India's fiscal policy is expected to become less contractionary from FY27 as the Centre prepares to pivot from a fiscal-deficit-focused approach to a debt sustainability framework, according to a pre-Budget note by BofA Securities. The shift comes as the government remains on track to meet its medium-term fiscal consolidation targets despite slower nominal GDP growth and sweeping tax cuts.

Fiscal Deficit Projections and Policy Shift

The Finance Minister will present the Union Budget for FY2026-27 on February 1, with the central government likely to meet its FY26 fiscal deficit target of 4.40% of GDP. BofA projects a modest reduction in the deficit to 4.30% of GDP in FY27, signaling a pause in aggressive consolidation and a move towards maintaining fiscal support in line with economic growth.

According to the report, stronger capital expenditure execution in FY26, combined with lower energy prices that helped contain subsidy outgo, has provided the government with fiscal headroom. Capital spending is expected to rise broadly in line with nominal GDP growth, which BofA estimates will rebound to 10.10% year-on-year in FY27.

Adoption of Debt Targeting Framework

A key structural shift anticipated from Budget 2026 is the adoption of a debt-targeting framework. The government is expected to aim for a central debt-to-GDP ratio of 55.00%, down from an estimated 56.10% in FY26, after achieving its earlier commitment of keeping the fiscal deficit below 4.50% of GDP.

This framework shift is designed to:

• Make the fiscal position less contractionary while maintaining sustainability
• Ensure spending rises broadly in sync with the nominal growth cycle
• Prevent fiscal policy from becoming a drag on economic activity

Revenue Projections and Non-Tax Income

On the revenue front, BofA expects FY26 collections to undershoot Budget Estimates by around 2%, largely due to personal income tax and GST cuts. However, this pressure is likely to be partly offset by a surge in non-tax revenues, particularly dividends from the Reserve Bank of India and public sector enterprises.

BofA sees scope for revenue growth of 10.70% year-on-year, aided by reasonable growth in direct taxes, mild recovery in GST and higher provisions for dividends and divestment inflows. The overall revenue-to-GDP ratio is expected to rise modestly to 9.60% in FY27 from 9.50% in FY26.

Expenditure Priorities and Capital Allocation

In terms of expenditure priorities, defence and capital spending are likely to remain in focus. BofA sees FY27 capital expenditure rising to ₹12.50 lakh crore, or 3.20% of GDP, with strategic sectors continuing to attract higher allocations.

Priority sectors for capital expenditure include:

• Defence
• Railways
• Shipbuilding

Sectors expected to see subdued spending:

• Roads projects
• Housing initiatives
• Rail infrastructure

The brokerage does not expect provisioning for the Eighth Pay Commission in FY27, with implementation likely to begin in FY28.

Divestment Strategy and Funding

Divestment is expected to play a larger role in bridging funding gaps. While FY26 disinvestment receipts have lagged, BofA expects the FY27 divestment target to be doubled to ₹80,000 crore, reflecting increased reliance on non-tax and non-debt capital receipts, including the proposed IDBI Bank stake sale.

This strategic shift towards a debt-targeting framework represents a significant evolution in India's fiscal policy approach, balancing the need for fiscal sustainability with economic growth support.

As Finance Minister Nirmala Sitharaman prepares to present Union Budget 2026 on February 1, expectations are building around targeted policy measures aimed at sustaining economic momentum and reinforcing India's global competitiveness. The budget comes at a time when India's economy is projected to expand by 7.00-7.50% in 2026-27, supported by steady consumption and continued public investment, while policymakers navigate challenges including tax litigation, climate risks in agriculture, and procedural hurdles in customs and GST.

Economic Outlook and Fiscal Framework

The Centre is expected to balance medium-term fiscal consolidation with strong emphasis on capital expenditure. The fiscal deficit is estimated at around 4.30% of GDP, while infrastructure spending is likely to see double-digit increases to support economic growth.

Tax Simplification and Dispute Resolution

Industry stakeholders are seeking comprehensive tax reforms to reduce regulatory friction and improve business environment. Key expectations include faster disposal of pending tax cases, tax neutrality for fast-track demergers, and rationalisation of holding periods for slump sales. The budget is also expected to provide clarity on Minimum Alternate Tax (MAT) for foreign companies and reduce transfer pricing disputes through clearer definitions and guidelines.

Customs and Trade Facilitation

Trade facilitation measures are expected to feature prominently in the budget, with focus on streamlining customs procedures and reducing compliance burden. Key demands from industry include rationalisation of customs duty slabs, implementation of fully operational single-window clearance system, and quicker Authorised Economic Operator certifications. The budget may also address measures to unlock large sums currently stuck in customs litigation.

Agriculture Reforms and Food Security

Budget 2026 is expected to strengthen India's agricultural self-sufficiency, particularly in oilseeds and pulses production. The government is likely to promote crop diversification initiatives, including support for millets cultivation. Significant investments are anticipated in storage infrastructure, cold chain facilities, and climate-resilient farming practices to reduce post-harvest wastage and improve farm incomes.

Sectoral Reforms and GST Relief

The budget is expected to include targeted sectoral reforms, particularly amendments to improve the financial health of power distribution companies. GST reforms are anticipated to focus on speeding up refunds, easing inverted duty structures, and reducing disputes. These measures aim to improve cash flows for exporters and Micro, Small, and Medium Enterprises (MSMEs), supporting their operational efficiency and growth prospects.

With India facing a challenging international environment, Budget 2026-27 represents a critical opportunity to implement policy measures that can sustain economic momentum while addressing structural challenges across key sectors of the economy.