Short of crossing the red line

Chief Minister Siddaramaiah’s Budget reflects the quiet pressures that are building on Karnataka’s economy. The immediate sign of this pressure is the lower revised estimates of revenue in 2025–26 ensuring that capital expenditure has been pushed below budgeted levels.

The Chief Minister has not let this dampen his plans for 2026–27. A part of the increased expenditure the Budget proposes will come from the higher share of central taxes recommended by the 16th Finance Commission, but he has gone further and significantly stepped up market borrowings. He has stopped just short of crossing the red line that has been set for States for their fiscal deficit, but only by the skin of his teeth. The ratio of fiscal deficit to GSDP in 2026–27 is expected to be 2.95% against the recommended upper limit of 3%.

The Budget attributes the decline in revenue primarily to the rationalisation of GST. As much of 43% of the State’s own tax revenue comes from GST and the reduction in the rates on a range of commodities did have an immediate dampening effect on Karnataka’s revenues. This dip was expected to be temporary as the lower prices to the consumer were expected to boost demand. As one of the States with the highest per capita income in the country, Karnataka would have been expected to see an increase in sales and hence higher GST collections. That this has not happened points to an underlying imbalance in Karnataka’s economy.

Karnataka has become increasingly dependent on foreign direct investment for its growth. As the Chief Minister pointed out in his budget speech, during the first half of 2025–26 Karnataka accounted for 26.7% of the total FDI equity inflows into the country. This investment is in high technology areas with low levels of employment per unit of output. Thus, even as income rises rapidly, employment does not keep pace. And much of Karnataka’s workforce does not have the educational requirements to be among the main beneficiaries of this growth. With substantial sections of the population being excluded from growth there is limited increase in demand. This could ensure a continued pressure on GST collections.

The flip side of this unequal growth is that it increases the political pressures for transfers of welfare to those who have not benefitted from the high growth rates. This has ensured that the Budget leaves the five guarantees untouched. It has also sought to address the MLAs’ concern for development of their constituencies by listing specific local projects to be undertaken across the State. The political dimension is quite explicit in the listing of Shramika Residential Schools by the Assembly constituency in which they are located.

Beyond the immediate political necessities, the Budget points to two routes to address the regional imbalance. First, it stresses the need to make Karnataka’s growth less Bengaluru centric. It seeks to develop Mysuru as a second IT hub to decongest Bengaluru, and to industrialise tier 2 and tier 3 cities.

These efforts will not be without their difficulties. Earlier efforts to develop Mysuru as an alternative IT centre have not quite worked. IT professionals and companies tend to agglomerate in cities that have better access to the world economy. Taking other industries to tier 2 and tier 3 cities has also proved to be a formidable task in the past. Even if there is greater success this time around, the plans for these cities also seem to prioritise industries with low levels of employment per unit of output. They may not then offer sufficient employment opportunities for persons in the backward regions of the State.

The second route the Budget takes is to directly benefit the backward regions through the recommendations of the Govind Rao committee report. The effectiveness of the strategy of that report is, however, not beyond debate. It follows a classification of backwardness that is relative. It divides the taluks in the State into four equal groups and treats the last of these groups as most backward. In this approach, no matter how much the worst-off regions of the State develop, there will always be 25% of the taluks that are most backward. It cannot distinguish between taluks that are backward in absolute terms and those that happen to be among the lowest quartile of taluks in the State.

In his 17th Budget, the Chief Minister has reiterated his commitment to stay within the outer limits of fiscal prudence but stops short of developing a cohesive strategy to address the structural strains in Karnataka’s economy.