The 16th Finance Commission has recommended that states cap their fiscal deficits at 3 per cent of gross state domestic product (GSDP) during 2026–27 to 2030–31, while warning against the growing use of off-budget borrowings that could undermine future financial stability.

In its report, the Commission said states should discontinue off-budget borrowings and bring all such liabilities onto their budgets. Where such borrowings are undertaken, it called for a formal framework for regular annual disclosure, preferably as part of the budget documents. It also recommended that the Comptroller and Auditor General include disclosures on off-budget borrowings in state finance accounts.

Flagging inconsistencies in state-level fiscal responsibility legislations, the panel urged states to amend their FRBM laws to align with the recommended consolidation path and to expand definitions of deficit and debt to capture off-budget liabilities. The commission said the 3 per cent ceiling on state borrowing should be strictly enforced.

It clarified that interest-free on-lending by the Centre to states under the Special Assistance to States for Capital Investment would remain outside the borrowing limit.

The Commission noted that states have increasingly relied on market borrowings to finance deficits in recent years.

On February 1, the Centre accepted the Commission’s recommendations and retained states’ share in the divisible tax pool at 41 per cent for 2026–31.