Budget 2025: Will the Finance Minister provide a fillip for demand growth?

Why media and policy circles are abuzz with expectations of big announcements on Saturday

Within days of Finance Minister Nirmala Sitharaman presenting her maiden Budget in July 2019, following Prime Minister Narendra Modi’s landslide victory for a second consecutive term, concerns about a deeper economic slowdown began to gain momentum. In response, the government announced a series of sector-specific measures, with the biggest highlight being a corporate tax cut to 22 per cent in September that year. It triggered the biggest market rally in a decade.

 

The current parallels with 2019 are striking. In FY20, economic growth slowed down to 5.1 per cent in the June quarter, the slowest pace in six years, followed by 4.7 per cent in the September quarter. Though the corporate tax cut was introduced to spur an investment-led economic revival, the Covid-19 pandemic ultimately derailed the effort.

 

With Sitharaman set to present her second Budget in the third term of the Modi government amid an economic downturn and slowing consumption demand, media and policy circles are abuzz with expectations of major announcements on Saturday.

 

2019 redux?

 

There are growing concerns about an economic slowdown, reminiscent of 2019, as economic growth unexpectedly decelerated to a seven-quarter low of 5.4 per cent in the September quarter of FY25. While the rural economy is believed to be on a recovery path, urban consumption is seen as a drag on the overall growth. High-frequency indicators, such as sluggish retail sales, slower non-food credit growth, and declining personal vehicle sales have further supported this narrative.

 

Pronab Sen, former chief statistician of India, says the 2019 episode reflected a huge distributional effect from demonetisation and that showed up in consumption, while this time around it is a distributional effect arising out of the Covid lockdown after the post-pandemic pent-up demand faded. “This distributional effect is going to stay for a while, because what you have now is a situation where the balance between MSMEs and corporations has permanently altered. And everything is going to depend on what the investment intent of corporations are. At the moment, the corporates seem to be happy to invest at a rate that will give you 6 per cent GDP (gross domestic product) growth,” Sen says. 

 

Kunal Kumar Kundu, India Economist at Societe Generale, said in a recent report that India’s post-pandemic cyclical upswing had hit a structural barrier. “Persistently weak job creation and anaemic wages lie at the heart of the slowdown, setting the structural limit to growth as weak household balance sheets pull down aggregate domestic demand that experienced short cyclical bursts,”he added.  

 

Sen agrees, holding that the 5.4 per cent growth in the September quarter is not an aberration but a return to what should be the normal, which was pretty much the pre-pandemic trend. “The labour income has lost big time. Employment is a problem, real wages are a problem, and hence one should expect demand to be weak,” he says.

 

In a recent paper by the Centre for Social and Economic Progress (CSEP) titled, “Will consumption revive”, economist Renu Kohli said the sharp slide in private final consumption demand in 2023-24 after a two-year expansion following the pandemic appeared similar to a deceleration from 2017–2018 followed by a growth collapse in 2019–2020. “A prolonged decline in consumption expenditure is a serious discouragement for business investments and slows down growth that critically hinges on the twin components (consumption and investment),” she added.

 

Sen says the capital intensity of the Indian economy has gone up, simply because the bulk of the growth impetus is coming either from the government or from corporates, both of which have very low labour intensity. “Government spending on capex depends on what you are constructing and who is constructing. If they are constructed by large construction firms, those are mostly mechanised and do not lead to employment generation,” he adds.  

 

Policy options

 

Though the corporate tax cut in 2019 is often criticised as an effort to solve a demand side problem through a supply side measure, the Modi government has opted for more supply side measures, including production-linked incentive schemes and higher capex spending, to revive the economy.

 

Sen says a corporate tax cut is good in the time of supply constraints, but completely useless during demand constraints. “The government tried to revive the economy by increasing government investment for three years, but it did not work. Now it has to think differently. In a situation of this kind, the government should be focussing much more on spending on rural development. Unfortunately, that runs into politics, because rural development is mostly in the hands of the states and the issue becomes who should get the political credit,” he says.

 

Therefore, Sen believes, the response this time should be to get MSMEs back on their feet to boost job creation. “You have too many people working in a job that is completely unremunerative. The answer is to facilitate funding for MSMEs for more investment. This looks like a supply-side measure but works on the demand side,” he adds.

 

Prasanna A, head of Fixed Income Research at ICICI Securities, said that with the government nearing a limit on how much it can spend on capex, as evidenced by the year-to-date spending, the Budget will have a decision to make on how to spend the excess resources available. “The government may be tempted to either increase the existing welfare outlays or introduce some new schemes. But as 2025 is not a major election year, we find that unlikely. With the Eighth Pay Commission set up, (which is) likely to be implemented in FY27 and FY28, there is an organic spending increase coming through in the subsequent two Budgets. That should limit the incentive  for going big in this Budget,” he added.

 

With consumption demand faltering and economic activity slowing, Prasanna believes this may open up space for the government to provide relief on income tax, as its share in overall tax collections has risen sharply from 2.4 per cent in FY19 to an estimated 3.8 per cent in FY25. “The low need for fiscal consolidation (because of the focus shifting to the debt-to-GDP ratio) should be treated as an opportunity by the government to provide some support to the economy. With the limits to capex spending seen over the last two years and the utility of further welfare spending questionable, the easiest path of fiscal support would be by cutting taxes. We expect the Budget to incorporate tax cuts and still target a fiscal deficit of 4.4 per cent of GDP (for FY26).”

 

Sen agrees that there is scope for widening the tax slabs. “The problem is, our tax slabs are too narrow and you hit the maximum tax rate pretty early. You can change that structure, but tax rates should not be tampered with,” he says.

 

When Sitharaman stands up to deliver her record eighth consecutive Budget at 11 am on Saturday, the middle class will be watching closely.