A comprehensive analysis of state finances conducted by the Reserve Bank of India (RBI) presents a nuanced picture of fiscal health across India's states. The study indicates that while the consolidated fiscal deficit of states has experienced a modest widening in recent years, the funding landscape has transformed significantly, becoming more disciplined and increasingly reliant on market mechanisms. Furthermore, the growth potential and fiscal challenges vary dramatically between younger, demographically vibrant states and their more mature counterparts.
Fiscal Deficit Trends and Budgetary Projections
The consolidated gross fiscal deficit for Indian states reached a peak of 4.1% of GDP during the pandemic year of 2020-21. Following this, it moderated to below 3% for a three-year period before climbing again to an estimated 3.3% in the 2024-25 fiscal year. According to the RBI, this recent increase is primarily attributable to two factors: weaker revenue receipts, largely stemming from reduced grants provided by the central government, and a concurrent rise in capital expenditure by the states. It is important to note that part of this breach above the 3% threshold reflects the inclusion of special 50-year, interest-free loans extended by the Centre, which are classified as borrowing above the normal limits.
Looking ahead to the 2025-26 fiscal year, state governments have collectively budgeted for a deficit that remains at 3.3% of GDP. This projection assumes that anticipated higher revenues will be effectively offset by increased expenditure plans. Notably, this consolidated deficit figure remains within the central government's prescribed ceiling of 3.5% of GDP, which includes a specific 0.5% allowance linked to the implementation of power sector reforms by the states.
Significant Disparities in State-Level Fiscal Positions
Despite the aggregate figure remaining within bounds, the fiscal situation at the individual state level reveals stark contrasts. The RBI study highlights that sixteen states have budgeted deficits exceeding 3% of their respective Gross State Domestic Product (GSDP) for 2025-26. Alarmingly, thirteen of these states have projected deficits above the 3.5% mark, underscoring the highly uneven fiscal space and capacity across the nation. This disparity points to significant challenges in achieving uniform fiscal discipline.
The Dominance of Market Borrowing
A pivotal shift identified in the study is the emergence of market borrowing as the principal source of funding for state deficits. The RBI's analysis projects that market loans are expected to finance approximately 76% of the consolidated fiscal deficit in 2025-26. This represents a substantial increase from the period before 2016-17, when market borrowing financed just over half of the deficit.
The scale of this borrowing has grown consistently. Gross market borrowing by states rose by 6.6% to reach Rs 10.7 lakh crore in 2024-25. For the 2025-26 fiscal year, states have budgeted an even higher amount of Rs 12.5 lakh crore. Demonstrating this active borrowing, by the end of September 2025, states had already raised Rs 4.7 lakh crore from the markets, which is 21% higher than the amount raised during the same period a year earlier.
Improvements in Borrowing Profile and Costs
The quality and structure of state borrowing have also shown marked improvement. States are increasingly opting for longer-maturity securities, with a growing share of bonds issued with tenures beyond 10 and 15 years. Some states have even ventured into issuing paper with maturities exceeding 20 years, indicating improved market confidence and a focus on long-term liability management.
Concurrently, borrowing costs have eased. The weighted average yield on state government securities declined to 7.2% in 2024-25, down from 7.5% in the previous year. Additionally, the spread—or the premium—that states pay over central government securities narrowed to 30 basis points, reflecting a perception of reduced risk and greater fiscal credibility among lenders.
Strengthening Quality of State Finances
Beyond the deficit numbers, the RBI study points to a strengthening in the underlying quality of state finances. A key positive indicator is the sharp decline in the share of the revenue deficit within the overall gross fiscal deficit. This share has plummeted from 46.1% in 2020-21 to a budgeted 6.9% for 2025-26. This suggests states are borrowing less to cover routine expenses and more for productive investments.
Complementing this trend, the share of capital expenditure in total state spending has risen significantly. It has increased from 13.4% to a budgeted 18% over the same period, indicating a greater focus on building infrastructure and assets that can spur future economic growth.
Demography as a Key Fiscal Differentiator
The RBI analysis introduces demography as a critical factor shaping the fiscal trajectories of different states. The study categorizes states and outlines distinct challenges and opportunities:
- Younger States (e.g., Bihar, Uttar Pradesh, Madhya Pradesh): These states possess a significant demographic dividend, with a growing working-age population. This provides them with greater inherent scope to expand their revenue bases through economic activity and a broader tax pool, offering more fiscal headroom for growth-oriented spending.
- Intermediate States (e.g., Maharashtra, Karnataka): These economically developed states face the dual challenge of sustaining high growth rates while simultaneously preparing for the impending demographic shift towards an ageing population. Their fiscal policies must balance current investment with future social security needs.
- Ageing States (e.g., Kerala, Tamil Nadu): States with advanced demographic transitions are poised to encounter mounting fiscal pressures. Their tax bases may narrow as the proportion of the working population declines, while expenditures on pensions, healthcare, and social support for the elderly are set to increase substantially. This scenario necessitates a fundamental rethink of revenue generation strategies and workforce policies to ensure long-term fiscal sustainability.
In conclusion, the RBI's study paints a picture of a state fiscal landscape in transition—marked by increased market discipline, improved borrowing terms, and a strategic shift towards capital spending. However, the path forward is not uniform, with demographic realities creating divergent fiscal futures for India's diverse states, demanding tailored policy responses to ensure stability and growth.
