Beyond the Fiscal Target: Aligning Fiscal Discipline with Growth

As the Union Budget for 2026-27 approaches, attention inevitably centres on tax measures, subsidies, capital expenditure, and sectoral allocations. However, a more critical issue will be the government’s progress towards its fiscal consolidation commitments. 

In the post-COVID-19 period, the central government adopted a dual strategy of supporting economic growth through public investment while gradually reducing the fiscal deficit. Between 2020-21 and 2024-25, capital expenditure increased nearly 2.5 times, while the fiscal deficit declined from 9.2% of GDP to 4.8%, helping stabilise the economy amid multiple external economic shocks. A further reduction to 4.4% in 2025-26 would reinforce the credibility of fiscal discipline and its role in sustaining growth. The upcoming Budget will therefore test whether this balance can be maintained over the long term.

In the post-pandemic phase, fiscal consolidation was aided by strong nominal GDP growth, buoyant tax collections, and healthy dividend receipts. The revenue strength enabled the government to expand capital expenditure while still narrowing the deficit. However, the macroeconomic environment has since shifted. In 2025-26, nominal GDP growth slowed to 8.8% in the first half of the financial year. In addition, revenue pressures are expected from revisions to income tax slabs and GST rationalisation measures aimed at supporting consumption. Although dividend income continues to provide some support, weaker tax collections could result in revenue loss of about ₹1.5 trillion in 2025-26, placing further strain on the fiscal balance. As of end-November, the fiscal deficit had already reached 62.3% of the Budget estimate, significantly higher than the 52.5% recorded during the corresponding period last year.

Amid slowing growth, the imperative to maintain fiscal balance constrains the government’s spending flexibility. A large share of revenue expenditure, such as interest payments, salaries, pensions, and statutory transfers, is largely inflexible in the short run. Consequently, when revenues fall short, discretionary spending, most notably capital expenditure, often bears the brunt, undermining long-term growth prospects. This pressure is evident in the capital expenditure allocation for 2025-26, pegged at ₹11.2 trillion, almost unchanged from the 2024-25 Budget estimate and only about 10% higher than actual spending in 2024-25.

Fiscal consolidation must therefore be aligned with growth-enhancing priorities. This requires a careful rebalancing of expenditure away from consumption-oriented spending, such as subsidies and concessions with limited long-term pay-offs, towards investments in productive assets, including infrastructure, human capital, and research and development. Such investments improve investment conditions, raise potential output, and generate sustainable long-term revenues.

The government’s front-loading of capital expenditure in recent years reflects this approach and has supported growth without triggering inflationary pressures or external imbalances. If the upcoming Union Budget continues to prioritise capital expenditure while restraining unproductive revenue spending, it would strengthen fiscal credibility, even as consolidation proceeds gradually.

The Budget will also be pivotal in shaping India’s medium-term fiscal trajectory. As already indicated, the next phase of consolidation, from 2026-27 to 2030-31, aims to reduce the debt-to-GDP ratio to 50% from an estimated 56.1% in 2025-26. Decisions on taxes, expenditures, and borrowing will therefore have implications beyond the coming fiscal year. Importantly, reducing public debt cannot rely solely on capital expenditure restraint, particularly in an economy with significant development needs. Sustained revenue buoyancy and growth-enhancing borrowing will be critical.

In this context, the significance of the Union Budget extends beyond meeting the 4.4% fiscal deficit target. What will matter most is whether it outlines a credible framework for a gradual, growth-friendly budgetary consolidation anchored in debt sustainability. Ultimately, fiscal sustainability depends on economic growth, and tighter deficit targets are meaningful only if spending remains productive and revenue assumptions are realistic. The greater risk lies in allowing revenue slippage to derail the consolidation path.