19

Jan

Beyond Comfort: Why the FY27 Budget Must Tackle India’s Hidden Growth Fault Lines

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By conventional macroeconomic yardsticks, India should enter the financial year 2026–27 (FY27) Budget cycle with a degree of comfort. Growth is expected to remain above 7 per cent, inflation has eased from its post-pandemic peaks, and fiscal consolidation appears broadly on track, with the fiscal deficit projected to narrow to around 4.4 per cent of GDP. In a slowing global environment, the economy appears resilient.

Yet budgets are not written for periods of comfort; they are crafted to anticipate stress. Beneath the reassuring aggregates lie deep structural pressures that the FY27 Budget cannot afford to overlook—weak household savings, skewed public expenditure priorities, a hesitant manufacturing sector, fragile private investment, rising external risks, and a farm economy trapped in low productivity. Stability, in short, risks masking stagnation. Inflation, which had moderated, is again edging up toward the RBI’s tolerance threshold of 4.5 per cent, reminding policymakers that the margin for complacency is thin.

India’s recent revenue performance has benefited from buoyant indirect taxes, better compliance, and steady nominal growth. But the quality of revenue matters as much as its quantum. Net household financial savings fell sharply to around 5.2 per cent of GDP in FY24, among the lowest levels in decades, even as household indebtedness rose.

This pattern suggests that tax buoyancy has been sustained partly by households consuming more and saving less. Such a base is inherently fragile. An economy cannot indefinitely extract revenue from households whose financial buffers are shrinking. The FY27 Budget must therefore be cautious about over-reliance on consumption-led revenues and should focus on broadening the tax base through formal job creation and productive investment, rather than deeper penetration into already-stretched household finances.

Despite strong headline indicators—over 7% growth, easing inflation, and a declining fiscal deficit—India’s FY27 Budget faces deep structural challenges. Household financial savings have fallen sharply while debt has risen, making consumption-led revenue growth fragile. Public spending is heavily skewed toward infrastructure, with insufficient investment in education, health, skills, and research, risking long-term productivity.
Monday Musing
By Shivaji Sarkar
Manufacturing and private investment remain cautious due to regulatory bottlenecks, weak demand, and delayed government payments. External risks, including potential US protectionism and modest gains from trade agreements, threaten export growth. Agriculture continues to suffer from low productivity and income volatility, with support tilted toward subsidies rather than investment. The Budget must therefore shift focus from short-term stability to strengthening human capital, boosting private investment, improving export competitiveness, and raising rural productivity to ensure sustainable, broad-based growth.

Recent revenue-enhancing steps underline the pressure. The government has raised GST rates on pan masala, cigarettes, tobacco and similar products to 40 per cent, with biris attracting 18 per cent GST. Rail fares were also increased twice during the year, yielding around Rs 3,900 crore against a surplus of Rs 2,517 crore in 2022–23. These measures may help contain the deficit, but they also reflect what the IMF has described as a potential “revenue squeeze” in the medium term.

Public expenditure has leaned strongly toward capital outlays since FY21, with central capex now exceeding Rs 11 lakh crore. This focus has supported growth and strengthened physical infrastructure. However, the composition of spending reveals an emerging imbalance.

Investment in human capital—education, skills, health, and research—remains inadequate. Education spending has stagnated around 3 per cent of GDP, teacher vacancies persist, and learning outcomes remain weak. Research and development outlays hover near 0.7 per cent of GDP, far below the levels seen in innovation-driven economies. Infrastructure without commensurate investment in people risks generating assets that the economy cannot fully utilise, diluting long-term returns on public investment.

Manufacturing continues to be a weak link. Capacity utilisation is still below the levels needed to trigger a sustained private investment cycle, and core industrial demand has softened. Production-Linked Incentive (PLI) schemes have attracted close to Rs 2 lakh crore in realised investments and generated over 12.6 lakh jobs, but they cannot substitute for a broad-based revival.

Recent PMI data point to a cooling of factory activity, with new orders and output growth slipping to multi-month lows. Sustainable manufacturing growth depends on predictable regulation, faster clearances, reliable logistics, and timely government payments—areas where constraints persist. Although corporate balance sheets are healthier than a decade ago, firms remain cautious amid regulatory uncertainty and an MSME credit system that prioritises short-term liquidity over long-term capacity building.

To unlock private capex, the Budget could mandate penal interest on delayed government payments, publish a transparent quarterly dashboard of outstanding dues, and redesign credit guarantee schemes to favour investment in capacity rather than only working capital. Such institutional reforms would likely do more to revive investment than additional fiscal incentives alone.

The global backdrop adds to the challenge. A possible return of aggressive US tariff policies could threaten India’s export prospects in steel, aluminium, pharmaceuticals and IT services. India cannot assume benign access to key markets in FY27 and beyond. Meanwhile, several free trade agreements have delivered only modest export gains while widening trade deficits, reflecting domestic competitiveness constraints rather than lack of market access.

Trade with Russia, though strategically significant, remains heavily skewed toward energy imports settled through complex payment mechanisms. It has done little to boost Indian manufacturing exports. The Budget must therefore prioritise export capability—logistics, standards, scale and technology—over reliance on geopolitics or preferential access alone.

Agriculture still employs nearly half the workforce while contributing less than one-fifth of GDP. Productivity is low, incomes are volatile, and climate risks are rising. Yet public support remains skewed toward subsidies rather than investment in irrigation, storage, diversification and agro-processing. Recent changes to rural employment schemes and procurement policies risk weakening income buffers without creating durable alternatives.

Weak farm incomes directly affect consumption, savings and overall stability. A credible strategy for FY27 would shift the emphasis from recurring fiscal band-aids to productivity-enhancing investment that can raise rural incomes sustainably.

Despite improvements in Direct Benefit Transfer targeting, household vulnerability remains high. Health shocks, income volatility and inadequate insurance suppress savings and risk-taking. An economy seeking higher investment cannot leave families one illness or crop failure away from financial distress. Expanding effective health coverage and income protection is therefore not merely social policy; it is a macroeconomic necessity that underpins both savings and long-term growth.

India does not face an imminent fiscal crisis. The challenge is subtler but more consequential: whether the FY27 Budget can convert macroeconomic stability into sustained, broad-based growth. Doing so will require difficult choices—redirecting expenditure toward productivity and human capital, removing institutional frictions that deter private investment, preparing for external trade shocks, and addressing long-neglected sectors such as agriculture and research.

The real test is not the management of aggregates, but the strengthening of foundations. The FY27 Budget will reveal whether the state is ready to move beyond short-term comfort and confront the structural constraints that will shape India’s growth trajectory over the next decade.

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