What Happened
- A report by Vedartha (the AIF and PMS brand under Bandhan AMC) highlights that State Government Securities (SGS) outstanding have surged five-fold since FY2015, significantly outpacing the 2.7-times growth in central government debt over the same period
- States are increasingly relying on State Development Loans (SDLs) — market borrowings via dated securities — to finance their fiscal deficits, shifting away from concessional central transfers
- The aggregate state debt remains sticky at approximately 28% of GDP, above the pre-pandemic level of approximately 25.3% of GDP
- Fragmented SDL issuances by individual states create market illiquidity, leading to higher term premiums (states pay more to borrow than the sovereign rate differential warrants)
- The weighted-average maturity of state borrowings has risen to 16 years, extending the duration of the state debt portfolio
- The report recommends standardised yield curves, limited ISIM (ISIN) creation, and mandatory credit ratings to improve SDL market efficiency and transparency
Static Topic Bridges
State Development Loans (SDLs) — Mechanism and Market Structure
State Development Loans are dated securities issued by state governments to finance their fiscal deficits through market borrowings. They function similarly to central government G-Secs (Government Securities) but are issued by individual state governments. The Reserve Bank of India conducts SDL auctions on behalf of state governments.
SDLs typically carry a spread of 0.25%–0.75% over comparable central government G-Secs. This spread reflects state-specific credit risk and market liquidity. SDL auctions are held fortnightly and states participate independently — hence the "fragmentation" problem: instead of a consolidated sovereign borrowing programme, 28 state governments each tap the market separately, creating numerous small ISINs with limited secondary market liquidity.
- SDL auctions conducted by: RBI on behalf of state governments
- Typical tenure: 10 years (though states are now extending to 15–30 years)
- Weighted average maturity of state borrowings: now 16 years (extended from earlier shorter tenures)
- Spread over G-Secs: typically 0.25%–0.75% (varies by state creditworthiness and market conditions)
- State SGS outstanding growth since FY2015: 5x (vs central govt debt growth of 2.7x)
- In FY2025–26 (Apr–Jul 2025): States borrowed ₹2.97 trillion via SDLs vs ₹2.14 trillion in the same period the previous year
Connection to this news: The five-fold surge in state securities outstanding reflects states' growing dependence on market borrowings rather than central transfers or own tax revenues, raising fiscal sustainability concerns.
Fiscal Responsibility Framework for States — FRBM and Borrowing Limits
The Fiscal Responsibility and Budget Management (FRBM) Act, 2003, and its amendments set fiscal consolidation targets for both central and state governments. States have their own FRBM Acts (enacted following the Twelfth Finance Commission's recommendations), which typically cap the Gross Fiscal Deficit (GFD) at 3% of Gross State Domestic Product (GSDP).
The FRBM Act for states was a condition attached to the Twelfth Finance Commission (2005–10) debt relief package: states receiving central debt write-offs had to enact their own FRBM legislation. Additionally, the Finance Commission under Article 280 of the Constitution periodically sets borrowing limits and conditions for state market borrowings.
- FRBM Act (Centre), 2003: Targets fiscal deficit at 3% of GDP; amended post-COVID to allow temporary relaxation
- State FRBM Acts: Typically cap GFD at 3% of GSDP; additional borrowing headroom of 0.5% GSDP linked to capital expenditure performance
- Net Market Borrowings cap: Article 293 of the Constitution — states cannot borrow from markets without the consent of the Centre when states have outstanding loans from the Centre
- Article 293(3): State may not raise a loan "without the consent of the Government of India" if a previous loan from the Centre is outstanding — key constitutional provision governing SDL issuance
- 15th Finance Commission recommendation: Allowed states to borrow 4% of GSDP (temporarily) during COVID years; reverted to 3% thereafter
- Aggregate state debt as % of GDP: ~28% (FY2025) vs ~25.3% pre-pandemic
Connection to this news: Despite FRBM limits, state debt has surged due to pandemic spending, post-COVID fiscal expansion, and revenue shortfalls — with market borrowings (SDLs) filling the gap that reduced central transfers left.
Centre-State Fiscal Transfers — Finance Commission and Devolution
The Finance Commission (constituted under Article 280) is the constitutional body that determines the formula for sharing central tax revenues with states (vertical devolution) and their distribution among states (horizontal devolution). It also recommends grants-in-aid under Article 275.
The 15th Finance Commission (2021–26, chaired by N.K. Singh) recommended 41% of the divisible pool of central taxes be devolved to states (same as the 14th FC). As this devolution becomes the primary transfer mechanism, states increasingly rely on market borrowings when their current expenditure exceeds available central transfers and own tax revenues.
- Finance Commission: Constitutional body under Article 280; constituted every 5 years
- 15th Finance Commission (2021–26): 41% share of divisible pool to states; ₹10.33 lakh crore grants
- 16th Finance Commission: Constituted in December 2023 under Dr. Arvind Panagariya for the period 2026–31
- Divisible pool: Central taxes (excluding cesses and surcharges) that are shared with states — cesses (e.g., Education Cess) are retained fully by the Centre, a major grievance of states
- Grants under Article 275: Unconditional grants to states in need; distributed by Finance Commission
Connection to this news: States' growing SDL dependence reflects that Finance Commission devolution alone is insufficient — especially for fiscally stressed states — prompting heavy recourse to market borrowings.
Key Facts & Data
- State Government Securities (SGS) outstanding growth since FY2015: 5-fold
- Central government debt growth over same period: 2.7-fold
- Aggregate state debt as % of GDP: ~28% (FY2025) vs ~25.3% pre-pandemic
- Weighted average maturity of state borrowings: 16 years
- SDL spread over central G-Secs: typically 0.25%–0.75%
- State borrowings via SDLs (Apr–Jul FY2025–26): ₹2.97 trillion vs ₹2.14 trillion (same period previous year)
- FRBM cap for states: 3% of GSDP (with additional 0.5% headroom for capex)
- Constitutional provision governing state borrowings: Article 293 (requires Centre's consent when outstanding central loans exist)
- Report author: Vedartha (AIF and PMS brand under Bandhan AMC)
- Recommendations: Standardised yield curves, limited ISIN creation, mandatory credit ratings for SGS