The revenue allocation to states is expected to drop in the current financial year, as compared with the last financial year, as per a report by a Mumbai-based ratings agency.
While capital outlay of states might grow from four per cent to six per cent in the FY26, touching approximately ₹7.5 lakh crore, it will be well below the decadal average of 11 per cent as rising revenue deficits are limiting financial flexibility, said Crisil Ratings in its report on Friday.
However, revenue expenditure is set to grow sharply by seven per cent to nine per cent, driven by committed spending and increased allocation towards social welfare schemes, it said.
The top 18 states will account for 94 per cent of capital outlay of the states, with water supply and sanitation, including housing and urban development and irrigation, continuing to be the main drivers of the capital expenditure, the report added.
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Senior director of Crisil Ratings, Anuj Sethi, said an increase in revenue expenditure will undoubtedly widen the revenue deficit of the states, and lower the fiscal space and borrowing capacity for carrying out capital expenditure.
The report attributes slow pace of growth due to moderation in GST rates post rationalisation, lower nominal GDP growth driven by easing inflation, and slowing devolution from the Centre to be the main reasons for higher revenue deficit of the states.
Government capital expenditure has a higher multiplier effect on economic output, since it encourages overall expenditure and aids economic growth, thereby crowding out private investments, the report explained.
Given the limited ability to raise resources by the states, the ability to balance social expenditure with capital outlay will be key factor in assessing their credit outlook, the report said.
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