Last year's Budget laid emphasis on fiscal consolidation and reconstruction, an objective it set to achieve in three years. After one year, we can get a glimpse of the progress made in improving public finances. We focus on the containment of the budget deficit, which impacts public debt, borrowing requirements, interest rates and many other variables. To that end, an analysis of revenue and expenditure trends is revealing.
Revenue buoyancy
Recurrent revenue was projected to increase from Rs184.4B to Rs223B between 2024/25 and 2025/26. The revised estimates of Rs203.1B indicate a shortfall of Rs20B, half of which is due to the non-materialization of the Chagos deal.
In spite of the lower revenue receipts, recurrent revenue remains buoyant, with a high growth of 10.1%. It outstrips the growth of 8.3% in GDP at current market prices, which takes into account both economic growth and inflation. As a result, the recurrent revenue/GDP ratio goes up from 25.7% to 26.1%. It is expected to increase further to 27.8% in the next fiscal year. The tax burden automatically increases due to the buoyancy of the overall tax system.
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Concern about inflation was high on government's agenda in framing the budget. No wonder that the Purchasing Power Shield is the first flagship among the four Projects. This determines the resource mobilisation strategy, depending more on natural growth of revenue, with new taxes being very selective. The budget adopted a strategy to shield the vulnerable groups from inflation.
Enhancement of taxes was limited to just a few items to protect the purchasing power of the low- and middle-income groups. These are related mainly to excise duties, which will have a relatively low impact on inflation, while the VAT rate is kept constant. Excise duty for tobacco, strong alcoholic drinks and sugarsweetened products has increased, a new levy in the form of an Insurance Premium Tax introduced, and an annual fee for registration of personalized registration mark for motor vehicles imposed. These tax measures will contribute about Rs2.6B in revenue, i.e., less than 10% of increase in revenue of Rs30B.
Complementary measures were taken to ensure that the budget remains noninflationary and provides the much-needed relief to consumers. It is not surprising that there has not been an outcry about inflation, as we witnessed in recent months. Some of these are as follows:
- The poverty threshold for SRM system will be raised from Rs14,000 to Rs16,400 in July 2026 and to Rs17,500 in July.
- The bulk purchase of essential consumer goods by the State Trading Corporation is expected to lower living costs. However, in practice, this may not be achieved given the record of STC in managing other products, which gives rise to much criticism and scepticism.
- The Price Stabilisation Fund allocation, which has been effective in cushioning the impact of higher prices on a few products, has been increased by Rs2B.
- Subsidies have been extended on more consumer goods from canned food to lentils. Our tax system is revenue-productive, which obviates the need for too many new taxes. Some of these revenue heads are highlighted below.
VAT, which is the highest revenue-yielding tax, grew by only 3.9%. It has not kept pace with the increase in final consumption expenditure, which grew by 5.8% in 2025. The high cost of living leads to a shift of consumption towards basic necessities, which are either exempted or zero-rated and which therefore bring down VAT receipts.
Corporation tax is the fastest-growing tax; it increased by 24.1% in a year, a big jump partly due to the fair contribution of up to 5% of chargeable income of domestic enterprises and 2.5% on banks. Corporation income tax represents 20% of tax receipts, a share that will go up in the years ahead.
Individual income tax, on its part, grew by 14.6%. This increase is in spite of the rise in the exemption limit from Rs390,000 to Rs500,000. However, its share in total tax receipts is only 9.1%, which is low; its share of recurrent revenue is even lower, 8%. Normally, individual income tax represents between 10% and 20% of revenue in middleincome countries.
On the basis of this yardstick, there is scope for higher revenue generation, not only because of its low share but, more importantly, in view of the disparities in income distribution and a fair distribution of the tax burden. Conspicuous consumption and abject poverty cannot go hand in hand. Another justification for a higher income tax rate is the need for solidarity, which should not only be on paper. In fact, there is not much evidence of sharing and solidarity at the moment. It seems to be a hollow phrase. At a time when the dire need for revenue is felt, it is surprising that income tax does not contribute its due share.
Perhaps, government does not wish to venture into making drastic changes now without a proper study. In this respect, the setting up of a High-Level Committee to fundamentally review the tax system with a view to enhancing its fairness, efficiency and international competitiveness is welcome. It appears that its mandate will be to look at the entire tax system rather than limited to direct or indirect taxes. As such, it will be a huge and complex task, which will no doubt help to formulate our tax policy, review the tax structure and assess the effectiveness of our relevant institutions. I hope to treat this subject in a subsequent article.
Expenditure squeeze
As far as recurrent expenditure is concerned, it was lower than the budgetary estimates by almost Rs5B (Rs230.6B compared to Rs235.5B). This is commendable, as it occurs at a time when interest payments alone rose by Rs5B. Expenditure savings were recorded under "other expense", which was squeezed by over Rs5B. The scope for savings is limited since many expenditure items cannot be easily curtailed. Compensation of employees, interest payments, social benefits and subsidies account for 70% of recurrent expenditure.
Consequently, recurrent expenditure growth was a mere 1.7%, which is far below inflation. Recurrent expenditure/GDP ratio has fallen below 30%, which is a good sign, and is expected to drop to 28.5% in 2026/27. Expenditure will increase by 4.3% in 2026/27, mainly due to payments for PRB increases and debt servicing.
Having decided to keep tax increases to a minimum, the budget puts more emphasis on expenditure control. It intends, inter alia, to set up a Steering Committee on Public Sector Efficiency and streamline certain parastatal bodies and institutions to prevent duplication and save costs. Fiscal discipline will be further strengthened with the measures announced in the closing statement by the Prime Minister and Minister of Finance, once again focusing on expenditure.
BUDGET DEFICIT
The above trends have a favourable impact on the recurrent revenue and expenditure gap, which has narrowed from Rs42.5B to Rs27.5B, or by 35%, as shown in the Table. The recurrent budget deficit has fallen from 5.9% of GDP to 3.5% and is projected to go down to 0.8% in 2026/27. This estimate will be exceeded given the freezing of the BRP reform, but there is no doubt that there is a discernible downward trend.
The overall budget deficit has fallen from 9.3% of GDP to 6.0% and will be further toned down to 3.7% next year. It cannot be denied that the deficit is still high.
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The deficit has been kept artificially low by squeezing capital expenditure. This is understandable given the exceptional circumstances of the current budget and should be only a temporary expedient. But this should not be overdone since it jeopardises the future growth of the economy. A decline in public sector investment has a bearing on overall investment and infrastructural development. Upgrading and modernization of infrastructural facilities is vital to ensure generation of economic growth.
The budgetary figures show a lower economic growth of 3.1% in 2025/26 compared to 4.3% in the previous year but a higher inflation rate (denoted by GDP deflator) of 5% compared to 3.4% in 2024/25. These trends are expected to be reversed in 2026/27, with a higher economic growth and relatively lower inflation. But this will not be achieved without investment. The government takes cognizance of this fact and states, "This fiscal situation is now the major constraint to our development and it is not something that can be reversed overnight." Getting the house in order is the top priority, which it strives to do.
The budget provides for a big increase in capital investment in 2026/27, which is, however, only a shade higher than the figure in 2024/25.
The negative aspect is that the key ratios are in the red and will remain so for years. But the message is positive. There is a genuine attempt to reduce the fiscal deficits, yielding already some concrete results. The adjustments are very slow, mainly due to the magnitude of the deficits as well as to unanticipated exogenous factors like the Chagos deal and the Middle East crisis. In spite of turbulences, the direction is clear and we are on the right track. There is ground for optimism if we maintain the same discipline.
