States’ capital outlay set for modest 4–6 pc rise amid widening revenue deficit

India’s states are expected to post only a modest increase in capital outlay this financial year, with growth likely limited to 4–6 per cent and total spending projected at around Rs 7.4–7.5 lakh crore. The pace is slower than the roughly 7 per cent expansion recorded last year and well below the decadal average of about 11 per cent, as rising revenue deficits constrict fiscal headroom.

A Crisil study of 18 major states, which together account for nearly 94 per cent of the country’s total state-level capital expenditure, shows that water supply and sanitation, including housing and urban development, along with irrigation, will remain the principal drivers of capex. In contrast, spending on transport, typically the largest single component, may moderate this year.

Revenue pressures squeeze fiscal space

States are confronting a sharp uptick in revenue expenditure at a time when growth in receipts has softened. GST revenues have moderated following rate rationalisation, central tax devolutions have slowed, and nominal GDP growth has eased due to lower inflation.

On the expenditure side, committed spending continues to account for almost half of total revenue outgo, while allocations for social welfare schemes, particularly direct benefit transfers, are set to rise.

“Revenue expenditure is increasing faster, and that will stretch the revenue deficit to an estimated Rs 3.0–3.1 lakh crore this year, about 45–50 per cent higher than last year,” said Anuj Sethi, senior director at Crisil Ratings.

“This leaves states with less room to borrow for capital projects. With the Centre’s 50-year interest-free capex loans to states remaining unchanged at Rs 1.5 lakh crore, we expect capital outlay growth to moderate to 4–6 per cent.”

Because of this squeeze, states are likely to achieve only about 80 per cent of the capital outlay they had budgeted. As a share of gross state domestic product, capital outlay is expected to dip slightly to 2.2 per cent, compared with the 2.3–2.4 per cent range of the past two years.

Capex composition and economic impact

Transport typically absorbs 23–27 per cent of state capital outlay, largely for roads and bridges. Irrigation follows with 18–22 per cent, while water supply and sanitation, including significant housing and urban development components, accounts for 16–20 per cent and is supported by centrally sponsored schemes such as the Jal Jeevan Mission and the Pradhan Mantri Awas Yojana.

Economists note that government capex delivers a significantly higher multiplier effect than revenue spending, helping attract private investment and supporting broader economic expansion. The ability of states to maintain this investment, despite rising welfare obligations, will remain central to their credit assessment.

Risks and possible upside

The outlook could weaken further if GDP growth slows more sharply. Conversely, stronger-than-expected tax buoyancy, including from GST rationalisation, or higher central grants could provide states with additional flexibility, allowing either lower borrowing levels or a more robust capital outlay.