Union Finance Minister Nirmala Sitharaman outside the Finance Ministry ahead of the presentation of the Union Budget 2025-26, in New Delhi.
Union Finance Minister Nirmala Sitharaman outside the Finance Ministry ahead of the presentation of the Union Budget 2025-26, in New Delhi.Photo | PTI

Budget 2025: Prudence in the time of macro turmoil

Given the severe headwinds, the budget’s promise to keep the fiscal deficit low is appreciable. The promised reform in regulations will go a long way if it leads to more consistent investment policies
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The global macroeconomic backdrop to the finance minister’s eighth budget is a turmoil caused by protectionist policies of the US and a stock market crash caused by a Chinese startup. The domestic macro situation is not promising either. Even the Economic Survey tabled just a day earlier forecast modest growth of around 6.5 percent for two years, much less than the 8.2 percent achieved last year.

The net foreign direct investment is down to zero. Thanks to the global nervousness, there is flight of capital toward the New York bond market, causing a strong demand for the dollar. This has made the rupee fall; and in trying to defend it, the Reserve Bank has contributed to an acute liquidity crunch in the banking system. To add to all this, the inflation situation is not yet comfortable and unemployment remains high.

The survey pointed out that while corporate profits are at a 15-year high, wages and salaries have been stagnant. Surely this is more because of the labour market situation, and not a moral issue. How then to revive employment, control inflation, attract foreign capital and stabilise the rupee? These were the questions facing the finance minister.

The challenge in a Union budget is to balance multiple and conflicting objectives of providing a growth stimulus, subsidies for the poor and higher social sector spending—all of it while balancing the books. This tightrope walk is difficult at most times. Against the backdrop painted above, it becomes even more difficult. Donald Trump’s stiff import duties against the Chinese will mean that they will try and dump their goods into countries like India, threatening domestic manufacturers.

The budget proposes expenditures of Rs 51 trillion and revenues of Rs 35 trillion. The spending next year will rise less than the expected growth in nominal GDP. To that extent, it is realistic, and not profligate. The deficit of about Rs 16 trillion will be made up by borrowings.

The headline-grabbing highlight is the tax cut for the middle class. Even then, the budget does not lose sight of the need for fiscal prudence. As promised a few years ago, when the Covid-era fiscal deficit hit 9 percent, next year’s deficit will go below 4.5 percent of GDP. This is a major milestone in India’s fiscal consolidation journey, achieved while maintaining an average of 7 percent GDP growth and having increased capital expenditure for the past few years.

The next year’s target of 4.4 percent fiscal deficit will be achieved despite forgoing income tax collection of nearly Rs 1 trillion. It’s aided by freezing capital expenditure at last year’s level. The ceiling below which no income tax is to be paid has been raised to 12 lakh for the salaried. This is a huge jump from the ceiling of Rs 7 lakh announced in 2019. This cut mainly addresses the middle class, whose mention was made even by the president in her speech, as well as by the prime minister.

With such a large exemption, millions will fall out of the tax net. This goes against the principle of widening the base of taxpayers. India has 80 million people filing income tax, but only around 25 million pay more than zero. The cut was necessitated by to sluggish growth in consumption spending, especially in urban areas. The middle class also has been complaining of the high inflation eating into their purchasing power.

Even though tax has been cut, the FM expects the total collection to go up faster than the nominal GDP, which itself has been assumed to rise on the revised estimate by about 10.1 percent next year. This is a heroic assumption given the global slowdown and turmoil, and the sombre projection given in the survey. India’s political economy is peculiar, in that we have only seven income taxpayers for every 100 voters. But this time, the taxpayer got some attention and relief.

India cannot ignore the precarious nature of its fiscal situation. Interest on the debt itself consumes 49 percent of all tax revenues of the Union government. The debt-to-GDP ratio has to decline. The high borrowing requirement, which will be nearly Rs 15 lakh crore this year, tends to put upward pressure on interest rates and crowds out private investment. Hopefully, with a lower fiscal deficit next year, softening inflation and injected liquidity in the banking system, the Reserve Bank can do its bit by reducing interest rates at its next meeting.

One of the major highlights of the budget is the continued push for regulatory simplification, including a commitment to reduce business regulations and legal complexities. This was flagged in the Economic Survey, which effectively said that the government must keep a hands-off approach. Let the entrepreneur run his business and not be bogged down by the inspector raj and compliance burden.

The survey advocated a trust-based regulation, whose contours will be visible soon as a new committee to look at regulations has been announced. A review of permits, clearances and licences aims to create a more business-friendly environment, which will certainly go a long way in reviving private sector investment.

The FM also announced the removal of seven tariff rates, following last year’s reduction of a similar number. She has promised a new Income Tax Bill aimed at procedural simplification. This, too, signals an intent to modernise tax administration and reduce litigation.

The budget has several sectoral initiatives for agriculture, tourism, aviation, and clean energy. It recognised the need to revive labour-intensive manufacturing in segments such as footwear, toys and agro-processing. How much investment will come into these sectors remains to be seen.

On balance, this is a workman-like budget that achieves some fiscal discipline and some tax-cut stimulus. It accepts the need to revive private sector investment by the long-term policy reforms reducing regulatory burden and unshackling the entrepreneur.

From her earlier speech in July, there were some expectations of an employment-linked incentive scheme along the lines of the production-linked ones. The fact is that wages are stagnant because employment is not picking up. Job creation will happen only when half a million new small and medium enterprises take birth. That calls for improving the ease of doing business, especially for small business. We will also need substantial net foreign direct investment, which has dried up. FDI not only brings in dollars, but also knowhow and best practices.

Let us hope that the proposed regulatory reform will give importance to stability, consistency and predictability of investment policies. That itself will go a long way in reviving economic growth domestically, aided by India’s demography, urbanisation and the fast-growing digital economy.

(Views are personal)

AJIT RANADE

Pune-based economist

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