Navigating the Tightrope, Budget 2026 and the Complex Calculus of India’s Fiscal Consolidation

Navigating the Tightrope, Budget 2026 and the Complex Calculus of India’s Fiscal Consolidation

Finance Minister Nirmala Sitharaman’s presentation of the Union Budget 2026-27 unfolded against the towering ambition of a “Viksit Bharat” by 2047. The speech was replete with visionary expenditure programs targeting advanced technology sectors—Artificial Intelligence, biopharma, semiconductors, and critical minerals—signaling a strategic pivot towards building a knowledge and innovation-driven economy. However, beneath this glittering facade of future-oriented spending lies a more prosaic and pressing narrative: the grinding, complex, and potentially slowing imperative of fiscal consolidation. The budget, while projecting a disciplined glide path, reveals a story of difficult trade-offs: between ambitious capital expenditure and a decelerating growth rate in that very spending; between the need for revenue to fund development and a worrisome drop in tax buoyancy; and between the constitutional duty to support states and a notable reduction in Finance Commission grants. Far from a simple balance sheet, Budget 2026 is a high-stakes tightrope walk, where the pursuit of long-term development goals is increasingly constrained by the short-term arithmetic of debt, deficits, and diminished fiscal space.

The Restructuring of Expenditure: A Capital Shift with Diminishing Momentum

A cornerstone of the government’s fiscal narrative over the past decade has been a significant restructuring of expenditure. The data is telling: the share of revenue expenditure (largely salaries, subsidies, and interest payments) in total spending has fallen from 88% in 2014-15 to approximately 77% in the 2026-27 Budget Estimate (BE). Within this, central subsidies alone have seen a 7-percentage-point decline as a share of total expenditure. This disciplined compression of recurring spending has created crucial, albeit narrowing, fiscal space.

The corresponding beneficiary of this restructuring has been capital expenditure (capex)—the spending on physical and social infrastructure that builds future productive capacity. This emphasis has rightly been credited with playing a vital role in supporting post-pandemic GDP growth. However, a closer look at the trajectory reveals a concerning deceleration in momentum. The annual growth rate of central capex has plummeted from a recent peak of 28.3% in 2023-24 to 10.8% in 2024-25, and further to a mere 4.2% in the Revised Estimates (RE) for 2025-26. While the budget projects a recovery to 11.5% growth for 2026-27, this is only marginally higher than the assumed nominal GDP growth of 10.0%. Consequently, capex as a percentage of GDP is set to remain static at 3.1% for two consecutive years (2025-26 RE and 2026-27 BE).

This stagnation is critical. For an economy that requires massive infrastructure upgrades to become “developed,” and where public investment is meant to “crowd in” hesitant private investment, a plateauing public capex ratio is a red flag. It suggests that the much-vaunted expenditure restructuring may be reaching its limits, with the government unable to significantly ramp up the very type of spending deemed most productive for long-term growth, even as it rhetorically champions it.

The Revenue Conundrum: Cautious Projections and the GST Buoyancy Crisis

On the revenue side, the budget’s projections are notably cautious—a prudent approach given past slippages. However, the underlying trend in tax buoyancy (the responsiveness of tax revenue growth to GDP growth) is alarming. For 2026-27, the buoyancy of the Centre’s gross tax revenues is projected at 0.8, significantly below the benchmark of 1, which indicates revenue growing in lockstep with the economy.

The breakdown reveals a two-tier system. Direct taxes (corporate and personal income tax), with a 61.2% share, maintain a healthy buoyancy of 1.1. The crisis lies in indirect taxes, particularly the Goods and Services Tax (GST), which exhibits a dangerously low buoyancy of 0.3. This means GST collections are projected to grow at less than a third the rate of nominal GDP. This structural weakness has multiple causes: continued rate rationalizations (often politically driven), compliance gaps, and the complexity of a multi-rate system that creates loopholes and inefficiencies.

The implications are severe. With mounting pressure for both developmental (tech, infrastructure) and welfare expenditures, a floundering indirect tax system starves the exchequer of vital resources. It forces a heavier reliance on direct taxes, which can be politically sensitive and risk disincentivizing formal sector growth. The budget’s silence on a comprehensive GST overhaul—beyond tinkering—is a missed opportunity. Raising indirect tax buoyancy to at least 1 is not a mere accounting exercise; it is a fundamental prerequisite for funding the Viksit Bharat vision without resorting to unsustainable borrowing.

