"The allocations to the scheme could see an increase by 20-30% in the upcoming budget," said the first person mentioned above.

The increase is being considered on the back of the record ₹2.11 trillion dividend that the Centre received from the Reserve Bank of India (RBI) last month, the people mentioned above said on condition of anonymity. 

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A big part of these loans, which were first introduced in FY21, began to be linked to reforms that the Centre wanted states to carry out since FY23.

In the latest iteration, several existing reforms linked to the scheme are likely to be scrapped, and new ones added to the list. These "will help the Centre better implement its policies at the state level", the second person mentioned above said.

"The reforms that need to be scrapped or updated are still being discussed. However, with regards to obtaining a large chunk of the funds under the scheme, states must ensure that they don't use these funds as a substitute for their capex," the second person added.

A finance ministry spokesperson didn't respond to emailed queries.

A matter of reforms 

In the interim budget for 2024-25 announced on 1 February, the Centre had earmarked ₹1.3 trillion for 'special assistance to states for capital investment', similar to FY24.

Of this amount, a chunk of ₹75,000 crore, or 58%, that is linked to outcomes and reforms by states is likely to be increased significantly in the upcoming annual budget. The remaining ₹55,000 crore in the interim budget came with "simple conditions" that were not reforms-linked.

Current reforms that states must meet include reforms in the housing sector, incentives for scrapping old government vehicles and ambulances, reforms in urban planning and urban finance, increasing housing for police personnel, and setting up libraries with digital infrastructure at panchayat and ward levels for children and young adults.

"The interest-free capex loans to states are often used to fund targeted investments across infrastructural segments. This will further drive up infrastructure spending and overall growth," the first person mentioned earlier said.

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States account for 20-25% of the overall infrastructure spending, a key focus area of the government, and the easy loans have helped states stimulate capital spending and catalyze the economy after the pandemic.

"The special assistance as loans to states for capital expenditure is an effective way of making the economy more progressive," said K. Lakshminarayanan, minister for public works of Puducherry, who represents the Union territory in GST meetings. "Normally, welfare schemes and committed expenses like salaries and pensions comprise 60-70% of the expenditure in our budget, leaving little for capital expenditure on infrastructure projects like roads, airports, railways and others." 

"However, Puducherry being a Union territory is not eligible for this loan. Our chief minister has written to the prime minister to make this loan available to us so we can spend more on infrastructure projects," Lakshminarayanan added.

"Since states account for roughly one-fifth/one-fourth of the infrastructure expenditure, this scheme will strengthen growth impulses, facilitate structural transformation, partly reduce regional imbalances and promote distributive equity within the constraints of the scheme," said Manoranjan Sharma, chief economist at rating agency Infomerics, and former chief economist at Canara Bank.

Special assistance scheme

The 'special assistance to states for capital investment' scheme was launched in FY21 to help states after the pandemic with an allocation of  ₹12,000 crore.

The Centre stepped up the allocation to the scheme to ₹15,000 crore in FY22 and dramatically scaled that up to  ₹1.07 trillion in FY23 with  ₹27,000 crore linked to specific reforms by states.

In FY24,  ₹1.3 trillion was earmarked for the scheme, and about  ₹30,000 crore of that allocation was marked as outcome-based.

The remaining  ₹1 trillion had the same condition as is being proposed for FY25—states had to ensure that the loan was used to supplement their own capex and not to substitute it.

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In FY24, 16 states had opted for the loan scheme—Arunachal Pradesh, Bihar, Chhattisgarh, Goa, Gujarat, Haryana, Himachal Pradesh, Karnataka, Madhya Pradesh, Mizoram, Odisha, Rajasthan, Sikkim, Tamil Nadu, Telangana and West Bengal. The central government's outgo was Rs 66,745.21 crore in 11 months (April 2023 to February 2024).

In its first year (FY21), according to finance ministry data, 27 states had availed this scheme, with the central government's outgo standing at Rs 11,830.29 crore, while 28 states availed the scheme in FY22, with the central outgo at ₹14,185.78 crore. In FY23, the outgo was Rs 81,195.35 crore, and 28states availed the loans.