Budget 2026 Outlook: Will India's debt-anchored fiscal reset make a mark?

The FY27 Union Budget will test India's shift to a debt-based fiscal framework as tax risks, Finance Commission changes, capex priorities and election pressures shape policy choices

The Union Budget for FY2027 will be the first test of India’s shift to a debt-anchored fiscal framework from the age-old practice of targeting fiscal deficit. The integration of the Sixteenth Finance Commission’s recommendations will be yet another highlight while observers will keenly watch how it guards growth momentum in a year when external uncertainty may only aggravate further.

Why the debt anchor has replaced the fiscal deficit target

Last year’s Budget replaced the traditional deficit target with a public debt anchor. The Centre aims to bring down the debt-to-GDP ratio from 56.1 per cent to 50 ±1 per cent by 2030-31. QuantEco expects the government to target a full percentage point reduction to 55.1 per cent in FY27, with a fiscal deficit range of 4.1–4.3 per cent of GDP. ICRA also sees the deficit capped around 4.3 per cent, assuming nominal GDP growth of 9.8 per cent.

 

However, in its Article 4 consultation report on India released in November last year, the International Monetary Fund (IMF) asked the government to review its medium-term debt target, and to make it “more ambitious” by broadening the debt anchor to include the state government debt as well.

 

The State Bank of India, in a report, said that given states account for a significant share of general government debt, state budgets should explicitly chart medium-term, preferably scenario-based, debt-to-GSDP (gross state domestic product) trajectories, aligned with realistic growth assumptions and development needs, rather than relying solely on annual deficit targets. “A similar approach needs to be institutionalised at the state level and could be re-emphasised in the Union Budget speech,” it added.

FY26 fiscal performance: Revenue risks emerge

However, the government is transitioning to a new fiscal anchor at a time it is likely to miss the revenue targets this year due to GST rate rationalisation measures, direct tax relief, and lower tax buoyancy on the back of weaker nominal growth.

 

Radhika Rao, senior economist at DBS, notes that income tax and corporate tax collections would have to rise 43 per cent and 11.7 per cent, respectively, in the remaining months of the current financial year to meet FY26 targets — an unrealistic outcome even with seasonal upticks.

 

DBS expects a tax shortfall of Rs 1.1 trillion–Rs 1.2 trillion (0.2–0.3 per cent of GDP). ICRA foresees direct taxes undershooting by Rs 800 billion, implying growth of 8.9 per cent, well below the budgeted target of 12.5 per cent.

 

However, the government ending the GST compensation cess and raising the excise duty on cigarettes, imposing a “Health and National Security Cess” on pan masala, may augment its revenue. As ICRA notes, this new cess “will not be a part of the divisible pool, solely accruing to the Centre”, giving New Delhi more fiscal room as the devolution formula is about to change.

 

Even with tax underperformance and delays in strategic sales — such as IDBI Bank’s long-pending transaction and Shipping Corporation — the government is likely to meet the 4.4 per cent deficit target in FY26 because non-tax revenue and revenue-expenditure savings are stronger than budgeted.

How the Sixteenth Finance Commission will shape FY27 Budget

The FY27 Budget must also incorporate the Sixteenth Finance Commission’s recommendations for the 2026–31 period. The earlier 41 per cent devolution to states under the Fifteenth Finance Commission ends this fiscal. With the Centre increasingly leaning on cesses and surcharges — now including a new health and security cess — the effective devolution has already drifted down to 30–33 per cent.

 

Aligning with the Finance Commission cycle, the finance ministry has instructed all departments and ministries to rationalise centrally sponsored (CSS) and central sector (CS) schemes — an exercise to be completed by March. There are 54 centrally sponsored schemes and 260 central sector schemes whose approvals end on March 31, 2026. Consolidation of schemes may help the government rationalise expenditure.

Capital expenditure outlook for FY27

Capital expenditure is expected to remain the focus of the FY27 Budget. DBS expects FY27 capex at 3.0–3.1 per cent of GDP, rising 7–8 per cent year-on-year, with a focus on shovel-ready and greenfield projects and continued concessionary support to states.

 

But capex momentum has cooled. Crisil notes that after averaging 24.5 per cent growth in FY21–24, budgeted capex growth has moderated to 11.3 per cent in FY25–26 as consolidation tightens. Budgetary capex is now more than three times CPSE capex, indicating a structural shift towards budget-led public investment.

 

While conditions for private investment are more supportive than in the pre-pandemic period, with higher capacity utilisation, healthier corporate balance sheets and relatively benign interest rates, corporate capex remains constrained by heightened global uncertainty and volatility.

 

Crisil argues the policy thrust must move from direct fiscal support to structural reform to boost private capex. “By lowering the cost of doing business and reducing execution risks, such measures could catalyse private capex and make investment-led growth durable and broad-based,” it added.

Election pressures and fiscal discipline risks

To top it all, the country is heading into a busy year for state elections, with Tamil Nadu, West Bengal, Puducherry, Kerala and Assam going to the polls in May–June 2026. Historically, schemes such as rural jobs guarantee and rural housing schemes swell in pre-election years. This time, both are under closer scrutiny. MGNREGA restructuring and replacement is already under way, and rural housing may be nearing saturation. Under a debt-anchored regime, fiscal space for politically guided expansion is thus narrower.

 

With GDP growth looking robust, the real test is improving the quality of growth so the benefits are durable and widely shared, says Partha Chatterjee, dean of academics and professor of economics at Shiv Nadar University. “The Budget must recognise that we live in a very uncertain world and it should insure the economy against uncertainty. The central challenge for Budget 2026 is uncertainty — currency volatility, shifting capital flows, tariff risks, and inflation spillovers.”