economy · 2026-06-28
How Inflation May Ease India's Fiscal Gap
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EY projects India's nominal GDP growth at ~12.5% in FY27, with higher inflation lifting tax collections despite real growth moderating to ~6.7%.Stronger nominal growth lets the Centre absorb excise duty cuts while keeping fiscal deficit near the budgeted 4.3% of GDP, avoiding austerity.Capex growth slowed sharply to 1.6% in FY26 from 10.8% prior year, pressuring infrastructure sectors and states dependent on central investment.
Why does inflation help the govt's books here?
Nominal GDP includes inflation. If prices rise 5.5% and real output grows 6.7%, total taxable value jumps ~12.5%. GST and income tax are levied on nominal values, so collections rise even without new taxes. For example, a ₹100 item taxed at 18% yields ₹18. At 5% inflation, it becomes ₹105, yielding ₹18.9, a 5% revenue bump with zero policy change.
How do nominal vs real GDP differ for taxes?
Real GDP strips out price changes, measuring only output volume. Tax authorities collect on nominal values. If a factory sells steel at ₹80K/tonne instead of ₹75K, the excise base grows 6.7% even if tonnage is flat. This is why govts quietly benefit from moderate inflation. India's income tax slabs aren't fully indexed, so wage inflation also pushes earners into higher brackets automatically.
Did FY26 tax collections actually beat targets?
Yes. The Centre hit its revised FY26 fiscal deficit target of 4.4% of GDP, with the gap narrowing to ₹15.2L Cr from ₹15.8L Cr in FY25. Direct tax collections grew ~15% YoY, partly because corporate profits at firms like Reliance and TCS were taxed on inflated nominal earnings, delivering buoyancy above the 1x GDP growth rate.
What share of Centre's revenue comes from GST?
GST contributes roughly 28% of the Centre's gross tax revenue. In FY26, monthly GST collections averaged ~₹1.9L Cr. The structural advantage is that GST is ad valorem, meaning it scales with prices. When nominal GDP grows 12.5%, GST collections grow at least proportionally. Compare this to specific duties like excise on fuel, which are fixed per litre and don't benefit from inflation.
Could the 4.3% deficit target still be missed?
EY flags two risks. First, subsidies may overshoot budget estimates, especially food and fertiliser. In FY26, fertiliser subsidy alone exceeded ₹1.6L Cr. Second, if crude oil spikes due to Hormuz disruptions, fuel subsidies could balloon. Together, these expenditure overruns could push the deficit to ~4.4% instead of the budgeted 4.3%, a marginal miss but one that narrows fiscal room.
What specific subsidies could blow past budget?
Food and fertiliser subsidies are the two biggest risks. The food subsidy under PM Garib Kalyan Anna Yojana covers ~800Mn beneficiaries and cost ~₹2L Cr in FY26. Fertiliser subsidy depends on global gas prices, since urea production is gas-intensive. If LNG prices rise even 10%, the fertiliser subsidy can overshoot by ₹15-20K Cr, eating into deficit headroom.
How does crude oil price affect the deficit math?
Every $10/barrel rise in crude oil adds roughly ₹45K Cr to India's import bill annually. This pressures fuel subsidies and widens the current account deficit. EY's 4.3% target assumes crude stays low and Hormuz shipping normalises. In the 2022 spike, when Brent hit $120, India cut excise twice, costing ~₹1L Cr in foregone revenue, exactly the scenario EY warns higher nominal GDP must absorb.
Has India ever missed its deficit target recently?
Yes. In FY20, India's fiscal deficit hit 4.6% of GDP against a 3.3% target, primarily because GST collections underperformed and corporate tax was slashed from 30% to 22% mid-year. That miss forced the govt to borrow an extra ₹1.5L Cr. The lesson: revenue shortfalls are harder to absorb than expenditure overruns, which is why EY emphasises the nominal GDP growth cushion.
Who loses if capex growth stays at 1.6%?
Infrastructure contractors and state govts bear the brunt. Capex growth crashed from 10.8% to 1.6% in FY26, meaning fewer new highway, rail, and port projects. Companies like L&T and NCC depend on central capex orders. States co-funding projects under the National Infrastructure Pipeline also see delays, slowing construction employment in rural districts.
Which state projects face the biggest delays?
National Highway Authority projects are most exposed. NHAI's FY26 award target was 12K km, but actual awards fell short at ~8K km. Railway capex, budgeted at ₹2.5L Cr, saw utilisation drop to ~85%. States like UP and Maharashtra, which co-fund expressways and metro rail, saw central releases slow, delaying projects like the Ganga Expressway and Mumbai-Ahmedabad bullet train.
How does capex slowdown hit employment numbers?
Construction employs ~70Mn workers in India, making it the second-largest employer after agriculture. CMIE data shows construction job additions in FY26 fell to ~1.2Mn from ~3Mn in FY25. When the Centre's capex grows only 1.6%, cement demand growth halves, equipment orders at firms like BEML and Escorts stall, and daily-wage labourers in districts like Bundelkhand see fewer workdays.
Could private capex fill the gap instead?
Partially, but not fully. Private capex tends to follow, not lead, public investment. RBI's OBICUS survey shows capacity utilisation at ~75%, below the ~80% threshold where firms typically expand. Exceptions exist: Tata Semiconductor's ₹91K Cr Gujarat fab proceeds regardless. But broad-based private capex in roads, ports, and power generation historically kicks in only after govt orders signal sustained demand.
Source: economictimes.indiatimes.com