State Finances on the Mend: Fiscal Deficit Expected to Shrink by FY27

An ICICI Bank report forecasts that states' fiscal deficit will moderate to 3.4% of GSDP by FY27, driven by robust tax collections and revenue increases. Improved state GST, increased stamp duty receipts, and other tax revenues are crucial contributors to the fiscal consolidation anticipated in the coming months.

An ICICI Bank report forecasts a moderation in states' fiscal deficit to 3.4% of GSDP by FY27, buoyed by strong tax collections and enhanced revenue receipts. The fiscal outlook for states has improved following a robust start to the fiscal year with higher State GST collections, stamp duty revenues, and other tax income projected to assist fiscal consolidation in the ensuing months.

Last year, receipts were on a downward trend, but with this year's uptick in nominal GDP, tax collections are expected to strengthen, offering a positive outlook for the deficit, according to the report. The fiscal deficit had expanded to 3.6% of GSDP in FY26, mainly due to sluggish tax collections and increased spending. However, stronger revenue generation in the current fiscal year is anticipated to bolster the fiscal stance.

For a sample of 24 states, total receipts increased 7.7% year-on-year during April-May 2026, propelled by an 18% rise in revenue receipts. States' own tax revenue surged 16.4%, spurred by a 22% growth in SGST collections and an 18% climb in stamp duty collections, indicating steady consumption activity and resilience in the housing sector. Transfers from the Centre rose 36% year-on-year during the period, though this growth rate is expected to stabilize over the fiscal year. Non-tax revenue also remained robust, supported by substantial collections from fees, royalties, and dividends.

While overall expenditure grew 7% year-on-year in the first two months of FY27, capital expenditure lagged as states focused on obligatory expenses like salaries, pensions, and welfare programs. The report suggests that this dip in capital expenditure is provisional. As the fiscal year unfolds, states are predicted to escalate productive capital expenditure, particularly in infrastructure, to promote medium-term economic expansion and asset creation. Healthier revenue inflows and enhanced fiscal resources are likely to underpin increased infrastructure investment later in the fiscal year, reinforcing the overall fiscal outlook for states.