Budget 2026: Balancing Fiscal Prudence with Strategic Ambition in a Shifting Global Order
The presentation of India's Union Budget for 2026 occurred against an extraordinary and rapidly evolving global economic backdrop. The established rules-based international order, though imperfect, is now unraveling at a swift pace, creating both immediate uncertainties and medium-term concerns for economies worldwide.
Navigating Near-Term Volatility and Medium-Term Challenges
In the near term, markets are experiencing significant volatility as the rules of global trade and finance are being rewritten arbitrarily. Questions loom large: which nation might face the next round of tariffs? Are there any truly risk-free assets remaining globally? Can the muscular industrial policies of developed economies successfully attract global capital back to their shores?
Looking further ahead, the political and economic fragmentation likely to result from these shifts poses a serious threat to the specialization and exchange that fueled global prosperity over the past eight decades. While this period saw its share of challenges, including rising inequality and unsustainable imbalances, the prospect of generating robust growth in a splintered world appears daunting.
The Central Tension: Conservative Fiscal Math vs. Aggressive Policy Reform
This complex environment presented the Budget with a fundamental tension: the need to be both conservative and aggressive simultaneously. The resolution involved maintaining fiscal discipline while pursuing expansive policy reforms.
The government successfully achieved its immediate fiscal targets. Despite implementing direct and indirect tax cuts and confronting a lower-than-expected nominal GDP, policymakers met the current fiscal year's deficit target of 4.4% of GDP. Furthermore, they signaled a modest consolidation path, aiming for a deficit of 4.3% of GDP in the following year. The forward-looking fiscal assumptions remain relatively conservative, suggesting this consolidation is not under immediate threat.
The Long Road to Fiscal Sustainability
However, medium-term fiscal sustainability involves numerous moving parts. It critically depends on future growth trajectories and the ability to rein in state-level finances. If nominal GDP growth averages 10% over the next five years, the central government would need to reduce its deficit to approximately 3.6% of GDP over four years to meet its debt target of 50% of GDP by FY31.
The challenge amplifies if state deficits remain unchecked. In such a scenario, combined public debt—the metric that truly matters for the overall economy—would barely decline from 82% to 79% of GDP by 2031. The situation becomes even more precarious if nominal GDP growth slips to 9%, a plausible outcome given disinflationary pressures from Chinese excess capacity across Asia. Under this growth scenario, achieving the debt target would require the central deficit to fall to 3% of GDP by FY31, all while accommodating the expected implementation of the Eighth Pay Commission from FY28.
The Shifting Dynamics of Public Capital Expenditure
Public capital expenditure was a primary driver of India's post-pandemic economic recovery, with central government capex growing at an impressive 30% annually in nominal terms for four consecutive years. This momentum has inevitably slowed. Central capex growth decelerated to 11% in FY25, and based on revised estimates for FY26, it is projected to slow further to 4.2% this year.
While authorities have budgeted for an 11.5% growth in central capex for FY27, the compound annual growth rate over the two-year period would still be below 8% in nominal terms. Concurrently, capital expenditure by central public sector undertakings has averaged 8% growth over the last three years, lagging behind nominal GDP growth. State government capex growth between April and December 2025 shows a compound annual growth rate of just 6% nominally over the preceding two years.
This broad slowdown in public sector capital expenditure as a growth driver is inevitable, constrained by both limited fiscal space and absorptive capacity. The clear implication is that the baton for driving investment must progressively and rapidly pass to the private sector.
Strategic Sector Reforms to Ignite Investment
This transition makes aggressive and expansive policy reform intent crucial for jump-starting animal spirits among both domestic and foreign investors. The Budget has taken significant steps in this direction by identifying seven strategic sectors for focused development:
- Biopharma
- The Semiconductor Mission
- Electronic Components
- Rare Earths
- Chemical Parks
- Capital Goods
- Textiles
For each of these sectors, the Budget proposed several targeted measures. Notably, it introduced a substantial two-decade tax holiday for any foreign company providing global cloud services using data center infrastructure located in India. Additionally, it created a safe harbor for the IT sector to protect it from tax-related uncertainties and signaled the establishment of a high-level committee to review the banking sector.
Critical Questions for the Path Ahead
While these are encouraging steps, structural reform is an ongoing process with a long horizon. Policymakers must remain focused on several key questions in the coming months:
- How can India effectively jumpstart Foreign Direct Investment (FDI) to bolster capital flows and safely finance the current account deficit?
- How should India balance investments in capital-intensive strategic sectors with the need to energize labor-intensive sectors that are crucial for employment generation and leveraging the country's vast, aspirational workforce?
- How can India ensure its recently signed Free Trade Agreements (FTAs)—a commendable achievement—actually move the needle on boosting exports?
- While the Budget announced changes to customs duties, will a more comprehensive simplification and rationalization of the import duty structure eventually be necessary to attract FDI and enhance export competitiveness within global value chains?
- What will it take for India's private sector to embark on a broad-based capital expenditure cycle in a world awash with Chinese excess manufacturing capacity?
Building Structural Foundations for Sustained Growth
India is currently experiencing a smart cyclical economic upswing, supported by a series of measures over the past year, including income and GST cuts, monetary and regulatory easing, a strong monsoon, and low inflation. However, these cyclical supports will inevitably fade, necessitating planning for the subsequent phase.
At that critical juncture, it is imperative that temporary cyclical supports are seamlessly replaced by robust structural underpinnings. In the current global economic storm, sustained policy reform leading to consistently strong growth will be India's most effective insulation mechanism. The Budget 2026 represents a careful step in this complex balancing act between immediate prudence and long-term ambition.
