Challenges and opportunities loom in equal measure ahead of FY26 Budget

While the formal meetings of Finance Minister Nirmala Sitharaman with various stakeholders seeking their wishlist for Budget 2026 is expected to begin next month, the budget-making exercise is gaining

On November 11, the finance ministry concluded its pre-Budget meetings with financial advisors of different departments and ministries on the revised estimates for FY25 and budget estimates for FY26. While the formal meetings of Finance Minister Nirmala Sitharaman with various stakeholders seeking their wishlists for Budget 2026 is expected to begin next month, the budget-making exercise is gaining momentum in North Block.   

 

It will be the second Budget of the Modi 3.0 government and the eighth straight Budget for Sitharaman, a rare distinction in Indian politics.   

 

Though the FY26 Budget will come just six months after the FY25 final budget which was presented in July after Modi’s return to power for the third consecutive time, it has all the signs of becoming a hallmark budget. The FY26 Budget is expected to chart a new fiscal consolidation path for the country focusing on debt from FY27 onwards, departing from the present practice of targeting fiscal deficit. Sitharaman had announced a comprehensive review of the Income Tax Act and customs duty rate structure by January 2026. Progress on both fronts are expected to be announced in the next Budget.   

 

Fiscal discipline is key 

 

“The fiscal consolidation path announced by me in 2021 has served our economy very well, and we aim to reach a deficit below 4.5 per cent next year (2025-26). The Government is committed to staying the course. From 2026-27 onwards, our endeavour will be to keep the fiscal deficit each year such that the Central Government debt will be on a declining path as percentage of GDP,” Sitharaman had said in her July Budget speech.   

 

D K Srivastava, chief policy advisor at EY India, said one has to see whether government’s approach will continue with the fiscal correction to come close to fiscal deficit of 3 per cent of GDP or if it would keep deficit at around 4.5 per cent of GDP and focus on debt-to-GDP ratio directionally without committing to any magnitude. "Reducing debt-to-GDP ratio in that case will depend a lot on growth. If they commit to reducing debt by a certain margin, that is also a meaningful target,” he added.   

 

However, it is the escalating geo-political fragmentation and a slowing domestic economy that will pose the biggest challenges for the next Budget.   

 

The latest Monthly Economic Report by the finance ministry said though the performance of the Indian economy has been satisfactory during the first half of FY25, supported by strengthened rural demand, enhanced agricultural activity, an improving services sector, and a stable external sector, but the underlying demand conditions bear watching. “Further, risks to growth arise from escalating geopolitical conflicts, deepening geo-economic fragmentation and elevated valuations in financial markets in some advanced economies. Their spillover effects on India could cause negative wealth effects, impacting household sentiments and altering spending intentions on durable goods,” it added.  

 

The perennial growth vs inflation question 

 

There is also seeming discomfiture within the government over higher interest rates impeding economic growth, especially given the slowdown in urban demand, in particular.   

 

Sitharaman on Monday called on banks to make interest rates more affordable, describing the current high cost of borrowing as “very stressful”. Her comments came days after Commerce Minister Piyush Goyal made a case for the Reserve Bank of India (RBI) to cut interest rates to boost economic growth, by looking past high food inflation while deciding on monetary policy. RBI Governor Shaktikanta Das, on the other hand, has maintained that there are significant risks to the inflation outlook and that any premature rate cut could upset the balance.    

 

After retail inflation hit a 14-month high of 6.2 per cent in October, ruling out a rate cut in the December monetary policy committee (MPC) meeting, economists have raised doubts of a rate cut even in the February 6-8 MPC meeting, which will take place just after the presentation of the FY26 Budget.   

 

A delay in policy rate cuts by the central bank may impact growth expectations and put additional pressure on fiscal policy to play a more active role in boosting demand.   

 

Lower growth, lower spending  

 

Slower economic growth could also impact tax buoyancy and thus revenue collections, restricting the central government’s ability to increase revenue and capital expenditure allocations significantly. The International Monetary Fund has projected India’s economic growth to slow to 6.5 per cent in FY26 from the estimated 7 per cent for FY25.   

 

“If RBI remains focused on targeting the inflation rate, the main burden of sustaining growth would then come on the government. In such a case the finance ministry has to offer a strong stimulus, particularly focusing on capital expenditure. They will perhaps take a call on the extent of fiscal deficit and borrowing depending how much fiscal space is required. Fiscal policy needs to be directed towards maintaining growth close to 7 per cent,” Srivastava said.      

 

Madan Sabnavis, chief economist at Bank of Baroda, said how the government balances expenses as the fiscal deficit comes down needs to be observed closely. “With GDP growth being stable and inflation coming down, tax buoyancy will be limited. Government may have to revisit schemes such as affordable financing as present norms are not profitable for builders,” he added.   

 

The FY26 Budget will be shaped by how the government assesses external headwinds and addresses the domestic challenges.