Sushma Ramachandran

The budget for the financial year 2026 is at a time when the economy is facing numerous challenges in the domestic and external arenas. Policymakers will thus have to tread carefully in providing a stimulus to growth in the coming year. The slowdown in the second quarter of FY 2025 had been disappointing but this is expected to be made up later in the year. As a result, growth is expected to reach around 6.5 percent. Despite this, India continues to be the fastest-growing major economy in the world though it is significantly lower than the buoyant 8.2 percent recorded last year.

On the external front, headwinds are likely to accentuate given the continuing geopolitical tensions in several parts of the world. The tentative truce in the Israel-Hamas conflict is welcome but it remains fragile. The advent of Donald Trump as U.S. President, also raises the specter of higher tariffs with the world’s biggest economy turning protectionist.

On the domestic front, last year’s sluggish demand especially inflation impacting food products is worrisome. However, there is now a pickup in rural areas. Rural consumption is surprisingly outpacing urban areas due to multiple factors like record foodgrains output, direct benefit schemes, and growing financial inclusion.

Market research agency NelsonIQ has found that rural demand has risen by six percent in the second quarter (July to September) compared to only 2.8 percent in urban areas. At this rate, the traditional gap between urban and rural spending may be bridged sooner rather than later. The concerns are now more about urban rather than rural demand.

The other issue - the slow pace of infrastructure spending in the first two quarters may be set at rest in the second half of the year. The relatively muted level of government capital expenditure in the first half was a fallout of the general elections. The lacuna is likely to be made up in the subsequent quarters. The budget is bound to bring more clarity and hopefully should also outline a sustained rise in capex in FY 26.

Yet it is evident the growth momentum will remain moderate in the current fiscal FY 2025. This has been corroborated by the first advance estimates of national accounts which pegged real growth at a realistic 6.4 percent for FY 25, lower than the 6.6 percent forecast made by the Reserve Bank of India. Other agencies have also downgraded growth projections including Moody’s which pegged it at seven percent from 8.2 percent earlier. For FY26, however, the World Bank and the International Monetary Fund still expect India to be the fastest-growing economy with forecasts of 6.7 and 6.5 percent respectively.

Geopolitical tensions are a major cause of pessimism regarding economic growth this year. Conflicts in Ukraine and West Asia are continuing despite efforts to reach settlements. U.S. President Donald Trump has declared an intent to resolve the Russia-Ukraine war but this may take considerable diplomatic initiatives. Even the latest peace agreement in West Asia has not halted sporadic strife. For India, conflicts mustn't disrupt the stability of oil markets. These have been facing fluctuations in the new year. Prices of the benchmark Brent crude crossed 80 dollars per barrel for the first time since last October. The reasons include last-minute additional sanctions imposed by the outgoing Biden administration and the extremely cold climatic conditions over the Atlantic Ocean.

The energy sector remains one of the biggest policy challenges before Finance Minister Nirmala Sitharaman as she formulates the budget. An economy that relies on imports of over 85 percent of its fuel needs must monitor global oil markets.. If crude oil goes beyond 75-80 dollars per barrel in the next fiscal - 2025-26 - it would create pressure on the current account deficit and push up inflation. On the plus side, Trump’s declaration of “drill baby drill” at his inauguration means that American oil production is set to rise. This could soften world prices which have been bullish in recent weeks.

Another factor that is bound to impact the domestic economy would be Trump’s proposed new tariff regime. The details of the new trade policy have not been outlined but higher import levies are certainly on the anvil for a slew of countries. This includes neighbours as well as China. For India, which has been described as a tariff king by Trump, there is a veiled warning that reciprocal levies are on the way. So exports to the huge U.S. market could soon face daunting tariff walls. On the plus side, this country has not yet been specifically cited for raising such levies.

While navigating both domestic and external headwinds, the upcoming budget must seek to create a more conducive environment for private investment in order to push growth. It is imperative to improve the ease of doing business. This is a major challenge for policymakers. Despite claims that much has been done to remove regulatory cholesterol, investors continue to find red tape enmeshing new projects. The result is that smaller countries like Vietnam and Indonesia with less bureaucracy are attracting higher investments.

The budget is an ideal opportunity to take bold action to cut back on redundant procedures and processes. This is one of the most crucial reform measures needed to revive the animal spirit of the economy. It is also the time to bring down this country’s high tariff walls. There is no doubt that import duties here are among the highest in the world. Reducing tariffs and giving a competitive edge to the industrial landscape would be a significant move to bring in much-needed economic reforms. One can only hope that the budget is used to carry out such reforms and thereby spur economic growth to greater heights.