New Budget to focus on fiscal prudence and growth

The lower-than-budgeted fiscal deficit is unlikely to translate into a cut in market borrowings.

The Union Budget for FY2026 is just a fortnight away, and there is considerable enthusiasm surrounding the possible announcements and the overall fiscal position of the Government of India (GoI). Global uncertainty remains high, domestic growth has moderated, and rate cuts from the 'new look' Monetary Policy Committee (MPC) are yet to begin, raising hopes that the Union Budget will inject optimism into the economy. Notwithstanding the high expectations, we believe that the GoI is likely to prudently continue along its fiscal consolidation path, while providing a modest impetus to growth.

The fiscal metrics for FY2025 have been somewhat less than ideal, with a feared sizeable miss in capital expenditure likely to help contain the fiscal deficit below the budget estimate (ICRA expects 4.8% of GDP). In FY2026, we anticipate the growth in the GoI’s tax collections to be anchored around the expansion in nominal GDP, which is likely to be pegged at ~10% for the fiscal. However, non-tax revenues are difficult to project, particularly due to the Reserve Bank of India’s (RBI) dividend. We expect this to decline in FY2026 from the record Rs. 2.1 trillion transferred in FY2025.

Capital Expenditure Growth

We expect the growth in the GoI’s total expenditure to trail that in nominal GDP, which would imply a fall in the total expenditure-to-GDP ratio for the fifth consecutive year, although it would still exceed the pre-pandemic level. Within this, the inclination towards a higher expansion in capital expenditure vis-à-vis revenue spending is likely to continue, with the former providing a relatively higher boost to growth compared to the latter.

ICRA projects the GoI to target a 12.5% growth in capital expenditure, boosting it to ~Rs. 11 trillion in FY2026 from the lower-than-budgeted level of Rs. 9.7 trillion expected in FY2025. This would provide headroom for adequate allocation towards the infrastructure sectors, such as roads and highways, and railways, even as the outlay for the interest-free capital expenditure loan scheme can be kept unchanged at the FY2025 budgeted amount of Rs. 1.5 trillion. Within this, a tweaking of the ratio of untied-to-tied loans could help accelerate capex in FY2026.

Fiscal Deficit and Tax Revenue Outlook

We peg the GoI’s fiscal deficit to widen to Rs. 16.0 trillion in FY2026 from the lower-than-budgeted Rs. 15.4 trillion projected for FY2025. Nevertheless, as a proportion of GDP, it would narrow to 4.5% in FY2026 from the 4.8% of GDP forecast for FY2025. Moreover, the quality of the fiscal deficit is expected to improve in FY2026 compared to the previous year, amid expectations of a decline in the revenue deficit and a double-digit rise in the GoI’s capital expenditure.

The lower-than-budgeted fiscal deficit is unlikely to translate into a cut in market borrowings for FY2025, given a possible miss in small savings inflows. On balance, the GoI may carry modest cash balances into the next fiscal, which could lead to a slightly lower proportion of the fiscal deficit being financed by market issuances in FY2026 compared to FY2025. Consequently, ICRA expects the net G-sec issuance to be pegged at ~Rs. 11.4 trillion, 1.6% lower than the Rs. 11.6 trillion estimated for FY2025.

Buybacks to Reduce Redemption Targets

Interestingly, the GoI has been conducting buybacks of securities maturing in FY2026, which has led to a modest reduction in the redemptions due in FY2026. Any further buybacks of such securities would reduce the FY2026 redemptions, which are currently pegged to increase sharply relative to FY2025. At present, we project the gross market issuances of the Centre at ~Rs. 14.9 trillion in FY2026, compared to Rs. 14.0 trillion in FY2025, with the possibility of a lower number if buybacks continue.

The final set of rolling targets over the medium term ends in FY2026. In the last Budget, the Government revealed a plan to move to debt targeting from FY2027 onwards. We will look out for any forward-looking guidance on the Central Government’s debt/GDP ratio over the medium term.

Two major sets of recommendations are in the offing, which would have an overarching impact on the Government’s fiscal metrics going forward. The first is the recommendations to be made by the 16th Finance Commission, which may be released later in FY2026. These would impact both the GoI’s revenues, via tax sharing with the states, and its expenditures, through different types of grants.

Additionally, the 8th Pay Commission has recently been announced after a decade. While its award is unlikely to affect fiscal metrics in FY2026, its potential impact should be built into the new medium-term fiscal consolidation path as well as into the Finance Commission's recommendations.