Fiscal Forecast: Defence Budget Can No Longer Be Defensive

In the aftermath of Operation Sindoor, the country noticed a critical gap in weapon inventory. The upcoming Budget must, therefore, be less of a balance sheet and more of a strategic blueprint. It must acknowledge that the country has been impeded by a revenue trap: the operational demands of the present are coming at the cost of capabilities required for the future.

The arithmetic is stark. In the fiscal year 2025-26, the defence allocation reached a historic ₹6.81 lakh crore. On paper, this signals robust intent. However, a granular analysis reveals that structural rigidities leave a narrow fiscal window for capital modernisation, as seen in the table below: 

Another worrisome trend is the recurring aspect of unspent funds and the surrender of capital outlays back to the treasury due to rigidities preventing timely procurement (more than ₹13,000 crore remained unspent by the Ministry of Defence in a single fiscal year). Budget 2026-27 must institutionalise a Non-Lapsable Defence Modernisation Fund. Security does not adhere to the fiscal calendar. Allowing unspent capital to roll over is a way to provide the multi-year financial certainty required for long gestation projects such as the Advanced Medium Combat Aircraft (AMCA) or the next aircraft carrier.

Furthermore, the government must aggressively operationalise the "Year of Reforms" initiatives, specifically the Defence Production Manual (DPM) 2025, which came into effect in November last year. The shift from import substitution to sovereign intellectual property is critical.

Incentivising IP Ownership

For too long, 'Make in India' has often meant assembling foreign kits with domestic labour. The new budget must incentivise the design and ownership of IP. This requires an approach that integrates Micro, Small and Medium Enterprises (MSMEs) into the supply chains of prime integrators. A scheme that offers tax rebates to major players who source the majority (say 60%) of their value chain from domestic MSMEs would do more for indigenisation than any protectionist tariff ever could.

The inefficiency of State-run production must also be taken into consideration. The "Government Owned, Company Operated" (GOCO) model, which is a standard practice in the US and the UK, has languished in India due to labour union resistance.

GOCO Model

The Budget should take the union concerns into consideration and fund the full transition of facilities to a GOCO model. By retaining government ownership of strategic assets while bringing in private sector efficiency for operations, the turnaround time for critical assets like tanks can be reduced.

Similarly, for strategic systems where development costs are prohibitive for the private sector alone, a venture capital approach can be adopted, creating special purpose vehicles (SPVs), where the government holds a share to help de-risk investment.

Another corner with evident deficit is in research and development. India spends less than 1% of its defence budget on R&D, compared to approximately 13% for the US and over 3% for China. To make a leadership mark in the Global South, borrowed technology can only take us so far. The budget must explicitly earmark at least 25% (to provide an innovation boost significant enough to catch up globally) of the R&D allocation for private startups and academia through the iDEX framework, helping DRDO enhance the current innovation framework.

Finally, the procurement philosophy, too, needs to be viewed in a new light. The current mechanism of the ‘Lowest Bidder’ (L1) may result in sub-par equipment. The Finance Ministry has already opened the door for quality-cum-cost based selection (QCBS) in the general rules. The 2026 Budget must mandate QCBS for all high-tech defence contracts, allowing the military to pay a premium for enhanced quality, reliability, and lifecycle value.

The Transition Phase

With a target of ₹50,000 crore in defence exports by 2029, the country is on a transitional path, from buyer to supplier of security. But this ambition requires a domestic industrial base that is robust, innovative, and fiscally supported. To unlock strategic modernisation, the upcoming Budget must institutionalise a Non-Lapsable Defence Modernisation Fund to ensure utilisation of unspent funds; incentivise sovereign IP creation through MSMEs, connecting them to large domestic players and, thereby, making a resilient domestic supply chain; transition state facilities to the GOCO model; expand R&D via iDEX; adopt SPVs for high-cost projects; and mandate QCBS procurement to ensure quality defence modernisation.

The 2026 Budget is an opportunity to break the revenue trap by treating defence spending as an investment in national resilience, rather than a recurring expenditure, and build a modern military-industrial ecosystem that not only secures the borders but also positions the country as a trusted partner in global security supply chains. This Budget can be the moment in which India decides to align the fiscal vision with a strategic ambition and transform challenges into opportunities, ensuring that our defence vision becomes the foundation of our economic and technological leadership in the decades ahead.

(The writer is a research analyst at the Centre for Economy and Trade, Chintan Research Foundation. Views are personal.)