How govt navigates headwinds, challenges will shape the FY26 Budget

On November 11, the finance ministry concluded the pre-Budget meetings with the financial advisors of different departments and ministries on the revised estimates for 2024-25 (FY25) and Budget estimates for FY26. Though the formal engagement of Finance Minister Nirmala Sitharaman with various stakeholders seeking their Budget wishlists is expected to begin next month, the Budget-making exercise is gaining momentum in North Block, the seat of the finance ministry in New Delhi.

 

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

 

Though the FY26 Budget will come only six months after the FY25 final Budget, which was presented in July after Modi’s return to power for a third consecutive term, it has all the signs of becoming a hallmark Budget.

 

New path

 

It is expected to chart a new path towards debt targeting for the country focussing on debt from FY27 onwards, departing from the current practice of targeting the fiscal deficit. Sitharaman had announced a comprehensive review of the Income Tax Act and customs duty rate structure by January 2025. Progress on both is expected to be announced in the next Budget.

 

“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.

 

GDP is short for gross domestic product, which is the monetary value of all goods and services produced in a country during a specified period.

 

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

 

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

 

Demand, growth, interest rates

 

The latest Monthly Economic Report by the finance ministry said though the performance of the Indian economy was satisfactory during the first half of FY25 — supported by strengthened rural demand, enhanced agricultural activity, an improving services sector, and a stable external sector — the underlying demand conditions must be watched. “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.  

 

There is also seeming discomfiture within the government over higher interest rates impinging economic growth with a slowdown in particularly urban demand.

 

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 trade minister Piyush Goyal made a case for the Reserve Bank of India (RBI) to cut interest rates to boost economic growth by looking through the 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 at 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.

 

Tax and revenue

 

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

 

“If the 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. The fiscal policy needs to be directed towards maintaining growth close to 7 per cent,” Srivastava says.   

 

Madan Sabnavis, Chief Economist at Bank of Baroda, says 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. The government may have to revisit schemes such as affordable financing as the present norms are not profitable for builders,” he adds.

 

Sitharaman recently indicated, amid Trump calling India the biggest tariff charger, that the government could roll back some increased tariffs if that does not hurt the domestic industry

 

Economic Affairs Secretary Ajay Seth said at an event last week that more than the policy of the Trump administration, how the two ongoing wars unfolded and what happened to the Chinese economy needed to be watched carefully. “China has a huge manufacturing capacity and if the demand is not increasing to the extent it has been in the past, there would be challenges for all countries including India.”

 

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