Managing Subsidies and Transfers for Sustainable Development in India

Expansion of subsidies and transfers

Recent fiscal trends indicate a divergence between the expenditure patterns of the central government and those of state governments. At the central level, subsidies increased sharply during the pandemic period due to emergency welfare measures, food security interventions, and elevated global commodity prices. Since then, subsidy expenditure at the central level has moderated.

Figure 1: Subsidies and Transfers, 2017/18 to 2024/25 (Revised Estimates)

GDP = gross domestic product, GSDP = gross state domestic product
Note: All fiscal data is obtained from publicly available state government and central government budget documents such as demand for grants and other statements submitted as part of the Union Budget; and GSDP from the National Accounts Division, Ministry of Statistics and Programme Implementation.
Source: Authors' estimates.

At the state level, however, subsidies and transfers have continued to increase steadily. A growing share of state expenditure is now directed toward recurring welfare commitments such as electricity subsidies, direct financial assistance, social pensions, transport subsidies, and targeted cash transfers.

The composition of subsidies also differs between the central and state governments. Central government expenditure remains concentrated on food and fertilizer subsidies, reflecting national priorities related to food security and agricultural support. State governments allocate a larger share of expenditure toward electricity subsidies, financial assistance programs, pension transfers, and food-related support schemes.

In their 2025/26 budgets, many states have either maintained existing schemes or introduced new ones. Moreover, allocations for several major programs have increased. As a result, total subsidies and transfers are likely to continue trending upward, particularly in certain states. Even when subsidies become fiscally unsustainable, such schemes may persist, as their rollback can be politically unpopular.

Electricity subsidies and fiscal pressures

Electricity subsidies represent one of the largest and most important components of state-level welfare expenditure. Subsidized or free electricity is commonly justified as a mechanism for improving affordability, supporting agricultural activity, and expanding access to essential services.

However, broad-based electricity subsidies also create substantial fiscal and structural challenges. In many states, electricity subsidies are not limited to vulnerable households and small farmers. A significant share of benefits is captured by relatively affluent consumers, particularly in states where free or heavily subsidized electricity is provided universally or with limited targeting.

Figure 2: Composition of State Government Subsidies as a Share of Gross State Domestic Product

GSDP = gross state domestic product.
Note: All fiscal data is obtained from publicly available state government and central government budget documents such as demand for grants and other statements submitted as part of the Union Budget; and National Income Accounts, Ministry of Statistics and Programme Implementation.
Source: Authors’ estimates.

This weak targeting reduces the efficiency and progressivity of subsidy systems. Higher-income households typically consume more electricity and therefore receive a larger share of subsidy benefits. As a result, universal electricity subsidies can produce regressive outcomes despite their stated redistributive objectives. Electricity subsidies also generate environmental and institutional concerns. Subsidized electricity for agricultural use contributes to excessive groundwater extraction and inefficient resource utilization in several states. At the same time, electricity distribution companies continue to incur substantial financial losses because tariffs often remain below the actual cost of supply.

Many of these subsidies are effectively off-budget, as they are absorbed by state-owned utilities rather than directly reflected in fiscal accounts. Continued accumulation of losses could eventually compel state governments to provide budgetary support to maintain the financial viability of electricity distribution companies. Some states, such as Assam, Gujarat, Karnataka, and Maharashtra, have introduced power sector reforms to manage subsidies and ensure the sector’s financial sustainability. Measures such as feeder separation, smart metering, improved collection efficiency, and other process improvements have proven effective in reducing losses and increasing revenue generation.

Consumption-oriented and investment-oriented subsidies

An important distinction in subsidy policy concerns the difference between consumption-oriented and investment-oriented expenditure.

Consumption-oriented subsidies primarily reduce the immediate cost of living through recurring transfers or subsidized access to goods and services. These measures can provide short-term relief and support household consumption during periods of economic stress. However, their long-term developmental impact may be limited if they do not improve productivity, human capital, or economic capacity.

Investment-oriented subsidies, by contrast, seek to strengthen long-term productive potential. Such measures may include support for renewable energy adoption, irrigation modernization, education access, public health systems, technology adoption, or infrastructure development. These forms of expenditure are more likely to generate durable economic and social returns.

The distinction between these approaches is important because governments face competing fiscal priorities. Expenditure directed toward recurring transfers may reduce fiscal space available for capital expenditure and growth-enhancing investment. Over time, this can weaken the capacity of governments to finance infrastructure, industrial development, logistics systems, and other productive sectors.

