Off-Budget Borrowing and its Implications on the Fiscal Health of States

Public Finance

FDR Blog

2025-07-26

Finance Commission, Fiscal Deficit, Fiscal Responsibility and Budget Management (FRBM) Act, Off-budget Borrowing, Public Finances

by Uday Kiran, Research Analyst at the Foundation for Democratic Reforms

In India, elections often see political parties make grand promises. These pledges are driven by the compulsion to win votes, even when parties are aware of the economic constraints that the governments face. When electoral mandates are given based on such campaign promises, the expenditure will be as tall as the promises made. Governments then scramble to gather resources to fulfil their promises, and when they fail to do so, they resort to debt.

A rising debt burden hinders the country’s potential for long-term economic growth and job creation. Recognising these risks, the Government of India enacted the Fiscal Responsibility and Budget Management (FRBM) Act in 2003 to institutionalise fiscal prudence and set limits on borrowings. The act directs the union government to limit its fiscal deficit to 3% of its GDP.¹ Subsequently, state governments have enacted their own FRBM acts, which mandate states to limit their fiscal deficit to 3% of their respective GSDP. In order to circumvent the fiscal limits set by the FRBM Act, many states resort to off-budget borrowings.

Off-budget borrowings (OBBs) represent government borrowing that is not explicitly included in the official budget presented to the public or approved by the legislature. These borrowings are typically raised through government-controlled Public Sector Undertakings (PSUs), or entities which depend heavily on budgetary support via equity infusions, loans, grants, or subsidies for their operations. So, when such PSUs raise debt, it is effectively the State government that repays the loan and interest, since these loans are guaranteed by the State.

However, these borrowings are not reflected in the State government’s official budget documents. This results in an underreporting of the fiscal deficit and obscures the true extent of public liabilities. This discrepancy leads to uninformed decision making while formulating policies and puts the burden of repaying the debt on future generations.

Telangana: An Illustration

The Fiscal Responsibility and Budget Management Act of Telangana requires the publication of a Medium Term Fiscal Policy Statement, a three-year plan of the state’s fiscal policy that includes debt to GSDP ratio, fiscal deficit, revenue deficit and other indicators reflecting the state’s fiscal health. As per the Medium Term Fiscal Policy Statement of Telangana (2025-2026), the state’s total liabilities are projected at 33.1% of the GSDP in the year 2023–24.² This figure excludes guarantees and off-budget borrowings. However, according to Section 2(l) of the Telangana FRBM Act, 2005, ‘Total Liabilities’ include borrowings by PSUs, SPVs, and similar instruments, including guarantees.

Inclusion of guarantees in the State Budget pushes Telangana’s debt-to-GSDP ratio to 42%, and further to 50% when the off-budget borrowings are included.³ While not all off-budget borrowings are to be repaid by the State Government, most of the debt raised by these SPVs, PSUs and Corporations do not have a revenue stream and have to rely on the state government to finance its interest payments and debt. Telangana’s off-budget borrowings stood between 7.4% and 10.1% of GSDP during 2019–20 to 2021-22, largely driven by entities like the Kaleshwaram Irrigation Project Corporation Limited (KIPCL) and the Telangana Drinking Water Supply Corporation Limited (TDWSCL).⁴ These two Corporations combined have a debt of Rs.88,373 crores which will have to be serviced by the state government as they do not have any sustainable revenue stream to repay the debt.⁵

Thus, off-budget borrowings, having remained undisclosed and subject to higher interest rates, could abruptly strain the state’s finances once officially added to the books.

Towards Greater Fiscal Transparency

Article 293(3) of the Constitution of India stipulates that a state cannot borrow money without the permission of the union government if it still owes a loan taken from or guaranteed by the union government. To curtail the enduring Off-Budget Borrowings, the Government of India in 2023 has explicitly mandated that ‘off-budget borrowings by state PSUs, SPVs, and other equivalent instruments, where principal and/or interest is serviced through the state budget will be treated as borrowings by the state itself’.⁶ This step ensures that all such liabilities are brought under the purview of the Net Borrowing Ceiling, and are accounted for when assessing compliance with fiscal targets under the State FRBM Act.

Perceiving the need for greater fiscal responsibility, the 13th Finance Commission proposed an independent body for annual public review of fiscal policies and their impact.⁷ This concept evolved through the 14th and 15th Finance Commissions, advocating for a full-fledged Fiscal Council. Such bodies, like the Congressional Budget Office (CBO) in the US, Office for Budget Responsibility (OBR) in the UK, and Parliamentary Budget Office in Australia, act as fiscal watchdogs, enhancing transparency and accountability.⁸

The proposed Fiscal Council, modeled on the UK’s OBR, would independently assess fiscal policies, monitor expenditure, and oversee expenditure which raise burden on future generations. It would conduct “fiscal stress tests” on states, evaluating debt, deficits, and expenditure. The Council should also mandate states to disclose Off-Budget Borrowings along with their budgets and oversee them to ensure comprehensive fiscal accountability.

Alternative solutions like expanding the roles of the Comptroller and Auditor General (CAG) of India and the Finance Commission to include oversight of national and state fiscal health can also be explored.

The credibility and stability of any elected government depends upon the management of its finances. A financially distressed state cannot make good upon its promises of welfare and prosperity to its citizens. Spending recklessly is not the way to prosperity. Emphasis must instead be placed on fiscal prudence and institution-building.