India's next Budget must balance fiscal discipline with growth push

The budgetary process for 2026-27 began in October with the issuing of the circular relating to it and commencement of pre-Budget meetings. With volatility and uncertainty caused by disruptive effects of Trump tariffs and their impact in slowing the world economy and continued international conflicts in spite of the claims by the United States (US) President of having stopped eight wars in the background, the Budget will have to be formulated to deal with formidable challenges. It must continue fiscal consolidation to reduce the fiscal deficit to bring down the ratio of debt to gross domestic product (GDP) — of the central government — to 50-52 per cent by 2031.  Besides, it has to provide relief to the major sectors affected by the punitive 50 per cent tariffs levied by the US, particularly because many of these are labour-intensive, like textile, leather, gems & jewellery, marine products, and chemicals. Hopefully, by the time the Budget is presented, we will have signed the trade agreement with the US, and that will provide some clarity in the trade environment. The phasing out of the import of Russian oil might increase the cost of importing crude oil and escalate Budget expenditure.

 

Despite the uncertain global environment, the Indian economy has performed well to record 7.8 per cent growth in April-June, the highest in the last five quarters. This impressive growth was propelled by a strong performance of the tertiary sector, growing at 9.3 per cent, and manufacturing and construction at 7.5 per cent. On the demand side, growth was driven predominantly by household-consumption expenditure and the frontloading of capital expenditure by the Union government. With a good water-reservoir position across India, agricultural production is likely to be good. Reforms in goods and services tax have propelled the purchasing managers’ index (PMI) in manufacturing from 57.7 in September to 59.2 in October though the PMI in services has eased marginally from 60.9 in September to 58.9 in October. This optimistic performance has led to the Reserve Bank of India (RBI) revising the growth forecast upwards to 6.8 per cent for the year from 6.5 per cent earlier. With a benign inflation scenario, the RBI is likely to cut the policy rate by another 25 basis points in its December 3-5 meeting. Overall, despite the subdued and volatile nature of the global economic environment, the Indian economy seems to be in good shape. Surely, there is some uncertainty in the growth scenario as we are yet to see the impact of the Trump tariffs playing out, and the pace of growth is likely to moderate as the base effect of last financial year wanes. The major concern, however, is the investment ratio (the ratio of gross domestic capital formation to GDP) has been stubbornly stagnant at about 30 per cent. It should not be forgotten that this was possible because of increases in government investment and the hope of crowding in of private investment though improvement in infrastructure and lower interest rates have not materialised. Accelerating the growth rate to achieve the aspirational goal of becoming a developed country in 2047 requires a substantial increase in the investment ratio as well as reduction in the incremental capital output ratio and the issue has to be addressed sooner rather than later. 

 

The progress of Budget implementation in the first half of the year has not shown any surprise. The estimated cumulative figures up to September, finalised by the Controller General of Accounts, shows the fiscal deficit at 36.5 per cent of the budgeted number.  Revenue collection was 49.5 per cent and expenditure was 45.5 per cent of the Budget estimate. The government has held back revenue expenditure, which is about 43.7 per cent of what was budgeted. In contrast, capital expenditure has been frontloaded to cover 51.8 per cent of the budgeted amount. During the remaining part of the year, there may be pressure to increase food and fertiliser subsidies and release revenue expenditure held back so far. Also, growth in corporation tax has been subdued and, more importantly, as the effect of change in the structure of GST unfolds, tax revenue may see a shortfall.  However, this may not affect the deficit position because the government may be able to garner revenues from other sources, more particularly the RBI dividend.

 

The fiscal maths for next financial year is much more challenging. Although the government has taken the debt-to-GDP ratio as its target, it is likely to target reducing the fiscal deficit to 4 per cent of GDP as the anchor to signal fiscal consolidation. With private investment subdued, the government has to continue with higher capital spending to keep up the growth momentum. There has been a worrisome deterioration in the quality of expenditure by states due to the election giveaways, and the states’ financing of the capital expenditure ratio has shown a decline, particularly if we deduct the Union government’s long-term loan at a zero rate of interest. Perhaps the time is opportune for a better targeting of the food subsidy. If we claim that the poverty rate has substantially declined, there is no case for continuing with providing free food grains for 813.5 million beneficiaries. We have the technology and information available to target subsidies better. However, due to political reasons, this is unlikely to happen.

 

On revenue, it is desirable that the government bring in greater clarity to income tax. It does not make sense to continue with two income-tax structures, one with preference for tax levied at a higher rate and another at a lower rate. The best practice approach is to have a tax system that has a broad base without any tax preferences and low and less differentiated rates. The objective is to raise revenue and avoid multiple objectives. That will ensure simplicity and reduce the cost of collection and compliance, and will not induce unintended distortions. It is also desirable to remove the differential treatment of domestic and foreign companies. Despite claiming it is not the government’s job to run businesses, progress on disinvestment has been slow and it is time this process was speeded up. In fact, the government must move beyond disinvestment and privatise all commercial enterprises even if they are making a profit. The government’s job is to govern and not run businesses.  Let us hope the Budget reignites the quest for reforms to accelerate the development process.

The author is chairman, Karnataka Regional Imbalances Redressal Committee. He was director, National Institute of Public Finance and Policy, and member, Fourteenth Finance Commission. The views are personal