The relationship between subsidies and developmental expenditure is therefore central to fiscal policy. There is a strong positive correlation between subsidies and the revenue deficit, suggesting that states with higher subsidies also tend to have wider revenue deficits. Once introduced, subsidies and transfers often become relatively sticky components of current expenditure, making them an important driver of higher revenue deficits.

Universal and targeted welfare systems

Another major policy consideration concerns the design of welfare systems. Universal schemes are inclusive and simpler to administer, as they avoid the complexities of identifying and verifying beneficiaries by applying broadly across populations. However, they often distribute public resources inefficiently by extending benefits to households that may not require state support. Targeted systems, on the other hand, aim to direct benefits toward vulnerable groups using income criteria, demographic indicators, or digital identification systems. In India, the expansion of Aadhaar-linked Direct Benefit Transfer (DBT) mechanisms has strengthened the government’s capacity to deliver welfare more effectively.

Digital transfer systems reduce leakages, improve traceability, and enable governments to replace generalized price subsidies with direct income support. The growing use of DBT mechanisms reflects a broader transition in India’s welfare architecture toward more targeted and data-driven approaches. Certain states, such as Odisha and Maharashtra, deliver cash transfers to women through DBT, ensuring timely delivery of funds while reducing costs and misallocations.

Welfare expenditure and development strategy

The broader policy challenge is not whether governments should provide welfare support, but how welfare systems can be aligned with long-term developmental objectives.

Not all subsidies generate adverse outcomes. Food security programs, targeted pension schemes, educational incentives, public health support, and conditional transfers can produce substantial social and economic benefits when they are effectively designed and well targeted. Subsidies that address market failures or strengthen human capital can contribute to inclusive growth and long-term economic resilience.

At the same time, poorly targeted and fiscally costly subsidy programs may reduce the resources available for productive investment. Persistent expansion of recurring transfers can weaken fiscal sustainability and reduce governments’ ability to finance infrastructure, energy transition initiatives, urban development, and industrial modernization.

The quality of expenditure therefore becomes as important as the quantity of expenditure. Effective subsidy systems require clear targeting mechanisms, transparent fiscal reporting, regular evaluation, and alignment with broader developmental priorities.

The continued expansion of subsidies and transfers has important implications for India’s fiscal management and development strategy.

First, rising welfare commitments may increasingly constrain fiscal flexibility. Governments must simultaneously finance social protection, infrastructure development, energy transition, urbanization, and industrial growth. Sustained increases in recurring transfer expenditure may reduce the fiscal space available for long-term productive investment.

Second, aggregate subsidies and transfers at the state level have shown a steady increase. State governments account for a critical share of public expenditure on electricity subsidies, transport support, pensions, and direct financial assistance. Differences in fiscal capacity across states may therefore lead to uneven developmental outcomes and varying degrees of fiscal vulnerability.

Third, improvements in digital infrastructure and financial inclusion systems are likely to reshape welfare delivery in India. Aadhaar-linked DBT systems demonstrate the potential for more targeted, transparent, and efficient subsidy mechanisms. Continued expansion of digital delivery systems could help governments reduce leakages and improve beneficiary identification.

Fourth, greater transparency in subsidy reporting and fiscal disclosure will become increasingly important. A more comprehensive and standardized framework for measuring subsidies and transfers would improve the quality of fiscal analysis and strengthen public accountability. Improved reporting systems would also facilitate more meaningful comparisons across states and sectors.

Finally, the long-term effectiveness of welfare policy will depend on the extent to which subsidies support both equity and productivity. Subsidies that strengthen human capital, improve economic participation, support clean energy adoption, and enhance productive capacity are more likely to contribute to sustainable and inclusive growth.

By contrast, universal consumption-oriented subsidies with limited targeting may generate substantial fiscal costs without producing comparable developmental benefits. Over time, these expenditures may crowd out investment in infrastructure, education, health systems, and other sectors critical to long-term economic transformation.

India’s future development path will therefore depend on the quality of public expenditure and its efficiency. The design of subsidy systems, the targeting of welfare delivery, and the management of fiscal resources will play a central role in determining whether welfare expansion contributes to durable and inclusive economic development.

Asian Development Bank. 2026. A Study of Subsidies and Transfers in India.