Basant Bafna, head of fixed income at Mirae Asset Investment Managers (India), expects the government to maintain its focus on fiscal consolidation while preserving growth momentum in the upcoming Budget 2026. Speaking in an interview, Bafna outlined his expectations for government borrowings, bond market dynamics, and monetary policy trajectory.

Fiscal Consolidation and Borrowing Outlook

Bafna believes India's fiscal consolidation story remains intact, though the pace may moderate. The government appears committed to balancing growth-oriented spending with fiscal discipline, prioritizing consolidation over populist measures. The debt-to-GDP ratio is expected to ease from nearly 56% to close to 50% over the next five years, supported by strong economic growth.

While central government borrowings are expected to remain stable, state borrowings are likely to rise compared to FY26. This growth trajectory is anticipated to be driven by steady government capital expenditure with support from GST rationalization. However, near-term revenue pressures persist, potentially requiring greater reliance on disinvestment and asset monetization.

Bond Market Dynamics and Investment Strategy

The bond market outlook reflects mixed conditions across different segments. Central government securities yields are expected to remain supported due to the government's commitment to fiscal consolidation and higher prevailing spreads compared to historical averages. However, elevated supply of State Development Loans (SDLs), coupled with muted demand, suggests limited scope for yield compression.

Bafna recommends a balanced barbell strategy combining accrual with selective duration exposure to navigate potential rate movements while managing supply-side pressures. This approach aims to capitalize on elevated spreads while maintaining flexibility amid ongoing market dynamics.

Monetary Policy and Rate Trajectory

Regarding RBI policy, Bafna notes that the central bank has already implemented 125 basis points of rate cuts in 2025, leaving limited room for further easing in the near term. Additional rate cuts would likely depend on growth slipping below 6% or inflation undershooting expectations. The policy focus is expected to remain on ensuring transmission of rate cuts already undertaken.

A potential catalyst for additional policy space could emerge from the new CPI series expected to be published in February, particularly if it significantly undershoots expectations. For corporate debt, demand-supply dynamics are expected to drive yields, with elevated levels in the near term due to supply pressures from high credit-deposit ratios for banks.

Geopolitical Considerations and Investment Approach

Amid ongoing geopolitical uncertainties, bond spreads remain elevated compared to three-year averages across various segments. As global volatility gradually stabilizes and the RBI continues measures to ensure smooth liquidity transmission, there is potential for spread compression as policy transmission takes effect.

Bafna suggests that investors need not make significant changes to their debt holdings ahead of the Union Budget, as the broader trajectory of consolidation and growth remains intact. The decision to increase bond exposure should be guided by individual risk appetite and investment horizon, considering the opportunity's sensitivity to broader market dynamics.

Morgan Stanley expects the government to target a fiscal deficit of 4.2% of GDP in FY27, marking a gradual consolidation from the 4.4% target set for FY26, as Finance Minister Nirmala Sitharaman prepares to present the Union Budget 2026-27 on February 1. The investment bank anticipates the budget will steer clear of populist measures while prioritizing capital expenditure and social infrastructure investment.

Fiscal Position and Outlook

India's current fiscal metrics show mixed performance compared to previous periods:

Morgan Stanley projects the central government debt will reduce to 55.1% of GDP from 56.1% in FY26, supported by improved tax buoyancy and nominal growth pickup. The government aims to achieve a debt-to-GDP ratio of 50% (±1 percentage point) by FY31.

Budget Priorities and Themes

The investment bank expects the budget to reflect five key priorities: social and physical infrastructure expansion, improving ease of doing business to boost private investments, creating productive jobs alongside workforce skilling, increasing manufacturing capabilities, and enhancing ease of living.

Sector-Specific Reform Expectations

Real Estate and Housing

Morgan Stanley anticipates significant policy changes for the real estate sector:

Infrastructure and Railways

The infrastructure sector expects substantial allocation increases:

• Overall Infrastructure: 8-10% allocation growth over revised FY26 estimates
• Railways: 5-6% growth focusing on track infrastructure, new routes, safety systems, and rolling stock
• Defence: 12-15% allocation increase with emphasis on local and private defence companies

Telecom and Technology

Key telecom sector expectations include relief on Universal Service Obligation Fund charges, AGR dues reform package, and extension of business loss carry-forward period from eight to 16 years. For data centre developers, the bank expects conditional tax holidays linked to capacity targets and customs duty waivers on imported equipment.

Energy and Clean Technology

Morgan Stanley sees potential for a ₹2.00 per litre increase in fuel taxes, alongside continued government thrust on renewable energy, battery energy storage systems adoption, nuclear power including small modular reactors, and pumped storage projects. The energy distribution sector may receive a financial package for discoms with reform conditions.

Healthcare and Pharmaceuticals

The pharmaceutical sector expects continued emphasis on increasing public health spending, with focus on primary healthcare, hospital infrastructure, and workforce capacity. Expected measures include R&D tax benefits, API support through PLI schemes, reduced import dependence for critical drugs, and Ayushman Bharat expansion.

Financial Services and Consumer Sectors

For financial services, analysts highlight needs for digital payment incentives, harmonized tax treatment on interest income, and expanded credit guarantee schemes for MSMEs and MFIs. The consumer sector anticipates general measures to revive consumption demand.

Morgan Stanley's comprehensive sector analysis reflects expectations for a budget focused on sustainable growth, infrastructure development, and gradual fiscal consolidation while maintaining India's economic resilience amid global uncertainties.