Aligning India’s defense spending to the Viksit Bharat vision

Listen to our podcast on why India’s defence spend dropped from 2.9% to 1.9% of GDP (FY26 BE) & how a non-lapsable fund could realign to Viksit Bharat goals.

Key takeaways

India's defence spending has dropped from 2.9% of GDP in 2002–03 to 1.87% in FY26 (BE).
The capital expenditure component of defence spending has been consistently declining.
Russia and the US spend over 3% of GDP on defence—India falls below this global benchmark.
Parliamentary Standing Committee (2022–23) recommended a benchmark of 3% of GDP for India’s defence allocation.
Transfers to states have steadily increased, reducing the fiscal space available for expenditures such as defense.
Multiplier effects of defense spending in India are lower due to import dependency but could improve through domestic manufacturing and private sector involvement.
To address volatility and underutilization, FC15 recommended setting up a non-lapsable defense fund.
The Government of India accepted this recommendation in principle, but the fund is yet to be operationalized.
The model for this fund is based on the National Calamity Contingency Fund (NCCF), justified by similar needs: unpredictability, shared responsibility, and sustained replenishment.

For India to realize its ambitions as a secure and developed nation, prioritizing and modernizing defence expenditure will be essential. A long-term, stable financial framework can help achieve this goal while strengthening national preparedness and resilience.

Dr. D. K. Srivastava

D. K. Srivastava EY India Chief Policy Advisor

For your convenience, full text transcript of this podcast is available below.

Ragini Trehan

Welcome to the EY India Insights podcast. I'm your host, Ragini, and in this episode, we try to examine whether defense funding in India is adequate in the context of requirements for a Viksit Bharat. To facilitate this discussion, we are joined by Dr. D.K. Srivastava, a distinguished economist, Honorary Professor, Madras School of Economics and Chief Policy advisor at EY India. A very warm welcome, sir.

D.K. Srivastava

Thank you. Thank you. Ragini.

Ragini

My first question to you is that India has historically spent around 2% of its GDP on defense. Now, is this optimal? And if not, what would be the optimal level of defense funding?

D. K. Srivastava

Well, in order to address this question, we should look at the pattern of spending on defense by the central government. At its peak in 2002-2003, the share of defense expenditure as a percentage of nominal GDP was as high as 2.9%, but this share steadily fell all the way up to 1.9% of nominal GDP in 2025-26 budget estimates.
Thus, there has been a fall on trend basis, and because of this, it is very difficult to say that India has been maintaining a commitment to defense expenditures that is adequate or as per requirement. In fact, sometimes a benchmark of 3% of nominal GDP is given for defense expenditures. In a number of countries, in the US and Russia, they have been maintaining over a long period of time 3% of GDP for their defense expenditures. We have to also look at the neighborhood conditions and study what are the broad geopolitical conditions that India is facing or is likely to face in the near future. Given the current volatility in the global geopolitical situation, it is probably useful to go back to a level of 2.9% or even more.
In order to ensure that defense expenditures are adequate for India in this context, it is useful to refer to the recommendation of the Parliamentary Standing Committee on Defense, which had suggested in its report for 2022-23 a global ideal is 3% of nominal GDP. And that should also be considered as the relevant benchmark for India.
So, we have to aim at 3% of GDP. Right now, we have come down to 1.9%.

Ragini

My next question to you is what are the key factors responsible for the decline in the share of defense expenditure in Government of India's total expenditure?

D. K. Srivastava

Well, one way of looking at this is to look at the different components of government expenditure from out of what I would call as Government of India’s total fiscal space. Now that fiscal space can be considered as consisting of total central government expenditure plus total tax devolution that is financed by tax and not tax revenues and not debt capital receipts as well as annual borrowing.
So, this is the financing of total fiscal space in which central government's net expenditures are included, but also tax devolution is included. It is important to consider the overall control on revenue resources to study why defense expenditures declined. Now you will notice that in this total fiscal space, there has been an increase overtime. From 16.1% in FY 2000-01 to 18.4% in FY 26 budget estimates.
Now from this, apart from the Center's net expenditures, there is a there are two main items that we can consider separately. One is net interest payments made by the central government and the other is transfers to states. Now, net interest payments have been stable in the range of 18.1% to 18.5% of the total fiscal space over the years.
On the other hand, the transfers to the states have increased over time. And in fact, there was a noticeable bulge in the period that was governed by the recommendations of the 14th Finance Commission. In fact, in that period, this bulge amount claimed their share of 35.9% of the total fiscal space.
In fact, if we look at the period from FC 11, when this share was only 25.4%, then it increased to 28.8% in FC 12 period, 29% in 13 period, and then all the way up to nearly 36% in the FC14 period. Since then, it fell marginally in the FC 15 period to 32.4%, but it is the inordinate rise of transfers to the state governments from out of the total fiscal space available for the central government that is accompanied by a fall in the share of defense expenditures.
So, one way of looking at this issue is to consider, as if defense expenditures have been crowded out by an inordinate rise in transfers to the state governments.

Ragini

So, very relevant points. My next question is, what would an increase in defense expenditure mean for India's economic growth?

