Case Study 3 - Reading a State's Fiscal Numbers Under FRBM
The finance department of a state places a note before the cabinet. For 2025-26 the advance estimate of GSDP is ₹9,60,000 crore. Revenue receipts are budgeted at ₹2,10,000 crore, revenue expenditure at ₹2,25,000 crore, capital expenditure at ₹75,000 crore, and non-debt capital receipts at ₹63,600 crore. Interest payments are ₹42,000 crore. Outstanding liabilities at the start of the year were ₹2,50,400 crore, and the budgeted net borrowing is the only addition to debt during the year. The state's FRBM Act sets a fiscal deficit ceiling of 3% of GSDP and a debt-GSDP ceiling of 25%. The Union Finance Ministry has communicated that an additional borrowing window of 0.5% of GSDP is open to states that complete specified power-sector reforms. A new scheme costing ₹9,000 crore in the current year is proposed, to be financed wholly by additional borrowing.
1. Compute the fiscal deficit, revenue deficit and primary deficit, and assess compliance with both FRBM ceilings.
Read the worked answer
Fiscal deficit = total expenditure − receipts excluding borrowing = (2,25,000 + 75,000) − (2,10,000 + 63,600) = 3,00,000 − 2,73,600 = ₹26,400 crore = 26,400 / 9,60,000 = 2.75% of GSDP → within the 3% ceiling, with headroom of 0.25% = ₹2,400 crore.
Revenue deficit = 2,25,000 − 2,10,000 = ₹15,000 crore = 1.56% of GSDP. This is the key signal: part of the borrowing is financing consumption, not asset creation.
Primary deficit = fiscal deficit − interest = 26,400 − 42,000 = −₹15,600 crore, i.e. a primary surplus.
Debt = 2,50,400 + 26,400 = ₹2,76,800 crore = 28.83% of GSDP → breach of the 25% ceiling by 3.83 percentage points.
Verdict: the state is compliant on the flow indicator and non-compliant on the stock indicator. A cabinet note that says only 'we are within 3%' is misleading, and a rating agency or the Comptroller and Auditor General will look at both.
2. Can the ₹9,000 crore scheme be financed entirely by borrowing without breaching the 3% ceiling even if the power-sector window is secured? Show the arithmetic and the alternatives.
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Headroom available:
- Unused space to 3%: 0.25% × 9,60,000 = ₹2,400 crore
- Power-sector window: 0.5% × 9,60,000 = ₹4,800 crore
- Total: ₹7,200 crore
Shortfall: 9,000 − 7,200 = ₹1,800 crore.
Check: borrowing of 9,000 would take the fiscal deficit to 35,400 = 3.69% of GSDP, above even the 3.5% ceiling available with the window; and debt would rise to 2,85,800 = 29.77% of GSDP, worsening an already breached ratio.
Therefore the scheme cannot be fully debt-financed. Options, in order of preference:
- Phase it - take ₹7,200 crore this year and the balance next year, when fresh headroom opens.
- Find ₹1,800 crore of revenue - every rupee of additional own-tax or non-tax receipt reduces borrowing rupee for rupee. A 1% improvement in own-tax collection efficiency on a base of ₹1,50,000 crore yields ₹1,500 crore.
- Reprioritise expenditure - defer low-return capital works of equal value.
- Reject off-budget devices - routing the scheme through a state corporation keeps it out of the deficit on paper but is exactly the practice that gets states flagged.
Conditionality to note: the 0.5% window is not an entitlement. If the power-sector milestones are not certified, the borrowing becomes unauthorised and the space is withdrawn in the following year.
3. The state meets the deficit ceiling yet is flagged on debt. Explain how both can be true, and what the primary surplus of ₹15,600 crore does and does not prove.
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How both can be true. The fiscal deficit is a flow for one year; debt is a stock. A state can sit under 3% for years and still be above 25% if it entered the year with a large stock, or if nominal GSDP growth is slower than the interest it pays. Debt sustainability follows the arithmetic of the interest rate against nominal growth: if the effective interest rate exceeds nominal GSDP growth, the ratio climbs even with modest borrowing.
What the primary surplus of ₹15,600 crore shows. Current receipts cover all expenditure including interest, and still leave a surplus. In other words, the state is not borrowing to pay interest - a genuinely strong position, and one that argues for a credible path back to 25% rather than for belt-tightening.
What it does not show. It says nothing about the quality of spending. With a revenue deficit of 1.56%, the state is still borrowing for consumption; a primary surplus financed by cutting capital expenditure would be a poor bargain, because capital spending is what generates future GSDP and therefore lowers the debt ratio.
Judgement for the cabinet: protect capital expenditure, close the revenue deficit, and publish a three-year glide path to 25%. The flow indicator alone is not the test the state will be judged on.