What to Expect as States’ Debt Rises to Record Levels

From the Editor’s Desk

January 4, 2026

Indian states are likely to borrow an unprecedented 5 trillion rupees between January and March 2026 to meet their routine government spending, the largest amount ever raised by state governments in a single quarter in India’s history, according to the Reserve Bank of India (RBI). This record debt may push up interest rates on home and business loans, delay government-funded work like school repairs, road construction and public healthcare, and leave less money for job schemes, rural wages and welfare payments.

If states borrow the full amount they have planned, it will be the highest ever in a single quarter, and it will also take their total borrowing for the year to a new record, Reuters reported.

To understand what this record borrowing means for you, it’s important to first see how governments raise money to pay for services and day-to-day expenses, how that affects loan rates and public spending on things like roads, schools, hospitals and welfare, and how the division of money and responsibility between the centre and states shapes what each government can actually do.

Borrowing

In India’s federal system, both the central government and the state governments often spend more than they earn, so they borrow the difference, known as a fiscal deficit, by selling bonds. A bond is a formal promise to repay borrowed money on a fixed date, with regular interest. It works like an “IOU,” short for “I owe you,” where the government promises to pay the lender back later. Investors such as banks, insurance companies and pension funds buy these bonds because they expect a safe return.

This borrowing is not necessarily bad in itself, as it allows states to fund infrastructure, public welfare schemes, or respond to crises, but there are limits on how much they can safely borrow.

Unlike the central government, which collects major taxes like income tax and customs duties, states rely on a smaller set of revenue streams, such as value-added tax on alcohol, stamp duties and property tax. Their spending responsibilities, however, are significant, as they include health, education, public transport and local development. As a result, many states often run deficits and need to borrow. The Constitution allows this, but within limits set by the central government and the RBI.

The RBI organises bond sales for states, monitors the market and regulates how much borrowing each state is allowed based on fiscal discipline rules.

The quarterly borrowing figure matters because it tells investors how much fresh government debt is going to hit the market, which in turn affects how investors price that debt, and what interest rates governments must pay to raise money.

Each bond has a market price, and that price, along with the interest, decides how much profit the investor makes. This profit is called the “yield.” If the price of a bond falls but the interest stays the same, investors earn more for every rupee they invest, so the yield goes up. If the price rises, the same interest gives them less in return, so the yield goes down.

If a flood of new bonds is issued, as will happen with this record 5 trillion-rupee borrowing, then there’s more supply in the market. Unless demand keeps pace, this oversupply pushes bond prices down and yields up. In simpler terms, the government has to offer higher returns to attract lenders.

Higher yields are not good for governments, because they translate into higher interest costs, meaning states will pay more to borrow the same amount of money. This adds to their debt burden over time, limiting future spending and potentially forcing cuts to public services or development plans.

Why More Borrowing

There are several reasons why states may be borrowing more. Some may have seen a drop in tax collections, especially if economic activity has been uneven. Others may be spending more on subsidies, welfare schemes, or capital projects like roads and electricity. The end of the financial year (March 31) is also a time when many states rush to complete spending targets, which can lead to higher borrowing in the final quarter.

There is also a deeper problem with how the system is set up. In recent years, the central government has reduced its own borrowing to show more control over spending. But instead of taking on fewer responsibilities, it has continued to announce large-scale schemes while shifting much of the actual cost and implementation to state governments. Finance Commission reports and Reserve Bank data show that states are now expected to fund more welfare programmes, subsidies, and local infrastructure, even though they have limited control over how much money they can raise.

Often, the money states expect from the centre reportedly comes late or falls short. Because of this, many states are forced to borrow more just to keep basic services running. This also means that if something goes wrong, like a flood, a drought, or a sudden loss of jobs, states may not have enough money left to respond.

In a federal system, how resources are distributed between the centre and the states affects the ability of each level of government to deliver services and maintain financial health. India’s Constitution assigns both responsibilities and revenue powers between the Union and the states. Over time, though, there has been a tilt toward greater centralisation of fiscal power, especially after the introduction of the Goods and Services Tax (GST), which merged many state and central taxes.

States now depend heavily on transfers from the centre, either through a share in central taxes or direct grants. If these flows are uncertain, delayed, or reduced, states have few alternatives but to borrow. This growing dependence undermines fiscal federalism, where states are supposed to have both responsibility and autonomy.

The sharp rise in state borrowing this year may be an indicator that states are being forced to take on more financial responsibility than their revenue powers allow. It may also signal the need to reassess how India’s fiscal federal structure functions, whether states are being given enough resources to carry out their duties, or whether they are being pushed into debt to fill a gap that the current system creates.

Impact

From a macroeconomic perspective, which is looking at the economy as a whole, high levels of government borrowing, whether by the centre or the states, affect the overall demand for capital in the country. If both the central and state governments are borrowing large amounts at the same time, they could end up competing for the same pool of investors, raising interest rates and making borrowing more expensive across the economy.

This situation is often referred to as a “crowding out” effect, where government borrowing crowds out private investment because companies also have to offer higher rates to raise funds. Over time, this can dampen economic growth, especially if the borrowed money is used for consumption rather than productive investment.

Moreover, if state finances are stretched too thin, it can lead to a downgrade of their creditworthiness. Investors may then see them as riskier borrowers, further increasing the yields they demand. In India, where state-level financial data is often opaque, this can add uncertainty to the bond market.

The surge in borrowing also influences the interest rates banks and other lenders offer. Government bonds compete with corporate and retail lending for investors’ money. If state governments offer higher yields to attract investors, banks may also raise their lending rates. That means home loans, education loans, or business credit could become more expensive. In short, your monthly EMI could go up because your state took on more debt.

You’ve just read a News Briefing written by Newsreel Asia’s Text Editor, Vishal Arora, meant to cut through the noise and bring you one important story of the day. We invite you to read the News Briefing daily. Our aim is to help you become a sharp, responsible and engaged citizen who asks the right questions.