D. K. Srivastava

Well, the relationship between defense expenditure and growth really depends on the empirical context in which this relationship is being studied. If we are dealing with a country in which a lot of defense production activities are domestically located, then the expectation is that there would be considerable input output effects, which would lead to high multiplier values.
On the other hand, if a country is really importing most of its defense needs, particularly defense capital assets, then most of the benefit of defense expenditure would be accruing to the countries from where the defense capital assets are being imported. Now, in India, we are going through a period in which a major transformation is taking place and multiplier values.
In fact, many multiplier values have been estimated in recent studies of the relationship between defense expenditure and growth in India. And these values differ across studies. But, as India is moving from a net, a large importer of defense assets to a situation of domestic production of defense capital, the multiplier values are improving and increasing and becoming larger than one.
We should study this issue in the context of India's Atmanirbhar strategy as more and more defense capital assets are to be produced within India, the multiplier values associated with defense expenditures will become higher than one, and then higher allocations for defense expenditures would have a positive impact on growth. So, I would consider that in the context of India's Atmanirbhar strategy, and in fact, even an increase in defense exports, we should expect that defense expenditures will have a positive impact on growth as more and more exports and less and less imports of defense capital assets are involved.
So, I would say two things. One is dependance, on the other one is Atmanirbhar strategy. And second is the change in this structure of defense expenditure as between defense revenue expenditures and defense capital assets. The larger the allocation for defense capital assets out of the total defense expenditure, the higher would be the positive spinoff for growth.

Ragini

Thank you for explaining these concepts in a very simple and clear way. So, my last question in this series is growth in defense expenditure is quite volatile, lumpy in some years and quite low in some other years. Now, how can this annual variation in defense expenditure can be overcome?

D. K. Srivastava

Defense expenditure has been volatile because of a lot of constraints on defense procurement and lots of administrative rigidities and so on. Now we have to ensure, given the current geopolitical situation, that our defense preparedness is quite robust and it does not depend on this kind of annual variation in the allocation of resources for defense.
For this purpose, in the context of the 15th Finance Commission, the Government of India raised an additional term of reference and asked the Commission to examine whether there is a case to set up a non-lapsable, earmarked fund for defense so that a certain portion of budgetary resources can be placed into the fund. And, then from out of the fund, defense expenditures can be undertaken. So, in a year where defense expenditures fall short of the budgetary allocation, whatever is the balance left would go into the fund. And this can be utilized over and above the current budgetary allocation, in later years.
That is a mechanism by which the allocations can be ensured, over time and there would be a stability that can be imparted to allocation of resources for defense purposes.
Now, this issue was examined by the 15th Finance Commission. They came out in favor of recommending setting up such a non-lapsable earmarked defense fund and as far as the Government of India is concerned, in its action taken report, it accepted those recommendations.
However, so far this recommendation has not been actually implemented or actualized. So, this is the reason why we are still waiting for setting up of such a fund. But in my view, it is important to earmark a constant allocation of budgetary resources. And if we go by the recommendation of the Parliamentary Committee, every year we should allocate 3% of GDP equivalent and draw it and place any shortcoming of this benchmark into the fund.
So, the allocation would be fixed. And depending on any surplus available, it can go into the fund for expenditure later in the later years. Also, in addition to normal budgetary allocation, we can have contributions from the private sector and we can constantly replenish this fund if there is any year in which the funds fall short of the target of 3%.
In fact, there is a precedent, also recommended by earlier Finance Commissions of setting up such a fund in the context of National Calamity Contingency Fund. So as far as national calamities are concerned, we already have one of these nature and defense should be considered of a similar status because it is the defense requirements often arise in an unanticipated way.
It is when this need arises, it is often in the nature of a calamity, and therefore our preparedness should not really depend on, as in, when the calamity occurs. Instead, it has to be financed by a mechanism such that a stable and robust defense preparedness can be given for India.

Ragini

These are extremely insightful perspectives. For the benefit of our listeners, I list out the key takeaways from this session.

There has been a fall in India's defense expenditure from nearly 3% of its GDP in the initial years of the decade of 2000 to almost 1.9% in FY26 budget estimates, and this is considerably lower than the benchmark of 3% of GDP.
There are also large annual variations and the pattern of growth of different components of defense expenditure.
Third, given the current geopolitical situation, it is desirable for India to allocate higher budgetary resources to defense and ensure that the share of capital expenditure in total defense expenditure increases.
And lastly, in order to overcome year to year volatility in growth of defense expenditure, it may be useful to institute a non-lapsable fund for defense and internal security as recommended by the 15th Finance Commission, just like the existing National Calamity Contingency Fund.

Thank you very much, sir, for joining us in this session.

D. K. Srivastava

Thank you, Ragini.

Ragini

Thank you to all our listeners. Stay tuned for more captivating discussions on EY India Insights. Don't forget to subscribe for the latest updates.
Until next time, this is Rajini signing off!

Explore the detailed analysis in our article, 'Aligning India’s defense spending to the Viksit Bharat vision.' It offers deeper insights into budgetary trends, international comparisons, and strategic recommendations including creating a non-lapsable defence fund and boosting domestic production to strengthen India’s defence preparedness.

Read the full article

Presenters

D. K. Srivastava

EY India Chief Policy Advisor

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Aligning India’s defense spending to the Viksit Bharat vision

Key takeaways

Ragini Trehan

D.K. Srivastava

Ragini

D. K. Srivastava

Ragini

D. K. Srivastava

Ragini

D. K. Srivastava

Ragini

D. K. Srivastava

Ragini

D. K. Srivastava

Ragini

Presenters

D. K. Srivastava

Budgeting for defence expenditure

Contemporary global challenges call for substantially increasing defence funding in India.