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As India gears up for the Union Budget 2026-27, the government faces a growing challenge around how to reduce the fiscal deficit further without weakening the investment-led growth momentum that has supported the economy over the past two years, EY highlighted in its Economy Watch for January 2026.
India's fiscal deficit is budgeted at 4.4% of GDP in FY26, and policymakers are expected to signal a further consolidation to around 4.0% in FY27, EY said. However, slower-than-expected nominal GDP growth and subdued tax collections have narrowed the room for manoeuvre. The pressure is compounded by the fact that government capital expenditure has emerged as the main driver of growth, rising 28.2% during April-November FY26, even as private investment remains cautious amid global uncertainty. EY said that any sharp cutback in capital spending could weaken growth at a time when external demand is already soft. On the revenue side, the government's options appear limited. Gross tax revenue growth slowed to 3.3% in the first eight months of FY26, reflecting the impact of GST rate rationalisation and personal income tax reforms introduced in recent budgets. Indirect tax collections have contracted, while direct tax growth has moderated. With nominal GDP growth estimated at just 8% in FY26, well below earlier assumptions, even maintaining the current deficit ratio has become more challenging. Lower nominal growth reduces the denominator effect, making deficit and debt ratios harder to compress despite spending restraint. Given these constraints, EY analysts expect the government to protect capital expenditure in FY27 and focus deficit reduction efforts on revenue expenditure, which grew only 1.8% in the first eight months of FY26. This could mean tighter control over subsidies, administrative spending and non-essential outlays, while preserving infrastructure investment. The government may also rely on higher non-tax revenues, including dividend transfers from the Reserve Bank of India, to help bridge part of the fiscal gap. Disinvestment and non-debt capital receipts are expected to play a supporting role, though they are unlikely to fully offset tax shortfalls. In recent budgets, the Centre has moved away from rigid annual deficit targets towards a broader focus on reducing the debt-to-GDP ratio over time. While this offers some flexibility, EY estimates suggest that public debt could still edge up marginally in FY26, even if the fiscal deficit target is met, largely due to weak nominal growth. The FY27 Budget is therefore expected to emphasise "quality of consolidation" rather than aggressive deficit cuts, maintaining public investment while gradually compressing consumption-oriented spending. The EY report said the success of the strategy will depend less on the headline deficit number and more on whether fiscal policy continues to support growth while setting out a credible medium-term path towards the FRBM target of a 3% deficit. (ANI)
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