A significant transformation in India's fiscal management framework is on the horizon. Starting from the financial year 2026-27, the government will adopt a new primary fiscal anchor, shifting its focus from the fiscal deficit to the debt-to-GDP ratio. This strategic pivot, while offering greater spending flexibility, introduces a distinct set of challenges, particularly against the backdrop of constrained tax revenues.
The New Fiscal Architecture
Under the new framework, the central government is mandated to manage the fiscal deficit in a manner that ensures the ratio of its debt to the Gross Domestic Product (GDP) declines to 50% (+/- 1%) by 31 March 2031. This marks a radical departure from the previous system anchored by the Fiscal Responsibility and Budget Management (FRBM) Act.
The change is profound for two main reasons. Firstly, it removes the rigidity of a fixed annual deficit target, granting the government enhanced spending flexibility to respond to economic crises without breaching fiscal rules. However, the overarching commitment to reduce debt acts as an automatic check against profligate expenditure. Secondly, it redirects the scrutiny of investors and rating agencies towards the government's long-term debt sustainability and its capacity to service obligations, inevitably putting the revenue side of the budget under a sharper lens.
India's Current Debt Standing and the Revenue Hurdle
India's current debt position provides a reasonably solid foundation for this transition. After spikes during the 2008-09 global financial crisis and the 2020-21 pandemic, debt levels have been on a downward trajectory. The Centre's liabilities have fallen from 63% of GDP in 2020-21 to just under 57% in 2024-25. In a global context, India's general government debt (Centre plus states) at 81.5% of GDP is comparable to peer emerging economies and lower than most advanced nations.
However, the core challenge lies in India's low tax revenue generation. While debt is assessed against the revenue available to service it, India's tax-to-GDP ratio stands at a mere 11.9%. This contrasts sharply with advanced economies like the G7 nations, which sustain higher debt ratios (averaging 124% of GDP) by generating tax revenues of 30-44% of GDP. India's narrow direct tax base, attributed to low incomes, a large informal sector, and tax-exempt agricultural income, is a well-known constraint.
This revenue shortfall makes the annual debt reduction target of 1-2% of GDP challenging. The government has historically relied on non-tax revenue, such as dividends from public sector units and the Reserve Bank of India, to meet deficit targets. As the fiscal anchor aligns with global standards, funding sources must also conform, necessitating a steady rise in tax collection to support public spending sustainably.
Upcoming Fiscal Pressures and the Path Forward
The road to 2031 is fraught with additional fiscal pressures. Several states have announced populist schemes despite revenue shortcomings, prompting warnings from the Finance Minister. Although states are not formally part of the new central compact, their fiscal discipline impacts the total government debt, a key metric tracked globally.
Furthermore, the implementation of the Eighth Pay Commission recommendations, expected around 2027, will significantly increase expenditure on salaries and pensions. On the revenue front, the government is banking on consumption-led growth from potential tax cuts to compensate for foregone revenues.
Traditionally, fiscal consolidation in India has been growth-led, where a rising nominal GDP shrinks the debt ratio. With nominal GDP growth projected at 8% in 2025-26 and 10-11% thereafter, this dynamic will aid the process. However, to uphold its hard-earned reputation for fiscal prudence, the government must prioritize building a robust and broad tax revenue base. The success of this pivotal shift hinges on navigating these complex challenges while maintaining the delicate balance between growth, equity, and fiscal responsibility.
