Budget has a demand problem

For much of economic history, the idea that production would eventually generate its own demand rested on a set of strong assumptions: flexible prices, full employment, and a financial system that transmitted savings smoothly into investment. When those conditions fail, as they often do in modern economies, output can remain unsold and investment decisions deferred.

When one reads the Union Budget 2026-27, which places considerable faith in supply-side momentum at a time when demand signals remain uneven, one is reminded that those assumptions still do a great deal of quiet work in policy thinking. Philosophically, this year’s Budget leans closer to Jean-Baptiste Say than to John Maynard Keynes. The Budget gets several things right. The fiscal deficit is pegged at 4.3 per cent of GDP, marginally lower than the revised FY26 estimate of 4.4 per cent. Public debt is projected to decline from 56.1 to 55.6 per cent, with a medium-term anchor of 50% (±1 %) by FY31.

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Capital expenditure is budgeted at Rs 12.22 lakh crore, maintaining the capex-to-GDP ratio at 3.1 per cent. Including grants to states, effective public investment now stands at Rs 17.15 lakh crore. The Finance Minister’s emphasis on fiscal consolidation and thrust on public investment is well-intentioned. The difficulty is that this supply-led, fiscally disciplined strategy now depends heavily on an assumed revival in growth. The Budget projects 10 per cent nominal GDP growth in FY27, up from roughly 8 per cent this year. That assumption underpins the Budget’s math on revenue buoyancy, deficit levels, and the ability to sustain elevated levels of capital expenditure.

The demand conditions, however, may not support that optimism. If nominal growth settles closer to 9-9.5 per cent, as several private forecasts suggest in a scenario of softer consumption, the difference could imply a revenue miss of the order of Rs 1–1.5 lakh crore (depending on buoyancy assumptions), which could force a trade-off between trimming capital expenditure or tolerating fiscal slippage later. India has consistently under-executed public capex in the second half of each fiscal year when revenues miss, a pattern well documented across FY24 and FY25.

And if the deficit were to slip to 4.5–4.6 per cent, it would directly test the credibility of the debt-anchor framework the Budget is simultaneously trying to establish. According to the First Advance Estimates, real private final consumption expenditure grew by 7.0 per cent in FY26. However, high-frequency indicators suggest some softening in underlying momentum. GST collections have not risen in tandem with the Budget’s nominal growth optimism, suggesting some loss of volume momentum.

At the same time, real rural wage gains appear modest, driven more by easing inflation than by strong nominal wage growth. All these point to consumption that is holding up in aggregate, but with clear pockets of fragility, particularly in rural and lower-income segments. Indirect tax revenues are budgeted to grow by only about 3 per cent in FY27 (BE) over FY26 (RE). In contrast, direct tax revenues are projected to increase by 11.4 per cent over the same period. This divergence is of significance because broad-based consumption growth typically lifts indirect tax collections.

When indirect taxes lag while direct taxes do the heavy lifting, it usually signals profit-led buoyancy rather than a broad expansion in household spending. What do these imply for private investment? Firms commit to capacity expansion when they expect sustained demand for output. RBI surveys show capacity utilisation well below the 78–80 per cent range that has historically preceded private capex cycles in India. Pricing power remains limited outside a narrow set of sectors, and order books – particularly for MSMEs catering to domestic markets – have not strengthened decisively.

The Budget’s MSME package captures this broader tension. The Budget proposes a Rs 10,000 crore SME Growth Fund, a Rs 2,000 crore top-up to the Self-Reliant India Fund, and a further deepening of the TReDS ecosystem. More than Rs 7 lakh crore has already flowed through TReDS, and new measures – ranging from credit guarantees and receivables securitization to the mandatory routing of CPSE purchases – are proposed to ease working-capital constraints.

Delayed payments and liquidity stress have long weighed on small firms, and improving cash-flow management can reduce financial fragility. These measures, however, are unlikely to address the demand environment in which many MSMEs currently operate. Easing receivables constraints on its own is unlikely to trigger fresh hiring or investment. A similar logic applies to the Budget’s manufacturing and trade-facilitation agenda. India’s share of global merchandise exports rose modestly to 1.8 per cent in FY25, still a thin slice of world trade. The sectors the Budget is backing – biopharma, semiconductors, electronics – are the ones where India has limited near-term export scale.

Also, the time from policy support to export volume is typically three to five years at a minimum. Export demand cannot be assumed as a reliable counterweight to soft domestic demand within the Budget’s FY27 horizon. The Budget is disciplined in its fiscal stance and notably resistant to short-term populism. But if household demand, export momentum, and capacity utilization do not recover within the government’s timeline, the tight fiscal arithmetic could entail painful trade-offs. Sound budgetary policy is as much about sequencing as it is about intent. The Budget has chosen its side. The question is whether the other side, demand, is ready to meet it.

(The writers are faculty members in the Economics & Public Policy Area at the Indian Institute of Management (IIM) Ranchi. Views are personal.)