Budget passes capex baton to states, RBI may foot bond bill, Goldman Sachs says

The budget kept its razor-sharp focus on sustained fiscal consolidation, while tilting towards the urban consumer, setting optimistic income tax collection targets, and delegating capital expenditure responsibilities to the states, Goldman Sachs said in a report.

Despite a slightly reduced fiscal deficit leading to marginally lower net market bond borrowings, the Reserve Bank of India will need to purchase government bonds in FY26 to counterbalance the liquidity drain caused by foreign exchange sales, the report by Goldman Sachs analysts Santanu Sengupta, Arjun Varma, and Andrew Tilton said.

The government stuck to its fiscal glide path in the first full budget of its third term, targeting a fiscal deficit at 4.4% of gross domestic product (GDP) in FY26 from the revised estimate of 4.8% in FY25.

The fiscal deficit had shot up above 9% of GDP in FY21 following the onset of covid, and finance minister Nirmala Sitharaman had then sought to bring it back below the 4.5% mark by FY26.

In a departure from the past and introducing a fresh parameter, the government this time also committed to keep the central government public debt (as a % of GDP) on a declining path towards 50% of GDP by FY31 from 56.1% of GDP in FY26.

The government also readjusted income tax slabs to provide 0.3% of GDP tax relief to personal income tax payers.

“We believe this will partly help the indebted urban consumer deleverage (and boost net household financial savings), and partly boost consumption in a section of urban households. The net fiscal impulse drag
on growth in FY26 will be smaller than in FY25,” the report said.

Despite the tax revenue foregone, the government has budgeted income tax to GDP at 4% from 3.9% in FY25.

“This, in our view, assumes a significant improvement in tax buoyancy (net of tax foregone), absent which, spending cuts will be required to meet the fiscal deficit target,” Goldman Sachs said.

The government’s capital expenditure in the next fiscal is budgeted to remain flat when compared with FY25 as a share of GDP, at 3.1%, which Goldman Sachs said is in line with its long-standing view.

Further, capex allocation to the states is up 22% year-on-year at 0.5% of GDP, which likely indicates that the government is passing the capex baton on to states, the report said, adding that defense capex allocation is up 13% y-o-y, while roads and railways are flat.

“Given that the government has fallen ~0.1% of GDP (average FY23-FY25 RE) short of spending the budgeted capex, a potential spending cut in case of revenue shortfall may likely be funded from here,” it added.

Even with a lower fiscal deficit, Goldman Sachs said that the net market borrowing via bonds was only marginally lower (in level terms), while other sources of financing were cut by 0.1% of GDP.

“As we have written recently, though natural domestic demand for bonds is likely to remain adequate, we believe RBI will have to be a net buyer of government bonds in FY26, to partly offset rupee liquidity drain from FX sales,” it added.