bill has been compressed to about 1.1% of GDP in FY2025–26 . Further, the Economic Survey 2025-26 advised the government to increase the retail price of urea, which has remained unchanged at Rs 242 per 45 kg bag since 2018. 
• Zero-Based Budgeting in Scheme Allocation: The government has adopted a Zero-Based Budgeting approach for central sector schemes, merging redundant programs to prevent fund parking and improve outcome-based spending.  
  • This ensures that every rupee borrowed contributes to measurable economic output, reducing the "Primary Deficit" which reflects the current fiscal impulse excluding interest payments. 
  • For example, Current Account Deficit moderated to 0.8% of GDP in H1 FY26 from 1.3% in H1 FY25 (Economic Survey 2025-26). 
• Cracking Down on Sub-National Off-Budget Liabilities: The Centre has structurally tightened sub-national fiscal discipline by incorporating Off-Budget Borrowings (OBB) into states' net borrowing ceilings, effectively ending the era of hidden leverage and opaque guarantees.  
  • This move forces states to boost Own Tax Revenue (OTR) and fix contingent liabilities, particularly by linking additional borrowing space directly to measurable power sector reforms to ensure DISCOM viability. 

What are the Key Issues Associated with the Fiscal Consolidation in India?  

• Rigid 'Committed Expenditure' Trap: The primary structural bottleneck is the high rigidity of "committed expenditure" (Interest, Pensions, Salaries), which severely limits the discretionary fiscal space available for developmental goals.  
  • This creates a "scissors effect" where debt servicing eats into capital creation, forcing the government to borrow just to pay off old interest rather than generating new economic value. 
  • For example, highlighting the structural drag of legacy debt, interest payments absorb nearly 37% of revenue receipts and about 25% of total expenditure in FY2024–25 (RE), implying that over one-third of tax revenues are pre-empted by past liabilities before resources can be deployed for future-oriented development. 
• Asymmetric Federalism & The 'Cess' Conundrum: A major friction point is the Centre's reliance on "Cesses and Surcharges" to shore up revenue, as these are not shared with States, effectively shrinking the true devolution pool below the constitutional spirit.  
  • This forces States into a fiscal straitjacket, compelling them to cut their own developmental spending or resort to expensive market borrowings to fund local infrastructure. 
  • While the Finance Commission mandates 41% devolution, the effective share to states often hovers ~33% due to cesses & surcharges  
    • The central government has budgeted to collect about ₹5.91 lakh crore from cess and surcharge in the current fiscal, a 9.43% growth over the collections in FY25, that raises concerns over fiscal federalism. 
• The 'Capex-Consumption' Trade-off : The aggressive pivot to "Capex-led consolidation" often comes at the cost of compressing revenue expenditure on social welfare, which risks exacerbating the "K-shaped" recovery by dampening rural consumption.  
  • If the government withdraws fiscal support from the bottom of the pyramid to fund highways, it may trigger a demand-deficient slowdown that ultimately renders the capex multiplier ineffective. 
  • At the same time, Gross Fixed Capital Formation expanded by 7.8% but remained capped at 30% of GDP.  
    • With private capex’s share in GFCF falling to 34.4% in 2023-24, the lowest since 2011-12, continued reliance on public capex risks a fiscal-constrained “growth cliff” if private investment fails to revive. 
• Sub-National Fiscal Opaqueness (OBB): While the Centre’s deficit numbers look cleaner, "General Government" health is undermined by States hiding deficits through "Off-Budget Borrowings" (OBB) via state-owned entities.  
  • This opaque leverage acts as a hidden sovereign risk, meaning the true public sector borrowing requirement (PSBR) is higher than the headline fiscal deficit numbers suggest. 
  • For instance, as per the RBI study on State Finances, aggregate state debt is estimated to rise to 29.2% of GDP by end-March 2026, far above the FRBM limit of 20%. 
• Human Capital Opportunity Cost: The obsession with "hard" infrastructure (physical assets) to boost the GDP multiplier often leads to the neglect of "soft" infrastructure (Health & Education), which has longer gestation periods but higher long-term productivity.  
  • Consolidating the deficit by capping social sector spending risks eroding India's demographic dividend, trading long-term human capability for short-term accounting solvency. 
  • For instance, combined public expenditure on health remains below 2% of GDP, falling short of the National Health Policy target of 2.5%. 
• Disinvestment & Asset Monetization Uncertainty: The government's fiscal math frequently relies on ambitious disinvestment and asset monetization targets (National Monetization Pipeline) which historically underperform due to market volatility or bureaucratic delays.  
  • When these "non-debt capital receipts" fall short, the government is forced to cut spending or borrow more, compromising the integrity of the fiscal glide path. 
  • For instance, the government raised ₹33,000 crore from share sales in FY25, missing its disinvestment target of ₹50,000 crore. 
• Vulnerability to Global External Shocks: India’s fiscal consolidation remains exposed to energy price volatility and global trade disruptions, as geopolitical fragmentation and tariff wars can erode trade-linked revenues while inflating subsidy outlays.  
  • A sharp rise in crude or fertilizer prices can quickly derail deficit targets, with every $10 per barrel increase in oil worsening the current account by nearly $15 billion, forcing counter-cyclical fiscal intervention. 

