India: FY26 Budget: Government looks to appease middle class
Metodi Tzanov
Helping finance professionals understand what is going on in Emerging and Frontier Markets
India's fiscal trajectory for FY26 reflects a delicate balancing act-driving economic growth while keeping public finances in check. As the government navigates a complex global environment marked by inflationary pressures, geopolitical risks, and shifting trade dynamics, it has laid out a fiscal roadmap that prioritizes infrastructure investment, tax rationalization, and financial sector reforms. The report examines key macroeconomic trends, revenue and expenditure patterns, major policy shifts, and their potential impact on growth, investment, and fiscal sustainability. Additionally, it highlights structural adjustments in taxation, social spending, and debt management. While the government remains committed to its path of fiscal consolidation, ambitious even, challenges such as inflation volatility, global trade disruptions, and subsidy rationalization could influence fiscal outcomes.
Macroeconomic Framework
India's nominal GDP is projected to grow by 10.1% in FY26, rising from 9.7% in FY25. Meanwhile, India's GDP is projected to grow between 6.3% - 6.8% in FY26, maintaining stability despite global uncertainties, as stated in the Indian Economic Survey released by the Finance Ministry today. The economy continues to expand close to its decadal average, supported by strong sectoral performance. Meanwhile, the first advance estimate released by the government on January 7 predicts GDP growth of 6.4% for FY25.
The Economic Survey highlighted that the agriculture sector remains robust, operating consistently above trend levels, while the industrial sector has recovered beyond pre-pandemic levels. The services sector is nearing its historical growth trajectory, driven by sustained expansion in recent years. On the inflation front, it mentioned that retail inflation has moderated, declining from 5.4% in FY24 to 4.9% in the April-December period of FY25. The easing of inflation, coupled with a strong Rabi harvest, is expected to help align inflation with the RBI and IMF's target of around 4% by FY26. However, risks from adverse weather events and rising global commodity prices remain, necessitating careful monetary policy management.
Fiscal deficit is estimated at 4.4% of GDP in FY26, continuing the path of consolidation from 4.8% in FY25. The government has set an ambitious capital expenditure target of INR 11.21tn, or 3.1% of GDP., in line with the six-year fiscal roadmap aimed at reducing it to 50% by FY31.
Revenue and Expenditure Breakdown
The central government seeks to generate INR 34.96tn in revenue receipts in FY26, marking an 11.1% y/y increase. The bulk of this growth will come from tax revenue, which is projected to rise by 12.5% y/y to INR 28.37tn, reflecting strong corporate tax, income tax, and GST collections. Non-tax revenue is estimated at INR 5.83tn, up 9.8% y/y, with major contributions from the surplus transfers of the Reserve Bank of India and dividends from state-owned enterprises.
Meanwhile, the Centre's total expenditure is projected to increase by 7.6% y/y to INR 50.65tn in FY26. This will largely be driven by a significant 9.8% y/y surge in capital expenditure, reaching INR 11.21tn, constituting 3.1% of GDP. The government remains committed to infrastructure development, with a sharp rise in grants to states and autonomous bodies for capital investments, up by 42% y/y.
Revenue expenditure is expected to increase by 6.4% y/y to INR 39.44tn, with approximately 30% allocated for interest payments, which are projected to rise by 11.2% y/y, reflecting the government's continued borrowing obligations. Subsidy allocations have been recalibrated, with reductions in petroleum subsidies, while food and fertilizer subsidies remain steady to support rural welfare and food security. Defence spending, one of the largest expenditure items, has also increased to bolster national security and procurement of advanced technology.
Major Ministry Allocations and Adjustments
Ministry of Finance: The largest recipient of budgetary funds, receiving INR 19.39tn, accounting for 38.28% of total government expenditure. This allocation reflects debt servicing, subsidies and financial sector reforms.
Ministry of Defence: Allocated INR 6.81tn, making up 13.45% of total spending. This increase ensures modernisation of defence infrastructure, procurement of advanced weaponry, and border security enhancements.
