FY27 Budget: Downward expenditure adjustments and slowing fiscal consolidation

Tax reforms and revenue sacrifice

Preceding the FY27 Budget, major tax reforms were undertaken in FY26 relating to PIT and GST, which had a revenue reducing effect. The PIT reforms-related revenue sacrifice was already budgeted although the revenue impact as given in the FY26 (RE) turned out to be larger than the budgeted magnitudes by INR1.26 lakh crore (Table1, Col. 10). In addition, the GST (CGST+IGST) revenue sacrifice is estimated at INR0.524 lakh crore in FY26 (RE). Thus, the tax revenue shortfall in GoI’s GTR amounted to INR1.925 lakh crore. This shortfall is partially shared with the states and their loss is estimated at INR0.295 lakh crore. Hence, the fall in the net tax revenues amounted to INR1.627 lakh crores (Col. 10). This shortfall was partly offset by higher non tax revenues, largely due to higher than budgeted RBI dividend revenues. However, non debt capital receipts were lower in FY26 (RE) on account of lower than expected disinvestment proceeds. Thus, non debt receipts fell short of the BE by INR 0.901 lakh crore in FY26 (RE). Fiscal deficit was also marginally reduced by INR0.104 lakh crore.

Downward expenditure adjustments

Given the shortfall in non‑debt receipts and the decision to retain the fiscal deficit to GDP ratio, the total adjustment needed on the expenditure side in FY26 (RE) amounted to INR1.005 lakh crore. Within this, revenue expenditure was lowered by INR 0.752 lakh crore and capital expenditure by INR 0.253 lakh crore, implying corresponding marginal reductions in government final consumption expenditure and gross fixed capital formation. 

FY27 Budget: Reduced growth

The FY27 Budget started with a lower base of tax revenues and expenditures in the FY26(RE). Growth in some key fiscal aggregates was raised in FY27(BE) over FY26 (RE) while that in FY26(RE) over FY25 was lower. While GTR is projected to grow by 8.0% in FY27(BE), its CAGR from FY25 to FY27 is only 7.7% (col(8) of Table 1). Net tax revenues show an even lower CAGR of 7.1%, implying buoyancy below one considering a nominal GDP CAGR of 9%. Consequently, primary revenue expenditure is shown to grow at a CAGR of only 4.6%, slightly lower than 4.9% in FY27(BE). Part of this reduction is due to lower subsidies.

One of the positive features is the increase in India’s defence spending, which shows a CAGR of 19.7%. However, most of this increase has already happened in FY26(RE), which shows a growth of 36.5%. In FY26 (RE), purchases of aircrafts and aeroengines accounted for an additional expenditure of INR28,415 crore over FY25. The growth budgeted for FY27 over FY26(RE) is only 5.1%, implying that total defence expenditure in FY27(BE) is only 2.0% of GDP, slightly lower than 2.05% in FY26(RE). To increase this to 3% of GDP, considered as a desirable norm, over the medium term, there is a need to augment the GTR-GDP ratio based largely on improved buoyancy and compliance. On the expenditure side, it may be useful to retain the emphasis on critical services such as health and education while continuing to rationalize committed expenditures.

Adjusted profile of fiscal consolidation

For FY27, given the revenue prospects and the need to maintain growth supporting capital expenditures, the pace of fiscal consolidation had to be brought down. The fiscal deficit to GDP ratio could be reduced only by five basis points from 4.36% in FY26 (RE) to 4.31% in FY27 (BE). A slowing pace of fiscal consolidation increases the period over which the FRBM (2018) targets of 40% of debt-GDP ratio and 3% of fiscal deficit to GDP ratio may be achieved. However, there is an annual cost to this adjusted fiscal consolidation path since the interest payment to revenue receipts ratio at nearly 40% in FY27 (BE) is high, pre-empting primary fiscal space for non-interest revenue and capital expenditures. 

There may be a need to re-examine the FRBM targets of fiscal deficit and debt relative to GDP which were last amended in 2018. This re-examination may look into two issues. First, there is an inconsistency in the debt-GDP ratio target of 40% for the central government vis-à-vis its fiscal deficit to GDP target of 3%; while states have a debt-GDP target of 20% and the fiscal deficit target of 3%. Since the underlying nominal GDP growth is common for the GoI and states, there is an issue of inconsistency. Second, over time there has been a steady decline in household sector’s financial savings relative to GDP from 11.2% in FY04 to 5.2% in FY24 (Table 2). The consequence of this is a narrowing down of the investible surplus of the economy which is almost pre-empted by the borrowings of central and state governments leaving little borrowing space for the non-government public sector or the private sector. 

16^th Finance Commission report: Vertical and horizontal dimensions

The 16th Finance Commission’s (FC16) report was tabled in Parliament along with the Union Budget. The FY27 Budget also indicates the impact of FC16 recommendations on state finances. Comparing FY27 (BE) with FY26 (RE), it is seen that there is a loss both in central tax devolution to states to the extent of (-)0.02% points of GDP and in FC grants to the extent of (-)0.10% point of GDP. The first loss arises due to the lower growth of GoI’s GTR. The second loss arises primarily due to discontinuation of revenue deficit grants by FC16. Thus, in terms of vertical transfers, there is a net loss to the state governments.

In terms of the horizontal dimension of tax devolution, there are two sets of states that have lost out when measured in terms of change in inter-se shares relative to FC15. The first set is the cost disadvantaged group consisting of six north-eastern states, namely Arunachal Pradesh, Meghalaya, Manipur, Nagaland, Sikkim and Tripura. The other group is a set of states characterized by relatively large population and lower fiscal capacity, namely Bihar, Chhattisgarh, Madhya Pradesh, Odisha, Rajasthan, Uttar Pradesh and West Bengal.