State fiscal deficits have risen steadily over the past three years to 3.2%, the Economic Survey 2026 said.
While states have stepped up spending, their revenue growth has failed to keep pace with nominal GDP growth.
The Survey flagged discretionary unconditional cash transfers as a key factor adding to renewed fiscal stress.
Fiscal deficits of states have gradually edged up over the past three years to 3.2%, reflecting emerging pressures on state finances, the Economic Survey 2026 tabled by Finance Minister Nirmala Sitharaman on Thursday said. The key document, which assesses the health of the economy ahead of the annual Budget, also noted that while states have increased spending, their revenue growth has lagged.
“A key driver of this renewed fiscal stress has been lagging revenue growth relative to nominal GDP growth, compounded by the incurring of expenditures such as discretionary unconditional cash transfers,” the Survey said.
1 January 2026
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States earn most of their revenue from their own taxes, which have grown steadily at an average rate of 12.6% since the pandemic. As a result, the share of states’ own tax revenue in total receipts rose from 46% in FY22 to about 50% in FY25.
Their second-largest source of income is their share in central taxes (around 32%), followed by grants and non-tax revenue.
However, total state revenues as a share of GDP have fallen, limiting fiscal space and making it harder to keep pace with economic growth, the Survey noted.
To support state finances and protect investment, the Centre has stepped in with interest-free loans, sharply raising allocations under the Special Assistance to States for Capital Investment from about ₹12,000 crore in FY21 to nearly ₹1.5 lakh crore in FY26.
This support has helped states keep capital spending stable at around 2.4% of GDP despite rising revenue pressures. The document noted that the government is well on track to meet the fiscal deficit target of 4.4% of GDP estimated for the current financial year, based on broad trends.
Expanding Cash Transfers
Unconditional cash transfers (UCTs) have expanded sharply across states and now account for a growing share of welfare spending, with total allocations—largely aimed at women—estimated at about ₹1.7 lakh crore in FY26, the Economic Survey said. The number of states implementing such schemes has increased more than fivefold since FY23, even as around half of them remain in revenue deficit.
Studies show these transfers form a meaningful part of household finances, accounting for “11–24% of monthly income for female casual labourers” and as much as “11–87% for self-employed women” in some states. In rural areas, these transfers reportedly make up “40–50% of monthly per capita consumption expenditure” for at least half the population.
However, the Survey cautioned that the speed and scale of expansion raise concerns over fiscal sustainability and medium-term growth, especially when not backed by investments in jobs, skills and human capital. Evidence also suggests that such schemes can “adversely affect female labour force participation”.
These concerns are sharpened by tight state finances. Combined gross fiscal deficits have risen from 2.6% of GDP in FY22 to 3.2% in FY25, while revenue deficits have widened and outstanding liabilities stand at about 28% of GDP. With salaries, pensions, interest payments and subsidies absorbing nearly “62% of states’ revenue receipts”, fiscal room is limited. In this context, higher spending on cash transfers involves clear trade-offs, as “additional allocations risk crowding out resources for critical social and physical infrastructure”.
The Survey also flagged design issues, noting that many schemes lack sunset clauses or periodic reviews, making revenue spending rigid. As fiscal pressures intensify, capital expenditure—“which has a stronger and more durable growth impact”—often becomes the casualty.
The document, prepared by Chief Economic Adviser V. Anantha Nageswaran, advised “careful reprioritisation within state budgets”.
“Preserving fiscal space for capital formation and human-capital investment yields stronger and more persistent gains in household incomes, labour productivity and welfare than a steady expansion of open-ended UCTs,” it said, adding that while the Centre’s incentives have supported higher state capital outlays in recent years, sustaining growth will depend on complementary discipline in revenue expenditure.
