ECOSCOPE :Fiscal policy complements monetary accommodation by Motilal Oswal Financial Services Ltd
1QFY27 Center (INR3.4t) + States’ capex (INR1.1t) = INR4.5t/15.4% YoY
* Capex-led fiscal support remains intact. The Center's capital expenditure increased 23.7% YoY in 1QFY27 to INR3.4t, while states' capex rose 4.8% YoY to INR1.1t, taking the combined Center-state capex to INR4.5t (+15.4% YoY) during 1QFY27. The Center continued to front-load investment despite geopolitical and commodity price uncertainties, while states are expected to accelerate spending in the coming quarters.
* The composition of capital expenditure remains growth-supportive. Central capex during 1QFY27 was driven by railways (+30.6% YoY), defense (+42.3% YoY), and a sharp increase in capital transfers to states (+223% YoY), while road spending remained broadly flat owing to project timing. Importantly, the Center's current capex run rate of INR1.1t per month remains well above the budgeted monthly run rate of ~INR0.9t, indicating that infrastructure spending is comfortably on track. The key takeaway is that the government has accommodated the temporary rise in revenue expenditure without compromising its infrastructure-led investment strategy, preserving the quality of expenditure even amid elevated geopolitical and commodity price uncertainties.
* Fiscal consolidation remains on track despite higher public investment. Strong growth in total receipts, led by resilient direct tax collections, higher non-tax revenues, and divestment receipts, helped keep the Center's fiscal deficit at 18.2% of the FY27BE in 1QFY27. Although states' fiscal deficit widened modestly due to weaker central transfers, the overall fiscal position remains manageable, providing room to sustain the public investment cycle.
Outlook:
* Fiscal policy continues to complement the RBI's accommodative monetary stance. Strong revenue collections, healthy progress in fiscal consolidation and sustained capital expenditure have enabled the govt. to support growth without compromising fiscal discipline. This also provides a supportive backdrop for the RBI to maintain its accommodative policy stance and improve monetary policy transmission.
* We expect the RBI to keep the repo rate unchanged at 5.25% in its upcoming policy while retaining its FY27 GDP growth forecast at 6.6% and CPI inflation forecast at 5.1%. Notably, average CPI inflation during 1QFY27 (3.9%) remained below the RBI's forecast of 4.2%, providing the MPC with additional comfort to maintain the status quo while monitoring the evolving domestic and global macroeconomic environment.
* We continue to expect the Center's fiscal deficit to widen to around 4.6% of GDP in FY27, compared with the Budget target of 4.3%, implying a slippage of around 30bp. Although the de-escalation of tensions in West Asia and the US-Iran peace agreement have reduced the risk of a prolonged commodity shock, the fiscal impact has already been embedded in government finances through the reduction in fuel excise duties and the front-loaded increase in fertilizer and food subsidies. Additional downside risks stem from a potential shortfall in disinvestment receipts and weaker corporate tax collections.
* Nevertheless, we view the expected slippage as manageable rather than structural. The government has protected the quality of expenditure, with capital expenditure rising 23.7% YoY during 1QFY27 and running ahead of the pace required to meet the Budget target.
* We do not expect the expected fiscal slippage to lead to additional dated G-sec borrowings, as the government has sufficient financing flexibility through cash balances, small savings and other funding sources. While higher US 10-year Treasury yields may keep some upward pressure on Indian bond yields, we expect the 10-year G-sec yield to remain broadly range-bound at 6.8-7.0%, with our end-FY27 target of 7.0%. A move towards 7.2% is possible only if geopolitical tensions in West Asia escalate again and crude oil prices remain above USD100/bbl for a sustained period. This is not our base-case scenario
Key takeaway:
The Center's fiscal position improved in Jun'26, supported by strong revenue collections and higher capital expenditure, resulting in a sharp decline in the fiscal deficit.
* The Center's fiscal position improved in Jun’26, with total receipts increasing 58.6% YoY to INR3.3t, driven by a broadbased improvement across tax revenues, non-tax revenues, and non-debt capital receipts, aided by a favorable base effect.
* Gross tax revenue rose 6.4% YoY in Jun’26, led by a 13.0% YoY increase in direct taxes, with corporate tax collections rising 17.5% YoY and income tax collections increasing 6.9% YoY. In contrast, indirect tax collections declined 6.8% YoY in Jun’26 due to weaker GST (-8.2% YoY) and excise duty (-24.8% YoY) collections, while customs duty receipts remained robust, growing 33.1% YoY.
* Non-tax revenues increased 65.6% YoY in Jun’26, while non-debt capital receipts surged 449.0% YoY, supported by divestment proceeds of INR113.1b during the month.
* On the expenditure side, total expenditure remained broadly unchanged in Jun'26 at INR4.8t vis-à-vis Jun’25 (0.01% YoY). Revex declined 8.4% YoY in Jun’26 to INR3.9t, primarily due to a 30.8% YoY decline in interest payments, although subsidy expenditure remained elevated, rising 21.6% YoY.
* In contrast, capital expenditure increased sharply by 66.0% YoY to INR0.9t, reflecting a pickup in infrastructure spending and the government's continued emphasis on capital formation.
* Consequently, the Center recorded a monthly fiscal deficit of INR1.5t in Jun’26 vs. a deficit of INR2.7t in Jun’25.
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