India takes the middle path

The Indian budget for the fiscal year ending March 2025 did not offer any major surprises. Policymakers chose a middle path by distributing the non-tax revenue bonanza due to a large central-bank dividend into revenue spending and fiscal deficit reduction. The capex target was maintained at an elevated level.

The conservative budget revenue assumptions on taxes and gross domestic product growth indicate fiscal targets will be met. The consumption and jobs boost limited to the formal sector may not be very effective, but higher transfers to states bode well for fiscal federalism.

The medium-term fiscal target looks achievable. ANZ Research believes the budget will be non-inflationary with no implications for monetary policy.

Bumper

A bumper dividend from the Reserve Bank of India (RBI) has allowed the government to balance fiscal consolidation and additional spending requirements due to weak consumption in the economy. The budget showed net receipts-to-GDP ratio of 9.8 per cent, 40 basis points higher than the interim figure. The bulk of this increase came from the RBI dividend.

This additional fiscal room was equally distributed between higher spending and deficit reduction, reflecting a middle path. The fiscal 2025 deficit target was lowered to 4.9 per cent of GDP, compared to 5.1 per cent in the interim budget, which was presented before the election in February.

The higher spending is sprinkled across several areas such as employment creation, financial support to micro and small enterprises, and urban development. The aggregate capex push has also been strengthened, but to a smaller extent. The allocations to subsidies, rural employment guarantee scheme and rural development were kept unchanged from the interim budget estimates.

The direct capital expenditure was kept unchanged at ₹11.1 trillion or 3.4 per cent of GDP. However, the overall capex push, including the transfers to states as grants-in-aid for asset creation and capital resources of the public-sector enterprises, was slightly higher than the interim budget estimate.

Overall, the government did not compromise the quality of fiscal spending, sustaining the downtrend in revenue-to-capex ratio witnessed in the recent years.

Conservative

Revenue assumptions appear conservative. The government maintained its nominal GDP growth assumption at 10.5 per cent. According to ANZ Research forecasts, that could easily be 11.3 per cent –creating additional fiscal cushion worth at least ₹100 billion.

Gross overall tax buoyancy was also kept unchanged from the interim budget estimates, even though monthly fiscal data show accelerating growth in taxes. While a slightly higher buoyancy has been budgeted for direct taxes and non-GST indirect taxes, an offsetting reduction has been assumed for GST.

This makes sense insofar as growth in fiscal 2025 is expected to be lower than in 2024 and buoyancy in indirect taxes may fall for cyclical reasons. The divestment target was retained at ₹500 billion, the same as the interim budget but ₹200 billion higher than 2024 revised estimates.

The composition of domestic borrowings has changed significantly from the interim budget estimates. The ₹720 billion reduction in the fiscal deficit did not translate into a lower market borrowing target. Gross and net market borrowings were cut by a mere ₹120 billion each.

Instead, the reliance on other domestic sources of deficit financing was reduced by a greater magnitude. This shift in the funding strategy makes sense, given elevated government cash balances with the RBI and the very flat yield curve, and should help lower the aggregate debt servicing cost for fiscal 2025.

Incentives

The Indian government announced three multi-year employment-linked incentive schemes. The total outlay for these is expected to be around ₹1.1 trillion. While positive overall, ANZ Research is sceptical these measures will ease India’s employment problem materially.

Firstly, the root cause of India’s employment problem is the lack of jobs rather than willingness to work. Several low-skill labour-intensive manufacturing sectors (like textiles, leather, garments) have not been able to reclaim their pre-pandemic output levels despite strong overall economic recovery.

Measures to strengthen these sectors would have had a stronger effect on jobs. In fact, the post-pandemic rise in the profitability of the listed private manufacturing sector has occurred on the back of curbing staff costs.

Secondly, these schemes exclusively target the formal sector. The informal sector in India is large for various reasons, and the burden to provide social security benefits to workers is only one of them.  A preference for contractual informal labour could also be due to low level of skills. It is unclear whether the measures will be enough to incentivise the informal enterprises to formalise on a large scale.

The modest income tax relaxations due to changes in personal tax rates and exemption limits may not boost consumption substantially. The recent rise in household leverage and high debt servicing cost means a part of increased net saving could be directed towards deleveraging.

Delivered

India’s government has delivered on its dual mandate of supporting the economy via higher spending while reducing the fiscal deficit ratio, enabled by higher non-tax revenues.

Given a lower primary deficit-to-GDP ratio and a favourable nominal GDP growth-interest burden differential, the central government’s debt-to-GDP ratio is expected to fall by 1.3 percentage points of GDP to 56.8 per cent.

A more aggressive fiscal deficit target for fiscal 2025 has also reduced the distance to the terminal target of 4.5 per cent in 2026. That said, the RBI dividend bonanza was a one-off event and is unlikely to repeat, although conservative revenue assumptions for taxes and growth give comfort.

The policy calculus for the RBI has not changed on the back of the budget. The central bank will wait for food inflation to ease before it can dial down its hawkishness. ANZ Research expects the first rate cut in December 2024.

Dhiraj Nim is an Economist and FX Strategist & Sanjay Mathur is Chief Economist, India and Southeast Asia at ANZ