India's Union Budget 2026 is expected to prioritise defence-led capital spending while maintaining fiscal discipline, according to a budget preview by Motilal Oswal. The brokerage anticipates the February 1 exercise will focus on defence and allied industries, infrastructure-linked manufacturing, power, electronics, pharmaceuticals and critical minerals, while keeping revenue expenditure under control.

Fiscal Deficit and Growth Projections

Motilal Oswal expects the gross fiscal deficit to decline marginally to 4.3% of GDP in FY27 from 4.4% in FY26, marking a shift towards using debt-to-GDP as the primary fiscal anchor. The budget framework assumes nominal GDP growth of approximately 10.1%, providing limited room for growth support without compromising fiscal consolidation.

Capital Expenditure Focus

The brokerage forecasts capital expenditure to rise 10.3% year-on-year to ₹12.40 trillion in FY27, maintaining its share at around 3.1% of GDP. Defence and allied industries are expected to lead this capex push, with the Defence Acquisition Council already approving capital acquisition proposals worth ₹790.00 billion in its winter session.

The FY26 year-to-date defence approvals of approximately ₹3.30 trillion represent nearly double the budgeted defence capital outlay for the year. Other priority sectors include nuclear energy, electronics manufacturing, power, pharmaceuticals and strategic investments in critical minerals.

Revenue Projections and RBI Dividends

On the revenue front, Motilal Oswal projects steady growth with direct taxes expected to track nominal GDP growth, reaching ₹25.70 trillion in FY27. Indirect taxes, including GST collections, are likely to grow at a slower pace. Non-tax revenues will play a crucial role, with dividends from the RBI and public sector undertakings estimated to rise to ₹3.80 trillion in FY27, supported by RBI's dollar sales boosting central bank profitability.

Borrowing Requirements and Bond Yield Outlook

Despite marginal deficit improvement, borrowing requirements remain elevated. The Centre's gross market borrowings are forecast at ₹16.50 trillion in FY27, with net borrowings of ₹11.90 trillion. State governments are expected to add ₹13.20 trillion in gross borrowing, taking aggregate Centre plus state gross borrowing to ₹29.70 trillion.

This heavy supply, combined with subdued demand from banks, insurers and foreign investors, is likely to keep the 10-year government bond yield in the 6.5% to 6.7% range through FY27.

Investment Themes and Market Outlook

Motilal Oswal views Budget 2026 as a reaffirmation of existing strategy rather than a policy pivot. For equity investors, preferred themes remain defence and allied industries, infrastructure-linked manufacturing, power, electronics, pharmaceuticals and critical minerals. The budget arrives after a normalisation in government capital spending execution and cooling investor enthusiasm for capex-linked sectors, making it a test of policy credibility for sustaining India's capex-led growth narrative.

The Union Budget 2026 is generating significant anticipation as India navigates challenging global economic conditions. According to Sonal Badhan, Economist at Bank of Baroda, the government is likely to set ambitious yet realistic targets while maintaining fiscal discipline across key economic parameters.

Growth Projections and Capital Investment Strategy

The budget is expected to project robust economic growth alongside substantial infrastructure investment. Key fiscal targets demonstrate the government's commitment to balanced growth and financial prudence.

The government has demonstrated strong execution capabilities, achieving approximately 60.00% of its budgeted capital expenditure target by November 2025. This performance provides confidence in the ambitious capex projections for the upcoming fiscal year.

Tax Policy: Stability Over Changes

Major revisions in direct or indirect taxes are unlikely this year. The previous year's budget and GST 2.0 rationalization have already addressed most tax-related concerns, shifting focus from tax cuts to strategic sectoral support initiatives.

The approach emphasizes maintaining current tax structures while directing resources toward targeted industry support and growth-enabling measures.

MSME and Export Sector Support

Given global economic uncertainties, the budget prioritizes support for Micro, Small, and Medium Enterprises alongside export-oriented sectors. Key support measures include:

• Interest Subvention Scheme: Financial relief for MSMEs and exporters
• Customs Duty Rationalization: Further reduction in duty slabs beyond last year's consolidation to eight categories
• Raw Material Support: Additional duty reductions to lower average customs duty rates
• Trade Agreements: Potential Free Trade Agreements to maintain export momentum

These measures aim to strengthen India's export competitiveness despite challenging global headwinds.

Innovation and Research Development Focus

A significant development could be the introduction of a dedicated Research and Development PLI scheme. Currently, R&D support is embedded within individual industry schemes, but a standalone program could attract innovation across multiple sectors.

The government may expand PLI coverage to include emerging technology sectors, positioning India as a global innovation hub while boosting domestic manufacturing capabilities.

Monetary Policy and Investment Climate

The Reserve Bank of India is expected to implement supportive monetary measures, including a potential 25 basis points policy rate cut in its final FY26 policy. The central bank's GDP forecast of 7.30% aligns closely with the first advance estimate of 7.40%.

Private investment, which has been selective recently, shows signs of revival. The government's Production Linked Incentive scheme may undergo modifications to sustain this positive momentum and encourage broader private sector participation.

Asset monetization is expected to play a larger role than disinvestment in government revenues, continuing the trend that began in FY26. This approach provides sustainable funding for development initiatives while maintaining government assets.

The Union Budget 2026 aims to balance growth ambitions with fiscal responsibility through higher capital spending, stable tax policies, and targeted sectoral support. The combination of MSME assistance, export incentives, innovation-focused PLI schemes, and accommodative monetary policy positions India to navigate global uncertainties while strengthening long-term economic competitiveness.