The direction of fiscal policy is never neutral; it is shaped by the fiscal rules a government chooses to bind itself to. Budget 2026–27 needs to be read not merely as an annual statement of revenues and expenditures, but as an outcome of a consciously redesigned fiscal rule framework. While recent changes to India’s fiscal rules offer greater flexibility on paper, their application in this year’s Budget raises important questions about growth, investment, and distribution.
From fiscal deficit to debt as the anchor
For nearly two decades after the enactment of the FRBM framework, India’s fiscal policy was guided primarily by a fiscal deficit–GDP target. The government’s borrowing in any year was the key policy variable, with debt reduction expected to follow as a consequence.
This has changed since last year. Under the new fiscal rule, the debt–GDP ratio has become the primary policy anchor. The government has set itself a medium-term target of reducing public debt to around 50% of GDP by 2031. This represents a clear departure from the earlier FRBM benchmark of 40%, implicitly recognising that higher public debt may be unavoidable in a post-pandemic, geopolitically uncertain world.
What the new rule implies for Budget 2026–27
Two immediate implications follow from this redesigned “sound finance” rule. First, since the current debt–GDP ratio remains above the new target, the government continues to pursue fiscal consolidation. Primary deficit is budgeted to decline from 0.8% of GDP in FY26 to 0.7% in FY27, while the fiscal deficit is reduced from 4.4% to 4.3%. This path mirrors the consolidation strategy followed since FY22.
Second, the higher permissible debt ceiling has created some additional fiscal space. Unlike the sharper deficit reductions seen immediately after the pandemic, the adjustment in FY27 is relatively modest. In that sense, the new rule has softened the pace—but not the direction—of consolidation.
How the fiscal targets are being met
Reducing deficits requires a gap between expenditure growth and non-debt receipts. The FY27 Budget Estimates indicate that non-debt receipts will fall slightly as a share of GDP, from 9.5% in FY26 to 9.3% in FY27. This decline is driven mainly by a reduction in indirect taxes and GST, each falling by about 0.3 percentage points of GDP.
Despite weaker receipts, deficits are reduced by compressing expenditure. Total expenditure declines from 13.9% of GDP in FY26 to 13.6% in FY27. Crucially, this adjustment does not come from capital expenditure, which is maintained at around 3.1% of GDP, but from revenue expenditure.
Changing the composition of spending
The government has consistently argued that capital expenditure has a higher multiplier effect and should therefore be protected. Budget 2026–27 continues this strategy of expenditure switching—shielding capex while cutting revenue spending.
However, the burden of this adjustment has fallen disproportionately on development expenditure, which includes spending on social sectors and economic services. The share of development expenditure in GDP is budgeted to decline from 6.1% in FY26 to 5.7% in FY27.
Rural and agricultural spending under pressure
The sharpest cuts within development expenditure are seen in rural development and agriculture and allied activities. Their combined share in GDP falls from 1.5% in FY26 to 1.2% in FY27. This is driven largely by reductions in revenue expenditure on rural employment.
As a result, the potential demand stimulus from lower indirect taxes and GST is effectively neutralised. Any positive consumption effect from tax reductions is offset by reduced rural incomes and spending, weakening aggregate demand rather than strengthening it.
Continuity brings comfort—and concerns
While the recalibration of fiscal rules is conceptually welcome, the continued reliance on fiscal consolidation as the dominant strategy raises two major concerns.
The first relates to investment. Corporate investment has remained subdued in recent years due to weak global demand and uncertain export prospects. The current fiscal stance offers little in the way of direct stimulus to private investment, relying instead on indirect crowding-in effects from public capex—effects that have so far been limited.
The distributional cost of consolidation
The second concern is distributional. Fiscal consolidation has been achieved largely by compressing development and agricultural expenditure, rather than by altering the tax structure. Notably, the corporate tax–GDP ratio remains close to its pre-pandemic level.
This implies that the adjustment burden falls disproportionately on sectors that support rural livelihoods, social services, and income security. While debt targets are being met, questions of equity and inclusion in the growth process remain largely unaddressed.
What to note for Prelims?
- Difference between fiscal deficit and primary deficit
- Debt–GDP ratio as a fiscal policy anchor
- Capital versus revenue expenditure
- Development expenditure and its components
What to note for Mains?
- Shift from fiscal deficit targeting to debt targeting in India
- Merits and limitations of sound finance rules in uncertain times
- Impact of fiscal consolidation on demand and growth
- Distributional consequences of expenditure compression
- Role of fiscal policy in stimulating private investment
