To understand this year’s budgetary choices and trade-offs, it’s first important to appreciate the global and domestic context against which it was presented. There seem to be two conflicting forces at play. First, even as global growth has remained resilient, global disinflation has been gradual and halting, such that interest rates in some parts of the world remain at multi-decade highs. Add to this, elevated geopolitical uncertainty and the prospect of a US election that could upend the world order, and the global backdrop borders on the hostile. At home, despite strong growth last year, India’s combined public debt/GDP actually edged up. All this would suggest there was no room for macroeconomic adventurism. Fiscal deficits would need to keep coming down. The only question was how much?
But there were other forces pulling in the opposite direction. Thus far, the heavy lifting on investment in India has been undertaken by the public sector. However, given the aforementioned fiscal and debt constraints, the investment baton will eventually have to be handed over to the private sector. The good news is that corporate balance sheets are the healthiest in years. The challenge is that firms need more demand visibility to invest with conviction. This is dramatically accentuated by events in China. The sheer quantum of manufacturing excess capacity there has created fears of a China Shock 2.0, wherein China’s excess capacity (and deflationary impulses) are being exported around the world. Consider this: The US Treasury estimates China’s planned production capacity of electric vehicles in 2030 will be above 70 million, even as total global EV sales that year will be just 44 million! All this simply raises the bar on-demand visibility for the private sector to invest around the world, including in India. Where will that visibility come from? In India’s case, with the public sector having to retrench, it will have to come from private consumption and exports.
This, then, was the delicate balance the budget had to pull off: It has to remain fiscally prudent and yet sow the seeds for private consumption and exports to lift more structurally.
On fiscal prudence and budgetary math, policymakers have checked all the boxes. First, this year’s deficit is pegged at 4.9 per cent of GDP, even lower than the interim budget. This, in conjunction with last year’s larger-than-expected consolidation, means the Centre’s fiscal deficit will be reduced by a sizeable 1.5 per cent of GDP across two years, which will go a long way in helping with inter-temporal debt sustainability. Second, assumptions on the revenue side are very conservative. After a realised tax buoyancy of 1.4 last year (gross taxes growing at 13.5 per cent on nominal GDP growth of 9.6 per cent) the assumed buoyancy is just 1 this year (taxes are budgeted to grow at 10.8 per cent on nominal GDP growth of 10.5 per cent). Third, the extra resources the government had (around 0.4 per cent of GDP) vis-à-vis the interim budget were used in a balanced manner, with half being assigned for more consolidation and the other half to increase revenue expenditures. Fourth, the quality of discretionary expenditure (measured as the ratio of capital to revenue expenditures, ex-interest) has doubled from 0.2 in 2020 to 0.4 in 2024. Fifth, one potential concern of reducing the deficit too quickly is the contractionary impact on aggregate demand.
Fortuitously, this year’s consolidation is helped by the large RBI dividend, a large fraction of which was non-contractionary because it accrued from foreign interest income and Rupee revaluation profits. Therefore, even as this year’s fiscal consolidation is a sizable 0.7 per cent of GDP, the contractionary impulse is less than half of that. A case of fiscal consolidation without commensurate economic compression.
The fiscal prudence was accompanied by financial vigilance. The relentless rally in equity markets and the surge in futures and options create the prospect of financial stability risks down the line. It was, therefore, important to throw some sand in the wheels, which authorities did in the form of increasing capital gains and securities transaction tax. In doing so, the budget has sent an important signal that asset prices should not veer too far away from underlying economic fundamentals.
Fiscal and financial prudence apart, the real contribution of this year’s budget is in starting a much-needed conversation on the plumbing of different parts of the economy. With fiscal space exhausted, demand will have to come from structurally lifting consumption and exports growth. In turn, the fate of private consumption is inextricably linked to quality employment. In particular, a growing concern over the last two decades is that, even as India is undergoing its demographic transition, manufacturing has been becoming increasingly capital-intensive. The key to boosting quality employment, apart from higher growth rates, is therefore to redress the balance between capital and labour in the production process. The budget signalled important first steps in this regard by announcing several “Employment-Linked Incentives” that will provide incentives to both employees and employers to increase formal sector employment.
Of course, incentives will only work if workers exceed a minimum threshold of employability to compete with capital, for which skilling and education are so crucial. On this account, the budget announced new skilling and internship programmes, alongside skilling and education loans. To be sure, making labour a more attractive factor of production will require a thousand small steps. And combined spending on health, education, skilling and health – which for now is the same share of GDP as last year – will eventually have to go up. But at least we have started that conversation and begun to take explicit measures to address the challenges.
Similarly, on the exports front, it was refreshing to see customs duties across several sectors reduced or done away with. A foundational theorem in trade theory is that an import tariff is equivalent to an export tax. If we can continue on this path of rationalising tariffs, we are simply making our exports more competitive.
Finally, the budget spoke about the need to undertake factor-market reforms encompassing land, labour and capital in conjunction with the states. It also spoke about developing a vision for the financial sector and undertaking a comprehensive review of the Income Tax Act, all important cogs in the structural reform agenda. Implementation, however, is now the key.
What is the bigger message? We live in a dangerous and unpredictable world. Cyclical policy space is largely exhausted. Sustaining growth will require the less flashy task of fixing the economy’s plumbing. This will be a hard slog but is unavoidable to improve competitiveness and ensure the fruits of growth are more equitably distributed across the factors of production. The budget must be commended for acknowledging this and starting down this path.
The writer is Chief India Economist at JP Morgan. Views are personal
