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Reserve Bank of India (RBI) | Ministry of Finance | NITI Aayog | Sixteenth Finance Commission (FC-XVI)
According to the Reserve Bank of India (RBI) report titled State Finances: A Study of Budgets of 2025-26, India’s subnational fiscal landscape is being fundamentally reshaped by a profound demographic transition. The report emphasizes that while consolidated deficits remain within prescribed limits, the diverging age structures of Indian states are creating distinct fiscal pressures and opportunities.
Consolidated Fiscal Position and Debt Dynamics States have budgeted a Gross Fiscal Deficit (GFD) of 3.3 per cent of GDP for 2025-26, maintaining the level seen in the previous year. This widening from the sub-3 per cent levels of earlier years primarily reflects the impact of 50-year interest-free loans from the Centre for capital investment, which are excluded from normal borrowing ceilings.
Liability Profile: Consolidated outstanding liabilities stood at 28.1 per cent of GDP in March 2024 and are projected to rise to 29.2 per cent by March 2026.
Expenditure Quality: There is a structural shift toward capital formation, with the Revenue Expenditure to Capital Outlay (RECO) ratio declining from 6.2 in 2015-16 to 5.0 in 2024-25.
The Demographic Turning Point and Divergent Transitions A central finding of the report is that Indian states are at vastly different stages of demographic transition, increasingly shaping their fiscal outlooks.
Youthful States (e.g., Bihar, UP, MP): Benefiting from an expanding working-age population, these states have a wide “window of opportunity” to harness a demographic dividend through investments in education and skilling.
Intermediate States: These states must balance current growth priorities with early preparation for an inevitable transition toward an ageing population.
Ageing States: Ageing states like Kerala and Tamil Nadu have already crossed the demographic turning point, defined as the stage where the share of the working-age population begins to decline. These states face a "narrowing window of opportunity" characterized by a shrinking tax base and rising committed expenditure, particularly for pensions and healthcare.
What is the “Demographic Turning Point” for Indian states? The demographic turning point refers to the specific year when the share of the working-age population (15-59 years) in a state’s total population begins to decline. While youthful states like Bihar will not reach this point until after 2031, ageing states like Kerala and Tamil Nadu have already crossed it, necessitating an immediate shift in fiscal policy toward elderly care and pension sustainability.
Emerging Fiscal Vulnerabilities Despite favorable debt sustainability indicators, several medium-term risks persist:
Committed Expenditure: Ageing states devote a significantly higher proportion of their budgets to pensions and administrative services, which can crowd out productive capital outlay.
New Pressures: The impending 8th Central Pay Commission awards (expected to impact finances from 2027-28) and rising climate-related risks present additional strain on state budgets.
Policy Relevance
The RBI report provides a strategic framework for the Sixteenth Finance Commission to consider demographic performance and elderly dependency as key criteria for equitable resource allocation.
Strategic Human Capital Investment: For youthful states, the priority remains scaling up education and health spending to ensure the burgeoning workforce is productive and contributes to revenue mobilization.
Workforce Policy Reforms: Ageing states may need to consider increasing retirement ages beyond 60 years and promoting the “silver economy” to mitigate the decline in labor supply.
Fiscal Consolidation Glide Path: Highly leveraged states must frame transparent, time-bound paths for debt consolidation to ensure interest expenses do not stifle investment in physical and social infrastructure.
Climate Budgeting: With nine Indian states among the most vulnerable to climate damage globally, mainstreaming climate budgeting is essential for long-term subnational fiscal resilience.
Follow the full report here: State Finances: A Study of Budgets of 2025-26