In the run-up to the Union interim budget presented by the Finance Minister on 1 February 2024, the three pertinent questions in the policy discourse were: i) would the government stick to the tradition of an interim budget and refrain from making any major announcements? ii) would they continue on the path of fiscal consolidation and if so, at what pace? iii) would their fiscal consolidation roadmap be based on reasonable assumptions? The answer to the first two questions has been a resounding yes. The budget has ticked all the right boxes and prioritised fiscal prudence. The third question merits a deeper analysis.
Interim budgets are presented close to a national election. Unlike a full term budget, an interim budget does not usually contain new expenditure plans or new taxation proposals; instead it is an interim measure to keep the current government going for one more quarter before the elections take place. Sticking to tradition, the FM presented a ‘vote on account’ budget and did not announce major schemes or tax changes.
This strategy allowed the government to fulfil its promise of fiscal consolidation. For the past few years, the central government has run a fiscal deficit much higher than the 3 percent 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 clearly reiterated its commitment to achieve fiscal consolidation. This is of crucial importance because persistently high fiscal deficits create a number of 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 percent, compared to the long-term average of 65-70 percent. 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 also increases the government’s interest expenses. On average, roughly 40 percent of the non-debt receipts of the government has been going towards interest payments on debt. Bringing the fiscal deficit down is therefore needed to also 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 that it had embarked upon in 2022-23.
In this respect the interim budget not only met but exceeded expectations.
It is important to recognise the achievement here. It is true that the fiscal math for this 2023-24 was helped by robust direct and indirect tax collections. But on the other hand, nominal GDP growth rate at 8.9 percent has been markedly lower than the government’s estimate of 10.5 percent. Despite this challenge, the Finance Minister announced that this year’s fiscal deficit would be held to 5.8 percent, against the targeted 5.9 percent. This was largely facilitated by lower than budgeted capital expenditure and high growth in non-tax revenues (including surplus cash transfer from the RBI and dividend payments by public sector enterprises), which pushed up non-debt receipts.
Even more striking, the budget projects a fiscal deficit of 5.1 percent for 2024-25, implying a 0.7 percent reduction from this year’s deficit. Given that most analysts were expecting the fiscal deficit target for 2024-25 to be around 5.5 percent, this is a positive surprise. One particularly welcome reason is that the government resisted announcing populist measures to appease specific electoral constituencies, even though elections are round the corner. But there are two other critical parameters.
The interim budget assumes that the tax revenues for 2024-25 will continue to exhibit a strong growth. And it assumes that capital spending will slow sharply. A crucial question then, is: how credible are these assumptions?
Start with revenue. Between 2022-23 (actuals) and 2023-24 RE, tax receipts grew at 10.8 percent. This is expected to increase to 11.9 percent between the RE of 2023-24 and BE of 2024-25.
It is important to understand that the robust growth in tax revenues in the last year was 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 high-value items that carry higher GST rates, such as luxury cars, SUVs etc.
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 both these phenomena to continue in a similar fashion in 2024-25 as well. In fact, services exports have already been plateauing and corporate margins are narrowing.
The other important factor backing up the 5.1 percent deficit projection is the drastic reduction in capital expenditure. From an average year on year growth rate of 30 percent or more over the last three years, the interim budget announced that capex spending by the government will grow by only 16.9 percent 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 percent reduction in 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 is able to adhere to the plan especially when the full budget is presented post elections.
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