The correct answer is 2: `spend more and more on interest payments`.

Here`s a run-down of each option:

Option 1: `Reduce expenditure of defence`: The data shows that defence expenditure decreased from 1989-90 to 1994-95. But it doesn`t necessarily mean that the economy is in poor shape due to this decrease; hence, this option is not correct.

Option 2: `Spend more and more on interest payments`: This choice correctly implies the country`s economy is under strain. The information shows a significant increase of interest payments from 1989-90 to 1994-95. This reflects the government`s borrowing, which is usually an indicator of economic stress, making this the correct option.

Option 3: `Reduce expenditure on subsidies`: The data shows that subsidies actually increased over the period. However, subsidies are a form of support to sectors, not a sign of the economy`s poor health, making this option incorrect.

Option 4: `Spend more and more as grants-in-aid to State Governments/Union Territories`: This data remained relatively stable over the period in question. Hence, it doesn`t support the assertion that the economy is in bad shape, making this option incorrect.