The Reserve Bank of India’s (RBI) yearly analysis of state finances is a wealth of information for anyone interested in fiscal federalism. This year’s analysis, which examines state budgets for 2025–2026, is no different.
Improving State Finances and Fiscal Health
The good news first. State governments’ financial situation is getting better. Indeed, after remaining below 3% for the preceding three years, their consolidated gross budget deficit increased to 3.3% of India’s GDP in 2024–2025. However, the Center’s 50-year interest-free loans under its special assistance program for capital investment are mostly to blame for this surge.
Simultaneously, states’ total outstanding liabilities decreased from a peak of 31% of GDP at the end of 2020–2021 to 28.1% at the end of 2023–2024.
Demographic Transition and State-Level Differences
This year’s study’s theme, “Demographic Transition in India—Implications for State Finances,” highlights the many stages of the country’s demographic transition. This inevitably affects their policies and revenues.
The percentage of their working-age population that is older, or their old-age dependency ratio, ranges from 14% in Bihar to 30% in Kerala. The ratio of fiscal deficits to gross state domestic product (GSDP) varies greatly as well, ranging from somewhat less than 3% in Gujarat to just over 8% in Arunachal. Because of this difference, distinct fiscal policy strategies that are appropriate for their different age structures are required. Additionally, it presents completely distinct financial difficulties.
📊 Demographic Transition & State Finances
- Theme: Demographic Transition in India
- Youngest State: Bihar (14% old-age dependency)
- Oldest State: Kerala (30% old-age dependency)
- Fiscal Gap: Deficits range from under 3% to over 8%
- Key Challenge: One-size-fits-all fiscal policy does not work
Opportunities for Young and Ageing States
Due to a growing working-age population and increased revenue mobilization, youthful states have a greater window of opportunity—but only if they embrace a favorable policy climate that prioritizes high-quality education, skill development, healthcare facilities, and employment possibilities.
Ageing states, on the other hand, confront a decreasing window due to budgetary challenges brought on by declining tax bases and increasing committed spending; this necessitates increased capacity for obtaining revenue as well as changes to labor, healthcare, and pension policies.
⚖️ Finance Commission & Population Criterion
- Commission: 16th Finance Commission
- Key Metric: Population-based revenue sharing
- Concern: Ageing states feel disadvantaged
- Impact: Rising inter-state fiscal tensions
- Need: Demographic-sensitive fiscal formulas
Migration, Representation, and Policy Silence
The impact of this disparity in demographic profiles on internal migration and the ensuing social conflicts between residents and migrants from populous states seeking employment are topics that the study does not address. It is also, understandably, quiet on another facet of divergent demographic trajectories: the consequences for political representation following the completion of the 2027 Census.
There is another reason why the study’s emphasis on the demographics of Indian states in relation to their economies is significant. It offers the background for an objective evaluation of the 16th Finance Commission’s (FC) proposals after they become public.
Finance Commission, Population, and Revenue Sharing
The Union and State lists in the Seventh Schedule of the Constitution explicitly outline how the Union and state governments share budgetary duties. On the revenue side, however, the distribution of revenues between the Union and the states is decided by the FC awards, which are made every six months.
All FCs have utilized “population” as one of the criteria for the sharing pattern among states thus far. The 16th FC’s report will likely include this as well. The reasoning behind this is that a state’s population directly affects the amount of money it must spend on general, social, and economic services. However, this has frequently caused conflict between governments that are further along in their demographic shift and those that are not.
Hopefully, the RBI study’s conclusion that we need diverse strategies to address different trajectories will lead to a more informed discussion on the 16th FC’s recommendations.
Frequently asked questions
1. What are the highlights of the RBI’s 2025–2026 state finance study?
The RBI analysis demonstrates that overall state fiscal health is improving, with reducing outstanding obligations, but it also draws attention to the increasing disparities in state fiscal demands brought on by unequal demographic aging.
2. Why do various states require varying budgetary allotments?
The demographic transition is happening at different stages in each state. While older governments must implement specialized fiscal plans due to the increased expenditures of healthcare, pensions, and social security, younger states must invest in education, skills, and employment.
3. What impact does aging have on a state’s financial situation?
States that are getting older have smaller tax bases and higher committed spending, which puts more strain on their finances. For long-term viability, revenue enhancement and expenditure reforms are therefore crucial.
4. Despite their demographic advantages, what difficulties do younger states face?
Younger states must make significant investments in human capital and job creation even though they benefit from a growing labor force. The demographic dividend may result in unemployment and financial strain in the absence of supportive policy.
5. Why is the Finance Commission’s population criterion controversial?
States that have effectively managed population growth are frequently disadvantaged by population-based income sharing, which exacerbates tensions between aging states and those with faster rates of population increase.
Conclusion
India’s diverse population necessitates distinct fiscal policies as opposed to a single budgeting strategy. Tailored revenue and expenditure strategies are crucial since the RBI’s study highlights the fundamentally different financial issues faced by youthful and aging nations.
Incorporating demographic realities will assist balance equity, efficiency, and sustainability—while reducing long-standing tensions between states at different stages of demographic transition—as the 16th Finance Commission completes its proposals.
Disclaimer:
This content is for informational purposes only and reflects analysis based on publicly available data. It does not constitute financial, legal, or policy advice.
