Most video games are large finite state machines (computers are finite state machines so you can't escape that part of it, just make it too big to see the box) while character 'actors' are very small ones because they're small parts of the game with high cost per significant state and transition, because those have to be explicitly scripted rather than emerging procedurally.
If you can use an LLM to make those actors able to react to more of the game's state, and also to respond to non-scripted player input? It could be different. And might make more-detailed NPC personal state more interesting, since the language model can actually present it in ways that would be infeasible for a writer. (Rewrite every line for each of a few dozen mood matrix possibilities...)
And then a bunch of this is "but it won't actually execute" to which I say all technologies are bad if you assume malfunction, and I am not going to play on that conversation node.
... so, the base problem remains, as it has always remained in this discussion, that somebody still need to program the NPC dialog stuff to interact with the rest of the game state.
It doesn't matter if it is a complicated finite state machine or an LLM, you still need to have the hooks made by the programmers for the details to be available.
Let me give an example: How do you make the NPC know how many times the player has broken a signpost?
Well, first you need a variable to track how many times that has happened. The game state itself doesn't know that detail unless it was programed to keep track of it.
Then you need to have that variable be explained to the NPC dialog system as the number of times a sign has been broken. This is either just a raw variable that is displayed in a text box unintelligently, a tree/table of variable responses based on number of signs broken, or a phrase that is provided to the LLM to prompt a response related to sign destruction.
At that point you can make accurate responses to how many signs have been broken by the player.
The LLM is more immersive than the first option, but harder to setup, and it is less controlled than the second option, while being a bit easier to setup. However, that is for a single check. There needs to be a setup LLM prompt detail for every part of the game state in order for your proposal to happen. A whole bunch of added complexity and context that is
created by the developers to support the LLM fed NPC dialog.
I understand that this sounds worth it to many, but I also suspect they have no idea how much work and effort that is for something that might not pay off at all.