
The Union Budget for FY26 has been presented in the backdrop of a challenging domestic and global macroeconomic environment. The state of the economy appears to be in a cyclical slowdown led by weakening urban consumption, lacklustre job growth and an investment cycle by the private sector that is yet to turn broad-based. Further, the global geopolitical and geoeconomic environment has become extremely uncertain, with serious risks of disruption to global trade.
Nevertheless, India’s macroeconomic strength remains uncompromised. GVA growth is expected to bounce-back in H2 FY25, core inflation appears to be benign, and the current account deficit has been lower than its long-term trend with structural support from a rising and buoyant services export. Last, but not least, India, unlike many other countries especially in Europe and Latin America, enjoys political and economic stability.
Promises have been kept
Against this somewhat half-glass full/half-glass empty macroeconomic backdrop, the Finance Minister rightly chose to retain a focus on macroeconomic stability with a display of prudent fiscal management.
At the outset, the Finance Minister not only sprung a positive surprise by revising the current year’s fiscal deficit target lower by 10 bps to 4.8% of GDP, but also delivered on her promise of incremental consolidation and lowered the fiscal deficit target further by 40 bps to 4.4% of GDP in FY26. We note that, FY20 (which was partially impacted by the COVID-19 pandemic) had seen a higher fiscal deficit of 4.6% of GDP. Hence, it can now be inferred that a bulk of the post-pandemic fiscal stimulus has now been unwound. This will help India in preserving fiscal policy space, curb longer term inflationary pressures and take one step further towards a potential upgrade to its sovereign rating. International investors would welcome this tremendously at a time when fiscal policy could come under pressures in many countries, including the United States.
One distinguishing feature of recent fiscal compression has been the tight leash on revenue deficit, which in FY25 and FY26 is estimated and projected at 1.9% and 1.5% of GDP, respectively — both lower than the pre-COVID level of 2.4% seen in FY19. While a structural improvement in revenue receipts has helped in this journey, reduction in revenue deficit in FY26 is going to be achieved by the curbing of discretionary revenue expenditure — revenue spending, excluding interest, salary, pension, and subsidies, is budgeted to grow by just 3.2% in FY26, lower than the expected rate of inflation.
This appears to be a balancing act since the focal point of consumption stimulus in the FY26 Union Budget is the reduction in the personal income tax burden, which as per the Budget estimates would amount to ₹1 trillion of potential revenue forgone. We believe the actual support to consumption (predominantly urban) would be more than the accounting loss on account of the multiplier impact.
Focus on personal tax and implications
In fact when seen through the lens of optimism, the reduction in personal income-tax burden when juxtaposed with the upping of tax claim benefits for individuals for self-occupied houses (from one earlier to two from FY26 onwards) could trigger a much larger growth multiplier by channelling household savings to the real estate sector, which in turn is known to have a rich backward and forward linkage with the rest of the economy.
While there was some disappointment among market watchers with respect to the perceived cut in capex allocation, we are not perturbed. The capex allocation for FY25 was revised lower from 3.4% of GDP to 3.1%. However, the entire cut got front loaded due to the administrative exercise of the general election 2024 and government formation thereafter. We can now say that the lacklustre momentum in capex disbursals is behind us — notably, the central government disbursed ₹1.72 trillion in capex in December 2024, the highest monthly disbursal ever. For FY26, the capex budget has been maintained at 3.1% of GDP, giving a sense of continuity.
Notably, the capex-to-revex ratio, one of the key markers to judge quality of fiscal spending, is budgeted to increase to 28.4%, the highest in over two decades.
From an industry perspective, enhancement of classification thresholds for micro, small and medium enterprises, creation of national manufacturing and export promotion missions, establishing an investment friendliness index for States, and a focus on labour intensive sectors such as agriculture, leather, toys, and tourism and hospitality etc. would provide a fillip to sentiment.
The Economic Survey’s influence
Further, a holistic feature of FY26 Budget lies beyond the numbers it projects. Intangible gains could be reaped, which if implemented and executed well, would boost productivity levels in the economy in the longer run. A focus on next generation ease of doing business measures, a simplification of the tax architecture (including various decriminalisation measures), and migration towards a light-touch regulatory framework in the non-financial sector are some of the steps that appear to have been imbibed from the Economic Survey.
While the Union Budget ticks most of the boxes, the long-term fiscal policy strategy remains less articulated. The central government is expected to switch to a debt targeting framework from FY27. As per the Budget documents, the endeavour would be to keep fiscal deficit in each year from FY27 such that the central government debt is on a declining path towards 49%-51% of GDP range by FY31 versus 56.1% projected for FY26. While this approach would impart operational flexibility in the conduct of fiscal policy, it could also infuse some volatility in market reaction function.
Vivek Kumar and Yuvika Singhal are with QuantEco Research
Published – February 02, 2025 12:08 am IST