The Centre’s debt-control strategy will be tested by uncertain nominal growth and new demands

The new edition of the budget that the finance minister will unveil this Sunday should thus be watched closely not only for its numbers. There may also be clues on how the government plans to help the Indian economy through uncharted waters in the years ahead. It will be about frameworks as well as figures.

First, the bean counting. Indian fiscal policy has gained credibility over the past five years for two reasons. The old habit of massaging the annual financial statement by either making unrealistic assumptions about revenues or parking government borrowings outside the budget has been done away with.

And the government has generally managed to stick faithfully to the fiscal glide path that it committed itself to after the pandemic ended. This year will be no different. It is very likely that the finance minister will announce a fiscal deficit for 2025-26 somewhere close to 4.4% of gross domestic product (GDP), as she had budgeted for a year ago.

There have been bumps along the way. The most important one is that tax collections in the ongoing financial year are likely to be significantly lower than the ₹34.96 trillion (on a gross basis) and ₹28.37 trillion (on a net basis) assumed in the 2025-26 budget.

Poor tax collections are themselves the result of a sharp deceleration in nominal GDP growth as well as reductions in the goods and services tax (GST) in the second half of the year. The upshot: The tax base has grown slower than expected, while tax rates have been reduced.

Hence the lower revenues. Dividends paid to the government by the Reserve Bank of India (RBI) have been larger than budgeted; this will provide a financial cushion against lower tax collections, but some spending cuts will also be necessary to ensure that the fiscal deficit does not overshoot the target.

The fiscal impulse—economist-speak for whether a government is adding demand to an economy or subtracting it—will continue to be mildly negative.

Budget analysis will now have to move to a new Holy Grail beyond the annual fiscal deficit target.

A year ago, Sitharaman had signalled an important shift in Indian fiscal strategy when she said: “The fiscal consolidation path announced by me in 2021 has served our economy very well… From 2026-27 onwards, our endeavour will be to keep the fiscal deficit each year such that the central government debt will be on a declining path as a percentage of GDP."

The forthcoming budget will be the first one under this new strategy, in which the fiscal deficit is only an operating lever to achieve a lower ratio of public debt to GDP from the current 57% to around 50% by the end of financial year 2030-31.

Bringing down India’s public debt burden over the next few years will depend on three variables: the primary balance in the government budget, the interest rates at which the government borrows and the rate of nominal GDP growth.

The first variable is under the control of the government, the second is under the control of RBI and the third is not directly controlled by either.

However, the last of these is perhaps the most important of the three and the success of the government’s new fiscal strategy will depend on nominal GDP growth inching back into the double digits—i.e., two percentage points higher than its level estimated for 2025-26—either through faster growth in output or higher inflation or some combination of the two.

These are tricky times as countries around the world adjust to new geopolitical realities. India is committed to bringing down its public debt burden by keeping budgetary deficits under control. In other words, there is little fiscal firepower in store in case the global storm becomes a hurricane.

However, the government will still have to adjust its fiscal policy to meet new goals such as higher defence spending, building capacity for key intermediate goods such as semiconductors and establishing an Indian presence along the technology frontier in areas such as artificial intelligence and green energy.

More traditional concerns, such as job creation, scaling up small enterprises, investing in urban growth and reviving the private-sector investment cycle, have not gone away either.

The Narendra Modi government did manage to ramp up infrastructure spending after the pandemic even as it brought down its fiscal deficit. The task ahead is an advanced version of what has happened earlier and will require a hard look at the components of government spending.

There are also two important external factors that will impact the government’s budget over the next five years. First, the report of the 16th Finance Commission on how the tax kitty is to be divided between New Delhi and the states will be made public.

Second, casting a long shadow over future budgets will be a decision on government salaries to be taken by the 8th Pay Commission in 2027. Both will matter.

The author is executive director at Artha India Research Advisors.