State governments’ ability to sustain high levels of capital expenditure is set to weaken over the next two financial years as rising welfare spending, moderating revenue growth and tapering central grants squeeze fiscal space, according to a report by CareEdge Ratings.
The agency’s analysis of finances across 15 major states, accounting for 89 per cent of India’s Gross State Domestic Product (GSDP), projects that while capital outlay will remain a priority, its growth will slow sharply to around 8–10 per cent in FY27 from an estimated 16.7 per cent in FY26.
Revenue receipts are expected to grow by 6.2 per cent in FY26 to Rs 37.2 lakh crore and by 7.9 per cent in FY27 to Rs 40.1 lakh crore, lagging nominal economic expansion. This moderation reflects softer consumption trends, volatility in fuel-linked taxes and a slower pace of growth in central transfers amid rising subsidy burdens linked to geopolitical developments in West Asia.
At the same time, revenue expenditure is projected to increase by 8 per cent in FY26 and by 11 per cent in FY27, driven largely by expanding social sector spending, welfare programmes, and higher subsidy commitments linked to energy and commodity prices.
“State revenue growth is expected to remain moderate through FY26 and FY27, primarily due to a tapering of grants from the Centre, with external headwinds further weighing on overall receipts in FY27. Meanwhile, revenue expenditure is likely to stay elevated, driven by continued social sector spending, a higher state share under select schemes, and additional inflationary pressures from elevated commodity and fuel prices amid geopolitical developments in West Asia, which may also push subsidy outgo at the state level," said Prasanna Krishnan, Associate Director, CareEdge Ratings.
As a result, the revenue deficit is projected to widen from 0.8% of GSDP in FY25 to around 1.2% by FY27. Maintaining fiscal discipline will therefore remain critical as states balance welfare commitments with the need to sustain capital investment,” added Krishnan.
Assistance From The Central Government
Grant receipts from the Centre have already declined by 17 per cent in FY25 and by 17.3 per cent during 9MFY26, largely due to the phased withdrawal of Revenue Deficit Grants. Grants are expected to fall by another 16 per cent in FY26, with the discontinuation of these grants after FY26 pushing states to rely more heavily on their own tax revenues and tax devolution.
States such as Andhra Pradesh, Kerala, Punjab and West Bengal, which have historically depended more on such grants, may face sharper fiscal adjustments as this support is withdrawn.
Despite these pressures, capital expenditure recorded 17 per cent year-on-year growth during 9MFY26, indicating continued public investment momentum. Capex is estimated at Rs 7.7 lakh crore in FY26, around 2.4 per cent of GSDP, though still falling short of budget estimates due to execution challenges such as delays in project approvals and land acquisition.
Large states including Uttar Pradesh, Madhya Pradesh, Gujarat, Maharashtra and Telangana continue to dominate overall capital outlay, while Andhra Pradesh, Haryana and Bihar are seeing faster growth from a lower base. Spending remains focused on transport connectivity, urban infrastructure, irrigation and water supply.
However, tighter fiscal headroom is expected to moderate capex growth in FY27 to around Rs 8.32–8.46 lakh crore, or 2.3–2.4 per cent of GSDP. Although the Centre’s Special Assistance to States for Capital Investment scheme, offering interest-free loans and backed by an allocation of Rs 2 lakh crore in FY27, will continue to support infrastructure spending, the report cautions that rising committed expenditure may crowd out investment.
“Prominent states such as Uttar Pradesh, Madhya Pradesh, Gujarat, Maharashtra and Telangana have continued to prioritise capital expenditure despite moderate revenue growth, reflecting a sustained focus on infrastructure creation. States like Andhra Pradesh, Bihar and Haryana reported higher capex growth in FY25. However, with fiscal space becoming tighter due to rising revenue expenditure commitments and moderation in revenue growth, state capex growth is expected to moderate to around 8-10 per cent in FY27," said Maulesh Desai, Director, CareEdge Ratings.
This would translate into a capex of about 2.3–2.4 per cent of Gross State Domestic Product (GSDP), supported by interest-free loans from the Centre. The fiscal deficit is expected to rise gradually from 3.2 per cent of GSDP in FY25 to around 3.5 per cent of GSDP in FY27, driven by widening revenue deficits. These deficits are also expected to exert upward pressure on debt levels, with additional downside risks stemming from evolving geopolitical developments, he stated.
"While capital expenditure remains a key growth lever, fiscal pressures may constrain flexibility. Therefore, meaningful traction in monetisation of state infra projects and bolstering of investor confidence for Public Private Partnership (PPP) projects in states are critical for funding higher capital outlay,” added Maulesh Desai, Director, CareEdge Ratings.
The fiscal deficit is projected at 3.3 per cent of GSDP in FY26 and 3.5 per cent in FY27, while outstanding debt is estimated to rise from 28.4 per cent of GSDP in FY25 to 29.5 per cent by FY27, reaching Rs 105.9 lakh crore. The report concludes that states will need to balance welfare commitments with infrastructure ambitions amid tightening revenues, with debt sustainability increasingly linked to their ability to sustain economic growth and improve revenue mobilisation. |