What Measures are Needed to Strengthen India’s Fiscal Health ?  

• Institutionalizing 'Sunset Clauses' in Subsidies: To curb the rigidity of committed expenditure, the government must legally mandate 'Sunset Clauses' for all welfare schemes, requiring them to automatically expire or face rigorous re-evaluation after a fixed tenure.  
  • This prevents temporary relief measures from morphing into permanent fiscal burdens and forces a periodic 'Zero-Based Budgeting' review. 
    •  It ensures resources are dynamically reallocated to high-priority sectors rather than getting locked into legacy entitlements that have outlived their utility. 
• 'Recycling Capital' via Asset Monetization: Instead of outright privatization, the focus should shift to the National Monetization Pipeline by leasing brownfield assets (roads, power grids) to long-term investors to unlock upfront liquidity.  
  • This strategy of 'recycling capital' allows the government to fund new greenfield infrastructure using the equity trapped in completed projects without raising fresh debt.  
    • It effectively transforms the government’s role from an asset operator to an asset developer, maximizing the velocity of public capital. 
• Performance-Linked Fiscal Devolution: The fiscal federalism framework needs to be recalibrated to incentivize fiscal performance efficiency where a portion of central transfers is strictly tied to states adhering to debt ceilings and eliminating off-budget borrowings.  
  • This encourages competitive federalism, compelling state governments to prioritize capital formation over populist revenue expenditure.  
  • By aligning state-level political incentives with national macroeconomic stability, the Centre can mitigate sub-national fiscal risks. 
• Algorithmic Intelligence in Revenue Mobilization: The administration must pivot from discretionary enforcement to AI-driven non-intrusive compliance, leveraging big data to cross-seed GST, income tax, and property databases for a '360-degree taxpayer view.'  
  • This automates the identification of tax evasion in the informal sector and high-net-worth non-filers without increasing tax terrorism or harassment.  
  • By fixing the 'missing middle' in the tax base, the state can improve tax buoyancy and revenue elasticity without needing to hike existing tax rates. 
• Outcome-Based Budgeting with Independent Oversight: India must transition from 'input-based' allocation to strict 'Outcome-Based Budgeting', where fund release is contingent upon verifiable, third-party audited milestones rather than just utilization certificates.  
  • Establishing an independent Fiscal Council to monitor the quality of spending ensures accountability and prevents the wasteful 'March Rush' of year-end spending. 
  • This institutional guardrail ensures that every rupee borrowed delivers a tangible multiplier effect on the economy. 
• Deepening the Sovereign Bond Market: To reduce vulnerability to interest rate volatility, the debt management strategy must focus on elongating the maturity profile of government securities and diversifying the investor base via global bond index inclusion.  
  • By attracting patient, long-term global pension funds into Indian debt, the government can reduce the 'crowding out' of the domestic banking sector.  
  • This lowers the cost of borrowing for the private sector and stabilizes the yield curve against domestic liquidity shocks. 
• Integration of 'Green Fiscality': Fiscal policy must be future-proofed by introducing 'Green Fiscal Reforms', such as differential taxation that penalizes carbon-intensive inputs while offering tax holidays for green technology adoption.  
  • Issuing Sovereign Green Bonds ring-fenced for climate-resilient projects allows the government to tap into lower-cost global ESG capital pools.  
  • This not only funds the transition but also insulates the economy from future cross-border carbon tariffs (CBAM) that threaten trade revenues. 
• Formalization via Digital Public Infrastructure: The government should leverage Digital Public Infrastructure (DPI) to incentivize MSME formalization through simplified presumptive taxation and cash-flow-based lending protocols (like OCEN), rather than regulatory coercion.  
  • Bringing the informal economy into the formal credit and tax net broadens the direct tax base naturally as small enterprises grow.  
  • This reduces the dangerous over-reliance on a handful of large corporate taxpayers and builds a resilient, diversified revenue structure. 

Conclusion 

India’s fiscal consolidation marks a shift from deficit arithmetic to debt sustainability, anchored in capex-led growth and revenue buoyancy. However, state-level discipline, quality of expenditure, and federal coordination will determine the durability of this path. Managing committed expenditure, off-budget risks, and global shocks remains crucial to prevent fiscal slippage. A credible mix of growth-led consolidation, cooperative federalism, and institutional fiscal safeguards is key to long-term macroeconomic stability.