Indian Budget 2026-27 – Challenges and Economic Outlook

The budgetary process for the financial year 2026-27 began amid global economic uncertainty. Disruptions caused by US tariffs and ongoing international conflicts create a challenging backdrop. Despite this, India’s economy showed robust growth in the first quarter, prompting cautious optimism. The Budget aims to balance fiscal consolidation with support for affected sectors and continued growth.

Global and Domestic Economic Context

The global economy faces volatility due to punitive US tariffs and unresolved conflicts. India confronts high tariffs on key labour-intensive exports like textiles and gems. The phasing out of Russian oil imports may raise crude oil costs, impacting expenditure. Nevertheless, India recorded 7.8% GDP growth in April-June, driven by strong tertiary, manufacturing, and construction sectors. Household consumption and government capital spending fuelled demand. Agricultural prospects look good due to adequate water reservoirs.

Fiscal Consolidation and Deficit Targets

The government targets reducing the central debt-to-GDP ratio to around 50-52% by 2031. Fiscal deficit reduction to 4% of GDP is the anchor for consolidation in 2026-27. Revenue collection is moderate with some shortfalls expected from GST changes and subdued corporate tax growth. Capital expenditure is frontloaded, while revenue spending is restrained. Additional subsidies for food and fertilisers may increase expenditure pressure later in the year.

Investment and Growth Challenges

India’s investment ratio remains stagnant near 30%, limiting growth acceleration. Government investment has increased but private investment has not picked up despite improved infrastructure and lower interest rates. Raising the investment ratio and reducing incremental capital output ratio are crucial to achieve development goals by 2047. The quality of state expenditure has declined due to election-related spending, affecting capital investment.

Taxation and Revenue Reforms

The Budget marks the need to simplify income tax with a broad base and fewer rates. Current dual tax structures cause complexity and distortions. Removing preferential tax treatments and aligning domestic and foreign company taxation is desirable. Greater clarity and rationalisation will improve revenue mobilisation and compliance efficiency.

Subsidy Rationalisation and Disinvestment

Food subsidy targeting needs improvement, given the decline in poverty rates and availability of technology. However, political challenges hinder reform. Disinvestment progress has been slow despite government claims it is not a business operator. Accelerating disinvestment and privatisation of commercial enterprises is necessary to focus government efforts on governance rather than business management.

Monetary Policy and Growth Forecast

The Reserve Bank of India raised growth forecasts to 6.8% for the year and may cut policy rates further due to benign inflation. Manufacturing PMI improved while services PMI eased slightly. The economic outlook remains positive but tempered by external risks and base effect moderation.

Budget Implementation and Fiscal Discipline

By September, fiscal deficit stood at 36.5% of the budgeted target. Revenue and expenditure were below estimates, reflecting cautious spending. The government prioritised capital expenditure to sustain growth momentum. Managing subsidy costs and tax revenue shortfalls will be key in the second half.

Questions for UPSC:

1. Critically discuss the impact of international trade tariffs on developing economies with reference to India’s export sectors.
2. Examine the role of fiscal consolidation in achieving macroeconomic stability and its challenges in the Indian context.
3. Analyse the relationship between investment ratio and economic growth, and suggest measures to enhance private investment in India.
4. Point out the significance of tax reforms in improving revenue mobilisation and reducing economic distortions, with examples from India’s tax structure.

Answer Hints:

1. Critically discuss the impact of international trade tariffs on developing economies with reference to India’s export sectors.

1. US imposed punitive 50% tariffs on key Indian labour-intensive sectors like textiles, leather, gems & jewellery, marine products, and chemicals.
2. Tariffs increase export costs, reduce competitiveness, and lead to loss of market share in global trade.
3. Developing economies heavily reliant on exports face revenue and employment challenges due to restricted market access.
4. Trade uncertainty hampers investment decisions and supply chain stability in affected sectors.
5. Potential signing of trade agreements (e.g., India-US) may provide clarity and mitigate tariff impacts.
6. Tariffs can incentivize diversification but short-term pain affects growth and livelihoods in export-dependent regions.

2. Examine the role of fiscal consolidation in achieving macroeconomic stability and its challenges in the Indian context.

1. Fiscal consolidation aims to reduce fiscal deficit and debt-to-GDP ratio, ensuring sustainable public finances.
2. India targets reducing fiscal deficit to 4% of GDP and central government debt to 50-52% of GDP by 2031.
3. Challenges include balancing consolidation with growth-supporting capital expenditure and social subsidies.
4. Revenue shortfalls from GST restructuring and subdued corporate tax growth complicate deficit management.
5. Political pressures, such as election-related state spending and subsidy commitments, hinder fiscal discipline.
6. Effective consolidation improves investor confidence, lowers borrowing costs, and enhances macroeconomic stability.

3. Analyse the relationship between investment ratio and economic growth, and suggest measures to enhance private investment in India.

1. Investment ratio (gross capital formation to GDP) at ~30% is stagnant, limiting growth acceleration.
2. Higher investment ratio is crucial to raise productive capacity and achieve development goals by 2047.
3. Private investment remains subdued despite improved infrastructure and lower interest rates.
4. Measures to enhance private investment include improving ease of doing business, policy stability, and faster disinvestment.
5. Reducing incremental capital output ratio through technological adoption and efficient resource use is essential.
6. Addressing state-level fiscal health and improving quality of capital expenditure can crowd in private investment.

4. Point out the significance of tax reforms in improving revenue mobilisation and reducing economic distortions, with examples from India’s tax structure.

1. Tax reforms aim to broaden the base, reduce multiple rates, and simplify compliance to enhance revenue mobilisation.
2. India’s current dual income tax structure creates complexity and unintended economic distortions.
3. Preferential treatments and differential tax rates for domestic vs foreign companies reduce fairness and efficiency.
4. Rationalising taxes can reduce compliance costs, improve transparency, and attract investment.
5. GST reforms have helped improve manufacturing PMI but structural changes may cause short-term revenue volatility.
6. Removing exemptions and aligning tax rates can promote equity and economic efficiency in the long run.