The Economic Survey 2026, tabled in Parliament today, sheds light on why India continues to face higher interest rates on loans, pointing towards the fiscal behavior of its states. While the central government is making strides in fiscal consolidation, rising deficits at the state level are contributing to the nation's higher borrowing costs.
Fiscal Prudence at the Center, Emerging Pressures at the State Level
The Economic Survey 2026 highlights a divergence in fiscal management between the central government and the states. The central government is on track to meet its fiscal deficit target of 4.4% of GDP for FY26, a goal achieved through a combination of public investment and fiscal consolidation. This commitment to fiscal discipline has been recognized by international credit rating agencies, with India receiving upgrades from S&P, Morningstar DBRS, and R&I in 2025.
However, the survey reveals that state government finances are facing increasing pressure. While the combined fiscal deficit of state governments remained stable post-pandemic, it has recently edged up to 3.2% of GDP in FY25, signaling emerging challenges. The central government has been incentivizing states to maintain capital expenditure through the Special Assistance to States for Capital Investment (SASCI). Despite these efforts, expansion of unconditional cash transfers across several states has contributed to rising revenue expenditure, thus impacting fiscal space and public investment at the state level.
Impact on Borrowing Costs
The rise in state deficits has implications for the overall cost of borrowing in India. As state governments borrow more to finance their deficits, it increases the overall demand for funds in the market, pushing up interest rates. This, in turn, makes it more expensive for businesses and individuals to borrow, potentially impacting economic growth. Chief Economic Advisor (CEA) V. Anantha Nageswaran has cautioned that fiscal indiscipline at the state level can weaken growth prospects and raise sovereign borrowing costs.
Strategies for Fiscal Consolidation
The Economic Survey 2026 suggests that both the central government and the state governments need to prioritize fiscal consolidation to lower borrowing costs and spur economic growth. The survey suggests that the central government should progressively bring down its fiscal deficit to 3% of GDP, and states may also stabilize their fiscal deficits at 3% of GDP.
The survey also proposes a change in fiscal consolidation strategy for a period of five years, focusing on annual reduction in the central government's debt-to-GDP ratio. This would free up borrowing space for the private sector, making it easier for them to access investible resources.
India's Economic Outlook
Despite the challenges posed by rising state deficits, the Economic Survey 2026 paints a positive picture of India's overall economic outlook. The survey has revised India's medium-term potential growth rate upward to 7.0%, driven by sustained domestic reforms, public investment, and infrastructure expansion. India is projected to remain the fastest-growing major economy, with a real GDP growth rate of 7.4% for FY26. The survey projects India's economy to grow between 6.8% to 7.2% in fiscal 2027.
The Economic Survey emphasizes that India's economic ambitions face global headwinds, but these can be turned into tailwinds if the state, the private sector, and households are willing to align and adapt. The survey suggests that policy credibility, predictability, and administrative discipline are strategic assets that can help India navigate the challenges and achieve its economic goals.
