This appeared in the Times of India on 2 February 2026 (link)
Sometimes, boring and predictable is good, if not great.
The FY2027 union budget ticks that box.Greater certainty of fiscal and regulatory policies for businesses and investors enables them to take business risk – an essential condition to reduce India’s long-term cost of capital.
A major driver of the remarkable macroeconomic stability that India has demonstrated in recent years, despite the geopolitical turbulence and volatility in global financial markets, has been the government’s fiscal prudence and predictability. Growth has been resilient, and inflation low.
A reduction in fiscal deficits has a negative impact on near-term growth and is politically difficult to do – the reason most countries have failed to reverse the Covid-era rise deficits. However, by reducing ‘crowding out’, it helps direct the economy’s savings to the private sector, where capital is generally more productive, and thus boosts medium-term growth prospects.
FY2027 marks a significant fiscal milestone: most of the Covid-driven increase in fiscal deficits has now been successfully wound down. Adjusted for the Rs2.2 trillion (0.55% of GDP) of interest-free loans to state governments for capital expenditure, the union government’s fiscal deficit ratio is now almost back to pre-Covid levels. In fact, adjusted for the undesirable ‘off balance sheet’ borrowing that used to occur till FY19, but has stopped now, effective deficits are now lower than they used to be. Revenue deficit (fiscal deficit minus capital expenditure) is nearly 1% of GDP below pre-Covid levels.
Fiscal deficit ratios now do not need to fall materially going forward, and the growth in nominal GDP should help drive the debt-to-GDP ratio lower towards the government’s FY2031 target of 50%. The implementation of the 8th Pay Commission, likely in FY2028, is likely to increase the salary and pension expenditure materially, especially as arrears will be due, given that hikes are effective 1 January 2026. However, this one-time bump may not drive a material divergence from the path to the target debt ratio.
If an aircraft can generate thrust to fly at 900 kmph, but faces a headwind of 200 kmph, its net speed versus ground slows to 700 kmph. But when the headwind disappears, its speed versus ground rises to 900kmph. Similarly, as the fiscal headwinds have now faded, the economy can get closer to its trend growth rates.
But that may not be sufficient to close the ‘output gap’. If the economy had grown at 7% over the past 8 years (the recent Economic Survey states 7% growth could be India’s trend growth), economic output currently would be nearly 10% higher than it is. Put another way, output is 1.5 years behind where it would have been if Covid had not happened. A large output gap (or economic slack) is visible in the low inflation we see currently and reflects slack in the labour market.
Policymakers are clearly relying on monetary policy to step in to help close this output gap, by helping translate the lower deficits to lower interest rates. But despite the RBI’s rate cuts and the remarkable fiscal discipline, yields on government bonds have been rising.
As important as the fiscal deficit is the plan to finance it, given its large size (Rs17 trillion). On this front, overly conservative assumptions have resulted in a target for bond issuance that is above what the bond markets were expecting despite the deficit being broadly in-line. While it may seem prudent for the government to under-estimate its financing from non-market sources, an important driver of recent volatility in the financial system has been excess cash held by the government.
The resultant tight liquidity conditions have forced banks to shed their holdings of government bonds to be able to meet the growing demand for loans. As they sell bonds, the prices of the bonds fall, and the effective interest rates on these bonds goes up. This has the opposite effect on interest rates than what the government intends to achieve through its fiscal discipline.
Beyond the fiscal arithmetic, the budget speech highlighted government policy priorities going forward.
The grant of Rs5000 crore each to City Economic Regions on a challenge mode, as well as the measures to increase the quantum of municipal bonds are important for the financing of urban infrastructure, which is likely to define India’s productivity trajectory over the medium-term. As per the United Nations, India’s effective urban population is already larger than China’s, but ‘official’ urbanization is fraction of that. This shapes labour markets, infrastructure demand and housing needs.
The high-powered Standing Committee on ‘Education to Employment and Enterprise’ to recommend measures that focus on the services sector as core driver of economic development would fill the vacuum for an entity that tracks growth and directs government policy on a regular basis. As with most such initiatives how this is positioned inside the government, the powers it has, and the initial members would be critical drivers of its effectiveness.
A period of macroeconomic stability also allows policymakers to take some policy risks – reforms can help improve the potential growth rate of the economy. These reforms though need not be announced in the budget speech and can happen throughout the year. The speech mentioned the 350 reforms announced since Independence Day. Given that the Prime Minister said at the start of the Budget Session that the Reform Express will continue to run, more should be expected.