The Economy Observer : FY27 Budget Preview: Defense-led capex growth by Motilal Oswal Financial Services ltd
FY27 Budget Preview: Defense-led capex growth
We expect the FY27 Union Budget to mark a pivotal moment in India’s fiscal framework, with the gross fiscal deficit targeted at 4.3% of GDP, lower than 4.4% in FY26. This underscores the government’s commitment to gradual fiscal consolidation and its shift toward debt-to-GDP as the primary fiscal anchor, in line with global best practices. Given the emphasis on fiscal discipline, we do not expect any populist measures or large tax giveaways in this budget. The budget is likely to be framed around a nominal GDP growth assumption of about 10.1%, providing some headroom to balance discipline with growth support.
On the expenditure side, we expect a clear prioritization of capital expenditure, which should grow at 10.3% YoY and remain close to 3.1% of GDP, with higher allocations for defense and allied industries, infrastructure-linked manufacturing, pharma, power, nuclear, electronics, critical minerals, and trade tariff-affected labor-intensive sectors. At the same time, revenue expenditure is likely to be tightly managed, with limited growth in subsidies and non-essential spending.
On the revenue front, we expect steady but unspectacular growth, with direct taxes broadly tracking nominal GDP, GST collections remaining muted, and continued reliance on non-tax revenues, particularly a strong dividend from the RBI
On the financing side, borrowing requirements for both the Centre and states are likely to remain elevated. We expect the Centre’s gross market borrowings to be ~INR16.5t in FY27 (net borrowings of about INR11.9t), while state governments are likely to raise roughly INR13.2t through gross SDL issuances (net borrowing of ~INR9.7t). Together, this keeps aggregate gross market borrowing elevated through FY27 at INR29.7t. This heavy supply, combined with relatively subdued demand, is likely to limit any sharp decline in yields. We expect the 10-year G-sec yield to trade broadly in the 6.5-6.7% range in FY27.
Bond market was hoping for inclusion in the Bloomberg Global Index, but for now, the inclusion is postponed. With the global rate cut cycle nearing an end or having ended in most countries, we note a synchronous rise in global yields. Japan’s latest rate hike has also pushed the yields upwards. The key event to track next would be the announcement of a new US Fed Governor. Although US fiscal metrics are worsening, any sharp revision in market expectations of interest rate cuts (from the current 50bp) can lead to some moderation in US yields, impacting India at the margin. More than that, we see limited reasons for any softening of India yields.
* The FY27 Union Budget is likely to be a historic document, as India will start using debt as the primary target for fiscal policy, aligning itself with global standards1 .
* The budget will prioritize the government’s commitment toward fiscal consolidation by lowering the gross fiscal deficit (GFD) marginally to 4.3% of GDP in FY26 from 4.4% in FY25, though it is not bound by the Fiscal Responsibility and Budget Management Act, 2003 (FRBM Act), unlike previously.
* The budget math is likely to be realistic assuming 10.1% YoY as the nominal GDP. It would clearly focus on the next set of reforms for further building the ‘Viksit Bharat’ narrative while extending benefits to sectors such as defense, nuclear, and critical minerals – the roadmap of which has already been placed in the winter session of the parliament.
* We do not expect any populist measures or direct tax code changes this year (CY25: income tax cuts, GST rationalization) given that the government is attempting fiscal consolidation; however, we see scope for an increase in capital expenditure (capex) in non-traditional or sunrise sectors, especially defense and allied sectors. This is due to India’s shift to tracking the debt-to-GDP ratio as its primary fiscal policy goal (the trajectory for which we will see in the budget document). India plans to reduce this ratio to 50% (+/- 1%) by FY31 from 56% currently.
* FY26 Budget recap: The outstanding contribution from non-tax revenue receipts, backed by the record RBI dividend of INR2.7t alone, has helped the government sail the boat in FY26. The dividend contribution by PSUs is also likely to be more than INR800b, as per media reports, almost double the budget estimate. Tax receipts were dragged down primarily by lower income tax and GST collections.
* On the expenditure side, we expect the capex target of INR11.2t to be met and expect a slight slowdown on the non-subsidy-non-interest revenue spending. On net basis, we expect the deficit target of 4.4% of GDP to be met (FD est.: INR15.9t; FD BE: INR15.7t).
* FY27 Budget preview: Dividends by the RBI and PSUs may once again skyrocket to INR3.8t in FY27E from INR3.7t in FY26 due to heavy RBI dollar sales (adding to the RBI’s profitability). With nominal GDP growth assumed at 10.1%, we expect the direct tax receipts to be broadly in line with the growth rate at INR25.7t in FY27E (FY26E:7.4% YoY). Indirect tax collections are likely to be boosted by a probable hike in excise duty collections, while GST collections are likely to see muted growth. We assume a disinvestment target of INR450b, marginally lower than last year’s INR470b. In our view, revenue expenditure (revex) would moderate, though capex may grow by 10.3% YoY or INR12.4t, representing 3.1% of GDP
Overall, GFD is expected to see a marginal reduction of 10bp in FY27 to 4.3% of GDP. Here are the broad budget expectations for FY27:
* Expenditure: Total expenditure growth rate is assumed at 7% YoY. Capital expenditure is assumed at INR12.4t (10.3% YoY). Revex is expected to grow by 6% on a yearly basis.
* Receipts: Total receipts growth rate is assumed at 6.8% YoY. Direct tax collection is expected to grow by 10.2% and indirect tax collection would rise by 6.3%.
* Centre’s Gross borrowing: It is expected at INR16.5t vs. INR14.6t in FY26E. ? Centre’s Net borrowing: It is expected at INR11.9t vs. INR11.3t in FY26E.
* Centre+State Borrowing: Gross borrowing is expected at INR29.7t vs. INR27.0t in FY26E. Net borrowing is expected at INR21.7t vs. INR20.3t in FY26E
For More Research Reports : Click Here
For More Motilal Oswal Securities Ltd Disclaimer
http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html
SEBI Registration number is INH000000412
