Union Budget 2026 Explained: Debt Shift, Borrowings & Market Impact

Union Budget 2026 presents a strong commitment to fiscal discipline with a clear shift toward debt-to-GDP targeting, but beneath the headline numbers lie growing market concerns.

Union Budget 2026 Overview

Elevated borrowings, weak tax buoyancy, and rising state-level pressures make this budget a delicate balancing act between stability and growth.

Both markets and economists have expressed differing opinions about the FY27 Budget. Although the government’s dedication to fiscal restraint—during the shift to a debt-to-GDP anchor through FY31—has received widespread praise, the headline figures conceal a complicated environment with immediate challenges like jitteriness in the bond market, possible revenue slippages, and a complex fiscal tug-of-war with state governments.

Fiscal Restraint and the Debt-Targeting Pivot

Fiscal restraint and the debt-targeting pivot: The government’s ongoing achievement in controlling the fiscal deficit is the budget’s most important structural lesson. The Center has budgeted for a further consolidation to 4.3% of GDP for FY27 and is still on pace to fulfill its updated deficit target of 4.4% of GDP for FY26.

Significantly, the budget signaled the beginning of a strategy change: the government formally changed its fiscal anchor from deficit-based targeting to debt-to-GDP targeting. Reducing the federal government’s debt to 50% (±1%) of GDP by FY31 is now the stated objective. The Center seems well-positioned to achieve this long-term goal based on the current consolidation trajectory, which should theoretically reassure credit rating agencies.

Pressure on G-Sec Yields

Pressure on G-Sec yields: The bond market is nonetheless tense in spite of these strong consolidation figures. For FY27, the Center’s gross borrowing amount of Rs 17.2 lakh crore greatly surpassed market projections, which ranged from Rs 16.5 lakh crore to Rs 17 lakh crore. This high borrowing requirement is occurring at the same time that tax income is continuing to stall, with weak buoyancy and a decline in GST collections causing it to rise at a moderate 7% rate for the second year in a row.

Due to these considerations, the 10-year G-sec yield has remained high at roughly 6.7%, which is in sharp contrast to policy rates, which have decreased the repo rate by 125 basis points since February 2025. The deferral of Indian bonds’ inclusion in the Bloomberg Global Aggregate Index, which has delayed expected passive inflows, has made the already severe supply overhang and pressure from high state borrowing needs worse. In order to absorb the excess supply and facilitate monetary transmission, the RBI may need to step in through Open Market Operations (OMOs).

Non-Tax Revenues and Disinvestment Challenges

The government is depending more and more on non-tax revenues, which now make up about 22% of overall collections, as tax revenues are under pressure. Although the disinvestment roadmap continues to be a bottleneck, dividends from the RBI and PSUs have offered dependable support. Given that the Center only met 23% of these commitments between FY20 and FY25, the FY27 disinvestment aim seems excessive.

The Economic Survey has suggested a daring solution to overcome this structural obstacle: changing the Companies Act to reinterpret what defines a “government firm.” The plan calls for reducing the current 51% minimum requirement for sovereign holdings to 26%. Without going through with full privatization, this reform would enable the Center to unlock substantial value through offer-for-sale (OFS) transactions while maintaining effective control and the ability to block special resolutions.

Capital Expenditure Push

The budget offers a comprehensive capital expenditure plan. In FY27, on-budget capital expenditures are expected to expand by 11.5%, with the infrastructure sectors—roads, railroads, and metro systems—continuing to occupy a sizeable 50% part of the budget.

Nonetheless, this budget clearly favors the defense industry. Defense capital expenditures have experienced a strong ~17.5% planned growth following years of sluggish growth (8% CAGR during FY20-25). Alongside this, there is a strategic mandate to purchase about 75% of capital equipment from domestic businesses in order to increase the economic multiplier.

Populism vs. Capex

Populism vs. Capex Lastly, the budget emphasizes how important states are to execution. States have maintained strong capital expenditure growth of about 15% CAGR (FY22–25), which is much faster than the Center’s capacity to absorb it. Acknowledging this, the Center raised interest-free capital expenditure loans to states by almost 29% year over year to Rs 2.26 lakh crore, which now accounts for one-fifth of the Center’s effective capital expenditures.

But there is a catch to this. State borrowing is still high, mostly to finance populist cash payments of Rs 2.6 lakh crore. The 16th Finance Commission’s decision to keep the tax devolution ratio at 41% instead of raising it may oblige states to maintain significant market borrowing in order to strike a compromise between populist demands and development objectives.

Frequently Asked Questions

1. In the Union Budget 2026, what is the most significant structural change?

The primary change is switching to a debt-to-GDP anchor from fiscal-deficit targeting. In an effort to demonstrate long-term fiscal restraint, the government now plans to reduce central debt to 50% (±1%) of GDP by FY31.

2. Why are bond yields still high if there is good fiscal discipline?

State borrowings are high and tax income growth is still poor since FY27 gross borrowings (₹17.2 lakh crore) were more than anticipated. Despite repo rate reductions, this supply pressure has maintained the 10-year G-sec yield at 6.7%.

3. What impact does low tax revenue have on the budget?

Only 7% growth in tax income is anticipated, mostly as a result of decreased GST collections. Because of this, the government is becoming more and more reliant on non-tax income, including as dividends from PSUs and the RBI, which currently account for roughly 22% of total collections.

4. What kind of reform might make disinvestment possible?

The Economic Survey suggests lowering the minimum government ownership from 51% to 26% in order to redefine a “government enterprise.” This would maintain strategic control while allowing value unlocking through OFS without complete privatization.

5. What effects are states having on budgetary dynamics?

In addition to expanding borrowing to finance ₹2.6 lakh crore in cash-transfer schemes, states are boosting the increase of capital expenditures. States may continue to rely on market borrowings if tax devolution stays at 41%, which would put further pressure on bond markets.

Conclusion

With its debt-to-GDP targeting structure and consistent deficit reduction, the Union Budget 2026 reaffirms India’s commitment to long-term fiscal stability. Bond markets are still under pressure, nevertheless, due to high borrowing requirements, muted tax buoyancy, and strong state-level populism.

The budget provides medium-term growth support through its strong drive for defense and infrastructure capital expenditures as well as the proposed disinvestment reforms. In the end, whether fiscal discipline results in sustainable growth without upsetting financial markets will depend on how well both the federal government and the states implement it.

Disclaimer: This content is for informational purposes only and does not constitute financial, investment, or policy advice. Readers should consult qualified professionals before making any financial or investment decisions.