India’s New Fiscal Anchor: From Deficit Targets to Debt Sustainability

Why in News ? 

As the Finance Minister prepares to present her ninth consecutive Union Budget, India’s fiscal framework is set for a structural shift. From FY 2026–27, the Centre will transition its fiscal consolidation anchor from the annual fiscal deficit to the debt-to-GDP ratio, aligning India’s fiscal strategy with global best practices.

This Budget will, for the first time, spell out the operational details of this new fiscal anchor for a full financial year.

Background: Why Shift the Fiscal Anchor ?

India’s fiscal policy has traditionally focused on controlling the fiscal deficit, a flow variable that measures the annual gap between government spending and revenue. While this approach promotes short-term discipline, it offers limited flexibility during economic shocks and does not directly capture long-term fiscal sustainability.

In contrast, the debt-to-GDP ratio is a stock variable that reflects the accumulated fiscal burden on the economy and is widely used internationally as a benchmark of fiscal health. Shifting to this anchor allows:

• Greater counter-cyclical flexibility,
• Smoother and more predictable consolidation, and
• Sustained space for growth-enhancing public expenditure.

Expected Changes

• Shift in anchor: From annual fiscal deficit targets to a medium-term debt-to-GDP ratio.
• Rationale:
  • Enhances flexibility to respond to economic shocks,
  • Enables gradual and credible fiscal consolidation, and
  • Creates space for development-oriented spending without compromising long-term stability.

Key Projections and Targets (Debt Trajectory)

• The Centre projects its debt-to-GDP ratio to decline to 50 ± 1% by March 2031, from an estimated 56.1% in March 2026.
• Most economists expect the Budget to peg the ratio at around 55% of GDP for FY27.
• Achieving this implies a steady annual reduction of roughly 1 percentage point in the debt ratio.

This trajectory signals a clear commitment to long-term fiscal sustainability while avoiding abrupt fiscal tightening.

Fiscal Deficit Implications

• A one percentage point annual reduction in the debt ratio translates into a fiscal deficit of about 4.2% of GDP in FY27.
• Despite this moderation, gross borrowings will remain high due to:
  • Large repayment obligations, and
  • Future liabilities such as the implementation of the 8th Pay Commission.

Thus, even with improved debt metrics, borrowing requirements will stay elevated, requiring prudent debt management.

Role of Growth and Borrowings

The debt-to-GDP ratio is shaped by three key factors:

1. Nominal GDP growth (denominator effect) :  Faster growth automatically lowers the debt ratio even if deficits remain moderate.
2. Borrowing and repayment profile : The scale, maturity, and rollover structure of debt influence sustainability.
3. Interest costs :  These are likely to ease with softer monetary conditions, improving fiscal arithmetic.

Debt sustainability improves more rapidly when nominal growth is high, underscoring the importance of growth-oriented fiscal and structural policies.

Economic Survey 2025–26: Validation of the Strategy

The Economic Survey 2025–26 endorses the new approach:

• India has reduced general government debt by around 7.1 percentage points since 2020, even while sustaining high public capital expenditure.
• The Survey supports 50 ± 1% debt-to-GDP as a credible and appropriate medium-term fiscal anchor.

This provides analytical backing for the shift from deficit to debt as the primary fiscal metric.

General Government Debt and the Role of States

Why States Matter

Global rating agencies assess India’s fiscal health using general government debt, which includes both Central and State government debt.

• States account for a significant share of total public debt.
• While the Centre will detail its debt-linked fiscal path, states’ fiscal behaviour will increasingly come under scrutiny.

Emerging View

• States may need explicit, medium-term debt-to-GSDP glide paths.
• The policy focus should shift from annual deficit ceilings to scenario-based debt trajectories, reflecting growth, interest rates, and fiscal risks.

Finance Commission and Federal Fiscal Architecture

The recommendations of the 16th Finance Commission (covering FY 2026–27 to FY 2030–31) will be critical in shaping:

• Tax devolution formulas,
• Revenue-sharing mechanisms, and
• Possible fiscal parameters for states.

The Chief Economic Adviser, V. Anantha Nageswaran, has emphasised:

• The need for empirical analysis and scenario modelling, and
• Avoiding premature adoption of a uniform fiscal metric for all states.

This reflects the diversity in states’ fiscal capacities, development needs, and growth trajectories.

RBI’s Concerns on State Finances

The Reserve Bank of India (RBI) has cautioned that high public debt crowds out private investment and restrains growth.

• Combined state debt declined from 31% of GDP (March 2021) to 28.1% (March 2024).
• However, it is projected to rise again to 29.2% by the end of the current fiscal.

The RBI has urged highly leveraged states to adopt clear debt consolidation glide paths to prevent fiscal stress and macroeconomic spillovers.

Rising State Borrowings

State borrowings have risen significantly over the past two decades:

• In the first half of the current fiscal, states borrowed 21% more than in the same period of the previous year.
• States are slated to borrow around ₹5 lakh crore in the current quarter ending March 31.

Historical Context

• A major surge in state debt occurred during 2015–20, partly due to the UDAY power sector reforms, under which states absorbed large amounts of DISCOM debt.

This legacy continues to shape state fiscal positions and borrowing needs.

Centre’s Fiscal Position Going Ahead

• The Centre is on track to meet its commitment of keeping the fiscal deficit below 4.5% of GDP by FY26, despite recent tax cuts.
• However, going forward:
  • Income tax reductions and
  • GST rate rationalisation
• may exert pressure on revenue, complicating deficit management.

FY27 Expectations

• Debt-to-GDP ratio: ~55%
• Fiscal deficit: ~4.3–4.4% of GDP

These targets reflect a careful balancing of consolidation and growth imperatives.

Challenges and Way Forward

To ensure the success of the new fiscal framework, India must address several challenges:

• Managing high gross borrowings even as deficit ratios decline.
• Institutionalising the debt-to-GDP ratio as the primary fiscal anchor across government levels.
• Ensuring state-level fiscal discipline without undermining cooperative federalism.
• Balancing development expenditure with long-term debt sustainability.
• Adopting scenario-based fiscal planning instead of rigid annual targets.
• Preparing for future liabilities such as Pay Commissions and welfare commitments.
• Leveraging higher nominal GDP growth and lower interest costs to rebuild fiscal buffers.
• Strengthening Centre–State coordination, especially after the 16th Finance Commission’s recommendations.