Continued fiscal discipline healthy; what next?

This appeared in the Times of India on 2 February 2025 (link). The choice of the title in the print version is not mine.

Even though the role of govt has shrunk meaningfully over the last three decades, muscle memory of years when GOI had a dominant footprint still builds up expectations around the Union budget. This year, in particular, FM had limited room for manoeuvre, especially given the commitment to bring the fiscal deficit ratio below 4.5% of GDP in the coming year.
Honouring that commitment was important to keep the cost of borrowing low. GOI being disciplined with its spending allows space for the central bank to work towards improving public’s access to financing, and to keeping India on the path of macroeconomic stability.

GOI kept its promise made four turbulent years ago. It significantly enhanced its credibility, and gave some guidance for the next five years. By using a debt-to-GDP anchor, it also kept for itself some flexibility, should the economy diverge from the path anticipated at present. While the pace of reduction in the debt-to-GDP ratio suggests that the worst of fiscal consolidation is now behind us, and GOI should have more room to manoeuvre in future years, the fall in the ratio makes India an outlier among major economies indulging in unsustainable fiscal profligacy.

Adding to GOI’s credibility are the reasonable assumptions made for growth and tax collection. It’s a sign of how far we’ve come that markets no longer think it important to comment on this improvement. Gone are the days when tax assumptions used to be aggressive, and a meaningful part of GOI spending was extra-budgetary.

With ghosts of Covid firmly behind us (except for the debt, which will take another few years to fall to acceptable levels), it is instructive to compare this budget versus the last pre-Covid year, FY2019. We see some remarkable changes. There has been a substantial increase in income tax to GDP ratio — other receipts as a share of GDP have been largely unchanged. There’s a commensurate increase in capital investment, mostly in infrastructure.

Going forward, this approach may not work. As became clearly visible this financial year, GOI ran out of areas to spend. As per the Constitution, it can only spend on national highways, Railways, defence, telecom, airports and major ports. With the pace of construction of national highways at a level where the network can be relaid every 10 years, limitations on the pace at which the Railways can spend, and BSNL’s 4G capex now nearly complete, there are limited avenues for Centre to further increase capital expenditure.

Aware that the country needs significant investments in cities and in tourist centres, FM’s speech mentioned schemes that encourage spending. However, given these are primarily state subjects, the pace of the ramp-up cannot be controlled directly, and the right calibration of incentives is necessary to get states to invest in these areas.

Given budget arithmetic, GOI had discretion only on around Rs 1L cr. It chose to spend it on forgoing income tax collections, rationalising tax slabs in the process. We estimate a large part of these funds is likely to reach the middle class, who are likely to spend these on items whose demand has been weak. In the process they may also take on loans, like a mortgage to buy a house, increasing the impact on aggregate demand.

More than just the arithmetic, the budget speech was also an indicator of GOI priorities. Many measures that ease compliance, simplify filings and decriminalise offences may not cost much fiscally, but can have significant impact on productivity growth in the economy, in addition to bringing ease to people’s lives. Some measures, like the active efforts to improve domestic supply of pulses and fruits and vegetables in collaboration with state govts may have a stronger macroeconomic impact through controlling inflation than the fiscal size of the intervention. State govts now transfer Rs 2L cr via income transfer schemes to households, much of which, in our estimate, is being spent on food. This is a good outcome. The challenge has been that due to regulations, the supply of vegetables is not very flexible. This has kept food inflation sticky, limiting the room for the central bank to ease financial conditions.

As we move forward, given the volatile environment globally, limitations in the fiscal space available can become a constraint on growth. Whereas efforts towards disinvestment and privatisation have mostly been relegated to the backburner in the last few years, it may be prudent to revisit those ideas. Prudent use of the more than Rs 40L cr value of govt holdings in listed public sector undertakings, most of which are non-strategic, can help GOI achieve faster fiscal consolidation, reduce debt to GDP to much lower levels, and provide a fiscal boost to growth, should it be necessary.

It can also provide opportunities to switch public assets toward more strategic investments that the country needs to make in critical minerals, energy self-sufficiency and in accelerating our strategic autonomy in technology.

Going forward, GOI may also need to devise new channels to accelerate spending on areas such as urban infrastructure, devising mechanisms to work with state govts who have primary responsibility for these.