In a challenging environment of volatile inter-governmental fiscal transfers and increased macroeconomic uncertainties, Kerala Finance Minister KN Balagopal on Thursday (January 29, 2026) presented the state budget for 2026-27, the last full budget of the present Left Democratic Front government before the assembly elections. This budget demonstrates remarkable subnational fiscal flexibility within India’s cooperative federalism framework, for more reasons than one.
Federal context and fiscal constraints
India’s federal structure has experienced increasing centralization of revenue-raising powers in recent years, especially amid geopolitical risks that strengthen the central government’s central role in macroeconomic stabilization. Nevertheless, subnational governments equally faced growing macroeconomic uncertainties and public spending responsibilities with limited fiscal space. Kerala’s budget speech clearly highlights the constraints imposed by low tax devolution, windfall grants and strict borrowing limits from the Centre. These factors have systematically compressed state finances, leading to protests over perceived inequities in fiscal federalism – including a recent hunger strike by the Chief Minister of Kerala.
Nevertheless, the state managed to avoid a sharp decline in the “size of government” (public expenditure to GDP ratio). Despite these headwinds, Kerala has prioritized high-quality public service delivery and development-oriented expenditure. The state has achieved this through strong own revenue mobilization, avoiding fiscal disruptions and maintaining fiscal discipline. In the tenure of the current government, Kerala raised an additional ₹1,27,747 crore in own tax revenue and over ₹1,52,645 crore including non-tax sources, underscoring a strategic quiet dependence, and it was not an easy call.
Revenue predictability and fiscal targetting
A key strength lies in improved fiscal acumen – alignment between budget estimates and actuals for own revenues. Variance has reduced substantially, reflecting strong revenue forecasting and administrative efficiency. Conversely, instability in central grants is complicating subnational budgets, highlighting the need for more predictable intergovernmental transfers.
For 2026-27, revenue receipts are estimated at ₹1,82,972 crore, while revenue expenditure is estimated at ₹2,17,559 crore, resulting in a revenue deficit of ₹34,587 crore (2.12% of GSDP). The fiscal deficit to GSDP ratio in this financial year is estimated at 3.40%. Net capital expenditure stands at ₹19,385 crore, maintaining investment in infrastructure despite headwinds. These parameters keep Kerala within the fiscal responsibility norms recommended by successive Finance Commissions, balancing development priorities with deficit control. However, the mutual sharing of the upcoming Union Budget 2026-27 and the 16th Finance Commission will affect this fiscal arithmetic.
prudent public debt management
Kerala’s public debt management deserves special attention. The public debt to GSDP ratio declined to 33.44% in 2021 from 38.47%, a notable improvement driven primarily by the revenue boom rather than expenditure compression or fiscal austerity. This puts Kerala in a stronger position than many peers. The 2026 RBI report shows that Punjab’s debt to GSDP ratio is over 44%, while West Bengal’s is around 38%.
The state’s ability to “exit debt” is evident, as nominal GSDP growth consistently outpaces the effective interest rate on state government securities, ruling out the classic debt instability situation (R > G). The Economic Survey 2026, published a day earlier, pegged the state’s real growth at 6.19%. While the broad debt maturity profiles are long-term in nature, as recent RBI data showed, the overall trajectory indicates prudent fiscal consolidation and low rollover risks and refinancing risks over a longer period of time.
Prioritizing social welfare and inclusive growth
With elections approaching, the Budget naturally emphasizes welfare and inclusive growth, yet it does so through structural measures rather than populist measures. The announcement of the 12th Pay Commission, the report of which is expected within three months, provides a systematic approach to increase disposable income in the hands of people. Targeted social assistance includes monthly transfers of ₹1,000 to women in the care economy, wage increases for frontline workers such as Asha workers, and expanded social welfare pensions.
Recognizing the dynamic nature of poverty, the budget maintains allocations to prevent anyone from being disadvantaged due to invisible factors, despite the state systematically eliminating extreme poverty. It also strengthens “employer of last resort” initiatives through job guarantee schemes and infrastructure-linked employment programmes.
Kerala’s long-term commitment to human development is clear: the state’s infant mortality rate (IMR) is 5 per 1,000 live births, lower than the United States (5.6) and well below India’s national average of 25. Continued investment in education and health is underpinning these results.
The budget introduces India’s first “elderly budgeting” framework, responding to Kerala’s advanced demographic transition – a point recently flagged in the RBI’s State Finance 2026 report published this week. This visionary approach addresses the emerging challenges of an aging population while preserving fiscal space for physical, social, digital and care-economy infrastructure. The term infrastructure is actually thought, beyond just being physical.
Investment climate, AI and innovation
Kerala has worked to dispel stereotypes as a difficult investment destination. Its top ranking in ease of doing business, high human capital index and active industrial relations reforms position it as an attractive hub.
Participation at global forums such as the World Economic Forum in Davos has yielded top investment partnerships in key sectors.
The budget focused on emerging sectors with allocations for artificial intelligence and quantum computing, the potential for future “blue bonds” through maritime public-private partnerships, a critical minerals mission and the establishment of a rare-earth hub leveraging coastal mineral reserves.
The space economy also features prominently, indicating ambitions beyond traditional sectors. Climate-resilient policies address significant climate-related risks and uncertainties, including sea-rise.
Strengthening fiscal decentralization
The budget strengthens fiscal decentralization, the cornerstone of effective fiscal federalism. Better devolution to local bodies through State Finance Commissions, investment in urban mobility and big ticket decisions for rapid transit systems, promotes sophisticated governance in creating world-class cities as investment destinations.
Initiatives involving citizen-centric progress reports and budget transparency at decentralized levels are particularly commendable, and other states can emulate this.
The high self-tax-to-GSDP ratio and tax buoyancy above unity have enabled Kerala to overcome transfer volatility while maintaining social sector commitments. Gender budgeting and care-economy transfers remain integral, aligning expenditure with the state’s specific strengths in health and education.
A blueprint for subnational resilience
Kerala’s Budget 2026-27 is more than an annual financial statement; It serves as a blueprint for addressing global dislocations and domestic financial challenges. By prioritizing revenue-based fiscal consolidation, prudent debt management, inclusive welfare, and innovative investment, the State demonstrates how subnational governments can maintain fiscal flexibility amid volatile intergovernmental transfers.
In an era of volatile geopolitics and inter-governmental fiscal relations, Kerala Budget 2026-27 stands out with fiscal flexibility. The potential change in global trade patterns and lack of global order reminds us to remain vigilant against any fascist forces, the Minister reminded us, while also reminding the State to think about ‘what holds a country together and why nations form federations’.
The author is Professor of NIPFP and member of the Governing Board of the International Institute of Public Finance (IIPF) – World Forum of Public Finance Economists, Munich
