Low Expectations, but Domestic Stimulus in Union Budget 2025-26 May Boost Equity Markets

India’s Finance Minister, Nirmala Sitharaman, faces a delicate balancing act while presenting this year’s Union Budget.

On one hand, the economy is experiencing a cyclical slowdown, driven by weakening domestic demand—partly due to the Reserve Bank of India's (RBI) macro-prudential tightening of consumer loans—and a reduction in government capital expenditure, which could fall short of the FY25 budgeted estimates by 10-15%. This situation heightens the need for government intervention to stimulate economic growth.

Conversely, the government must adhere to fiscal consolidation efforts, with the Union Budget 2025-26 potentially targeting a fiscal deficit of approximately 4.5% of GDP for FY26. Additionally, revenue sources that supported FY25—such as dividends from the RBI and tax collections from capital markets—are expected to decline. Simultaneously, increasing financial commitments toward newly announced welfare and populist schemes by various states may limit the government’s ability to implement aggressive growth measures. Compounding these challenges, global uncertainties and the depreciation of the Indian rupee further constrain the RBI’s capacity to provide fiscal stimulus.

Despite the need for fiscal prudence, the government is likely to introduce incremental reforms and measures to boost consumption. This could involve revising existing direct tax slabs or simplifying/reducing indirect taxes. There may also be initiatives to strengthen farm incomes, support the agricultural sector, and promote construction—key employment-generating industries.

The Budget is also expected to emphasize rural housing, affordable healthcare, renewable energy, and domestic manufacturing—possibly through enhanced Production-Linked Incentives (PLIs), some of which might be introduced outside the Budget framework. Additionally, measures to expand credit access for Micro, Small, and Medium Enterprises (MSMEs) could be a focal point.

To encourage the new tax regime, the government might introduce marginal benefits for taxpayers. However, capital expenditure is likely to fall short of FY25 estimates, and growth in FY26 is expected to be lower than the 15% compound annual growth rate (CAGR) observed over the past five years due to revenue constraints. The government may also introduce policies to shield Indian trade and industries from potential tariff increases under a renewed Trump administration.

Disinvestment has been a weak spot in FY25, and this trend may persist amid subdued capital market activity. However, if the government prioritizes this area, some viable options for resource mobilization remain.

From an equity market perspective, no major sector-specific expectations are anticipated, as indirect tax adjustments may be handled outside the Budget. Instead, the focus will be on broader policies that drive consumption and investment, influencing related industries. Any significant sectoral relief, particularly in response to global tariff shifts, could have positive implications. Investors will closely monitor the government’s borrowing plans, fiscal deficit targets, and overall approach to stimulating growth. While expectations remain modest, any unexpected measures to bolster domestic demand could be positively received by the markets.