The first full Budget of the Modi government’s third term allocated ₹6.81 trillion, marking a 9.5 per cent increase from the ₹6.21 trillion allocated in the 2024-25 Union Budget. However, with an allocation of ₹4.88 trillion, revenue expenditure—covering salaries, pensions, maintenance, repairs, and infrastructure—constitutes 71.75 per cent of the total defence budget.
The impact of the latest Budget indicates that the pension bill, which is covered under the head of revenue expenditure witnessed a 13.8 per cent increase from ~1.41 trillion in 2024-25 to ~1.60 trillion in 2025-26. Pensions have generally exceeded 20 per cent or more of the annual defence budget for several years in succession. This large increase in the pension bill is largely due to the government’s implementation of the One Rank One Pension (OROP) scheme in 2015, with pension amounts revised upward every five years.Consequently, As a result, the resource allocations made by the government create distortions in the defence budget, skewing spending towards revenue expenditure at the expense of capital expenditure.
The government cannot entirely overlook the need to evaluate and determine expenditure based on the military threats and capabilities of China and Pakistan, as well as their military expenditures relative to India’s.
The government cannot entirely overlook the need to evaluate and determine expenditure based on the military threats and capabilities of China and Pakistan, as well as their military expenditures relative to India’s. Nevertheless, there are several ways in which the government can address its budgetary shortfall for capital allocations to modernise India’s armed forces to make up for the gap in capabilities between India and its adversaries.
A crucial way to proceed is by adopting at least partially the recommendations of the 15th Finance Commission, which called for reducing pension and salary liabilities. In June 2022, the Modi government introduced the Agniveer scheme, which sought to limit recruitment into the armed services to four years. The 15th Finance Commission’s work did not, per se, include recommendations on the Agniveer scheme, which seeks to cap the retention rate in the regular cadre of the armed services for Agniveer personnel at 25 per cent following a four-year stint. Those who are not retained receive a payout of ₹11 lakh following their four-year service tenure.
Although currently the retention rate is still being finalised and proving to be more contentious than expected with the Indian Army still deliberating and consulting with stakeholders on whether it should be raised above 25 per cent. If successfully implemented, the Agniveer scheme could bring down the pension liabilities incurred under defence revenue budget. One of the pitfalls of raising the retention rate to a much higher percentage than the initial 25 per cent cap is that it risks diluting the cost-saving benefits of the scheme or even defeating its purpose— to limit the salary and pension liabilities, which have surged significantly. In any case, the savings on costs and pay-offs from the Agniveer scheme will not materialise until well into the 2030s, making it imperative to begin its implementation as soon as possible.
One of the pitfalls of raising the retention rate to a much higher percentage than the initial 25 per cent cap is that it risks diluting the cost-saving benefits of the scheme or even defeating its purpose— to limit the salary and pension liabilities, which have surged significantly.
However, the 15th Finance Commission made several recommendations based on inputs from the Ministry of Defence (MoD) that the government needs to seriously consider implementing, at least in part. The first is the sale, or at least the lease, of defence properties.
The second mechanism through which the government can raise resources for defence acquisitions is by issuing defence bonds. All profits earned by the Defence Public Sector Units (DPSUs) and the Ordinance Factories (OF) from exports should be exclusively dedicated to defence purposes. Financial proceeds from the disinvestment of DPSUs can help cover part of the costs of capital acquisitions under the defence budget.
Another option is to create defence bonds by tapping into debt securities. Generally, defence bonds are emotional appeals to citizens, urging them to lend money to the government to finance military acquisitions for a set period, during which the government—or even a company—will pay interest on the amount invested, typically below the market rate. The principal amount will be returned at the end of the investment period. The 15th Finance Commission also recommended “one-time lump sum grants,” which could involve re-appropriating funds that are insufficiently utilised by the Finance Ministry.
Defence bonds are emotional appeals to citizens, urging them to lend money to the government to finance military acquisitions for a set period, during which the government—or even a company—will pay interest on the amount invested, typically below the market rate.
In addition, a policy could be instituted to comprehensively exempt all purchases made by the defence services from Customs duties and tax regimes like Goods and Services Tax (GST) and Integrated Goods and Services Tax (IGST). Among the most challenging recommendations by the Commission was the creation of a non-lapsable defence fund—an idea that has existed since the 2004-05 interim Budget, which the Modi government has hesitated to implement due to the constitutional challenges it would face. The final, and possibly most feasible, option for financing capital acquisitions is through a defence cess.
Regardless of the path the government chooses for financing capital acquisitions for the services, the status quo will need to give way to a more ambitious restructuring.
This commentary originally appeared in Business Standard.
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