Fiscal opacity distorts the financial picture that India’s Finance Commissions need to do their role justice

But equalization is only as effective as the information it uses. When fiscal data is incomplete or opaque, the FC’s recommendations—however well intentioned—risk misallocating resources, weakening incentives and undermining fiscal discipline.

Fiscal transparency is foundational to India’s fiscal federal system. However, India’s public financial management system continues to face persistent data gaps—misclassification of expenditure, incomplete reporting of liabilities, fragmented data across levels of government and limited visibility of off-budget operations. These distort the measurement of fiscal capacity and need.

Consider capital expenditure. A significant portion of reported ‘capex’ consists of financial transactions—loans, equity injections into public entities or transfers through special purpose vehicles. If such spending is treated as capital formation, it inflates the apparent investment effort and obscures expenditure quality.

For the FC, this matters directly. If states appear to invest more than they actually do, assessments are distorted and transfers may reward accounting practices rather than asset creation.

A similar distortion arises on the revenue side. Both the Union and some states treat proceeds from asset sales—privatization and just disinvestment—as current revenue. These are one-off capital receipts, not recurring revenue streams. International standards treat them as financing items. Classifying them as revenue creates a misleading picture: deficits appear lower and revenue buoyancy stronger than is actually the case.

For the FC, this has direct implications. A state reporting higher revenues due to one-time asset sales may appear fiscally stronger and less in need of transfers, while another relying on stable tax revenues may appear weaker.

A more serious concern is the opacity of public debt. A significant share of borrowing by both the Union and states has taken place off-budget—through public enterprises and special purpose vehicles. In sectors such as power, losses have often been financed through state-guaranteed borrowing or mechanisms that shift liabilities outside the budget. Infrastructure financing through state-owned entities similarly obscures the true fiscal position.

This creates two problems for the FC. First, it understates the true fiscal burden of some states. Second, it allows others to circumvent fiscal rules, which results in an uneven playing field. States that adhere to on-budget discipline may appear weaker than those that shift liabilities off-budget—rewarding opacity and penalizing transparency.

Subsidy reporting presents a related challenge. Subsidies—particularly in power, agriculture and food—are often fragmented across budgetary and off-budget channels. In some states, electricity subsidies have been financed through either delayed payments or borrowing by state-owned companies.

For the FC, the absence of a unified subsidy framework makes it difficult to evaluate expenditure commitments. A state with hidden subsidies may appear stronger than it is, while one that transparently reports its subsidy burden may appear weaker.

These issues are not confined to states. India still lacks fully consolidated fiscal accounts aligned with international standards. This fragmentation matters because fiscal responsibilities are shared. Without a consolidated view, it is difficult to assess the overall fiscal stance and the balance between Union and state finances.

Recent developments underscore the importance of transparency. The 16th FC marks a shift away from gap-filling transfers in favour of a framework that expects states to undertake fiscal adjustment.

But these projections rest on implicit assumptions, such as improved revenue mobilization, rationalized subsidies, reduced off-budget borrowing and stronger expenditure management—precisely where transparency is weakest.

Without reliable data and consistent classification, it is difficult to assess whether such adjustment is feasible—or to monitor whether it is occurring.

There are encouraging signs of reform. The Comptroller and Auditor General has taken steps to improve reporting. The FC has emphasized bringing off-budget borrowing onto the books. Conditional transfers to local bodies are increasingly tied to audited accounts and disclosure.

But progress remains uneven. What is still missing is a system-wide approach to fiscal transparency—uniform classification standards, correct treatment of capital receipts, full disclosure of off-budget liabilities, consolidated accounts and clear reporting of subsidies and contingent liabilities.

Ultimately, fiscal transparency is not just about better data, but aligning incentives. When fiscal information is clear and credible, it supports both equalization and discipline. For the FC, this is essential. Strengthening fiscal transparency will strengthen the foundation on which it makes its decisions.

The author is a distinguished fellow at the Centre for Social and Economic Progress and was a member of the 15th Finance Commission.