Expect no drama in the Budget

But over the medium term, India's fiscal health needs attention

India’s economy has emerged from the pandemic in relatively good shape compared to others. Its adroit fiscal policy has played a key role in this recovery. Finance Minister Nirmala Sitharaman has already stated that on February 1, the government will present an interim Budget, a vote on account, and that the real Budget would be presented in July 2024 when a new government is in place. While no major new initiatives should be expected, some budgetary imperatives and parameters are already in place that will shape both the interim and the eventual real Budget for FY25.

India’s growth trajectory looks more promising, and the need going forward is to try and consolidate the budget deficit, which is expected to decline from 5.9 per cent of gross domestic product (GDP) in FY24 to 4.5 per cent of GDP in FY26. Unless some unexpected shocks hit India, the fiscal deficit should follow a glide path downwards and hit 5.2-5.3 per cent of GDP for FY25. How will this reduction be achieved? What the interim Budget might reveal is whether it will result from expenditure compression or rely largely on revenue increases and disinvestment. Tax revenues, especially from direct taxes (including an increase in corporate tax receipts), have shown buoyancy in FY24. The expectation is that the tax/GDP ratio will cross 18 per cent in FY24 and hopefully continue in the future.

Expenditure compression will be difficult. The government has already extended the free food grain Pradhan Mantri Garib Kalyan Anna Yojana scheme for 810 million people (almost 60 per cent of the population) for another five years. This announcement was clearly aimed at the elections but was made in November 2023 to avoid attracting a reprimand from the Election Commission. If the government claims poverty has been reduced hugely — so that only about 230 million people are poor according to the multi-dimensional poverty estimate done by the NITI Aayog, and other estimates from the World Bank show even lower numbers of poor, why is there a need for free food grains for 810 million people at an estimated cost of Rs 12 trillion over five years? The costs of delivering this promise are even larger.  The system required to deliver free food involves a market support price-linked procurement system, costly FCI operations with heavy storage costs, and delivery through the public distribution system fair price shops. It also means, more than likely, that the inefficient fertiliser subsidy (which largely goes to inefficient fertiliser firms and larger farmers) and free electricity to farmers will continue. Expect no major farm reforms for the next five years. 

The government is committed to maintaining high infrastructure spending to meet its targets for the next five years and fulfil its commitments, such as the expenditures on the production-linked incentive scheme. The interim Budget is unlikely to change that, as well as spending on health and education, and handouts to women and the elderly, especially before the elections. An interim Budget will probably not announce new schemes but do expect to see tweaks in the funds handed out in existing schemes, such as PM Kisan, PM Awas Yojana, and others. 

The Budget always contains a very unrealistic disinvestment number. The target for FY24 of Rs 61,000 crore is unlikely to be achieved. Fortunately, dividends from the Reserve Bank of India and public sector units will be higher and compensate for the disinvestment shortfall. I have demonstrated in a detailed study for the National Institute of Public Finance and Policy that if the government is serious about disinvestment, the way to go forward is with a five-to-10-year plan, not yearly targets that are never consummated. Worse, in trying to meet yearly targets, shares are forced onto other public institutions such as the LIC, hurting their finances. The time is right to achieve higher disinvestment targets — the markets are liquid and sentiment for India is good — but unless the finance ministry changes the ways in which it goes about it, it’s unlikely to happen. Perhaps, a separate disinvestment ministry — as was the case during the successful phase of disinvestment under the Vajpayee government — may be needed.

Looking forward, we should aim to see faster fiscal consolidation. So far, a high fiscal deficit has not translated into a high current account deficit, but if the spotty recovery in private investment widens, then India must make room for faster fiscal consolidation, as otherwise the current account deficit will increase. According to International Monetary Fund data, India’s public debt ratio, currently at 83 per cent of GDP, is higher than all other non-G7 major G20 economies, including China (77 per cent), Indonesia (40 per cent), Mexico (50 per cent), Saudi Arabia (30 per cent), South Africa (67 per cent), South Korea (54 per cent), Turkey (32 per cent). Only Argentina and Brazil (85 per ent) have slightly higher public debt ratios. If India’s economy shifts to 7 -7.5 per cent growth over the medium term, that will bring the debt ratio down. But at 6-6.5 per cent GDP growth, more fiscal consolidation will be needed — especially if state fiscal deficits continue at 3-3.5 per cent of GDP, so that the public sector borrowing requirement stays at 9 per cent of GDP. And in any case, India must try to reduce the public debt ratio significantly if it wants to create fiscal space to deal with future crises, which will inevitably come.

While new initiatives will not be introduced, do expect the finance minister to announce with a flourish how key expenditure priorities that may help during elections, such as support to the poor, women, farmers, and tribals, will be maintained. Ms Sitharaman will also most likely show continued support for the defence forces, clean energy, water and sanitation, as well as the small and medium sector, along with G20-related initiatives. So, expect no fireworks in the Budget and not much debate on it either, especially as the focus will shift now to the electoral battle of May 2024. But India’s fiscal health over the medium term will need attention at some point after the elections, when the pressure to spend is hopefully reduced and the options to raise revenues are more feasible.

The writer is a distinguished visiting scholar, Institute for International Economic Policy, George Washington University, and a former distinguished visiting professor at NIPFP, New Delhi