Budget 2026: Onus of executing incremental capex shifting towards states

Aditi Nayar analyses the Budget's fiscal prudence, higher public capex via states, a 4.3 per cent deficit target, debt consolidation, and the impact of higher gross borrowings on bond yields

Against the backdrop of heightened global uncertainty, the Union Budget for 2026-27 (FY27) seeks to balance growth with macroeconomic stability, while initiating some important policy changes. This approach should support India’s economic outcomes in FY27 and beyond. Overall, the Budget arithmetic looks largely realistic, even as the responsibility for incremental capital expenditure appears to be shifting more towards states.

 

After a consumption push in FY26—through personal income-tax relief and goods and services tax (GST) rate cuts — the Centre has shifted its focus back to capital expenditure (capex). It has set a capex target of ₹12.2 trillion for FY27, an 11.5 per cent increase over the ₹11.0 trillion in the revised estimates (RE) for FY26. A double-digit rise in capex looks appropriate at this stage, especially as the implementation of the 8th Central Pay Commission (including arrears) is likely to constrain fiscal space in FY28.

 

 

Within capex, the allocation for 50-year interest-free loans to state governments and Union territories for capital expenditure has been raised to ₹2 trillion in FY27 from ₹1.5 trillion in RE for FY26. This accounts for nearly half of the increase in gross capex between the two years. The higher allocation also appears sensible, given the wider scope of expenditure under this scheme, compared with the Centre’s on-Budget capex, which is largely concentrated on roads and highways, railways and defence.

 

Beyond its own capex, the Centre has sharply raised the allocation for Grants in Aid for the creation of capital assets by 60 per cent to ₹4.9 trillion in FY27, albeit from a lower RE for FY26. This lifts effective capital expenditure to ₹17.1 trillion, up 22.1 per cent from the FY26 RE.

 

The expansion in public capex should help support gross domestic product (GDP) growth in FY27, especially as private capex is expected to remain uneven. However, the burden of executing a larger share of this spending has clearly shifted towards states.

 

There is a slight fiscal compression, with the fiscal deficit at 4.3 per cent of GDP in FY27, against 4.4 per cent in FY26 RE. This adherence to fiscal prudence underscores the government’s emphasis on macro stability amid a challenging global environment. It is also accompanied by an improvement in the quality of the deficit, with borrowings fully financing asset creation — through both the Centre’s own capex and grants for the creation of capital assets.

 

On the policy and expenditure front, the government has announced support for several manufacturing segments, including biopharma, semiconductors, electronic components, chemicals, capital goods, textiles and sports goods. These measures should help expand domestic capacity and reduce import dependence over the medium term, although timely execution will be critical. The Budget also announced a set of Customs duty measures to simplify the tariff structure and address inverted duty structures. This should improve competitiveness and support domestic manufacturing.

 

It is commendable that the Centre has stuck to its commitment of shifting the fiscal anchor towards medium-term debt consolidation, moving away from annual fiscal-deficit targets. It has pegged central government debt — under the Fiscal Responsibility and budget Management (FRBM) definition — at 55.6 per cent of GDP in FY27, 50 basis points lower than the FY26 RE of 56.1 per cent. However, the pace of consolidation is somewhat slower than expected.

 

The fiscal-deficit target translates into net dated market borrowing of ₹11.7 trillion for FY27, only 3.6 per cent higher than in the ongoing year. But with a sharp rise in redemptions, gross issuances have been set at ₹17.2 trillion, up from ₹14.6 trillion in FY26. This is well above market expectations and could add stress in the bond market. We had expected the Centre to reduce the redemption load through buybacks, switches or conversions, and/or a larger drawdown of cash balances, to keep gross issuances closer to around ₹16 trillion and ease pressure on Gsec yields, which have been rising since November 2025.

 

Further, the Centre has once again abstained from laying out a near-to-medium term road map for divestment. While it has set the target for miscellaneous capital receipts, which largely comprises disinvestment, at ₹800 billion or 0.2 per cent of GDP in the FY27 BE, history suggests that this target has largely been undershot year after year. Revenues under this head have been in the range of a minuscule 0.07 per cent of GDP to 0.17 per cent between FY22 and FY26. Enhancing this materially, to about 0.5 per cent of GDP on a sustained basis with a credible road map around divesting in public-sector enterprises would provide the government with more discretionary spending space and ensure fiscal consolidation is not largely dependent on expenditure compression, as has largely been the case in the past. 

---

 

The author is chief economist and head of research and outreach at Icra. Views are personal