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How FY27 Budget can sustain India’s growth momentum while pursuing fiscal consolidation.
In brief
- First Advance Estimates (FAE) for FY26 put India’s real and nominal GDP growth rates at 7.4% and 8.0%, respectively.
- It may be possible to meet the budgeted fiscal deficit target of 4.4% of GDP with some cuts in revenue expenditures.
- A further reduction in fiscal deficit of 0.4% points of GDP may be expected in FY27.
- A slight fall in revenue expenditure to GDP ratio can be expected while maintaining the capital expenditure to GDP ratio in FY27.
Recent growth performance: India’s key macroeconomic challenges
NSO’s First Advance Estimates (FAE) for FY26 indicate a narrowing of the difference between nominal and real GDP growth rates for India at 8.0% and 7.4%, respectively (Chart 1). Real growth is primarily led by investment comprising both private and government, as captured by growth of gross fixed capital formation (GFCF), estimated at 7.8% in FY26. The growth of private final consumption expenditure (PFCE) was also high at 7%. Thus, while domestic demand strongly supported growth, the contribution of net exports was negative at (-)1.9% points.
On the output side, it was the services sector followed by the manufacturing sector with growth rates of 9.1% and 7.0%, respectively, that led the overall GVA growth. The three main services sectors, namely trade, transport et al., financial and real estate et al., and public administration et al., showed growth rates of 7.5%, 9.9% and 9.9%, respectively.
With implicit price deflator-based inflation at only 0.5%, the consequently low nominal GDP has significant implications for the FY26 budget aggregates which would serve as the base for the FY27 budget estimates.
Evolution of GoI’s fiscal contours: key structural changes
The GoI has carried out extensive structural fiscal reforms in the last decade, affecting both the revenue and expenditure sides of the Budget. Tax reforms include implementation of GST in 2017, corporate income tax (CIT) reforms in 2019, and personal income tax (PIT) rate reform and GST 2.0 in 2025. The effective tariff rate of import taxes has been reduced over time[1]. The Direct Tax Code as per the Income Tax Act, 2025 will also be effective from 01 April 2026. Together these reforms almost complete the current generation of tax reforms in India. On the expenditure side, there has been a notable structural shift from revenue to capital expenditures. With respect to fiscal consolidation, in the FY26 Budget, the annual targeting strategy was changed to focus on a reduction in the debt to GDP ratio rather than the fiscal consolidation targets of the FRBM Act 2018.
The following trends with respect to the fiscal aggregates over the period FY13-FY25 are notable.
- The share of indirect taxes in total GoI’s gross tax revenue (GTR) has fallen from 46.1% to 41.5% while that of direct taxes increased from 53.9% to 58.5%.
- The share of PIT revenues in the GTR exceeded that of CIT in FY23. By FY25, the share of PIT at 32.5% exceeded that of CIT by 6.5% points.
- The share of revenue expenditure in total expenditure has fallen by 10.8% points from 88.2% to 77.4%, led primarily by a fall in government subsidies along with defence revenue expenditures.
- The share of primary revenue expenditure has fallen from 65.9% to 53.4%, a fall of 12.5% points.
- The share of capital expenditure in total expenditure has increased by 11.0% points from 11.8% to 22.6% attributable mainly to a faster increase in non-defence capital expenditure as also that in loans and advances.
Alongside, the following may be identified as significant macroeconomic structural changes during the period FY14 to FY26:
- Together, total final consumption expenditure in real terms fell by a margin of nearly (-)1.6% points of GDP, led by a (-)1.7% points fall in GFCE.
- GFCF to GDP ratio showed a marginal fall in real terms with its level at nearly 34.1% in FY13 and about 33.8% in FY26.
