Opinion Interim budget: Fiscal discipline at the expense of growth

This strategy allowed the government to fulfil its promise of fiscal consolidation. For the past few years, the Centre has run a fiscal deficit much higher than the 3 per cent medium-term target set by the Fiscal Responsibility and Budget Management (FRBM) Act of 2003. This was necessary and inevitable during the pandemic period. But given that the economy has been growing rapidly, it makes little sense for the government to keep running a high deficit. The government too has reiterated its commitment to fiscal consolidation. This is crucial because persistently high fiscal deficits create several problems. At the most basic level, they raise concerns about financial and macroeconomic stability and can be detrimental to the economy’s growth. At a more day-to-day level, they increase the government’s indebtedness.

Since the pandemic, India’s debt-to-GDP ratio has been 80-85 per cent, compared to the long-term average of 65-70 per cent. This has two adverse consequences: It crowds out borrowing by the private sector by raising their cost of borrowing in the bond market, and it increases the government’s interest expenses. On average, roughly 40 per cent of the non-debt receipts of the government have been going towards interest payments. Bringing the fiscal deficit down is, therefore, needed to create more room for the government to spend during future crises.

Hence, an important question was whether the government would continue on the path of fiscal consolidation it had embarked upon in 2022-23. The interim budget not only met but exceeded expectations.

It is important to recognise this achievement. The fiscal math for 2023-24 was indeed helped by robust direct and indirect tax collections. However, nominal GDP growth rate of 8.9 per cent has been markedly lower than the government’s estimate of 10.5 per cent. Despite this challenge, the FM announced that this year’s fiscal deficit would be held to 5.8 per cent, against the targeted 5.9 per cent. This was largely facilitated by lower-than-budgeted capital expenditure and high growth in non-tax revenues.

Even more striking, the budget projects a fiscal deficit of 5.1 per cent for 2024-25, implying a 0.7 per cent reduction from this year’s deficit. Given that most analysts were expecting the fiscal deficit target for 2024-25 to be around 5.5 per cent, this is a welcome surprise. One reason is that the government resisted announcing populist measures to appease specific electoral constituencies. But there are two other critical parameters.

The interim budget assumes that the tax revenues for 2024-25 will continue to exhibit strong growth. It also assumes that capital spending will slow sharply. How credible are these assumptions?

Start with revenue. Between 2022-23 (actuals) and 2023-24 RE, tax receipts grew at 10.8 per cent. This is expected to increase to 11.9 per cent between the RE of 2023-24 and BE of 2024-25.

The robust growth in tax revenues in the ongoing year is the result of two windfalls, both of which are likely to be temporary: A boom in service sector exports and a decline in commodity prices. The first phenomenon sharply increased the incomes of individuals associated with Global Capability Centres (GCC) and consulting services, thereby expanding the income tax base and giving a boost to direct tax revenues. It also pushed up indirect tax revenues because high-income earners began spending more on items that carry higher GST rates, such as luxury cars.

The second phenomenon, the fall in commodity prices, led to the expansion of corporate margins, boosting profits and thereby corporate income tax revenues. There is no reason to expect that both these phenomena will continue in 2024-25. In fact, services exports have already been plateauing and corporate margins are narrowing.

Another factor backing up the 5.1 per cent deficit projection is the drastic reduction in capex. From an average year-on-year growth rate of 30 per cent or more over the last three years, the interim budget announced that capex spending by the government will grow by only 16.9 per cent in 2024-25 compared to the RE of 2023-24. With the drastic reduction in government capex, the drivers of growth for the Indian economy might be called into question, given that private investment is still moderate and an exports boom is unlikely amidst a global slowdown.

Summing up, if the tax revenue growth for the next fiscal is not as strong as expected, the onus of the 0.7 per cent reduction in the fiscal deficit will fall on capex, as well as another sizeable transfer of surplus from the RBI to the government. This also implies that there is no room left for the government to incur any additional spending in 2024-25.

While the interim budget has checked all the right boxes, it will be interesting to see to what extent the government can adhere to the plan especially when the full budget is presented post elections.

The writer is associate professor of Economics, IGIDR, Mumbai