Why low inflation is a problem for government’s finances, Budget targets

The growth angle

Inflation matters to the fiscal arithmetic via the GDP – the nominal GDP, to be precise. While the GDP growth figure usually cited is after adjusting for inflation to arrive at the ‘real GDP growth rate’, the number more relevant for the government’s accounts is the unadjusted, or nominal GDP.

Data released last month showed India’s real GDP growth rate unexpectedly rose to a five-quarter high of 7.8 per cent in April-June. However, the ‘nominal’ GDP growth rate was at a three-quarter low of 8.8 per cent. And this is crucial, for it is lower than what the government expected.

In the Union Budget for 2025-26, presented on February 1, the finance ministry had assumed that India’s nominal GDP in the current fiscal would be Rs 357 lakh crore, 10.1 per cent higher from the revised estimate of Rs 324 lakh crore for 2024-25. The growth in nominal GDP assumed in the Budget is important as it is used to guide how much tax collections may rise in the coming year. For instance, the 2025-26 Budget projected that the central government’s net tax revenue would rise just under 11 per cent.

However, with inflation being low, nominal GDP growth has been weaker than anticipated so far this year – GDP, after all, is just the final value of goods and services in a year, and low growth in prices can lead to GDP growth being subdued even if production increases somewhat. In the first five months of 2025-26, WPI inflation has averaged 0.1 per cent as against the 2024-25 average of 2.3 per cent. Average CPI inflation, meanwhile, has fallen to 2.4 per cent from 4.6 per cent last year.

The impact of weak price increases and nominal GDP growth is showing up in the government’s finances: latest data shows that in April-July, the central government’s gross tax revenue was up just 1 per cent year-on-year, while net tax revenue was down 7.5 per cent.

“While the low inflation trajectory is good news for the consumers, it is not so good for the government balance sheet,” Paras Jasrai, an economist at India Ratings & Research, said. “Impact of slower GDP growth is already visible in government finances and tax collection growth trailing FY26 budget targets.”

Missing nominal GDP growth targets

To be sure, nominal GDP growth regularly misses the government’s Budget assumption; after all, making economic forecasts is difficult at the best of times. Over the last 13 years, actual nominal GDP growth of the Indian economy has been lower than the Budget assumption on nine occasions. The recent past, though, is in the government’s favour: in three of the last four years, nominal growth has been higher than what the Budget had anticipated.

There is also what is called the base effect. The GDP for 2024-25 has now been revised higher by 2 per cent to Rs 331 lakh crore. This means that to meet the Budget assumption of Rs 357 lakh crore for the current fiscal, nominal GDP growth only has to be 8 per cent.

Meeting this nominal GDP number is important for two key indicators: the fiscal deficit and central government debt, both of which are measured as a percentage of the nominal GDP. As long as the nominal GDP number is achieved, the fiscal deficit target of 4.4 per cent and the debt-to-GDP ratio estimate of 56.1 per cent will be satisfied – assuming the fiscal deficit does not exceed the Budget estimate.

However, the growth in nominal GDP, irrespective of the absolute level of nominal GDP, cannot be ignored. Economists already expect the nominal GDP growth to be well below the Budget estimate, with those from Morgan Stanley expecting it to come in at 8.3 per cent for the full year.

This suggests a further decline in nominal growth from 8.8 per cent in April-June. This is likely, given the across-the-board reductions in Goods and Services Tax (GST) rates that will come into effect from next week — which will, hopefully, lead to price cuts and a decline in inflation. This will, in turn, impact nominal GDP growth.

Is low inflation bad?

Low inflation is not always bad when it comes to impacting nominal GDP growth. What matters is why its low. It’s best if prices are subdued because of oversupply and not weak demand.

However, a Reserve Bank of India (RBI) study from last month showed that while private companies saw a 5.5 per cent rise in sales in April-June, their net profit rose at a far more rapid 17.6 per cent. For private manufacturers, the variation was even more stark on account of cooling global commodity prices: sales rose 5.3 per cent while net profit was up 27.7 per cent. But will companies use these profits to invest?

“…we have a situation where corporate profit margins are robust (and companies are also reportedly sitting on large cash pile), but the capex sentiment has stayed weak,” economists from ICICI Securities Primary Dealership said in a note on August 31. “Strong productivity growth could be one potential theoretical reason for low inflation. However, that doesn’t appear to be the case given weaker capex backdrop. Moreover, there would not be much reason to worry about urban wage growth and demand if productivity growth was rising.”