• 03 Feb 2025 05:56 PM
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Arvind Chari: This is a budget to optimize growth within constraints

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The first full-year budget of India’s new National Democratic Alliance government, sworn in after the 2024 general election, was presented against the backdrop of a noticeable slowdown in economic growth over the last four quarters. I discussed the issue of whether this slowdown is cyclical or structural in a recent column for Mint, summarizing it as being an issue of expectations.

The first full-year budget of India's new National Democratic Alliance government, sworn in after the 2024 general election, was presented against the backdrop of a noticeable slowdown in economic growth over the last four quarters. I discussed the issue of whether this slowdown is cyclical or structural in a recent column for Mint, summarizing it as being an issue of expectations.

Also Read: Is India's slowdown structural or cyclical? It depends on your expectations.

The economic commentary at that time was about slowing consumption dragging down overall economic activity and growth. However, the consumption problem, as we know, is fundamentally one of incomes.

To understand this, we must go back to the post-demonetization period (after November 2016, i.e.) and subsequent shocks or changes like the rollout of India's Goods and Services Tax, implementation of the Real Estate Regulatory Authority law, a crisis of credit, and then the 2020 outbreak of the covid pandemic. Income growth for many segments of the workforce, especially in the informal sector (which accounts for about four-fifths of the country's total), has remained anaemic since then.

The government has also been receiving criticism, particularly on social media, from the 'middle class' and 'honest' salaried taxpayers for being overburdened with taxation at a time of weak income growth, a complaint that is often made in the context of government amenities claimed to be less than satisfactory.

Also Read: Union Budget 2025 strengthens the middle class for a consumption-driven economy

Politicians, being closest to their 'vote banks,' are often the first to react. Fiscal policies at the state level, across all parties in power, have shifted towards supporting incomes and providing subsidies, often in the form of direct handouts. Various research studies now estimate that close to 1% of state GDP is spent only on cash transfers to women and other such schemes. This should alleviate some of the income anxiety that seems to have held back consumer demand in India.

On Saturday, as part of the Union budget for 2025-26, the Centre provided another 'income and consumption' boost by easing income tax. Those with an annual salary or business income below 12 lakh will not be required to pay any income tax.

From last year's income tax data, only about 10 million of the country's 75 million odd tax filers reported a salary income above 10 lakh. India's per capita annual income is below 3 lakh. So the tax relief offered is a significant policy move which will have some marginal impact on consumption.

Also Read: Mint Quick Edit | Sitharaman's income tax bonanza: Time to rejoice

I call it a 'budget to optimize growth within constraints' because that is the reality of India's fiscal and growth dynamics. This is also an honest admission that capital expenditure spending by the government has its limitations in boosting GDP growth.

Despite the increased rhetoric and visible changes in infrastructure, total capital expenditure by the Centre plus states and public sector units has remained below a level of about 7% of GDP.

Also Read: India needs reliable data to track capital expenditure across the economy

India needs private-sector capex to rise for overall economic growth to increase. For the private sector's share of investment and exports to rise, we need a combination of receding government control, simplification of taxation, freer goods and services trade, and a recognition that risk capital must be treated in a fair, transparent and consistent manner. The Economic Survey released prior to the budget had some wise recommendations for the same.

Also Read: Economic Survey 2025 is worth preserving for this one piece of advice

The other obvious constraint is on the fiscal side. This government has been fiscally prudent and has stuck to its fiscal consolidation path by bringing the fiscal deficit down to 4.8% of GDP in 2024-25 and aiming for 4.4% of GDP in 2025-26.

The Centre's fiscal planners has taken the right path by announcing they will henceforth focus on debt as a proportion of GDP, rather than the annual fiscal deficit number. The central government debt-to-GDP ratio is expected to fall below 50% by 2030; this would mean an annual reduction in the fiscal deficit of about a quarter percentage point every year. This is a good policy trend and should be lauded.

Also Read: Prudent policy: India should not let public debt eclipse the fiscal deficit

The budget appears conservative on expenditure. However, it may be realistic, given limits to how much can actually be spent on the ground. This year's overall capex spend has fallen short by about 1 trillion of the 2024-25 budget estimate, with major shortfalls in the Jal Jeevan Mission and Awas Yojana, which may have exacerbated the slowdown.

On the revenue side, with the 2025-26 budget's income-tax relief expected to result in about 1 trillion forgone, direct revenue growth adjusted for that is estimated at over 20%. This seems a bit optimistic, given that income from capital gains might be muted in comparison with the previous year.

Overall, based on the government's policy measures and the economy's general trends, we should see income, consumption and sentiment improve even at lower levels of the Indian pyramid.

Bond markets will be a tad disappointed with the Centre's higher-than-expected market borrowings. However, with the Reserve Bank of India's indication of a change in its monetary policy, bond purchases and potential rate cuts should support bond prices, and we would expect interest rates to soften. The equity market will notice a decisive shift in government priority (both Centre and states) from 'infrastructure/capex' to 'consumption,' given the fiscal, social, political and growth constraints.

Overall, based on the government's policy measures and the economy's general trends, we should see income, consumption and sentiment improve even at lower levels of the Indian pyramid.

The author is chief investment officer at Q India (UK) Ltd.