FY26 Union Budget: Diversifies stimuli and rethinks fiscal consolidation

Government has shifted fiscal consolidation target from fiscal deficit to debt relative to GDP.

In brief

• The FY26 Union Budget introduced a stimulus of INR1 lakh crore by increasing household disposable income through rationalization of personal income tax rates.
• Central government wants state governments to be more active on capital expenditure and continues to provide 50-year interest free loans for states and allocate higher amount towards grants-in-aid for capital asset formation.
• In FY26, the GoI has adhered to its fiscal consolidation path by reducing the fiscal deficit to GDP ratio to 4.4% from 4.8% in FY25 (RE). 

Government of India’s (GoI) FY26 budget has been formulated in the context of continuing global economic headwinds, considerable uncertainties in India’s bilateral and multilateral economic relations and some signals towards a deceleration of growth. India’s real GDP growth fell from 8.2% in FY24 to 6.4% in FY25 as per the first advance estimates release by NSO. If we consider the mid-point of projected ranges of growth in the Economic Survey 2023-24 and that in 2024-25, there is a reduction in the real GDP growth of FY26 by 0.2% points to 6.55%¹ from 6.75% in FY25. Even nominal GDP growth in India has been showing a downward trend from 14.1% in FY23 to 9.7% in FY25 (Chart 1). In its FY26 budget, GoI estimates a nominal GDP growth of 10.1% for FY26, lower than 10.5% budgeted last year for FY25.

Macro arithmetic: reducing the fiscal deficit

The FY26 Union Budget took a realistic view of tax revenue growth in FY26. In view of the relief given through personal income tax rate revision and rationalization amounting to INR1 lakh crore and some revisions in customs duty structure, it provided for a downward revision in personal income tax buoyancy from 2.09 in FY25 (RE) to 1.42 in FY26 (BE). Overall, the buoyancy of gross tax revenues (GTR) has fallen for three successive years from 1.4 in FY24 to 1.15 in FY25 (RE) and further to 1.07 in FY26 (BE). As a result, growth in GoI’s GTR has kept falling from 13.5% in FY24 to 11.2% FY25 (RE) and further to 10.8% in FY26 (BE). Within GoI’s tax revenues, the growth rate of GST has also fallen from 12.7% in FY24 to 10.9% in FY26 (BE). Thus, the growth of resources available to the central and state governments has fallen over the last three years. Alongside, GoI’s access to resources through borrowing has also fallen both in terms of growth and relative to GDP. These trends together have led to a fall in GoI’s total expenditure relative to GDP from 15% in FY24 to 14.2% in FY26 (BE) (Table 1). In this scenario, the FY26 Union Budget has attempted to stimulate the economy through the consumption route while continuing to emphasize capital expenditure growth.

Stimulus: delineating channels

Until FY25, the GoI sought to introduce a stimulus through capital expenditure expansion, as it is known to have a higher multiplier. This strategy worked eminently in FY24 when capital expenditure growth was at 28% and real GDP growth was also at a relatively high level of 8.2%. This strategy was sought to be continued in FY25 also with a budgeted capital expenditure growth of 17.1% over CGA actuals. However, in terms of implementation, growth in capital expenditure as per the revised estimates could only be 7.3% in FY25. In tandem, the real GDP growth is estimated to fall to 6.4% in FY25. In the FY26 budget, for capital expenditure, only a 10.1% growth has been provided. As such, the GoI has shifted the route of stimulus from investment to consumption expenditure in the current budget. The additional household disposable income through income tax rate revisions is estimated to be INR1 lakh crore, which is the estimated magnitude of revenue foregone. This is expected to increase aggregate demand through a multiplier effect. The magnitude of the multiplier depends on the marginal propensity to consume of the households in the income ranges that are expected to benefit from this relief.  There are supplementary steps to further stimulate the economy through GoI’s capital expenditure. First, the GoI has continued with its scheme of on-lending through 50-year interest-free loans to states for undertaking infrastructure investment amounting to INR1.5 lakh crore. This will have an associated multiplier value of more than 3². Another route through which infrastructure spending is encouraged is through grants-in-aid to the states for capital asset formation budgeted at INR4.3 lakh crore.  Adding this to the GoI’s total capital expenditure, the effective capital expenditure is budgeted at INR15.5 lakh crore for FY26 as against INR13.2 lakh crore for FY25 (RE), reflecting a growth of 17.4%. In spite of these stimuli, the GoI estimates India’s nominal GDP growth to remain low at 10.1% in FY26.

How the Union budget 2025-26 impacts fiscal consolidation in India

The Budget FY26 has confirmed the announcement that was made in the July budget of FY25 that the GoI would now shift its target from fiscal deficit to an incremental reduction in the debt-to-GDP ratio. In the Annexure titled ‘Statements of Fiscal Policy as required under the Fiscal Responsibility and Budget Management Act, 2003’ alternative paths of the debt-GDP ratio with nominal GDP growth assumptions of 10.0%, 10.5% and 11.0% are given along with mild, moderate and high degrees of fiscal consolidation. In these alternative scenarios, the debt-to-GDP ratio falls to levels ranging from 47.5% to 52.0% by FY31.

If we consider the moderate scenario along with a 10.0% nominal GDP growth, we can derive the path of fiscal deficit to GDP ratio as falling from 4.4% in FY26 (BE) to about 3.5% in FY31 in incremental steps. The debt-to-GDP ratio would remain significantly above the FRBMA norm of 40% and the fiscal deficit norm of 3% of GDP. In fact, there would be additional pressure in FY27 on government finances, pertaining to both central and state governments, on account of pay and salary revisions. This is likely to derail the fiscal consolidation process further. Given the current trajectory, achieving the debt-to-GDP ratio target of 40% by the early 2040s appears challenging. But maintaining a higher debt-to-GDP ratio for an extended period of time would imply progressively higher interest payments relative to GoI’s revenue receipts, besides a relatively higher fiscal deficit to GDP ratio, which has been the trend in recent years. Further, the effective interest rate for the GoI is also increasing as they borrow on behalf of the states and pass it on to states at zero interest rate.