The Big Question For Budget 2026
The Indian economic recovery in 2025 was real, but it was also unusually narrow (Government Open Data License – India)
For much of 2025, India’s macroeconomic story was told in peaks and troughs. Growth levels in India surged when much of the world slowed. The macro-inflation numbers remained more or less manageable in the given monetary policy environment within a volatile rupee, while foreign exchange reserves, despite high Foreign Institutional Investment (FII) outflows, appear robust for now.
In a year when macroeconomic management elsewhere resembled crisis containment, India appeared to have achieved something rarer, a certain calm without contraction.
On February 1, the Union Budget for 2026-27 will be presented. As the date approaches, the central question is no longer how effectively India may have managed the past year, but what kind of economic structure that macro-management has produced for economic prosperity for all. It is in the latter (shared economic prosperity) where the government’s track record may warrant greater scrutiny.
Let’s see the data.
Real GDP growth accelerated to 8.2 percent in the July-September quarter. Consumer price inflation averaged only 1.8 percent in July-August. Foreign exchange reserves crossed USD 690 billion, covering over 11 months of imports.
Yet, macroeconomic moments defined by calm often demand the most scrutiny. 2025 may well be remembered as the year India mastered stability and discovered its limits.
Ensuring stability is not the same as a strategy for progressive realisation of higher growth and shared economic prosperity.
Growth without breadth
India’s recovery in 2025 was real, but it was also unusually narrow. Unlike earlier high-growth phases driven by investment surges, this cycle rested primarily on consumption and services. Private Final Consumption Expenditure grew by roughly 7.0 percent in the first quarter of the fiscal year.
Services exports continued to expand, with net receipts exceeding US$ 50 billion.
What did not materialise with comparable force was private investment. Despite corporate profits reaching a 15-year high, total investment announcements stood at US$ 355.45 billion (Rs 32.01 lakh crore) in the nine months in FY25, marking a 39 percent increase from US$ 276 billion (Rs 23 lakh crore) in the same period last fiscal.
Consumption-led growth can deliver strong headline numbers, but it does not expand productive capacity at the same pace. Without a sustained private capex cycle, the economy risks operating below its long-term potential.
The persistence of this investment hesitation under near-ideal macro conditions suggests a deeper structural constraint rather than a cyclical pause. When capital flows into consumption credit rather than industrial capacity, the economy generates debt rather than durable wages.
Monetary policy, meanwhile, did everything it could within its mandate. India’s retail inflation eased to a five-month low of 4.31 percent in January 2025 as against 5.22 percent in December 2024, on slowing food price rises.
The RBI responded with decisive easing and liquidity injections of US$ 33,28,31,40,000 (Rs 3 trillion) through open market operations and forex swaps. Yet, lending rates remained sticky.
Credit growth averaged around 11 to 12 percent, but much of it flowed into retail loans rather than long-gestation productive investment. The disconnect between policy rates and real-economy transmission revealed that the constraint on growth was no longer monetary.
External stability and capital account paradox
On the current account side, stability prevailed. The current account deficit for FY25 remained contained at around 0.6 percent of GDP, with the January-March quarter of 2024-25 recording a surplus of over 1 percent.
Services exports and remittances, which together exceeded US$ 80 billion in quarterly inflows, continued to offset a structurally large merchandise trade deficit.
On the capital account, however, 2025 marked a rupture. Foreign institutional investors withdrew approximately US$ 1.9 billion to US$ 2.1 billion (Rs 1.58 lakh crore) from Indian equities, the largest annual outflow on record. The rupee depreciated by over 5 percent, against the dollar year-to-date, breaching the Rs 90 per US$ mark and emerging as Asia’s weakest major currency.
The RBI’s response was strategically restrained. Despite record reserves, it avoided defending any specific exchange rate level, intervening primarily to smooth volatility. This reflected an implicit acceptance of the open-economy trilemma.
With capital mobility intact and monetary easing underway, the exchange rate absorbed the adjustment. The result was a managed depreciation that supported export competitiveness without triggering disorderly movements.
Trade policy also shifted, albeit belatedly. This pivot acknowledged a reality that macro data had long suggested. The shift is positive, but it is also reactive. Without parallel improvements in logistics, standards compliance and access to long-term finance, FTAs alone cannot revive manufacturing exports at scale.
Risk beneath stability
By standard indicators, India’s banks appear healthier than at any point in the past decade. Gross non-performing assets fell to around 2.6 percent, public sector banks posted quarterly profits exceeding US$ 54,36,167.80 (Rs 49,000 crore), and capital adequacy ratios stood comfortably above regulatory thresholds.
This apparent strength has encouraged a renewed policy push toward consolidation and the creation of large, globally competitive banks.
This narrative obscures a more troubling reality. Bank balance sheets are clean not because of efficient credit allocation, but because of sustained risk aversion. Public sector banks hold government securities far in excess of statutory requirements, often close to 30 percent.
This preference for sovereign assets ties banking stability directly to fiscal health.
The result is a sovereign-bank nexus that suppresses credit creation and weakens monetary transmission. Even after 125 basis points of policy easing, lending rates adjusted slowly because banks remained constrained by deposit shortages and elevated credit-deposit ratios, which crossed 80 percent in late 2025. Competition for deposits forced banks to keep deposit rates high, blunting the pass-through of monetary stimulus.
Consolidation under these conditions risks magnifying rather than resolving systemic fragility. Larger banks without a deep corporate bond market, a credible resolution framework or reduced sovereign dependence become not engines of growth but repositories of concentrated risk. The deeper problem is not bank size, but capital allocation.
Financial resources continue to flow toward sovereign paper and retail consumption rather than toward productive private investment.
This is the macroeconomic tension the upcoming budget cannot evade. Government capex has reached its fiscal limits, with the deficit targeted at 4.4 percent and tax buoyancy moderating. Private investment has not yet taken over as the primary growth driver. The financial system remains stable, but stability itself has become a constraint when it is achieved through risk avoidance rather than risk pricing.
The transition from a US$ 4 trillion to a US$ 5 trillion economy will not be determined by how well risks are contained, but by how willingly capital is deployed. The real test of the coming budget is whether it recognises that difference. If not, 2025 will be recorded as the year India perfected macroeconomic management and postponed development.
