Youthful states build fiscal muscle; ageing states pay pension price

Demographics now drive state revenue, spending, debt: RBI report

India’s states are heading towards sharply different budgetary paths as population age structures begin to drive revenue capacity, spending composition, and debt dynamics, according to the Reserve Bank of India’s (RBI’s) latest State Finances: A Study of Budgets of 2025-26.

 

The report groups states into three categories based on the share of people aged 60 and above: youthful (less than 10 per cent), intermediate (10–15 per cent), and ageing (15 per cent or more).

 

Youthful northern giants like Bihar and Uttar Pradesh are riding a swelling workforce tide, with revenues reaching 19.5 per cent of gross state domestic product (GSDP). In contrast, southern ageing states like Kerala and Tamil Nadu are struggling with pensions consuming 30 per cent of social sector expenditure amid 30 per cent old-age dependency ratios (OADR), according to the report.

 

“The youthful states have a wider window of opportunity, benefiting from an expanding working-age population and stronger revenue mobilisation. In contrast, the window is narrowing for ageing states which face fiscal pressure from shrinking tax bases and rising obligations from committed expenditure,” the RBI observes.

 

The report notes that India’s median age of about 28 years masks sharp interstate differences, with OADR ranging from 14 in Bihar to 30.1 in Kerala. This demographic heterogeneity already appears in fiscal numbers when states are grouped by age structure.

 

Average revenue receipts of youthful states stood at 19.5 per cent of GSDP in 2024–25 (FY25), compared with 15.9 per cent for intermediate states and 12.6 per cent for ageing states, according to the report. Youthful states also recorded higher average tax revenues, at 14.3 per cent of GSDP in FY25.

 

“Public finances are highly sensitive to demographic changes. Changes in the population age structure can have a significant effect on fiscal sustainability since they can affect both government revenues and expenditures,” the report adds.

 

On the expenditure side, the RBI notes that in youthful states, education remains the largest component of social sector spending, and their revenue expenditure-to-capital outlay ratio has declined from 6.2 in 2015–16 to 5 in FY25. This indicates an improvement in the quality of expenditure and greater space for capital outlay.

 

The report links this to lower committed expenditure in these states, which “has generated greater fiscal headroom to prioritise demographically sensitive areas such as education, skilling, health, and infrastructure”.

 

In ageing states, by contrast, spending is more heavily skewed towards pensions and social security, with states allocating over 30 per cent of social sector expenditure to pensions — the highest among the three cohorts.

 

The interest payments-to-revenue receipts ratio — used by the RBI as a debt service indicator — has remained persistently lower for youthful states than for intermediate states, with the gap widening over time. Ageing states carry the heaviest debt-service burden, which the report says constrains spending flexibility and can “crowd out productive public spending, such as investment in human and physical capital”.

 

In Kerala, the challenge goes beyond an ageing population. Steady emigration of young people abroad for education and jobs is affecting growth rates, according to Madhavankutty G, chief economist at Canara Bank. “Education and awareness levels prompt couples to prefer a single child, which exacerbates the problem. And when growth suffers due to unfavourable demographics, the debt-to-gross domestic product ratio becomes unsustainable,” he adds.

 

Going forward, the RBI cautions that uniform fiscal strategies will not be adequate in this environment and calls for forward-looking policies incorporating population dynamics and related fiscal challenges. “Youthful states may harness their demographic dividend by strengthening human capital investment. Intermediate states may balance growth priorities with early preparation for ageing. Ageing states may enhance revenue capacity alongside healthcare, pension, and workforce policy reforms,” it recommends.