Compulsions of the Budget arithmetic
The lower nominal GDP growth along with the impact of GST 2.0 is expected to lead to a shortfall in GoI’s GTR in FY26. However, with some revenue cushion from RBI’s higher dividends and also some additional revenues on account of the newly introduced central excise tax on tobacco and tobacco products and the Health Security and National Security cess, it may be possible to meet the budgeted fiscal deficit target of 4.4% of GDP in FY26. For FY27, a further reduction of 40 basis points in the fiscal deficit to GDP ratio is possible assuming an underlying nominal GDP growth of 9.5%, a GTR buoyancy of 1, along with some downward adjustment in revenue expenditure to GDP ratio while maintaining capital expenditure to GDP ratio.
Challenges to fiscal consolidation in India
In the Medium Term Fiscal Policy cum Fiscal Policy Strategy Statement (MTFPFPSS) of FY26 Budget, the Budget had indicated mild, moderate and high fiscal consolidation adjustment paths with alternative assumptions regarding nominal growth rates of 10%, 10.5% and 11.0% in the next five years. This may need to be revised in view of the likelihood of the nominal GDP growth being lower.
The relatively low nominal GDP growth in FY26 has implications for GoI’s strategy of targeting an annual reduction in the debt to GDP ratio. Calculations show an increase in the GoI’s debt to GDP ratio from 56.0% in FY25 to 56.1% in FY26 even if the fiscal deficit target of 4.4% is achieved.
Chart 2 shows a medium-term profile for the GoI’s debt and fiscal deficit paths relative to GDP assuming (1) a nominal GDP growth of 9.5% in FY27, and 10% thereafter and (2) a continuing reduction in the fiscal deficit to GDP ratio in the range of 35-40 basis points per year for the next four to five years. This may enable to reach a fiscal deficit of 3% of GDP by FY30, after which it may be stabilized at this level. Then, the rate of reduction in the debt to GDP ratio would depend on the profile of nominal GDP growth. It is also notable that from a saving-investment perspective, as GoI’s fiscal deficit goes down to 3% of GDP, additional investment space will open up both for the private corporate sector and the non-government public sector.
Maintaining capital expenditure momentum, options for revenue expenditure compression
Considering government spending, against an estimated full year revenue expenditure of INR39.4 lakh crore, only INR20.1 lakh crore has been spent during April-October FY26 (Table 1). This is 50.9% of the budget estimate. With respect to the capital expenditure outlook, out of a budgeted amount of INR11.2 lakh crore, GoI has spent INR6.2 lakh crore. In growth terms, while GoI’s capital expenditure grew by 32.4% during April-October FY26, revenue expenditure growth was contained to only 0.026%. A supplementary demand amounting to additional expenditure of INR41,455.4 crore may also have to be accommodated(2).
In order to adhere to the fiscal deficit target in the backdrop of some shortfall expected in GTR and net tax revenues, the GoI may spend less than the budgeted amount as far as revenue expenditures are concerned. With respect to capital expenditure, GoI may endeavor to meet the budget target.
Budgetary support to growth for FY27 and the medium term
India’s medium-term growth prospects are characterized by continuing external demand uncertainty accompanied by reliable domestic growth drivers. An impressive phase of post-Covid infrastructure expansion has led to progressive reduction in the logistics costs for the production sectors of the economy. Real investment to GDP ratio has remained stable at 34.0% of GDP and the incremental capital output ratio has averaged around 5.0.
From a medium-term perspective, the impact of the recommendations of the 8th Pay Commission and those of the 16th Finance Commission (to become applicable with effect from 01 April 2026) may need to be incorporated.
For the objective of Viksit Bharat, fiscal policy may be able to play a key role while keeping certain changes in focus:
- The share of capital expenditure in total GoI expenditure may be increased further, but changing its composition in favor of advanced technology sectors such as AI, Gen AI, space, robotics and advanced infrastructure as also defence capital expenditure.
- This should be financed largely by progressively increasing the GTR-GDP ratio primarily based on improved compliance and buoyancy and not through additional structural tax reforms.
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Summary
Fiscal consolidation may be continued while emphasizing an improvement in the composition of GoI’s capital expenditure, to support a robust medium-term growth.
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