(Co-authored with Abhishek Singh)
In the Union Budget 2025-26, Finance Minister Nirmala Sitharaman reaffirmed the government's commitment to fiscal consolidation by setting a target of reducing the debt-to-GDP ratio to 50% (±1%) by 2030-31. This target is part of a new fiscal consolidation strategy for the five-year period from 2026-27 to 2030-31. Although the target falls short of the 40% recommendation of the FRBM review committee, it still represents a significant reduction from the soaring debt-to-GDP ratio witnessed after the COVID-19 pandemic. Notably, the current fiscal strategy marks a significant departure from the earlier strategy of prescribing rigid numeric targets for fiscal and revenue deficits. To assess the fiscal headroom available under the current strategy, we compute the fiscal deficit path the government should follow to support the targeted debt-to-GDP ratio.
Evolution of India’s Fiscal Strategy
With the enactment of the Fiscal Responsibility and Budget Management (FRBM) Act in 2003, India embarked on a rule-based fiscal regime, targeting revenue and fiscal deficits as a percentage of GDP. The Act was amended in 2018 to include government debt as the primary anchor of fiscal consolidation strategy, with the fiscal deficit as the key operational target. The amendment set ambitious targets: a 3% fiscal deficit by 2020-21 and a 40% debt-to-GDP ratio by 2024-25.
However, the COVID-19 pandemic severely disrupted public finances, leading to an unprecedented fiscal deficit of 9.2% of GDP in 2020-21. The government responded with a robust stimulus package, including fiscal and monetary measures to restore economic momentum and protect livelihoods. While the amendment to the FRBM Act included an ‘escape clause’ allowing deviations of up to 0.5% of GDP in the fiscal deficit for unforeseen contingencies, this proved inadequate for managing the scale of the crisis. Recognizing the need for flexibility in budgetary planning, the Union Budget 2021-22 introduced a more adaptive approach to fiscal consolidation, shifting away from rigid intermediate targets towards a glide path to reduce the fiscal deficit below 4.5% of GDP by 2025-26.
Fiscal consolidation glide path from 2021-22 to 2025-26
As the Union Budget 2025-26 projected a fiscal deficit of 4.4% for 2025-26, the government seems to be on track to achieving the targeted fiscal deficit. From the high of 6.7% at the beginning of the glide path, the fiscal deficit has declined to 4.8% of GDP in the current year (See Figure 1). This trajectory has been instrumental in reducing the debt-to-GDP ratio from 61.4% in 2020-21 to 57.1% in 2024-25 and an estimated 56.1% by the end of the glide path.
This consolidation has been achieved through improvement on both the revenue and the expenditure side. Figure 1 presents the trends in total revenue and expenditure as a percentage of GDP during the five-year period of the glide path. Revenue mobilization has witnessed a significant uptick, with government revenue as a percentage of GDP increasing from 9.2% in 2021-22 to 9.6% in 2025-26 (BE), surpassing the five-year pre-pandemic average of 8.5%. This surge is primarily driven by robust growth in tax revenue, particularly income tax. Concurrently, expenditure has been rationalized, with a notable decline in total expenditure from 13.6% to 11% of GDP during this period. This reduction is largely attributed to decreased revenue expenditure, signifying improved government efficiency.
Crucially, capital expenditure, an essential driver of long-term growth, has witnessed a significant boost, nearly doubling from the pre-pandemic five-year average of 1.7% to 3.1% of GDP in 2025-26 (BE). This surge in capital investment primarily focused on sectors like energy, irrigation, and general economic services, is vital for bolstering infrastructure and driving economic growth.
