New Delhi, India | January 24, 2026
After maintaining fiscal discipline for three consecutive years, Indian states have seen their combined fiscal deficit cross the 3% mark, according to the latest report released by the Reserve Bank of India (RBI). The report states that in FY 2024–25, states’ fiscal deficit rose to 3.3% of GDP, reversing the earlier trend of remaining below the 3% threshold.
However, the RBI clarified that the increase does not indicate fiscal stress or poor financial management. Instead, it reflects higher capital expenditure, primarily due to states availing 50-year interest-free loans provided by the central government for infrastructure development.
Capital Investment Drives Deficit Increase
According to the RBI, the breach of the 3% limit is largely linked to borrowings under the Centre’s “Special Assistance to States for Capital Investment” scheme. These long-tenure, interest-free loans are over and above states’ normal net borrowing limits, leading to a temporary rise in fiscal deficit figures.
The central bank noted that such borrowing is aimed at productive asset creation, rather than financing revenue expenditure. For FY 2025–26, states have again budgeted a fiscal deficit of 3.3% of GDP, while targeting improvements in spending quality by curbing revenue expenditure and prioritizing capital outlays.
Debt Position: Moderation Followed by Mild Uptick
The RBI report presents a mixed but largely reassuring picture of states’ debt levels.
Phase of Decline: States’ consolidated liabilities peaked at 31% of GDP in March 2021, largely due to pandemic-related stress. Following fiscal consolidation efforts and favorable debt dynamics, this figure declined to 28.1% by March 2024.
Forward Outlook: Budget estimates project a moderate rise to 29.2% of GDP by March 2026.
Despite this expected increase, the RBI emphasized that debt sustainability indicators remain favorable, suggesting that states’ finances are still on a stable footing.
Demographic Transition: Emerging Fiscal Challenge
A key theme of this year’s RBI report is “Demographic Transition in India: Implications for State Finances.” The analysis highlights how changing population structures across states will significantly influence fiscal outcomes in the coming years.
The RBI categorized states into three broad groups and recommended differentiated policy strategies:
Young Population States: These states have a growing working-age population and stronger revenue potential. The RBI advised them to invest aggressively in human capital to maximize the demographic dividend.
Intermediate States: Such states should balance current development needs while preparing for an aging population in the medium term.
Aging States: These states face a narrowing demographic window, shrinking tax bases, and rising committed expenditures such as healthcare and pensions. The RBI urged them to focus on enhancing revenue capacity, workforce policies, and pension reforms.
Policy Roadmap for the Future
The RBI concluded that while the rise in fiscal deficit is driven by growth-oriented capital spending, states must align their long-term fiscal strategies with demographic realities. The analysis of FY 2025–26 budget estimates, the central bank noted, could serve as a policy roadmap for sustainable state finances in the years ahead.
