India’s fiscal strategy in 2026-27 reflects a careful balancing act between consolidation and growth. After a relatively sharp correction in the fiscal deficit in 2025-26, the Union Budget 2026 signals a deliberate slowdown in the pace of adjustment. This approach, shaped by tax reforms, macroeconomic constraints and the recommendations of the Sixteenth Finance Commission, raises important questions about aggregate demand, Centre–State finances and the credibility of long-term fiscal targets.
A Slower Glide Path on Fiscal Consolidation
Tax reforms in 2025-26, particularly GST-related measures, helped reduce the fiscal deficit-GDP ratio by 40 basis points — from 4.8% in 2024-25 to 4.4% in 2025-26 (RE). However, the reduction in 2026-27 (BE) is a modest 10 basis points. This signals a shift from aggressive consolidation to a calibrated, growth-sensitive approach.
Both net tax revenues and non-tax revenues, as a share of GDP, are projected to fall by 20 basis points each in 2026-27 (BE) compared to 2025-26 (RE). This shortfall is partially offset by higher non-debt capital receipts — largely expected disinvestment proceeds — amounting to about 20 basis points of GDP. Consequently, total government expenditure has been compressed to 13.6% of GDP in 2026-27 (BE), down from 13.9% in 2025-26 and 14.1% in 2024-25.
Debt Targets and Fiscal Flexibility
The Finance Minister’s confirmation of the debt-GDP target — 50% ±1 percentage point by 2030-31 — aligns with the guidance provided in the Economic Survey 2025-26. This medium-term anchor provides the government with flexibility to adjust annual fiscal deficit targets in response to revenue performance and macroeconomic conditions.
The asymmetry of fiscal cycles remains a concern. Following the Covid-19 shock, the fiscal deficit surged from 3.4% of GDP in 2018-19 to 9.2% within two years. Yet, it has taken six years to bring it down to about 4.3% of GDP by 2026-27 (BE). Against this backdrop, the Fiscal Responsibility and Budget Management targets of a 3% fiscal deficit and 40% debt-GDP ratio under the Fiscal Responsibility and Budget Management Act appear several years away.
The Finance Commission and Centre–State Transfers
Alongside the Budget, the report of the Sixteenth Finance Commission was presented. On vertical devolution, the Commission retained the States’ share at 41% of the divisible pool of central taxes. As a result, transfers to States remain unchanged at around 3.9% of GDP in 2026-27 (BE), the same level as in 2025-26 (RE).
The more consequential shift lies in horizontal transfers. The Commission chose not to recommend revenue-deficit grants or sector- and State-specific grants, nor did it publish a State-wise assessment of fiscal positions over its award period. Its justification — that the aggregate revenue deficit of States is only 0.3% of GDP — is contentious. Revenue deficits are inherently State-specific; a surplus in one State cannot offset a deficit in another. Ignoring this heterogeneity weakens the equalisation role of fiscal transfers.
Implications for Aggregate Demand
The Economic Survey’s growth narrative assumes expansion in both private and public demand. While private demand may receive a boost from earlier tax concessions, government demand is clearly contracting. The ratio of total government expenditure to GDP is falling, and primary revenue expenditure has declined from 7.3% of GDP in 2025-26 (RE) to 6.9% in 2026-27 (BE). Capital expenditure, meanwhile, remains broadly static as a share of GDP.
In such a scenario, growth impulses can come only from changes in expenditure composition rather than scale. This raises a macroeconomic risk: if global uncertainties persist, a contraction in aggregate demand could constrain real GDP growth, making the 7% potential growth target harder to achieve.
Constraints on State Finances
States are unlikely to compensate for the Centre’s reduced expenditure thrust. With no additional support through revenue-deficit or sector-specific grants, their fiscal space remains constrained. Moreover, States may face additional expenditure pressures arising from the transition from the Mahatma Gandhi National Rural Employment Guarantee Act to the Viksit Bharat G-RAM-G scheme, further tightening their budgets.
What to Note for Prelims?
- Fiscal deficit targets for 2025-26 (RE) and 2026-27 (BE).
- Debt-GDP anchor of 50% ±1% by 2030-31.
- 41% vertical devolution retained by the Sixteenth Finance Commission.
- Difference between revenue-deficit grants and tax devolution.
What to Note for Mains?
- Trade-offs between fiscal consolidation and growth.
- Asymmetry in India’s fiscal response to economic shocks.
- Impact of withdrawing revenue-deficit grants on fiscal federalism.
- Role of government expenditure composition in sustaining growth.
Overall, the Budget reflects a pragmatic pause in fiscal consolidation rather than a reversal. Yet, with shrinking government demand and limited fiscal support to States, the onus of sustaining growth increasingly rests on private investment and consumption — a strategy that may prove fragile in an uncertain global environment.
