WHICH Indian state sounds more likely to repay a loan: Bihar, the country’s poorest, with a budget deficit of nearly 6% of its state GDP last year and a hole in its finances after it banned alcohol sales; or Gujarat, a relatively prosperous coastal region with a deficit nearer to 2%? According to bond markets at least, both are equally good credits, and so pay the same interest rate. As welcome as such mispricing might be to the Bihari authorities, it is brewing trouble for the rest of the Indian economy.

The borrowing habits of Bihar, Gujarat, and India’s 27 other states used to be below the radar of all but the pointiest financial eggheads. The indebtedness of India, and its annual budget deficits—both high by emerging-market standards—could largely be blamed on the profligacy of the central government in Delhi. But an explosion in the net amounts borrowed by states over the past decade (see chart), from 154bn rupees in 2006 ($3.5bn then) to an estimated 3.9trn in the fiscal year just ended ($60.4bn now), means they now require nearly as much funding as the centre.

The shift in financial gravity from Delhi to the states is fraught with problems. For one, there is a data vacuum: state-budget documents are compiled, if at all, by central authorities after over a year’s delay. And though the central government has done its utmost to pare the country’s budget deficit, mindful that interest payments guzzle up around a third of central-government tax revenue, state chief ministers have spent much of the saving. That has left the combined state- and central-government budget shortfall at the same level (see chart)—and India’s credit-rating stuck just one notch above “junk” territory.

Investors are lending money to all the states at the same rate for good reason: the central government, through much nudging, winking and head-shaking, has indicated it will look after them if the states default. It also compels publicly owned banks, pension funds and insurance companies to pile in. So states’ chief ministers have every incentive to binge on the artificially cheap debt; a 3% annual deficit cap is waived as often as it is enforced.

Some states are running deficits because of sagging revenues. A handful plan to copy Bihar’s prohibition, although booze brings in over a quarter of some states’ income. The sudden “demonetisation” of the economy in November stalled construction, and so stamp-duty receipts. Increased central-government transfers have made up only part of the shortfall.

Runaway expenditure has a bigger impact. Not all the spending is wasteful: states have sensibly restructured the debts of power-distribution companies, an expensive but worthwhile exercise. But much is politically indulgent. Most of the new outlay is about current expenditure rather than on growth-enhancing capital investment, says Pranjul Bhandari of HSBC, a bank. A pay rise to central-government civil servants is expected to be matched by states. Some spending is outright populist, notably the waiver of repayment of loans to farmers recently enacted in Uttar Pradesh, the biggest state, at a cost of over 2.5% of its GDP. Worryingly, other states are contemplating this, raising the risk of what Ms Bhandari calls “competitive populism”.

The states’ profligacy pushes up the interest rates the central government has to pay, because of the risk it will have to bail out a wayward state. But it has a wider impact. In India capital is scarce, and foreign inflows restricted, so states compete with companies and consumers hoping to borrow from the same sources. Because states’ bonds are less liquid than the central government’s, they pay a slight premium to attract investors. That used to be around 0.4 percentage points, but has swollen to just under 1 percentage point recently.

Sajjid Chinoy of JPMorgan Chase, a bank, says that increase has in turn affected how much it costs companies to issue bonds. Why lend to a company such as Tata or Reliance or to a homebuyer at 1% over what the central government pays to borrow, if lending to any state government yields the same and bears an implicit guarantee from Delhi?

Companies rely predominantly on bank finance. But banks are undercapitalised, their equity cushions wiped out by rash lending. By hogging the money investors such as pension funds and insurance firms could be investing in companies, states have made it harder for those companies to move away from bank borrowing to bond issuance. That in turn makes it more likely that the government, which owns most of the banks that do most of the lending, will have to inject more capital into them, so worsening the deficit in yet another way.

Crunching data from disparate states, Mr Chinoy says state borrowing rose by a whopping 32% in the year to March 2017, after a 25% rise in the previous year. Even in a fast-growing economy, that is enough to set nerves jangling. To convince states to enact a nationwide goods-and-services tax from July, the central government has committed to guarantee the revenues received by states for five years. If only it had struck a deal to limit their spending instead.