Figure 1: Trends in fiscal deficit, debt, total revenue, and expenditure during 2021-26
Debt-based fiscal consolidation roadmap for 2026-27 to 2030-31
With the existing glide path concluding in 2025-26, the government has outlined its next fiscal consolidation roadmap for 2026-27 to 2030-31. Highlighting the need for operational flexibility, the government has shifted away from setting specific targets for the fiscal and revenue deficits in the current framework, instead making the debt-to-GDP ratio as the fiscal anchor. Figure 2 illustrates this glide path as presented in the statements of fiscal policy, in accordance with the FRBM Act. The glide path outlines three scenarios based on annual GDP growth rates of 10%, 10.5%, and 11%. Under each scenario, it presents the projected reduction in the debt-to-GDP ratio under mild, moderate, and high degrees of fiscal consolidation. For example, with a 10.5% growth rate of GDP, the debt-to-GDP ratio is projected to reach 51% by the terminal year under mild fiscal consolidation, whereas under high fiscal consolidation, it is expected to decline to 48.4%.
Since fiscal deficit is an important determinant of debt, only a specific fiscal deficit path can support the debt-to-GDP target. To assess the fiscal space available to the government under the current strategy, we calculate the fiscal deficit trajectory necessary to support the Union government’s debt-to-GDP glide path. The first step in that process is to adjust the definition of debt to reflect the fiscal operations of the government.
Figure 2: Glide path for debt-to-GDP ratio under various GDP growth scenarios
The glide path defines debt according to the 2018 amendment to the FRBM Act. Based on this definition, debt or outstanding liabilities amount to ₹ 200.15 lakh crore or 56.1% of GDP in 2025-26 (BE)1. Since this definition of debt includes several components that are not impacted by the Union government’s fiscal operations, we make adjustments to ensure that the outstanding liabilities accurately reflect the fiscal operations of the Union government. Table 1 lists the components of debt and the adjustment undertaken in the FRBM definition of debt to arrive at Net Adjusted Liabilities. Net Adjusted Liabilities account for approximately 55% of the GDP in 2025-26 (BE). We utilize this definition of debt to compute the fiscal deficit path for 2025-26 to 2030-31.
Table 1: Components of Debt
Next, we make two assumptions for our computation. First, we assume that the reduction required in Net Adjusted Liabilities is the same as the targeted reduction in debt (FRBM definition). This implies that if a 6% reduction is targeted in debt (FRBM definition) to bring it close to 50% by 2030-31, the same reduction should be seen in Net Adjusted Liabilities. Second, we assume that the reduction in debt targeted during the five year period is distributed evenly. Based on these assumptions, we compute an indicative fiscal deficit path that will support the Union government’s debt-to-GDP glide path. Figure 3 gives the indicative fiscal deficit path under high, moderate and mild degrees of fiscal consolidation, similar to the debt-to-GDP glide path.
Figure 3: Assessed fiscal deficit path under various GDP growth scenarios
According to our computation, when the nominal GDP growth rate is 10% and there is moderate degree of fiscal consolidation, fiscal deficit should reach 3.5% by the terminal year, whereas with mild and high degrees of fiscal consolidation, it should reach 3.9% and 3.1% respectively. Similar fiscal deficit paths under GDP growth rate of 10.5% and 11% can be seen from the figure. Notably, it is only with a high degree of fiscal consolidation that the fiscal deficit approximately reaches the 3% limit recommended by the FRBM Act.
Conclusion
Since the enactment of the FRBM Act in 2003, binding fiscal deficit targets have played a crucial role in reducing the debt-to-GDP ratio from a peak of 67.1% in 2002-03 to 49.6% in 2018-19. The absence of a rigid fiscal deficit target in the post-pandemic landscape, while introducing flexibility to deal with economic uncertainties, also carries the risk of fiscal slippage if not carefully managed. As the government gears for a 50% debt-to-GDP target by 2030-31, it should try to limit its fiscal deficit within a defined range. Our estimates show that a fiscal deficit of 3.5% (±0.2%) of GDP by 2030-31 can support the desired debt target. Achieving this would require concerted efforts towards enhancing revenue streams and effectively controlling expenditure while maintaining a healthy trajectory for capital expenditure to spur growth.
1. The term debt and liabilities are used interchangeably in the article.
References
Resham Nagpal is Assistant Professor, and Abhishek Singh is Research Associate, National Institute of Public Finance and Policy, New Delhi.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.
