Strategy : FY2027 Budget: Balancing act on a slippery slope by Kotak Institutional Equities
FY2027 Budget: Balancing act on a slippery slope
The FY2027 Union Budget stayed the course on fiscal consolidation, even as the pace moderated, given the revenue constraints. The government budgeted GFD/GDP at 4.3% (debt/GDP at 55.6%), led by (1) an 8% increase in gross tax revenues, (2) a 7% increase in revenue expenditure and (3) a 12% increase in capex. It left tax rates broadly unchanged while rationalizing (1) MAT rates, (2) STT rates in F&O and (3) taxation on buyback of shares, etc.
GFD/GDP of 4.3% underpins fiscal prudence at a moderate pace
The central government projected GFD/GDP at 4.3% in FY2027BE (Rs17 tn), in line with our expectations and lower versus 4.4% (Rs15.6 tn) in FY2026RE. We find the fiscal deficit targets realistic in the context of a moderate 10% nominal growth assumption, with (1) a 7% increase projected in net tax revenues after accounting for an increase in devolution to states by Rs1.3 tn (10% yoy), based on the 16th Finance Commission recommendations; (2) 6% growth in revenue receipts; (3) 8% growth projected in expenditure (revenue expenditure: 7% and capex: 12%); and (4) gross market borrowings of Rs17.2 tn (FY2026RE: Rs14.6 tn).
Spending growth remains modest; maintains focus on capex
The capital expenditure is budgeted to grow at 12% to Rs12.2 tn for FY2027BE, driven by (1) defense (Rs2.3 tn; +17% yoy), (2) loans for capex to states (Rs2 tn; +33% yoy) and (3) railways (Rs2.8 tn, +10% yoy), while modest capex growth is budgeted in other segments. Meanwhile, revenue expenditure growth is budgeted to grow a modest 7% yoy to Rs41.2 tn, with the bulk of the increase coming from (1) the new rural employment scheme, (2) elevated allocation for drinking water in FY2027BE (a large miss on spending in FY2026RE), (3) education, etc. We note an increased reliance on states for capex, as central capex growth beyond defense remains moderate.
Interest rates likely to remain elevated
We expect the long end of the yield curve to remain elevated, as financing the fiscal deficit will entail gross borrowing of Rs17.2 tn, including Rs5.5 tn of redemption (FY2026RE: Rs3.3 tn). In addition, at the shorter end of the curve, the T-Bill borrowing of Rs1.3 tn could put pressure on yields. This, coupled with the RBI’s rate cut cycle nearing its end, will weigh on yields, with demand-supply dynamics for domestic SLR securities dependent on the RBI’s interventions. We expect the 10-year government benchmark yield to be in the range of 6.65-7.15% in FY2027.
Key sector highlights: Minor changes for select sectors
The government did not make any major changes to customs duty rates or taxation policies for sectors, with minor changes done in select sectors. Key changes in the budget were (1) taxation of buybacks, (2) higher STT rates for F&O, (3) increased allocation to electronic component manufacturing, (4) permitting foreigners to invest in listed equities directly, (5) tax holiday for foreign companies on data centers, (6) new initiative for bio-pharma and (7) BCD reduction on capital goods for lithium-ion cell manufacturing, etc.
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