Budget 2026 must aim to fix the weak link in India's R&D ecosystem

Restoring weighted tax deductions and adopting a petty patents regime can foster firm-level innovative activity critical for competitiveness

Innovative activity is widely recognised as a key driver of competitiveness and economic growth. Its importance has only increased in the context of the artificial intelligence (AI) revolution and the compulsions of net-zero. Hence, India’s underperformance in gross research & development (R&D) expenditure (GERD) as a proportion of gross domestic product — stagnating at around 0.7 per cent, much lower than the global average of 1.93 per cent — has attracted much debate.  Other countries like China spend a far higher proportion on R&D, at about 2.6 per cent. 

The output indicators of innovative activity — for example, India’s rank improving from 81st to 38th between 2015 and 2025 in the World Intellectual Property Organization’s Global Innovation Index — present a more encouraging picture. Patents filed in India have also surged, from 24,326 in 2020-21 to 68,176 in 2024-25. ISID’s India Industrial Development Report 2024-25 finds India’s GERD to be underestimated and projects it at around 1.25 per cent — more respectable than 0.7 per cent, but still low. 

Another concern about GERD is that over 60 per cent of it is spent not by business enterprises, where it could help sharpen their competitive edge, but in government laboratories, including those run by the Council of Scientific & Industrial Research, the Defence Research and Development Organisation, and the Indian Council of Medical Research, among others. While mission-oriented R&D organisations such as the Indian Space Research Organisation have achieved considerable success, government laboratories often face challenges in commercialising their innovations. 

The bulk of business R&D is conducted by a handful of large companies and is heavily concentrated in the pharma and auto sectors. Benchmarking the R&D activity of Indian firms against their global counterparts, industrialist and economist Naushad Forbes, in his column in this newspaper, makes a case for expanding business R&D activity by a factor of five. 

The neglect of R&D activity by Indian industry is curious, especially given its role in driving competitiveness. This can be explained by the market failures inherent in innovative activity, which do not allow investors to reap the full rewards due to its public good-like nature. 

Recognising the market failures and its strategic importance, governments in the United States and other industrialised countries spend billions of dollars on subsidies and R&D contracts awarded to national enterprises, including through agencies such as the Defense Advanced Research Projects Agency, NASA, and the National Institutes of Health. Public funding has been an important source of industrial innovation in Western countries; for example, Tesla received substantial support from the US government — in addition to tax credits and contracts — while developing its innovative electric vehicles. 

Advanced countries also built an exception for R&D subsidies to the tune of 50 per cent of project costs in the World Trade Organization Agreement on Subsidies and Countervailing Duties, which debarred all other forms of industrial subsidies. 

In India, until 2017, R&D activities in industry were encouraged mainly through weighted tax deductions at the rate of 200 per cent, and 150 per cent during 2017-2021. Since 2021, only a 100 per cent deduction is allowed. In 2024, the government established the Anusandhan National Research Foundation (ANRF) to mobilise ₹50,000 crore over five years to promote academia-industry linkages for high-impact research. In November 2025, the government launched the Research, Development and Innovation (RDI) Scheme with a corpus of ₹1 trillion to boost private sector-driven innovation, focusing on strategic sectors such as AI, quantum, energy, and biotech, by low-cost loans and equity through a two-tiered structure managed by the ANRF. The ANRF and RDI are clearly important and desirable initiatives to foster innovative activity. Yet, they need to be complemented by other incentives and policies to realise the Viksit Bharat and Aatmanirbhar Bharat visions. 

The finance minister in the Union Budget 2026-27 may consider restoring 200 per cent weighted deduction for R&D expenditures. Weighted deductions provide greater freedom to firms for undertaking R&D to respond quickly to emerging market needs or other strategic considerations. 

While the weighted deduction may be provided based on an audited statement, there could be a provision for reporting the activities undertaken under the scheme, the processes and products developed, foreign exchange saved or earned, patents filed, and licensing fees earned. This will ensure that tax benefits are not claimed as routine and that they actually lead to innovative activity. 

Another policy to promote local innovation could be to protect minor innovations through the so-called petty patents, as practised in Japan, South Korea, Taiwan, and China. The patent system fails to encourage minor innovations because the criteria for inventiveness tend to look at novelty. India could consider adopting a petty patents regime that provides limited protection for three to five years to minor incremental innovations, especially those by micro, small and medium enterprises. 

To sum up, therefore, the Union Budgets of the past few years have taken major initiatives to foster innovative activity. The 2026-27 Budget should build on these initiatives by restoring weighted tax deductions and creating a petty patents regime to foster incremental innovations needed to realise the Aatmanirbhar and Viksit Bharat visions.

 

The author is director, Institute for Studies in Industrial Development, New Delhi, and a member of  the Monetary Policy Committee. The views are personal. nkumar@isid.org.in