Tamil Nadu and Kerala White Papers: The fiscal tightrope for State governments
Kerala and Tamil Nadu are among the most socially and economically developed states in India. But the financial situation of both governments, like that of many other States, is under stress. White Papers recently published by the two governments described their outstanding debts as worrying. State government debts are often maligned as a result of fiscal mismanagement. But in fact this may reflect a mismatch between development aspirations and the limited fiscal capacity of State governments.
White Paper puts Kerala’s liabilities at ₹5.07 lakh crore, CM says finances are under ‘serious’ pressure
financial dilemma
Debts accumulate over the years, with deficits occurring when government spending exceeds its tax and other revenues. While the power to raise taxes in India largely rests with the Union government, a larger share of overall government expenditure is borne by State governments. The majority of state government spending is allocated to social sectors such as health and education and economic sectors such as agriculture and irrigation, all of which have a direct impact on people’s lives and livelihoods. In Kerala, the State government’s high spending on social sectors since the 1960s has been a central component of public action driving social progress. Compared to the corresponding average for all Indian States, per capita State government social expenditure was higher in Kerala and Tamil Nadu (30% and 20% respectively). In contrast, it was significantly lower (35% and 40%) in Bihar and Uttar Pradesh (for the period 2020-23, according to an analysis based on State Finances: A Study of Budgets, Reserve Bank of India).
White Paper addresses adverse impact of ‘income collapse’ on people of Tamil Nadu
States meet their expenditure partly through their own revenues (which mostly include State Goods and Services Tax (SGST) and sales tax) and fiscal transfers, grants and loans from the Union government. Kerala has a good enough track record of mobilizing its own tax revenues; This per capita figure is 1.5 times the average of all Indian States and Union Territories. However, the Union government’s share in tax devolution to the States was 1.92%; this was lower than its share of 2.6% in India’s population in 2023-24.
Kerala has been able to direct only 10% of its limited financial resources towards capital expenditure to enhance its future production capabilities.
The excess of expenditures over revenues was covered by borrowing from the market, to which States paid interest. (Graphs 1 and 2).
Kerala has been able to direct only 10% of its limited financial resources towards capital expenditure to enhance its future production capabilities. The rest was spent on income or daily expenses. Approximately one fifth of the state’s budget expenditures were allocated to the salaries of public employees, especially teachers, nurses, doctors and police personnel. 15.3 percent of the total budget expenditures were pensions, and 16.5 percent were market borrowing interest. (Table 2).
Investment challenge facing Kerala
Kerala therefore faced a fiscal dilemma. If it tries to create more fiscal space by reducing revenue expenditure (cutting pensions, laying off employees), it risks eroding its strengths in the social sector. At the same time, Kerala urgently needs large-scale state-led investments in infrastructure, higher education and research, and public transport to realize its potential in modern, knowledge-intensive economic sectors. A large number of educated youth leave Kerala because the State is unable to create educational and employment opportunities that meet their aspirations.
In Kerala, the government’s weak fiscal capacity contrasts with clear signs of private prosperity – lavishly built houses, expensive cars and a high concentration of gold shops – and threatens to worsen inequalities.
In Kerala, the loan/deposit ratio of scheduled commercial banks is only around 66%; this rate exceeds the national average of 76% and 100% in Maharashtra and Tamil Nadu (2023). The fact that bank deposits exceed bank loans is an indication of the volume of untapped savings in Kerala. Between 2016 and 2026, if Kerala could invest at least some of its savings surplus, the State government’s capital expenditure could be at least doubled (Graphs 3 and 4).
Borrowing opportunity for China’s local governments
Most of the major investments that boosted economic growth in China were undertaken by provinces and lower-level local governments. Local governments borrow heavily to finance these investments, draw on the large pool of domestic savings held by Chinese banks, and their efforts are coordinated through central government planning. China’s local governments are raising resources through the sale of local government bonds (LGBs), land sales, and off-budget borrowing through local government financing vehicles (LGFVs) and supporting fiscal transfers by the central government.
In addition to restrictions on state governments’ borrowing in India, the cost of debt has also become quite high. State governments pay 6.5% to 7.5% interest on securities they issue, known as State Development Loans (SDLs), to borrow from the market. This is 0.25 to 0.75 percentage points higher than the Union government’s borrowing rate and significantly more expensive than the cost of borrowing from Chinese local governments’ banking systems (around 2%).
High interest burden further tightens the debt clamp around State governments.
State and Union government bonds issued in India are largely purchased by domestic financial institutions, including commercial banks and insurance companies, which use the savings they mobilize from the public to support government finances. In fact, the state’s debt is its debt to its own people. A government that borrows to finance projects that increase prosperity and opportunity serves a greater purpose than a tight-fisted government.
Instead of destroying their savings to send their children to study in a distant country, a family chooses to use their savings to establish a public university in their area.
We need fiscal structures that will enable State governments to access domestic savings more easily and at lower cost to finance carefully planned development projects.
(Jayan Jose Thomas is Professor of Economics at the Indian Institute of Technology (IIT) Delhi and visiting researcher at the South Asia Institute, University of Heidelberg.)
It was published – 01 July 2026 07:30 IST
