Can the Union Budget 2026-27 unveil a low debt-deficit path to growth?

The forthcoming Budget could think of maintaining public capital expenditure at 3% so that domestic resources are available for private investments

The Union Budget for 2026-27 will be presented on the back of India experiencing a classic ‘goldilocks’ situation with high real GDP growth and lower inflation. However, it also faces a stress point with regard to nominal gross domestic product (GDP) growth, which is projected at 8 per cent, well below the FY26 Budget assumption of 10.1 per cent.   

As nominal GDP growth is a crucial variable for the rest of the Budget numbers, a lower-than-assumed growth rate could have implications for fiscal deficit numbers, as well as FY27 nominal GDP growth assumptions and budget deficit calculations. In addition, implementation of the recommendations of the 16th Finance Commission (especially regarding fiscal consolidation), as well as the review of the monetary policy framework means that we will have a new macro-fiscal-monetary policy framework for the period 2026-31. 

In the last Budget, as part of the macro-fiscal framework, public debt (as a ratio to GDP) has been adopted as a policy anchor in place of deficit. Under this new framework, the aim is to bring down the government’s debt-to-GDP ratio to 50 plus/minus 1 per cent by 2030-31 from the current 56.1 per cent.   

With the assumption of nominal GDP growth between 10 and 11 per cent and with various degrees of fiscal consolidation, nine different scenarios were presented. However, as growth is a flow concept while debt is a stock, the exact causation from growth to debt as well as its reverse causation is not clear from the framework. 

The original FRBM (Fiscal Responsibility and Budget Management) Act, where debt-GDP was also a dominant objective, actually suggested the causation from growth to debt through fiscal deficit, a flow variable.  And the disaggregation of fiscal deficit into revenue deficit and public capital expenditure ensured reverse causation from debt-deficit to growth.   

In that sense, to make the new debt-GDP framework internally consistent we still need to have deficit as an instrument. Further, as the post-Covid fiscal policies show, we need to focus on improving the quality of expenditure, especially by sustaining the focus on capital expenditure. In other words, we still need to make the distinction between revenue deficit and capital expenditure as they will act as instruments to anchor debt. 

With the present debt-GDP path in place, the forthcoming Budget could provide the deficit path consistent with growth-inflation assumptions. While this framework needs to be solved in a simultaneous set-up with forward- looking assumptions, we have derived the fiscal deficit paths for nine debt paths presented in the last Budget. The numbers are presented in the accompanying graph and table. It may be noted in the table that in all the three GDP growth scenarios and under different degrees of fiscal consolidation, it suggests that fiscal deficit could be brought down to 3 per cent by the terminal year, i.e., 2030-31. 

In the graph, the fiscal deficit path under three different degrees of consolidation under the GDP growth assumption of 10.5 per cent is presented. This shows that there is a need to have a clear deficit path through which the Budget could focus on long-term public debt objectives.   

While deriving these deficit paths, one major assumption we made is that there would be no off-budget borrowings by the Union government. This has been an important hallmark of past Budgets since the Covid-19 period. This has also helped improve fiscal transparency and for the same reason major rating agencies have expressed confidence in India’s fiscal numbers and upgraded India’s ratings.   While the fiscal deficit could be derived from the nominal GDP growth, for fiscal policy, to ensure macro-stability, as is seen in the current year, it is also important to understand how this nominal GDP growth is distributed between real GDP growth and inflation.   

Our experience with the FRBM roadmap till recently also suggests that it is not just the headline fiscal deficit that matters for growth-inflation balance, but also the quality of fiscal deficit in terms of revenue deficit and public capital expenditure. 

Our simulation studies to various finance commissions suggest that reducing fiscal deficit by containing revenue deficit could ensure macro-fiscal balance and, at the same time, anchor public debt over the medium-term fiscal path. 

This is also evident in the post-Covid fiscal policies that focused on higher capital expenditure while containing revenue deficit. Currently the revenue deficit is targeted to be brought down sharply to 1.5 per cent (with effective revenue deficit at as low as 0.3 per cent) from 5.1 per cent in 2021-22.  This has provided space for capital expenditure and in 2025-26, capital expenditure is budgeted at 3.5 per cent.   

For the past three financial years, the Union government has been allocating capital expenditure at over 3 per cent, higher than what the original FRBM Act suggested.  However, this strategy has some risks going forward.  The proposed debt-deficit path needs to endogenise the 8th Pay Commission recommendations as and when it is implemented. It is also important to assess the public capital expenditure, especially when private investments are not picking up sufficiently enough despite a 125 basis point reduction in the repo rate (recently there has been a pick-up in private credit off-take, but this needs to be sustained). The forthcoming Budget could think of maintaining public capital expenditure at 3 per cent so that domestic resources are available for private investments.   

Analysts would be looking closely at this Budget for medium-term debt-deficit path and, most importantly, the nominal GDP growth assumption.   

While 8 per cent growth in FY26 is largely due to low inflation and GDP deflator growth, for the same reason as inflation is expected to firm up (as per Reserve Bank of India forecasts), it is reasonable to assume a nominal GDP growth of 10 per cent for FY27. This will also be consistent with the suggested medium-term macro-fiscal path that has both debt and deficits.   

 

 

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The writer is the director of Madras School of Economics, Chennai. Views are personal