The 2026-27 budget is being presented at a time of rare macroeconomic stability in India—strong growth with low inflation. This is a result of the government prioritising economic stability over short-term growth imperatives: a conservative and predictable fiscal policy and better expenditure quality.
As the immediate impact of a reduction in fiscal deficits is to slow the economy, it can be politically costly. India bringing the deficit ratio back to pre-pandemic levels is a rarity among major economies. The medium-term impact, the result of the government limiting its borrowing, is to bring down interest rates. By first laying out a medium-term fiscal path and then sticking to it, the government has brought the cost of capital down to low levels rarely seen in non-crisis times (that it can be lower is another challenge that we will discuss later in this article). This is a remarkable achievement, as a high cost of capital has been a competitive disadvantage for the Indian economy over the past few decades.
The hard miles on fiscal consolidation have been crossed, and the annual reduction in the fiscal deficit need not be meaningful going forward to meet the government’s 50 percent debt-to-GDP ratio by 2031. From 0.5 percent of GDP in 2022-23, 0.8 percent each in 2023-24 and 2024-25 and 0.4 percent in 2025-26, the reduction in fiscal deficit need not be more than 0.2 percent in 2026-27. This means that the headwinds to economic growth from fiscal consolidation are now largely behind us. The Economic Survey prescribes a medium-term target of 6 percent for the government (Centre plus states), consistent with the government’s debt-to-GDP target, and is not very far away from the 6.6 percent we expect next year.
The 16th Finance Commission report tabled with the budget will affect the Union budget arithmetic, too, via transfers to states: the devolution ratio (share of centrally collected taxes given to states), grants and other transfers. Our 2026-27 budget assumptions assume a status quo.
In 2027-28, government spending on salaries and pensions would rise significantly once the Eighth Pay Commission recommendations are implemented. As the hikes are effective from January 1, 2026, arrears would need to be paid as well (possibly split between 2027-28 and 2028-29). This will make it harder to reduce debt-to-GDP by much in 2027-28 and possibly 2028-29 too, making 2026-27 the year for some heavy-lifting.
The necessity of staying on the stated fiscal path limits flexibility in the budget arithmetic, especially as meaningful changes to direct and indirect taxes are either unwise (frequent changes to personal or corporate income tax rates has deleterious effects over the medium term) or impractical (GST changes can only be done by the GST Council). Put together, interest costs, salaries and pensions, defence expenditure, and hard-to-cut subsidies (food, fertiliser) form the bulk of annual spending for the Union government; so there is limited flexibility on the expenditure side as well. The government has also guided to keeping capital expenditure consistent with the growth in nominal GDP—within this, though, a revival in the pace of ordering of national highways can be an important catalyst for growth.
As nominal economic growth in 2026-27 is expected to be better than in 2025-26 (inflation hit record lows, but a rebound is expected), growth in taxes should improve too. The steady increase in income-tax-to-GDP (5 basis points or one-hundredth of a percent annually from 2001 to 2019, and 20 basis points a year from 2019 to 2025) was disrupted by the tax cuts announced last year and should continue in the future. Improving corporate profitability should mean better corporate tax growth. Lower and simpler GST rates should boost compliance. Non-tax receipts should also be healthy, given higher seigniorage income for the RBI, and better public sector profitability.
As the deficit ratio falls, government’s ‘crowding out’ reduces further. The demand for government bonds from banks, pension and insurance funds as well as retail investors grows broadly in line with the economy. The government also has significant non-market borrowing (via small savings schemes), which is currently growing much faster than assumed in the last budget. If this were to persist, market borrowings next year can come in below what bond markets expect.
A challenge for the government and the RBI is that the benefits from politically difficult but necessary fiscal discipline are not adequately flowing through to the cost of capital in the economy: bond yields have risen in recent months despite rate cuts and continuing fiscal discipline. While there are many factors driving this anomaly, the government can help address a few of these. It must reduce the average maturity of bonds it issues and raise the share of treasury bills in its borrowing plan. The transition to just-in-time transfers to states, while well-intended, has caused disruptions in financial markets, and necessitates better management of the government’s own cash balances.
While the budget arithmetic may afford limited flexibility, the second part of the budget speech can provide excitement. Given the need to sustain strong growth for the next few decades, a period of stability is also an opportunity to take some policy risks. It is unwise to drive a broken car fast on a bumpy road; but with a new car, one can take risks to get faster to the destination.
The Economic Survey believes reforms can lift India’s potential growth to 7 percent from the earlier 6.5 percent despite the headwinds from global fragility, tariff uncertainty, AI-driven vulnerabilities and capital flow volatility. This is in line with our earlier estimates, but higher than the 6-6.5 percent assumption most forecasters worked with. The survey notes that State capacity is a binding constraint and prescribes a shift from a control-oriented regulatory state to a capability-driven enabling state.
An important area of reform needs to be urbanisation: the survey flags it as both an opportunity and a constraint, demanding governance, land use, digital and financing reforms to unlock productivity. Urban transformation is likely to define India’s productivity trajectory and institutional reforms, like in governance, zoning and finance, are as important as physical infrastructure. As per the UN, India’s effective urban population is already larger than China’s—this shapes labour markets, infrastructure demand and housing needs. However, ‘official’ urbanisation is a fraction of that number and lags other middle-income countries.
(Views are personal)
Neelkanth Mishra
Chief Economist at Axis Bank and part-time member of PM’s Economic Advisory Council