The Budget and the imperative of fiscal consolidation

UPSC Syllabus: Gs Paper 3- Indian economy

Introduction

The Union Budget 2026–27 places strong focus on spending programmes to support the goal of becoming a developed country by 2047. It shifts attention towards advanced technology and long-term growth drivers. At the same time, it raises concerns about implementation capacity, revenue strength, Centre–State finances, and the slowing pace of fiscal consolidation, all of which shape the credibility of this development strategy.

How the government is changing its spending approach

1. Shift from revenue to capital expenditure: The share of revenue expenditure in total spending has declined from 88% in 2014–15 to about 77% in 2026–27, creating space for higher capital expenditure.
2. Reduction in subsidies: Central subsidies have fallen by about 7 percentage points of total expenditure, signalling tighter control over recurring spending.
3. Capital expenditure as a growth tool: Higher capital expenditure has supported GDP growth in the post-COVID period and remains a key policy lever.
4. Slowing momentum in capital spending growth: Capital expenditure growth peaked at 28.3% in 2023–24 but fell to 10.8% in 2024–25 and 4.2% in 2025–26, before being budgeted at 11.5% in 2026–27.
5. Capital spending stagnation as share of GDP: Capital expenditure remains nearly unchanged at about 3.1% of GDP in both 2025–26 and 2026–27, as the budgeted growth of 11.5% is only marginally higher than the assumed nominal GDP growth of 10.0%.
6. Implementation gap in capital expenditure: Although capital expenditure growth of 10.1% was budgeted for 2025–26, only 4.2% growth was actually achieved, raising concerns about implementation capacity.

Whether revenues are strong enough to support these priorities

1. Cautious tax revenue projections: Tax revenue estimates for 2026–27 appear realistic and are likely to be met, reflecting conservative budgeting.
2. Weak overall tax buoyancy: Gross tax buoyancy is projected at only 0.8, well below the benchmark of 1, raising concerns about revenue responsiveness to growth.
3. Dependence on direct taxes: Direct taxes show buoyancy of 1.1 and account for 61.2% of gross tax revenues, supporting collections.
4. GST drag on indirect taxes: Indirect tax buoyancy is only 0.3, with GST collections not expected to match GDP growth in 2026–27.
5. Need to reform indirect taxes: Given rising developmental and welfare spending, improving indirect tax buoyancy to at least 1 becomes essential.

What this means for States and federal finances

1. No increase in States’ tax share: The Sixteenth Finance Commission retained the States’ share in the divisible pool at 41%, unchanged from the previous period.
2. Stagnant tax assignment to States: States’ assigned taxes remain at 3.9% of GDP in both 2025–26 and 2026–27, offering no additional fiscal room.
3. Discontinuation of revenue deficit grants: The absence of revenue deficit and sector-specific grants reduces overall transfers to States.
4. Decline in Finance Commission grants: Total Finance Commission grants fall from 0.43% of GDP in 2025–26 to 0.33% in 2026–27, contrary to the usual first-year increase.
5. Pressure on State finances: Lower transfers increase stress on State budgets and constrain their spending capacity.

Why fiscal consolidation and debt sustainability matter

1. Slowing reduction in fiscal deficit: The annual reduction in the fiscal deficit to GDP ratio has slowed from 0.7 percentage points in 2024–25 to just 0.1 point in 2026–27.
2. Shift in targeting strategy: Moving focus from fiscal deficit to debt-GDP ratio reduces clarity, as both indicators depend on nominal GDP growth.
3. Need for a clear glide path: A transparent five-year path for fiscal deficit and debt-GDP ratios, with growth assumptions, is required.
4. Delayed FRBM targets: The Budget does not clearly indicate when the FRBM targets of 3% fiscal deficit and 40% debt-GDP ratio will be achieved.
5. Rising interest burden: The effective interest rate on government debt is estimated at 7.12% in 2026–27, increasing steadily over recent years.
6. Crowding out primary spending: Interest payments consume nearly 40% of revenue receipts, squeezing funds for essential expenditure.
7. Impact on private investment: High combined fiscal deficits of the Centre and States reduce investible resources, discouraging private sector investment.

Conclusion

The Budget sets a clear development vision and identifies priority sectors for long-term growth. However, slower fiscal consolidation, weak indirect tax buoyancy, and reduced State transfers weaken its foundation. Sustained growth needs fiscal discipline, transparent targets, and stronger revenues. Re-aligning consolidation strategy is necessary to support stability, investment, and the 2047 development goal.

Question for practice:

Evaluate how the Union Budget 2026–27 balances development-oriented expenditure priorities with the need for fiscal consolidation and debt sustainability.

Source: The Hindu