India’s revenue collection is lagging budget expectations. But there could be more slowdown ahead. According to a report by Morgan Stanley, total revenue growth in the first half of FY26 was just 4.5% year-on-year, far below the budget estimate of 12.6%. They believe that “the second half of the year will be crucial to meet the deficit target. The government may have to slow spending to stay within its fiscal goals.”
Morgan Stanley on India: State of the economy
Morgan Stanley listed out key facts drivings its assumptions. They noted that the tax collection has slowed down, the fiscal deficit has widened, government spending, on the contrary has increased, and GST rationalization may soften collections further.
H1FY26 tax revenue growth drops to 2.8%
Direct tax collection grew only 3.1% in the period, compared to the full-year target of 16.1%. Indirect taxes rose 2.5%, well below the projected 7.7%. Gross tax revenue growth has slowed sharply to 2.8%, from 12% a year ago, with its share in GDP softening to 10.2% on an annualised basis against 11% in the previous year.
GST reform clouds outlook
Indirect tax trends remain subdued despite stable GST collections. The Centre’s share of GST mop-up has reached Rs 5.3 trillion, about 45% of the full-year target. However, Morgan Stanley warns that the GST rate rationalisation implemented in September 2022 could weigh on indirect tax revenues, even as improving demand conditions may support buoyancy.
Personal income tax and corporate tax underperform
Within direct taxes, corporate profit taxes have grown just 1.1% year-on-year in the first half, down from 2.3% last year. Income tax collections have slowed to 4.7%, compared to 25% in the same period last year. Despite a reduction in personal income tax in the Union Budget, the government has budgeted a 21.6% growth in income tax revenues in FY26, a target Morgan Stanley believes is unlikely to be met.
RBI dividend boosts non-tax revenues
However, non-tax revenues have emerged as the biggest positive surprise. These receipts rose 41.3% year-on-year, reaching about 80% of the budgeted target in the first half. The surge was driven largely by the Reserve Bank of India’s record dividend of Rs 2.7 trillion, equivalent to 0.7% of GDP.
Centre plans up to 20% stake sale in five PSBs
Disinvestment proceeds stood at Rs 234.2 billion, or 49.8% of the full-year target, accounting for around 30.8% of capital receipts. The government has adopted an internal timing model to maximise value in stake sales. It has signalled plans to sell up to 20% in five public sector banks and continues discussions on a strategic stake sale in LIC.
Capital expenditure remains strong
Government spending has picked up, led by heavy capital expenditure. Total expenditure grew 9.1% in the first half, after contracting 0.4% a year earlier. Capex grew 40% year-on-year and has already reached 51.8% of the FY26 budgeted estimate. On an annualised basis, capital spending is tracking at 3.4% of GDP, up from 2.6% last year. About 54% of this spending is concentrated in railways and road infrastructure, while 10.2% has been transferred to states.
Revenue expenditure, in contrast, grew only 1.5% year-on-year and has reached 43.7% of its budget target. A third of this spending goes toward interest payments, while subsidies form another 10%. Morgan Stanley notes that revenue spending excluding interest and subsidies is significantly weaker and could face slippages in the second half.
Morgan Stanley on fiscal deficit rises on weak revenue
The fiscal deficit is tracking at 3.3% of GDP on an annualised basis, nearly 36.5% of the full-year target, compared to 3% a year earlier. The overall deficit is up 21% in the first half due to slower receipts and front-loaded spending. To achieve the FY26 deficit goal of 4.4% of GDP, tax revenue will need to grow around 30% in the second half, which Morgan Stanley sees as challenging.
The Morgan Stanley report warns tax collections could miss the budget estimates by 40–50 basis points of GDP. “We see potential downside risk to government spending growth in HwF26 in order to meet the deficit target,” the authors note. Revenue deficit has, however, moderated to 1.5% of GDP on a trailing basis, from 1.7% in March 2025, reflecting expenditure discipline.
Morgan Stanley on India; State finances show stress
States are also experiencing weak revenue growth. Revenue receipts rose 5.8% year-on-year in the first half of FY26, down from 6.7% last year. State tax revenue growth slowed to 8.2% from 11.7%. Overall spending has increased 9.8%, with capital expenditure up 13% and revenue expenditure up 9.3%.
The combined state fiscal deficit widened to 2.9% of GDP, while the revenue deficit rose to 1.3% and the primary deficit increased to 1.4%. Morgan Stanley says the widening deficit is driven primarily by higher spending even as revenue growth remains soft.
Fiscal strategy turning toward debt stability
Over the medium term, the government intends to maintain a pragmatic fiscal stance. The Union Budget FY26 indicates a shift toward debt sustainability, with the aim of keeping the fiscal deficit aligned to ensure central government debt declines as a share of GDP. The government aims to reduce central government debt to around 50% of GDP by FY2031.
Morgan Stanley noted that it continues to monitor the movement in the GDP deflator and nominal growth, which directly influences revenue collections; the pace and composition of government spending; and signs of fiscal profligacy at the state level, especially as redistributive spending rises rapidly.
