- The central government is on track to halve the fiscal deficit from Covid highs.
- The FY25 deficit target at -4.9% of GDP is on course to be met …
- …and FY26’s to be set at a lower -4.5%.
- Lower revenue deficit will allow for consolidation without compromising on expenditure.
- We expect FY25 borrowings to be maintained, with FY26 dated issuance to be higher.
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The FY26 Union Budget will be tabled on February 1. This marks the first full-year Budget for the coalition government after assuming power for a third consecutive term in 2024. Post pandemic, the centre returned to its consolidation path, lowering the fiscal deficit from -9.2% of GDP in FY21 to -4.9% of GDP in FY25. Plans to lower this metric to -4.5% (or below) in FY26 will effectively halve the ratio in over four years.
The FRBM review committee had outlined the need for a shift to debt to GDP ratio as a budgetary anchor in 2017. Back then, the Committee suggested using debt as the primary target for fiscal policy, with the cap for general government debt to GDP ratio at 60%, with 40% limit for the centre and 20% limit for the states. At the July 2024 Budget, the Finance Minister suggested that from FY27, deficit targets might be set such that the central government’s debt will be on a declining path. We’ll wait to see if there are any follow up on this thought process.
FY25 deficit target within reach
In our view, the central government is on track to meet the fiscal deficit target of -4.5% of GDP in FY25. In the first eight months of FY25 (Apr-Nov24 i.e. 8MFY25), the fiscal deficit added up to 60% of the full year target, lower than 65% in the corresponding period year before. Revenue and expenditure breakdown points to a likelihood that the lower pace of capital spending will help to offset any miss in revenue targets as well as slower nominal GDP growth than budgeted.
FY26 math – Striking a balance
We expect the central government to prioritise macro stability by sticking with the fiscal consolidation path, and steer clear of populist measures. This will help keep additional spending and incremental inflationary impact in check. Instead moves might include fine-tuning existing measures and focus on medium-term demand boost. This budget is also set against the backdrop of slower domestic consumption and activity, which is likely to be in focus in the announcements. Emphasis will be on employment and skilling with a focus on boosting incomes, support labour intensive sectors, draw in private sector players, and defend against a tougher geopolitical environment. The FY26 Budget deficit target is likely to be set at -4.5% of GDP, ~40bp of consolidation compared to FY25. The underlying nominal GDP assumption of 10%, a shade faster than 9.7% in FY25 (see table), based on 6.4% real growth and 3.6% GDP deflator. Total expenditure is expected be lower by 0.4% of GDP, which along with higher tax revenue assumptions is likely to narrow the fiscal deficit.
Borrowings
Despite our projection for a narrower budget deficit at INR15.7trn for FY25, we don’t anticipate a material reduction in borrowings from the current gross issuances target, with any surplus to be maintained as cash buffer for the next fiscal year. For FY26, with the centre’s fiscal deficit estimated at INR 16trn, we expect the net borrowings to stand at INR 11.4trn, marginally lower than FY26. Redemptions however are expected to rise to INR 3.7trn, which will effectively push up gross dated issuances to INR 15.0trn.
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