New Delhi . After keeping its expenditures under control for three consecutive years, the fiscal deficit of Indian states has once again increased. According to the latest report of the Reserve Bank of India, the total deficit of the states has increased to 3.3 percent of the GDP in the financial year 2024-25, which earlier remained below 3 percent. However, it is a matter of relief that this increase in deficit is not due to the poor financial condition of the states, but due to taking 50 years interest-free loan from the Central Government for development works (capital investment).

The RBI report points out that the deficit going above the 3 per cent limit is not necessarily a sign of poor financial management. This increase mainly reflects the 50-year interest-free loans given by the Central Government to the states under the Special Assistance Scheme for capital investment.
This borrowing is above the normal net borrowing limit of the states, which has had a direct impact on the fiscal figures.
Even for the upcoming financial year 2025-26, states have budgeted their gross fiscal deficit at only 3.3 per cent of GDP. However, during this period the target has been set to improve the structure of expenditure by controlling the revenue expenditure.

New challenges and opportunities for states
The central theme of this year’s RBI report was the demographic transition in India – implications for state finances. The report sheds in-depth light on how the changing demography of different states is impacting their coffers. RBI has advised states to adopt different strategies depending on the age of their population saying that younger states have a wider opportunity to take advantage of the growing working age population and stronger revenue generation capacity. RBI has suggested that these states should strengthen human capital investment to take advantage of their demographic dividend.
Intermediate states must prepare now for future population aging while balancing development priorities. The window for aging states is narrowing. They are facing fiscal pressures arising from shrinking tax base and committed expenditure on health care and pensions.

RBI has advised that such states should focus on workforce policy and pension reforms along with increasing revenue potential. This RBI report makes it clear that while on one hand the fiscal deficit has increased due to the incentives given by the Center for capital expenditure, on the other hand the states will have to adapt their future fiscal strategies according to the nature of their population. The report can serve as a roadmap for policymakers by analyzing the budget estimates for 2025-26.

-Signs of slight increase after improvement
On the total liabilities front of states, the report gives mixed but positive signals. Consolidated liabilities of states peaked at 31 per cent of GDP at the end of March 2021, which declined to 28.1 per cent by the end of March 2024 due to fiscal consolidation efforts and favorable debt dynamics. However, the budget estimates these liabilities to rise to 29.2 percent of GDP by the end of March 2026. Despite this, the central bank has stressed that despite debt levels being high, debt sustainability indicators remain favourable.