Ministry of Road Transport and Highways: With an allocation of INR 2.87tn, the focus remains on highway expansions, expressway development, and logistics infrastructure to improve connectivity and economic competitiveness.
Ministry of Railways: INR 2.55tn has been earmarked to modernise railway networks, expand metro projects, and enhance high-speed rail connectivity.
Ministry of Housing and Urban Affairs: Despite playing a crucial role in urban infrastructure, its allocation has been reduced to INR 967.7bn, indicating a potential shift towards rural-centric development.
Fiscal Deficit and Policy Considerations
The fiscal deficit is targeted at 4.4% of GDP in FY26, maintaining the government's commitment to fiscal consolidation. While capital spending remains a priority, the fiscal deficit trajectory aligns with the medium-term goal of bringing the ratio below 4.5% by FY27. The government aims to achieve this through expenditure rationalization and efficient revenue mobilization. The revised fiscal roadmap also targets a gradual reduction of the central government's debt-to-GDP ratio to 50% by FY31. The debt-to-GDP ratio is expected to decline to 56.1% in FY26 from 57.1% in FY25. However, long-term fiscal sustainability will hinge on continued revenue growth and rationalized subsidy spending, particularly in food and fertilizer sectors, which have historically strained public finances, in our view. Non-tax revenue, which includes interest receipts, dividends, license fees, and charges for government services, is estimated at INR 5.8tn. Dividends are expected to form 55.7% of the total budgeted non-tax receipts for 2025-26. The dividend from RBI and nationalized banks is targeted at INR 2.6tn.
In FY26, gross and net market borrowings by the central government through dated securities are budgeted at INR 14.8tn and INR 11.5tn, respectively. For FY26, the government expects to use about 99% of borrowed resources to finance effective capital expenditure. The net borrowing is higher than the INR 10.5tn recorded in the previous budget. Additionally, the government has planned a debt switch worth INR 2.5tn, replacing older securities with new ones, which the report states will not impact the overall fiscal situation.
领英推荐
Tax Measures and Economic Impact
The budget introduces significant tax relief aimed at boosting consumption. This follows after the ruling Bhartiya Janta Party government faced some setbacks in the recent parliamentary elections in June 2024, which saw their majority decline. The middle income group was increasingly disgruntled with the government given high tax rates and sustained elevated price levels. The government was attracting criticism particularly from the middle income voters on this front. As a consequence, the government appears to have delivered some relief to the public. A series of measures were announced by the finance minister on February 1, which have been welcomed by the public. These include:
While these measures provide relief to middle-class households, maintaining fiscal discipline without additional revenue sources could be a challenge, especially as the government looks to provide freebies ahead of state elections and also intends to drive manufacturing sector growth through infrastructure development.
In addition to the above, the Finance Minister made several other announcements with respect to multiple sectors. These are highlighted below:
Financial Sector and Global Trade Considerations
In a bid to drive FDI in the insurance sector, it will be opened fully and the limit will be raised from 74% to 100%. Further, Central KYC Registry revamp to simplify compliance will also be carried out.
Agriculture and Rural Development
Infrastructure Development
Energy and Sustainability
Digital Transformation and Innovation
Social Welfare and Employment
Conclusion
The budget prioritises economic growth through strategic investment in infrastructure, digital transformation, and rural development while ensuring fiscal consolidation. Increased allocations in agriculture, defence, and transportation signal the government's focus on self-reliance, economic expansion, and national security. However, the reductions in urban development funds suggest a pivot towards decentralised rural growth, which could have long-term structural implications.
With substantial investments in technology, energy, and financial reforms, the government aims to balance economic expansion with social equity, setting the stage for a more resilient economic framework. However, maintaining fiscal discipline will become challenging for the government in the coming year, especially as it looks to counter global trade tariffs, safeguard domestic industry and provide continued support to low income households. In our view, a large dividend from the Reserve Bank of India will support fiscal health, but the potential cut back on goods and services tax alongside the income tax relief could derail fiscal consolidation gains in FY26.