Fiscal Deficit and Its Impact on the Indian Economy

Each year, during the Union Budget presentation, the fiscal deficit emerges as a primary economic measure. The word fiscal originates from Latin word fiscus, which means a public basket of money. In simple terms, fiscal relates to government finances and the management of public funds.

Key Takeaways

• For the financial year 2026-27, India’s fiscal deficit is estimated at 4.3% of GDP.
• In absolute terms, the deficit stands at ₹16.96 lakh crore.
• The government successfully met its previous target of 4.4% for FY 2025-26, continuing a steady path of fiscal consolidation.
• A high deficit can lead to increased interest rates, higher inflation, and a rise in national debt.
• The government aims to bring the central government debt-to-GDP ratio down to approximately 55.6% this year, moving towards a long-term goal of 50% by 2031.

What is Fiscal Deficit?

Fiscal Deficit refers to a gap in government’s budget; a gap that arises in any financial year when the government’s total expenditure exceeds its total income in that year and consequently it borrows money to cover that gap.

In the 2026 Union Budget, the government estimated total receipts (excluding borrowings) at approximately ₹36.5 lakh crore, while total spending is projected at ₹53.5 lakh crore. Because the planned spending is higher than the income, the resulting gap is the fiscal deficit.

Causes of India’s Fiscal Deficit

Several structural factors contribute to India's financial gap:

• Subsidies: Significant spending continues on food, fuel, and fertilisers to support vulnerable sectors.
• Interest Payments: A large portion of annual spending is dedicated to paying interest on previous loans.
• Public Sector Salaries: Regular updates to dearness allowances for government employees increase recurring costs.
• Informal Economy: A significant portion of the economy remains informal, which limits the total tax base.
• Global Headwinds: Slow global growth can impact export-related tax collections and force the government to increase domestic stimulus spending.

Trends in India’s Fiscal Deficit

Over the last few years, the Government of India has chosen to spend more on long-term work like roads, railways, and big infrastructure. This helps future growth, but it also puts pressure on today’s finances.

What the numbers say

• Capital spending was about 1.6% of GDP in 2014-15.
• It has reached an all-time high of 4.4% of GDP (Effective Capex) in 2026-27.
• In absolute terms, Capital Expenditure has increased from ₹2 lakh crore in 2014-15 to ₹12.22 lakh crore in 2026-27.
• Tax income is projected to grow by 8% in FY 2026-27 compared to the previous year's revised estimates.
• For the 2026-27 financial year, the government plans to spend ₹53.47 lakh crore.
• In the same period, it expects to earn (non-debt receipts) about ₹36.51 lakh crore.
• The resulting gap is estimated at ₹16.96 lakh crore.
• This gap equals a fiscal deficit of 4.3% of India’s GDP.

Impact of Fiscal Deficit on the Indian Economy

A high fiscal deficit changes money flow in the economy. It affects borrowing, prices, debt, and confidence.

• Interest rates go up
  
  
  • The government borrows more money
  • More borrowing increases demand for loans
  • Loan supply stays limited
  • Loans become costly for people and businesses
  • RBI keeps rates unchanged due to high deficit
     
• Inflation increases
  
  
  • Historically, a 1% rise in the fiscal deficit can correlate with a significant increase in the Consumer Price Index (CPI)
  • Prices of goods and services increase
  • Buying power of people falls
     
• Private investment reduces (crowding out)
  
  
  • Government uses more bank credit
  • Less credit remains for private companies
  • Borrowing cost increases
  • Businesses invest less
     
• Government debt increases
  
  
  • Debt in FY 2025–26 (Revised Estimate): ₹197.18 lakh crore (56.1% of GDP).
  • Debt in FY 2026–28 (Projected): ₹218.63 lakh crore (55.6% of GDP).
  • Higher debt increases future interest payments
     
• Revenue pressure increases
  
  
  • GST rates cut
  • Customs duty exemptions
  • Tax collection slows 
    
     
• Investor confidence weakens
  
  
  • High deficit signals risk. Sticking to the 4.3% target signals economic discipline
  • Controlled deficit helps the Rupee stay stable
  • Interest rates may rise further
  • Economic stability weakens

Comparative Trends: RE 2025-26 vs BE 2026-27

To understand the trajectory, here is how the primary fiscal components have moved between the last two budget cycles:

India’s Fiscal Deficit in 2026 - Current Scenario

The current trend highlights a successful "fiscal glide path." In 2021, the government set a target to bring the deficit below 4.5% by 2025-26. By achieving 4.4% in the revised estimates of 2025 and projecting 4.3% for 2026, the government has moved from emergency pandemic-era spending (which saw deficits over 9%) back to a disciplined fiscal regime.

The Union Finance Minister Nirmala Sitharaman has led this shift through the Union Budget. The government has increased tax collections and it has also controlled expenses. As a result, borrowing needs have reduced.