The year 2026 is shaping up to be a critical juncture for India's public finances, with both the central and state governments facing mounting pressure to reconcile their budgets with reduced revenue streams. The primary catalyst for this looming fiscal challenge is the clear impact of Goods and Services Tax (GST) rate reductions on government income, compelling a period of stringent expenditure control.
Centre's Fiscal Deficit Widens Alarmingly
Recent data from the first eight months of the fiscal year 2025-26 (April to November) paints a concerning picture for the Centre. The fiscal deficit has already reached 62.3% of the full-year budget estimate, a significant jump from the 52.5% recorded in the same period of 2024-25. An even more startling indicator is the primary deficit, which excludes interest payments. This has soared to 78.9% of the annual target, compared to just 41.8% a year ago.
The root of the pressure lies in tax collections. By November, the Centre had netted only 49.1% of its budgeted tax revenue. With GST cuts directly eroding revenue, the government has little room for maneuver. To adhere to its deficit targets, significant cuts in expenditures are now inevitable.
States Grapple with Costlier Debt and Rising Deficits
The fiscal strain is even more pronounced for state governments. Their cost of borrowing has risen despite a supportive monetary policy from the Reserve Bank of India (RBI). For instance, on December 30, Andhra Pradesh raised Rs 1,000 crore at 7.50% interest, while West Bengal secured Rs 2,000 crore at 7.56%. Just a year earlier, these states paid lower rates of 7.16% and 7.15% for similar loans.
This trend coincides with a worrying rise in state-level deficits. The combined fiscal deficit of states has increased from 2.4% of GDP in 2018-19 to 3.2% in 2024-25. Their primary deficit has also widened from 0.8% to 1.5% in the same period. Several states are carrying heavy debt burdens, with outstanding liabilities exceeding 30% of their Gross State Domestic Product (GSDP). Notable examples include:
- Punjab
- Himachal Pradesh
- West Bengal
- Bihar
- Kerala
- Rajasthan
Market discipline may soon intensify, as bond markets begin to differentiate between fiscally responsible and reckless state governments, potentially raising borrowing costs further for the latter.
The Broader Economic Imperative for Fiscal Prudence
This fiscal reckoning comes at a time when the corporate and banking sectors have recovered from previous crises. With healthier balance sheets in the private sector, the economy cannot afford a relapse caused by weak government finances. Excessive government borrowing risks crowding out private investment, which is crucial for sustained growth.
Economists argue that governments should refocus on their core responsibilities: providing public goods and investing in long-term physical and social infrastructure. However, a trend has emerged where taxpayer money and borrowed funds are increasingly directed towards short-term populist measures like freebies and cash transfers, aimed at securing electoral gains rather than durable development.
This approach has found acceptance across the political spectrum. The hope for 2026 is that it marks the year when this "fiscal gravy train" begins to slow, if not halt entirely, forcing a return to sustainable public finance management for both the Centre and the states.
