In less than two weeks, the Finance Minister will present the Union Budget for 2025-26. The budget will be presented against the backdrop of a slowing economy characterised by high levels of fiscal deficit and debt. That means the FM will have to find a way to announce policy initiatives to revive growth while also achieving fiscal discipline. While calls for tax cuts and increased infrastructure spending are loud, this Budget must do a lot more to drive sustained growth.
The two key questions are: What is the diagnosis of the economic slowdown? And what can the Budget do to address it?
Let's tackle the question of slowdown first. The consensus is that the slowdown is temporary, but data suggests otherwise. Barring one quarter, the economy has been slowing steadily since mid-2023, with real GDP growth rate falling from more than 8 percent to under 6 percent in just a year. High-frequency indicators also show that the post-Covid growth momentum is fading, possibly signalling a deeper, structural slowdown.
Before Covid, the economy was already struggling, growing at less than 4 percent in Q4 2019. Post-Covid, many high frequency indicators pointed to the emergence of two different economies within one: an "Old economy" in middle and rural India, and a "New economy" driven by a boom in service exports. The latter was fuelled by the rise of global capability centres (GCCs), mainly US-based, employing high-skilled Indian workers in sectors like Research and Development. The New economy boosted luxury consumption, like SUVs, and sparked a mini-boom in construction. In comparison, the Old economy has been weaker from even before the pandemic, the result of low private sector investment and weak goods exports. Workers in the Old economy have also been getting battered by high food inflation and falling real wages. And now, the New economy is slowing down too, normalizing to a more moderate growth pace. Together, these dynamics are creating a serious demand problem.
How should the Budget address this, while also reducing fiscal deficit? Two things are worth considering.
The Budget should focus on rationalizing expenditure to achieve fiscal consolidation. In February 2023, the FM had set a target to reduce the fiscal deficit to less than 4.5 percent by 2025-26, but this will be challenging in a slowing economy with nominal GDP growth under 10 percent. However, lowering the fiscal deficit is essential for macroeconomic stability, which is key for growth. To achieve fiscal consolidation, the government should reduce revenue expenditure, which includes schemes and transfers, and accounts for nearly 77 percent of total spending. For example, why is it important to provide free food grains to 800 million people annually when there is no pandemic emergency any more?
On the issue of growth, there is a lot of clamour for more government spending on infrastructure. While some infrastructure is needed, it is unclear if this alone will boost GDP growth. For sustained economic growth, a revival in private sector investment is crucial, but public infrastructure spending does not seem to encourage this. Moreover, with much infrastructure already built, the marginal benefits of new roads or highways are diminishing. In short, government infrastructure spending might be a blunt tool for stimulating growth when private sector confidence remains low.
Likewise, tax cuts can boost consumption, but given the limited fiscal space, there is little room for widespread cuts. Moreover, large segments of the Old economy, where falling wages and poor job prospects are hurting demand, aren't even in the tax base. As a result, some tweaks here and there with the tax structure are unlikely to make a significant impact.
To facilitate high, sustained growth, the Budget must revive a key element missing from India’s economic agenda: Reforms. Since the rollout of Goods and Services Tax (GST) in 2017, no major reforms have been introduced. Many say that no new reforms are needed since all the key policy initiatives have already been adopted. But this is not true. There is in fact much that needs to be done.
Given the current economic climate, the Budget could propose liberalizing import tariffs, removing non-tariff barriers where import-dumping is not a concern, scrapping Quality Control Orders that restrict the imports of vital supplies to the manufacturing sector, overhauling the tax system (including residence-based taxation to attract foreign investment), further simplifying the GST, eliminating cesses and surcharges, curbing excessive industrial policy so as to create a level playing field for all firms and incentivising states to do land and labour reforms. Long-overdue regulatory reforms should also be prioritized. The conversation around reforms has faded, but now is the time to bring it back.
This Budget must serve as a blueprint for the government’s long-term economic vision, laying out a comprehensive medium-term strategy to restore private sector confidence. Incremental changes to taxes or spending will not be enough to turn the tide, and the economy will continue to struggle. The time is ideal for a "dream budget" akin to the 1991 reforms that sparked high growth and unlocked significant gains in productivity.
