The external environment is challenging. The Suez Canal is crimped, which has pushed up costs of transportation from Mumbai to Europe. The 50 per cent tariff on exports to the United States is forcing firms to suffer one-time costs to reorganise themselves to participate in global commerce, including holding companies, production facilities, and customers. India has become less interesting to global investors, and there is a sluggishness in capital flows.
This is the context in which we view the Budget announcements. The Budget is not just a statement of government finances. The Budget speech is a commitment device through which the Union government commits itself to policy reform projects of the year. As an example, the economic policy achievements of the Bharatiya Janata Party — the goods and services tax, inflation targeting and the Insolvency and Bankruptcy Code — were all initiated through paragraphs in Budget speeches.
There has been some optimistic talk, in recent months, about important economic reforms being initiated, now that conditions are difficult and the cost of the status quo has gone up. The announcements of the Budget speech, however, are exclusively in the nature of industrial policy. We see a government that is poking and prodding the economy in myriad sectors, like a class monitor trying to shape how the economy works out. We have seen this movie before: The scene is reminiscent of Indian economic policy from the socialism of the 1980s. Such an effort should be viewed with scepticism for three reasons.
The first is the “socialist calculation problem”. The best policymakers do not know enough about the complex world to figure out what businesses should be doing. We in India have had remarkable intellectual power in the leadership in the past, and that was not good enough to solve the socialist calculation problem. By the time a policymaker is talking about details of products, processes and technology, she is on thin ice.
The second problem is that of state capability. The Indian state has a long history of faring poorly on detailed interventions in the economy, as government organisations are not able to act correctly.
The third problem is political economy. Once the coercive power and the spending power of the government are available, as a player in the marketplace, firms’ incentives shift from boosting productivity to building government engagement. This harms the economy because firms’ energy is diverted away from economic growth, and because their lobbying often reshapes government policy in the wrong directions.
Alongside the industrial policy push, there is a long list of genuine policy problems that have not been touched in the Budget speech. As an example, there is much clarity in the field of tax policy about the mistakes of GST (including input tax credit blockage, which reduces GST to a cascading production tax), the mistakes of source-based taxation for foreign investors, and the taxation of transactions (which has been further exacerbated in this Budget). There is much waiting to be done by way of building a better financial sector, including removing capital controls, establishing the resolution corporation and the public debt management agency, and fixing the legal foundations of the financial agencies as the Securities Markets Code was supposed to have done for the Securities and Exchange Board of India. There are fundamental problems of the foundational processes of government, including human resources, public financial management and contracting. There is a large agenda on protectionism, of non-equal treatment of foreign producers and foreign companies trying to sell into India or operate in India. There are burning problems of the electricity system that are holding back the clean energy transition. These are just illustrations; there is a lot waiting to be done.
Of course, there is nothing that prevents the government from taking on these things in the coming days. We hope this will happen.
The government has, for many years, tried to be cautious on public finance. The expansion of the deficit during Covid was smaller than what many in the country were then proposing. However, the situation remains an unhealthy one. Everyone recognises that Covid was an exceptional moment, that temporarily surged the debt-to-gross domestic product ratio. Bringing down the debt-to-GDP ratio requires small primary surpluses. But we’ve been stuck at significant primary deficits of 1.4, 0.8 and 0.7 per cent of GDP, respectively, from 2024-25 to 2026-27.
There are difficulties in measuring debt and GDP in India. Hence, the best measure of fiscal health is interest payments divided by revenue receipts. In terms of levels, we should recognise that the Indian financial repression system generates borrowing for the Indian state at artificially low interest rates, so the values that we see are artificially shaded down. When we drill into the recent values, we see a significant escalation from 36.74 to 39.74 between 2024-25 and 2026-27. This is cause for concern.
The government plans to borrow ₹11.7 trillion from the markets and ₹1.3 trillion from “T-bill etc”, which adds up to a nominal increase of 25 per cent, compared with the 2025-26 revised estimate of ₹10.4 trillion. This could be hard. About 95 per cent of the Indian State’s borrowing is coerced out of the financial system through financial repression. This system might face capacity constraints in meeting these borrowing requirements, and there are very few voluntary lenders who could respond to price signals.
The author is a researcher at the XKDR Forum
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