Budget 2026: EY Flags Tightrope Between Fiscal Deficit Cuts and Growth

As India prepares for the Union Budget 2026–27, the government faces a narrowing policy corridor: how to reduce the fiscal deficit further without derailing investment-led growth, according to EY’s latest Economy Watch.

India’s fiscal deficit is pegged at 4.4% of GDP in FY26, with policymakers expected to signal further consolidation towards around 4% in FY27. But EY warns that slower nominal GDP growth and muted tax collections have sharply reduced the room to manoeuvre.

The challenge is compounded by the fact that government capital expenditure has become the primary engine of growth, rising 28.2% between April and November FY26, while private investment remains cautious amid global uncertainty. Any abrupt cut in public capex, EY notes, could weaken growth just as external demand softens.

On the revenue front, options are limited. Gross tax revenue grew just 3.3% in the first eight months of FY26, reflecting the impact of GST rate rationalisation and income tax reforms. Indirect tax collections have contracted, while direct tax growth has moderated. With nominal GDP growth estimated at only 8%, maintaining even the current deficit ratio has become more difficult due to an unfavourable denominator effect.

Given these constraints, EY expects the government to protect capital spending in FY27 and focus deficit reduction efforts on revenue expenditure, which grew a modest 1.8% during April–November FY26. This could translate into tighter controls on subsidies, administrative expenses and non-essential spending, while preserving infrastructure investment.

The government may also lean on non-tax revenues, including dividend transfers from the Reserve Bank of India, to partially bridge the fiscal gap. While disinvestment and non-debt capital receipts could help, EY cautions they are unlikely to fully offset tax shortfalls.

Recent budgets have already shifted away from rigid annual deficit targets towards a broader focus on reducing the debt-to-GDP ratio over time. Even so, EY estimates suggest public debt could edge up marginally in FY26, despite meeting deficit targets, largely because of weak nominal growth.

The FY27 Budget, EY concludes, is likely to prioritise “quality of consolidation” over aggressive deficit cuts, maintaining public investment while gradually compressing consumption-oriented spending. The success of this strategy will depend less on headline deficit numbers and more on whether fiscal policy continues to support growth while outlining a credible medium-term path towards the FRBM target of a 3% deficit.

(With inputs from ANI)