Budget 2026 as Harbinger of Good Times Ahead

The year 2026 began with unusual geopolitical tensions, as the U.S. administration’s capture of the president of Venezuela was followed by aggression over Greenland, which threatened NATO unity. Meanwhile, U.S. President Trump moved to establish a ‘Board of Peace,’ an intergovernmental body to oversee the resolution and reconstruction of Palestinian land in Gaza. The invitation to member states, however, was conditional on monetary contributions to the Board. India, with its neutral foreign policy stance, had to proceed cautiously.

Thankfully, the state of global affairs improved as the month progressed, with India and the European Union (EU) signing a long-pending free-trade agreement (FTA), dubbed the ‘Mother of all deals’. In this FTA, the EU side has respected India’s sensitivity around the farm sector while gaining access to a large consumer market, especially for manufactured products. India, on the other hand, gained access to European markets for more than 99% of exports by value, covering agrarian goods, labor-intensive manufactured products in textiles and gems & jewelry, and IT-enabled services. The FTA will take time to take effect, as the deal is ratified by the EU Parliament and the legislative bodies of the member states.

The India-EU FTA had a tilt in favor of India ahead of the Union Budget 2026-27, as the Government could confidently address domestic priorities of growth and debt management, thereby lowering the cost of capital for the economy. The center’s fiscal marksmanship stood the test of time, as it successfully kept the fiscal deficit target for FY2025-26.

The Union Budget for 2026–27 is based on credible assumptions of 10% nominal GDP growth, with real GDP around 7% and the deflator improving to around 3% from 0.6% in FY2025-26 as food inflation normalizes and a weaker rupee raises import prices. A gross tax buoyancy of 0.8 (vs 0.9 in FY2025-26) seems pragmatic given the revision to goods & services tax rates.

The Budget maintained its capital expenditure bias, raising allocations to ₹12.2 trillion (3.1% of GDP) while signaling a shift in spending priorities toward urban infrastructure and connectivity. The focus has broadened to multimodal logistics, including freight corridors, high-speed rail, and inland waterways, along with investments in supporting ecosystems such as skilled labor and tourism infrastructure.

A notable feature is the renewed emphasis on empowering urban local bodies, particularly outside tier-two cities, complemented by stronger incentives for market-based financing through municipal bonds.

Manufacturing continues to command attention, with policy priorities focused on building domestic capital goods capabilities and supporting labor-intensive sectors such as textiles. The Budget proposes tax holidays for data centers until 2047, recognizing the dawn of the artificial intelligence era and India’s need for domestic capacity. The Budget also flagged geriatric care as an emerging policy priority, reflecting the steady rise in India’s aging population.

The Budget marks a shift in the fiscal anchor from the fiscal deficit to the debt-to-GDP ratio. The center expects the debt-to-GDP ratio to fall to 55.6% from 56.1% of GDP, a 50-basis-point decline by March 2027. The fiscal deficit is budgeted to fall modestly to 4.3% of GDP for FY2026-27 from 4.4% of GDP in FY2025-26, implying that debt consolidation will come more through higher nominal GDP. Gross and net market borrowings through dated securities are budgeted at ₹17.2 trillion and ₹11.7 trillion, respectively, compared to ₹14.8 trillion and ₹11.5 trillion in BE 2025-26, implying no let-up in supply pressures. Bond yields are therefore unlikely to soften, prompting further OMO purchases by the RBI.

Bond markets and money markets have been on divergent paths post July 2025. The term premium has been at historical highs, alongside a rise in the risk premium, underscoring weakening confidence in India’s strong macro narrative ahead. The cost of capital has not changed much, even as revenue growth expectations have softened over the last couple of years. This needs to be addressed more than a rate cut now.

With the US-India trade deal also concluded, the US has reduced reciprocal tariffs on India to 18% from 25%, and the likely removal of the additional 25% penalty on purchases of Russian oil places India favourably among its Asian peers.  The Rupee, therefore, is likely to recoup its recent losses and trade in the 88-90 per US Dollar range as financial portfolio investors return to Indian markets. Monetary policy can thus focus on ensuring effective monetary transmission across the money, lending, and bond markets.

To conclude, India has navigated the trade turmoil of 2025 effectively, with the government introducing several structural reforms. With fiscal and monetary policy attuned to domestic priorities, 2026 could mark a phase in which India’s growth story sails ahead as global macroeconomic winds turn favorable.