RBI report assesses state finances, demographic transition implications

The Reserve Bank of India (RBI) has released its 'State Finances: A Study of Budgets of 2025-26' report. The report provides a comprehensive assessment of state government finances, focusing on the implications of India's demographic transition.

Fiscal deficit rises, capital spending sustained

States' consolidated gross fiscal deficit increased to 3.3 percent of gross domestic product (GDP) in 2024-25, after remaining below 3.0 percent during the previous three years.

This increase mainly reflects 50-year interest-free loans from the Centre under Special Assistance to States for Capital Investment, which is over and above the normal net borrowing ceiling.

For 2025-26, States have budgeted a gross fiscal deficit of 3.3 percent of GDP, maintaining the elevated level.

The thrust on capital expenditure was sustained, remaining steady at 2.7 percent of GDP in 2023-24 and 2024-25, and is budgeted to rise to 3.2 percent of GDP in 2025-26. However, the consolidated outstanding liabilities of States remained elevated in the post-pandemic period, with a budget estimate of 29.2 percent of GDP at end-March 2026, indicating ongoing fiscal challenges despite investment efforts.

Demographic shifts shape state finances

The report highlights how India's states are at different stages of demographic transition, profoundly shaping their financial outlooks.

Youthful states benefit from an expanding working-age population, offering a wider window of opportunity for stronger revenue mobilisation, which can be leveraged through increased investment in human capital.

Conversely, ageing states face a narrowing demographic window, encountering fiscal pressures from shrinking tax bases and rising committed expenditures.

These states require higher revenue capacity and reforms in healthcare, pensions, and workforce policies.

Intermediate states must balance immediate growth priorities with early preparation for the challenges of an ageing population, ensuring long-term fiscal sustainability.

A ticking demographic fiscal clock

The RBI's report underscores a critical juncture for state finances, where demographic realities are rapidly becoming fiscal imperatives.

While capital expenditure is commendable, the persistent high fiscal deficit and elevated liabilities, particularly in ageing states, signal an urgent need for structural reforms beyond central assistance.

Without proactive policy adjustments in revenue generation and expenditure management, India's demographic dividend risks becoming a significant fiscal burden for many states.