The Union Budget and RBI credit policy will shape India’s fiscal and monetary trajectory amid slowing growth, low inflation and rising borrowing needs | Photo: Pixabay
With the new year starting, the two immediate policies that are awaited are the budget and the credit policy. The credit policy will come just after the budget is announced and will also be the last one for FY26. The budget will come just after the FOMC meeting, and while it has no bearing on its content, the RBI will also pay attention to what the Federal Reserve has in mind. What can one expect from these policies?
Fiscal deficit path under focus
The budget to be presented will be special for several reasons. The first is that the path of the fiscal deficit will be tracked. Post-Covid, there has been a tendency for the deficit to be rolled back. While a 3% ratio is the ideal level, it is not possible to do so at one stroke and has to be done in a phased manner.
Pay Commission and food subsidy concerns
Second, this budget will also have to keep in mind the impact of the possible recommendations of the Pay Commission. While the direct impact will not be in FY27, a call has to be taken on whether provisions have to be made for the arrears component as and when the new dispensation is enforced. Third, there has to be internal discussion on the free food project, which is set to end by December 2028. A plan to roll back the same has to be put in place.
Support for exporters amid tariff backlash
Fourth, addressing the immediate concerns of exporters on account of the tariff backlash has to be provided for. It is expected that a trade deal will be signed by the end of March 2026, which will give space for the budget to address these concerns. Therefore, more than numbers, it is the ideology that will be of prime importance.
Nominal GDP assumptions crucial
What specifically will economists be looking for in this budget? To begin with, the assumptions on nominal GDP growth will be of interest. FY26 has been quite different from earlier years, with very low inflation, thus bringing about a virtual convergence between real and nominal GDP growth rates. This becomes important since the fiscal deficit ratio depends on the nominal GDP value.
If the ratio is to be lowered, then the fiscal deficit has to be lower if nominal GDP growth remains in single digits. Normally, nominal GDP growth of around 11% is assumed, which allows scope for a higher deficit value while still maintaining a lower fiscal deficit ratio. The growth assumed in the budget sets the tone for the implicit GDP growth, on which the Economic Survey usually offers guidance.
Capex constraints and expectations
Another major area of focus is government capital expenditure. At around Rs 11 lakh crore in FY26, capex accounts for a little over 20% of the total budget size. While the budget size grows annually by 5–10%, it may not always be possible to raise capex proportionately. Capacity constraints in project execution and completion are key reasons why capex targets are often not met at both central and state levels. An increase of not more than Rs 1 lakh crore can be expected.
Disinvestment and asset monetisation
The third area of interest will be disinvestment and asset monetisation, which have become increasingly important for budget formulation. Tax collections are constrained by GDP growth, making non-tax revenues and RBI transfers critical in determining overall fiscal space.
Limited scope for tax relief
Certain measures are unlikely, particularly in individual taxation. The government has already rationalised tax rates, especially for lower income groups in FY26, and is unlikely to provide further relief. However, there may be scope for tax benefits on interest income from bank deposits, given the slowdown in such savings. There is also a strong case for harmonising tax structures for debt and equity returns.
GST and customs duty outlook
On the indirect tax front, with GST 2.0 being implemented, there is limited scope for further changes. Attention will instead focus on potential changes in customs duty structures, especially in light of trade deals with the US and other countries that are signed or under negotiation.
Borrowing pressures ahead
The fiscal deficit level will indicate net borrowing for the year. FY27 will see redemptions of Rs 5.5 lakh crore, rising sharply to nearly Rs 9 lakh crore by FY31. This will test the market’s ability to absorb increasingly large government borrowings.
Credit policy outlook
Following the budget, the credit policy will be announced. Inflation and growth targets are unlikely to differ significantly from the December policy. One more rate cut, bringing the repo rate to 5%, may be expected, but this could mark the end of the easing cycle as inflation rises to the 4–4.5% range due to base effects.
The key challenge will be how policymakers respond to potentially lower GDP growth in FY27 compared to FY26. The limits of rate cuts in stimulating growth will be tested both at the policy level and on the ground.
The author is Chief Economist, Bank of Baroda, and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal.
