What is the story about?
As India prepares for the Union Budget 2026–27, the government’s central challenge will be to further reduce the fiscal deficit without derailing the investment-led growth momentum that has supported the economy over the past two years, according to EY’s Economy Watch report for January 2026.
India’s fiscal deficit is budgeted at 4.4 per cent of GDP in FY26, and policymakers are expected to signal a further consolidation to around 4.0 per cent in FY27, EY said. However, the scope for aggressive tightening remains limited due to slower-than-expected nominal GDP growth and subdued tax collections, which have narrowed fiscal headroom.
The pressure is heightened by the fact that government capital expenditure has emerged as the primary driver of growth, rising 28.2 per cent during April–November FY26, while private investment continues to remain cautious amid global uncertainty. EY cautioned that any sharp curtailment of capital spending could weaken growth at a time when external demand remains fragile.
Instead, the report suggests that fiscal consolidation is likely to focus on tighter control over subsidies, administrative expenses, and non-essential spending, while protecting infrastructure investment.
The government may also lean on higher non-tax revenues, including dividend transfers from the Reserve Bank of India, to bridge part of the fiscal gap. Disinvestment and other non-debt capital receipts are expected to play a supporting role, though they may not fully offset tax shortfalls.
In recent budgets, the Centre has shifted away from rigid annual deficit targets towards a broader emphasis on reducing the debt-to-GDP ratio over time, offering greater policy flexibility. However, EY estimates indicate 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 stress the “quality of fiscal consolidation” rather than aggressive deficit cuts—maintaining public investment while gradually compressing consumption-oriented spending.
According to EY, the success of this approach will depend less on the headline deficit number and more on whether fiscal policy continues to support growth while laying out a credible medium-term path towards the FRBM target of a 3 per cent deficit.
India’s fiscal deficit is budgeted at 4.4 per cent of GDP in FY26, and policymakers are expected to signal a further consolidation to around 4.0 per cent in FY27, EY said. However, the scope for aggressive tightening remains limited due to slower-than-expected nominal GDP growth and subdued tax collections, which have narrowed fiscal headroom.
The pressure is heightened by the fact that government capital expenditure has emerged as the primary driver of growth, rising 28.2 per cent during April–November FY26, while private investment continues to remain cautious amid global uncertainty. EY cautioned that any sharp curtailment of capital spending could weaken growth at a time when external demand remains fragile.
Instead, the report suggests that fiscal consolidation is likely to focus on tighter control over subsidies, administrative expenses, and non-essential spending, while protecting infrastructure investment.
The government may also lean on higher non-tax revenues, including dividend transfers from the Reserve Bank of India, to bridge part of the fiscal gap. Disinvestment and other non-debt capital receipts are expected to play a supporting role, though they may not fully offset tax shortfalls.
In recent budgets, the Centre has shifted away from rigid annual deficit targets towards a broader emphasis on reducing the debt-to-GDP ratio over time, offering greater policy flexibility. However, EY estimates indicate 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 stress the “quality of fiscal consolidation” rather than aggressive deficit cuts—maintaining public investment while gradually compressing consumption-oriented spending.
According to EY, the success of this approach will depend less on the headline deficit number and more on whether fiscal policy continues to support growth while laying out a credible medium-term path towards the FRBM target of a 3 per cent deficit.
