Budget 2026: Navigating Fiscal Challenges Through VUCA

As the Union Budget on Feb. 1, 2026 approaches, the global environment remains challenging, with increasing geopolitics uncertainties, elevated tariffs and a sharp rise in gold and silver prices instead of safe-haven treasuries across the world are probably indicating that the geopolitical logjam may persist longer and, if not, then we may see a reversal of the trend in 2027.

Domestically, while the GDP growth is tracking well for FY26, the growth prospects in near term could come under pressure if the tariff environment persists. The RBI has tried to ease the situation by cutting repo rate and infusing durable liquidity via OMO, CRR and FX swaps.

The weakening of rupee has pushed bond yields higher than the underlying fundamentals, the same has added to fiscal complexities. In this VUCA (Volatile, Uncertain, Complex and Ambiguous) setting, the Budget is likely to balance consolidation with growth while ensuring inflation remains contained.

A revenue shortfall of Rs 1.7 lakh crore is expected in FY26, driven by lower income tax and GST collections, as well as weaker corporate tax and import duties. The impact may be partly cushioned by a higher‑than‑usual RBI dividend and partly by lower expenditure.

Despite these headwinds, the government is likely to meet its fiscal deficit target of 4.4% of the GDP for FY25-26. However, the nominal GDP growth estimate of 8%, lower than the budgeted 10.1%, poses a risk.

Financing conditions appear stable. However, states finances are constrained amid weaker tax revenues. While the Q4 FY26 calendar for SDL issuance was in line, the real test will be the projection of SDL issuance for FY27.

The RBI is expected to maintain comfortable liquidity in the banking system and given OMO purchase of bonds likely to be the preferred route to manage liquidity will also anchor bond yields.

Looking to FY27, we expect the Govt to maintain fiscal deficit at 4.3% and gross borrowings may rise to Rs. 16.5 lakh crore (if Govt switches bonds with RBI and uses T bill, then gross borrowing programme may be below Rs 16 lakh crores as well). Fiscal consolidation is likely to continue with the debt‑to‑GDP ratio projected at 55.1% and primary deficit below 1%. The new GDP series (with base year 2022-23) is likely to be released in February 2026, which may change the debt-to-GDP dynamics.

The government's focus on capex, subsidy rationalisation, and structural reforms strengthens prospects for sustainable growth. Overall, we expect a growth supportive fiscally responsible budget and if it's market friendly with minor tweaks as explained above, then, it will be positive for bond markets too.

The article has been authored by Abhishek Bisen, head of fixed income at Kotak Mutual Fund.

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