Federal Friction: The Sixteenth Finance Commission’s Constrained Mandate

The recommendations of the Sixteenth Finance Commission (FC16) cast a long shadow over the budget’s federal compact. In a significant departure, FC16 has maintained the states’ share in the divisible pool of central taxes at 41% but has made a stark reduction in grants-in-aid. It has discontinued revenue deficit grants entirely and reduced sector/state-specific grants. Consequently, total Finance Commission grants to states will fall from 0.43% of GDP in 2025-26 (the last year of FC15) to 0.33% in 2026-27.

This represents a substantial fiscal squeeze on state governments. Typically, the first year of a new Finance Commission award sees a “step jump” in grants; FC16 delivers a step down. This comes at a time when states are already grappling with their own fiscal stresses, increased spending responsibilities (especially in health and education post-pandemic), and the need to contribute to national capital projects. The reduction in untied funds via grants limits their fiscal autonomy and ability to address local priorities, potentially exacerbating regional inequalities. It effectively centralizes fiscal authority while decentralizing expenditure burdens, a recipe for strained Centre-State relations and possibly slower implementation of national programs that depend on state-level execution.

The Glacial Pace of Fiscal Consolidation and the Debt Trap

The most significant macro-fiscal concern is the dramatic slowdown in the pace of fiscal consolidation. The annual reduction in the fiscal deficit-to-GDP ratio has dwindled from 0.7 percentage points in 2024-25, to 0.4 points in 2025-26 (RE), to a barely perceptible 0.1 point in 2026-27 (BE). At this rate, achieving the Fiscal Responsibility and Budget Management (FRBM) Act target of 3% appears to be receding far into the future.

The government’s shift in strategy—from targeting the fiscal deficit to targeting the debt-to-GDP ratio—offers little solace. As the analysis correctly notes, the two metrics are mathematically intertwined via nominal GDP growth. A transparent strategy would require publishing a clear, growth-assumption-based glide path for both ratios over the medium term, indicating a credible date for achieving the FRBM targets. The current approach lacks such transparency, creating uncertainty for markets and policymakers.

The cost of delay is brutally quantified by the interest payment burden. The effective interest rate on central government debt is estimated to rise to 7.12% in 2026-27. Consequently, interest payments will consume a staggering 40% of the Centre’s revenue receipts. This is not expenditure; it is the cost of past fiscal profligacy. It represents a massive “primary deficit” in economic opportunity, squeezing out resources for essential primary expenditures on health, education, and infrastructure. Every rupee paid as interest is a rupee not spent on a school, a hospital, or a research lab.

Furthermore, the logic of the 3% deficit limit remains sound. If the Centre (with a 4.3% deficit) and states (collectively around 3-3.5%) are pre-empting 8-9% of GDP via borrowing, they inevitably “crowd out” private sector investment by dominating the pool of domestic savings and keeping cost of capital high. The persistent weakness in private corporate investment, despite corporate tax cuts and production-linked incentives, can be partly attributed to this crowding-out effect. The government cannot simultaneously be the dominant borrower and expect a vibrant private investment revival.

Conclusion: The Imperative for a Fiscal Reboot

Budget 2026-27 presents a paradoxical picture. It articulates a bold, technologically sophisticated vision for India’s future but is constrained by a fiscal framework showing signs of exhaustion. The growth engine of public capex is idling. The revenue engine, particularly GST, is sputtering. The federal fiscal transfer system is applying brakes on states. The path to deficit reduction has nearly stalled, while the debt servicing burden is becoming suffocating.

The article’s concluding call for a “reboot” in the path of fiscal consolidation is apt. This reboot must be multifaceted:

1. A Revenue Revolution: Undertake a thorough, non-populist review of the GST structure to simplify it and buoy revenues. Broaden the direct tax base through better data analytics rather than increasing rates.

2. Expenditure Quality & Efficiency: Move beyond capex vs. revenue binary. Ensure every rupee spent—whether on a semiconductor plant or a health mission—is subject to rigorous outcome budgeting and zero-based reviews to eliminate waste.

3. Credible, Transparent Glide Paths: The government must publish and commit to a clear, five-year trajectory for deficit and debt reduction, backed by realistic growth assumptions, to restore macroeconomic credibility.

4. Reinvigorating Cooperative Federalism: A review of the FC16 grant reductions may be necessary, alongside better coordination on joint infrastructure projects to ensure states are enabled, not encumbered, in the national development mission.

The dream of a Viksit Bharat by 2047 is an inspiring one. However, it cannot be built on a foundation of stagnant public investment, weak revenues, and a mountain of debt. Budget 2026 highlights the urgent need to repair the fiscal plumbing before the grand architectural plans can be safely realized. The tightrope is getting narrower, and the walk must now be executed with even greater precision and purpose.

