16th Finance Commission Outlines Fiscal Path with Emphasis on Long‑Term Capital Expenditure

The 16th Finance Commission has stated that building world‑class infrastructure will require sustained and elevated capital expenditure by both the Centre and the States. It emphasised that this level of investment will need to continue for “a decade or two” to support long‑term economic development.

The Commission’s recommendations focus on maintaining fiscal space for infrastructure while ensuring stability in public finances. It has outlined a multi‑year approach to achieving this balance for the period between FY27 and FY31.

Fiscal Glide Path Proposed for FY27–FY31

The Commission has recommended that the combined fiscal deficit of the Centre and States be set at 6.5% during FY27–FY31. It suggested that the Centre gradually reduce its fiscal deficit to 3.5%, while States maintain a limit of 3% annually beginning next fiscal year.

This glide path is designed to accommodate the heavy capex push while ensuring compliance with fiscal discipline norms. The Commission highlighted that these targets take into account the need for predictable budgeting and macroeconomic stability.

Treatment of Interest‑Free Loans in Deficit Calculations

The Commission clarified that the Centre’s eventual 3.5% fiscal deficit target will include a 0.5% impact from 50‑year interest‑free loans extended to States for capital expenditure. In contrast, the States’ annual 3% deficit target will exclude the fiscal impact of these loans.

This distinction reflects the Centre’s role in enabling additional State‑level capex without breaching their fiscal limits. The Commission stated that such arrangements are necessary to maintain adequate funding for infrastructure expansion across the country.

Rationale Behind the Combined 6.5% Fiscal Deficit

According to the Commission, States maintaining a revenue balance is essential for supporting the proposed deficit structure. It noted that a combined fiscal deficit of 6.5%, including the 0.5% on‑lending by the Centre, will be required to achieve the desired levels of capital expenditure.

This calculation incorporates the cumulative impact of both central and State finances on infrastructure creation. The Commission highlighted that this framework supports sustained investment while maintaining fiscal responsibility.

Current Borrowing Provisions and Near‑Term Fiscal Targets

At present, States are permitted additional borrowing beyond their 3% fiscal deficit limit to meet capital expenditure thresholds. For FY27, the Commission recommended a fiscal deficit target of 4.2% for the Centre.

It further advised that the Centre reduce this deficit by 0.2% annually until FY30, followed by a 0.1% reduction in FY31, ultimately reaching 3.5%. This phased approach aims to ensure a smooth transition toward fiscal consolidation.

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Conclusion

The 16th Finance Commission’s recommendations outline a structured long‑term approach to balancing fiscal consolidation with the need for continuous capital expenditure. Its projections highlight how both the Centre and States must coordinate fiscal strategies to maintain momentum in infrastructure building.

The framework also underscores the significance of interest‑free loans in supporting State‑level capex without breaching fiscal thresholds. As India advances toward FY31, adherence to these guidelines will shape the country’s broader macroeconomic stability.

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