India’s bond market has been impacted by dynamics in the external account (two consecutive years of negative BoP balance, INR depreciation pressures) and fiscal (G-sec + SDL supply, moderation in demand across the curve and particularly for duration). While BoP remains a key factor, the upcoming union budget could provide clarity on bond supply in FY27 and the fiscal trajectory over the next few years.
The union government’s FY26 fiscal deficit target of 4.4% of GDP is widely expected to be met, with a likely shortfall in tax revenue offset by higher RBI dividend and lower expenditure. Thereafter, the new fiscal framework with Debt-to-GDP as the anchor will be adopted from the upcoming budget for FY27. The stated endeavour of this framework is to keep the fiscal deficit each year such that the central government Debt to GDP is on a declining path to ~ 50±1% by FY31, while offering flexibility (vs. rigid fiscal deficit targets each year) and helping rebuild fiscal buffers to support growth or respond to unforeseen developments. The approach is also holistic and transparent.
The question, particularly in the current context of elevated global economic and policy uncertainty, is whether the government should consolidate the FY27 fiscal deficit further, keep it flat or respond to external growth headwinds. One, any of these can be done while still being fully committed to the new framework, by adjusting the level of consolidation in subsequent years. The total fiscal deficit and net G-sec borrowing during the five years (FY27 to FY31) can be very similar whether the debt consolidation is smooth/equal each year or whether it is back-ended due to frontloaded growth support (see scenarios and figures 1 to 4 below). Two, all the options entail a delicate act as the immediate fiscal space is moderate given income tax cuts and GST rationalisation implemented. Therefore, the government could even consider a fiscal deficit range, say 4.2% to 4.6%. It will allow potential cyclical growth support, quantified and communicated, through automatic stabilisers (lower revenue if any) or additional spending. Importantly, it will offer flexibility while staying within the five-year debt-based glide path.
Scenario Analysis:
Scenario 1: Growth Support + Debt Glide Back – Domestic growth is impacted due to elevated global economic and policy uncertainty, and fiscal policy responds to this through higher deficit. Thus, Debt-to-GDP declines less in the initial years but falls faster thereafter to get to 50 ± 1% by end-FY2031.
Scenario 2: Smoother Debt Glide Back – Domestic growth stays buoyant, not warranting additional fiscal support and thus Debt-to-GDP declines steadily each year from FY2027 to FY2031 to get to 50 ± 1% by end-FY2031.
FY27 Budget: The Elements
The FY27 budget will be presented based on the current GDP data but the new series with updated base year, data sources and methodology (to be released at the end of February) will subsequently be used. How this, particularly the wider adoption of ‘double deflation’ methodology, impacts the number is to be seen. All said, nominal GDP should rebound to ~10% from 8% in FY26 as WPI and CPI inflation also mean-revert. Tax buoyancy will be the key, as gross tax collection so far this year has been modest. The recommendations of the 16th Finance commission on tax sharing and grants for states, applicable from FY27 to FY31, will soon be tabled. This will impact the net tax revenue for the centre, and states’ SDL borrowing (including Q4 FY26) by providing clarity on future receipts. Non-tax revenue in the form of RBI dividend (Rs. 2.7tn in FY26) could again be large or even higher in FY27, as FX sales by the RBI would have resulted in profit booking vs. its historical acquisition cost. This is possible even after maintaining the Contingent Risk Buffer, as per the revised Economic Capital Framework of May 2025, at the upper end of the range. A meaningful momentum in disinvestments is still awaited.
On the expenditure side, although it could end lower than budgeted this year, the broad capex momentum through the centre and through interest-free loans to states is expected to continue in FY27. The effect of the recommendations of the 8th Central Pay Commission, the terms of reference of which was approved by the cabinet in October 2025, is expected from January 2026. However, given this will be implemented ‘ later with arrears, its impact then on the fiscal deficit and debt must be kept in mind. Policy focus or reforms this time could be on defence, trade and correcting any inverted duty structure for goods. The overarching focus will likely be on growth while maintaining a credible and transparent fiscal trajectory based on Debt-to-GDP.
This brings us to funding of the fiscal deficit. Small savings collection, previously also utilized to fund public agencies like FCI and NHAI, have been higher while the budgeted collection is lower this year (Figure 5). Given rates on these schemes are administered and are higher than bank deposit rates which have moderated this year with RBI rate cuts, inflows could remain robust in FY27. Net t-bill borrowing was negative in FY25 and zero in FY26 (Figure 6). Given this, higher average maturity of G-sec issuance in recent years and the moderation in risk appetite across the curve, some FY27 borrowing could be shifted from G-sec to t-bills.
In FY26, ~73% of the fiscal deficit was funded through net G-sec borrowing. Even under scenarios of lower shares of G-sec borrowing to fund the deficit (i.e. higher funding by small savings, t-bills, etc.), the total gross supply is likely to rise meaningfully (Figure 7 below from our note last month).
A point to note above is that the FY27 G-sec redemption of Rs. 5.5tn is considerably higher than Rs. 3.3tn in FY26. However, there is some uncertainty regarding the final amount left in the GST compensation cess pool at the end of FY26, how this will be shared between the centre and states, and whether the centre’s share will be used to repay the GST-related bonds and thus reduce total FY27 G-sec redemption. More clarity is awaited from the GST Council and the union government.
Conclusion
The new 5-year Debt-to-GDP based framework offers the flexibility to respond to economic circumstances and still be on the committed glide path, with total net G-sec borrowing similar to that if the debt consolidation is smooth/equal each year. For FY27, estimates of growth, tax buoyancy, RBI dividend and thus the headline fiscal deficit will be watched. Higher small savings and t-bill borrowing to fund the deficit could ease some pressure from G-sec supply, but it is still expected to be large. While the budget’s focus will likely be on growth and maintaining a credible fiscal trajectory, with further details on the envisaged debt glide path, external account dynamics will be a prominent factor.
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