Q&A: Unpacking the Fiscal Challenges in Budget 2026-27

Q1: The budget highlights increased focus on advanced tech sectors, but the analysis points to stagnant capital expenditure (capex) as a percentage of GDP. Isn’t this a contradiction?

A1: Yes, it represents a significant policy-speech versus fiscal-reality gap. While the budget speech rhetorically prioritizes future-oriented investments in AI, semiconductors, etc., the hard numbers show that the engine for such investment—public capex—is losing steam. The growth rate of central capex has crashed from 28.3% (2023-24) to a projected 11.5% (2026-27), which barely outpaces nominal GDP growth. As a result, capex’s share of GDP is stuck at 3.1%. This suggests the government’s ability to finance its own visionary projects through direct public investment is increasingly constrained. The ambitious sectoral focus may have to rely more on private capital or public-private partnerships, which are less certain, rather than robust, state-led capital formation.

Q2: What is “tax buoyancy,” and why is the low buoyancy of GST (0.3) such a critical problem?

A2: Tax buoyancy measures how much tax revenue grows for every 1% growth in the economy (GDP). A buoyancy of 1 means revenues grow in line with the economy. A buoyancy of 0.3, as projected for GST in 2026-27, means that for a 10% nominal GDP growth, GST revenues are expected to grow only 3%.
This is a critical problem because:

• Structural Revenue Shortfall: It indicates the GST system is failing to capture the growing value of economic transactions, due to rate cuts, evasion, or inefficiencies.

• Funding Deficit: It creates a structural hole in government finances, limiting its ability to fund welfare and development without borrowing more.

• Over-reliance on Direct Taxes: It forces greater dependence on direct taxes (income/corporate tax), which can be politically sensitive and may discourage formalization if rates are perceived as too high. A healthy tax system requires both direct and indirect streams to be buoyant.

Q3: How do the recommendations of the 16th Finance Commission (FC16) create a fiscal squeeze for state governments?

A3: FC16 creates a double bind for states:

1. Frozen Share, Reduced Grants: While keeping the states’ share of central taxes at 41%, FC16 has discontinued revenue deficit grants and cut sector-specific grants. Total FC grants will fall from 0.43% to 0.33% of GDP.

2. Increased Burden, Reduced Resources: This reduction comes when states face rising expenditure mandates (health, education, infrastructure co-funding). The reduction in untied grants specifically limits their flexibility to address local needs.

3. Historical Anomaly: This is atypical, as the first year of a new Finance Commission usually sees a grant increase. The squeeze forces states to either cut their own development spending, raise their own taxes (potentially hurting intra-state competitiveness), or increase their borrowing, compromising their fiscal health.

Q4: The pace of fiscal deficit reduction has slowed to 0.1 percentage points. Why is this slow pace dangerous, especially with high interest payments?

A4: The glacial pace of consolidation is dangerous due to a vicious cycle of debt and crowding-out:

• Interest Payment Trap: With the effective interest rate on government debt rising to 7.12%, a staggering 40% of all central government revenue is consumed by interest payments. This is deadweight spending that provides no current social or economic return.

• Crowding Out Private Investment: A high combined Centre+State fiscal deficit (≈8-9% of GDP) means the government is absorbing the lion’s share of domestic savings, keeping borrowing costs high and leaving fewer resources for the private sector to borrow and invest. This stifles the very private investment needed for growth.

• Lost Fiscal Space: The high interest burden “squeezes out” primary spending on health, education, and infrastructure. The slow deficit reduction perpetuates this trap, making it harder to escape over time.

Q5: The article calls for a “reboot” of fiscal consolidation. What key elements should this reboot include?

A5: A meaningful fiscal reboot requires action on four fronts:

• 1. Revenue-Side Overhaul: Launch a comprehensive GST 2.0 reform to simplify the rate structure, plug compliance gaps, and aim for a buoyancy of at least 1. Simultaneously, widen the direct tax base through data intelligence instead of raising rates.

• 2. Expenditure Quality & Transparency: Implement rigorous outcome-based budgeting for all major schemes, especially the new tech initiatives. Publish a clear, 5-year medium-term fiscal framework with assumed growth rates, showing credible glide paths to 3% fiscal deficit and 40% debt-to-GDP targets.

• 3. Cooperative Federalism Review: Engage with states to review the impact of reduced FC16 grants. Explore mechanisms for co-financing national priority projects without bankrupting states, ensuring they are partners in development.

• 4. Debt Management Strategy: Develop a proactive strategy to manage the cost and profile of debt, potentially locking in longer-term borrowings to mitigate rollover risks and interest rate volatility. The goal must be to reduce the interest-to-revenue ratio decisively.