India's finance minister faces a difficult choice when preparing the annual budget - boost growth or reduce the deficit?

As the Indian government walks a tightrope between fiscal prudence and reviving growth, experts suggest it will favor reducing the deficit in its annual budget over spending aimed at turbocharging Asia’s third-largest economy.

For the fiscal year ending March 2026, the Indian government may cut its fiscal deficit target by 50 basis points to 4.4% of the country’s gross domestic product from the current fiscal year’s 4.9% target, economists at investment bank UBS said.

They also estimated that the government will set a modest GDP growth target of 10.5% for the next fiscal year.

Indian Finance Minister Nirmala Sitharaman will present the national budget on February 1, which will be the coalition government’s first full-year budget since taking office in June.

The budget comes against a backdrop of slowing growth in the world’s fifth-largest economy, weak domestic demand, a depreciation of the rupee and rising global uncertainties.

The main reasons for the slowdown in the economy are factors such as unseasonal rains, fiscal tightening and a slowdown in private sector lending as the central bank has taken steps to curb unsecured credit growth.

The upcoming budget is likely to re-emphasize employment growth in the labour-intensive manufacturing sector, while boosting rural housing programmes and taking additional measures to control price volatility, Goldman Sachs said.

With domestic consumption and economic activity slowing, the budget is likely to focus on “improving existing measures and boosting medium-term demand”, said Radhika Rao, senior economist at DBS.

“Tax relief [also] tops the list ... even though a reduction in the personal income tax rate or standard exemption will affect a small segment of the population, there is still a possibility of some support in the pipeline,” Rao added.

To boost consumption, the central government is expected to reduce personal income tax for middle-income households, while continuing to prioritize spending on infrastructure by upgrading the country's roads, railways, airports and highways.

Focus on the deficit

After reaching 9.2% of GDP during the pandemic, the Indian government has been steadily reducing its budget deficit in recent years, a key requirement for the country to secure a credit rating upgrade.

S&P Global Ratings in May downgraded India's sovereign rating outlook to "positive" from "stable", while maintaining the country's credit rating at "BBB-" - its lowest investment grade level - citing the country's strong economic expansion and political commitment to fiscal consolidation.

The finance minister had pledged in his July budget speech to reduce the deficit to 4.9% in the current fiscal year and 4.5% in the next fiscal year. "From 2026-27, our effort will be to maintain a fiscal deficit every year so that the central government's debt as a percentage of GDP remains on a declining path," she said.

The government is expected to achieve a deficit of less than 5% in the current fiscal year, thanks in part to a record dividend of $25 billion from the central bank. Nomura economists attributed this partly to a "sharp underspending" in capital spending.