Budget 2026: Bond market faces supply, rupee pressure but FY26 deficit target seen intact

India’s bond market is facing a twin set of pressures from currency weakness and elevated government borrowing. With Budget 2026 approaching, Sreejith Balasubramanian, Senior Economist – Fixed Income at Bandhan AMC, said the bond market has been impacted on the external-account front as the rupee has come under depreciation pressure, and on the fiscal front due to a heavy supply of government securities amid only moderate demand.

While central government tax revenues in FY26 are likely to undershoot budget estimates, partly because of income tax and GST rate cuts, this shortfall should be offset by stronger non-tax revenues and lower spending, keeping the deficit target intact, he said.

Balasubramanian expects nominal GDP growth to rebound to around 10% in FY27, from about 8% this year, as inflation gradually mean-reverts from current low levels. However, he cautioned that the impact of the new GDP series, with an updated base year, revised data sources and methodology—scheduled to be released at the end of February—remains uncertain and could alter fiscal ratios going forward. Tax buoyancy and the carryover of revenue momentum from FY26 will therefore be closely watched. 

“While central government tax revenues in FY26 are likely to fall short of budget estimates due to income tax and GST rate cuts, higher RBI dividend transfers and lower expenditure should offset the gap," Balasubramanian said.

Another key variable will be the 16th Finance Commission’s recommendations on tax devolution and grants to states for the next five years. These proposals will influence the Centre’s net tax revenues and could also affect states’ borrowing plans by providing greater visibility on future receipts. On the non-tax side, the RBI dividend could be higher than expected, reflecting profits from foreign exchange operations, even after maintaining the contingent risk buffer at the upper end of its prescribed range.

On the spending front, the government is expected to sustain the momentum in capital expenditure, either directly through the Centre or via interest-free loans to states. The implementation of the 8th Central Pay Commission, meanwhile, is likely to be deferred, although arrears may be payable later.

Balasubramanian emphasised that the new five-year fiscal framework provides valuable flexibility. While the stated objective is to keep the fiscal deficit on a path that brings the Centre’s debt-to-GDP ratio down to about 50% (±1%) by FY31, the framework allows room to rebuild fiscal buffers or respond to unexpected shocks. The upcoming budget is expected to provide more clarity on the five-year glide path.

The immediate policy choice, he noted, is whether the government opts for faster consolidation, maintains the deficit at current levels, or allows a slightly higher deficit to counter external growth headwinds. All three options are compatible with the framework. A deficit range of 4.2–4.6% of GDP could even be considered, offering quantified and transparent cyclical support while remaining within the medium-term trajectory.

On funding, small savings collections have been robust this year and may remain strong in FY27, supported by administered rates that are higher than bank deposit rates following RBI rate cuts. Some borrowing could also shift toward Treasury bills, though overall gross G-sec issuance is still expected to rise sharply, potentially exceeding Rs 17 lakh crore, with net borrowing of Rs 11.5–12 lakh crore. Including states, total net bond supply could cross Rs 20 lakh crore, underscoring the importance of fiscal clarity in the Union Budget.