India’s combined fiscal deficit to be 7% of GDP in FY26: Morgan Stanley Research

State and central government's to bring down deficit further

India’s combined fiscal deficit is projected to decline to 7 percent of GDP in FY26, Morgan Stanley economists noted on Wednesday, highlighting that an improving fiscal position is likely to support both medium-term growth and inflation management.

The investment bank’s research team stated that the central government’s fiscal deficit will consolidate gradually, reaching 4.4 percent of GDP in FY26, while the states’ deficit is expected to narrow to 2.6 percent.

“The fiscal glide path reinstates the government's commitment to fiscal discipline, with a focus on improving tax buoyancy and reorienting spending towards capital investments,” Morgan Stanley economists noted.

India’s tax buoyancy in FY25 stands at 0.98, compared with a pre-pandemic average of 0.9. Since the pandemic, the average has improved to 1.2. The country has also made notable progress on the capital expenditure front.

“The share of capital expenditure in total expenditure has increased to 22.6% in FY25, up from 12.5% in the pre-pandemic period. This has enabled capital spending to rise to a 19-year high of 3.2% of GDP in FY25, compared with just 1.6% pre-pandemic,” the report added.

While capital spending is expected to remain at 3.2 percent of GDP in FY26, Morgan Stanley highlighted that grants-in-aid for the creation of capital assets will likely support an effective capex growth of 17.4 percent. The government has set a capital expenditure target of ₹11.2 lakh crore for the current fiscal year.

Morgan Stanley also noted that the improvement in capital spending is not limited to the Centre. States have shown better performance as well.

“The share of capital expenditure for states has increased to 14.7% in FY25, up from 12.3% in FY20. As a share of GDP, states' capex has remained steady at 2.3% for the second consecutive year, compared with 1.9% in FY20,” the report noted.