Budget's consumption bet: Tax cuts boost demand, capex lag poses risks

The Union Budget for 2025-26 provides much-needed personal income tax relief to boost private consumption while maintaining fiscal discipline. This augurs well for macroeconomic stability and improved fiscal-monetary policy coordination at this critical juncture when the economy is slowing down.

 

The gross fiscal deficit (GFD) target for 2025-26 has been budgeted at 4.4 per cent, a tad better than the 4.5 per cent target set out in 2021.  The Budget has now indicated a shift towards using the debt-gross domestic product (GDP) ratio as a fiscal anchor.   The Statement of Fiscal Policy indicates the government’s commitment to keeping the fiscal deficit in check from 2026-27 to 2030-31, ensuring that the debt-to-GDP ratio reaches 50 per cent  (±1) by March 2031. The shift to a debt-GDP ratio as a fiscal anchor is a welcome move.  It is also encouraging to note the government’s intention to pursue further fiscal consolidation to reduce the debt-GDP ratio.  This is needed to create fiscal space to deal with potential exogenous future shocks.

 

For the debt-to-GDP ratio, however, the primary balance is more relevant than the overall fiscal balance, as it removes the risk of unpredictability of interest payments in a volatile rate environment.

 

Since debt-GDP ratios under different scenarios in the Budget have been estimated based on the reduction in the gross fiscal deficit, interest payments could turn out to be an unpredictable factor.  If there is a sharp increase in interest rates, the projected debt-GDP ratios could go awry, unless higher interest payments are offset by reduced expenditure on other items. However, this may be challenging given the predominant share of committed liabilities. In other words, the projected debt-to-GDP trajectory relies on interest rates remaining broadly stable over the next six years. Any marked increase in interest rates would remain a significant risk to the projected debt-GDP ratios and would need to be navigated deftly.

 

The Budget has rightly provided significant relief in personal income tax. With heightened global uncertainty and hardly any signs of a revival in the private capex cycle, it was extremely important to swiftly reinforce the driver of private consumption.

 

The push to household consumption through personal income tax relief, however, has come at the expense of the central government’s own capital expenditure, which in 2024-25 (Revised Estimates or RE) fell significantly short of Budget Estimates (BE). As a result, despite an increase in capital expenditure to Rs 11.2 trillion in 2025-26, compared to Rs 10.2 trillion in 2024-25 (RE), it remains broadly unchanged from the Rs 11.1 trillion in 2024-25 (BE). This was perhaps a key reason why the stock market response on Budget day was muted, despite the significant relief in personal income tax.

 

Corporate tax collections have continued to disappoint, with their share in total revenue receipts (including states’ share) falling from a peak of 42.7 per cent in 2018-19 to 31.7 per cent in 2024-25 (RE) and 31.6 per cent in 2025-26 (BE).  A significant reduction in corporate taxes in September 2019 has not paid off. Hopefully, with the expected impetus to private consumption, private capex cycle will pick up. The central government has done the heavy-lifting in pushing public sector capex in the last few years. It is now for the private corporate sector to step up capex — failure to do so could exacerbate macroeconomic challenges.

 

The Budget has proposed a six-year aatmanirbharta (self-reliance) mission for pulses, with a special focus on tur, urad, and masoor. Pulses are one of the most volatile components of the food basket and often pose a significant challenge in managing food inflation.  India is the largest producer and consumer of pulses. However, in the case of a shortfall in production, the price of pulses turns highly volatile. This is because varieties consumed in India are not widely produced elsewhere, except some varieties in countries like Myanmar, Canada, and Australia. Therefore, in the case of a supply shock, even imports are only a limited option for pulses. Hence, the proposed aatmanirbharta mission in pulses is a significant measure. If India achieves self-sufficiency in pulses over the medium term, it should help manage food inflation more effectively.

 

The allocation for centrally-sponsored schemes (CSSs) is budgeted to rise sharply by 30.5 per cent in 2025-26 (BE), though the rise is muted at 7.6 per cent on a BE-to-BE basis. Such transfers, which fall under Article 282 of the Constitution, have long been a subject of huge controversy for two reasons. 

 

First, funds under Article 282 are tied in the sense that the states do not have the freedom to spend the resources as they deem fit. The design features of CSSs also lack sufficient flexibility for states to innovate and adapt. Secondly, the central government uses CSSs to intervene in areas that fall within the domain of the states. In contrast, Finance Commission transfers under Article 270 (distribution of taxes between the Centre and the states) are untied and states are free to spend as they deem fit. It is, however, concerning that the ratio of tied transfer to untied transfers to states (including grants-in-aid under Article 275) will rise to 34.8 per cent in 2025-26, thus reversing the declining trend of last four years (to 29.6 per cent in 2024-25 from 49.3 per cent in 2020-21).

 

Overall, the Budget has done well in initiating measures to address the immediate challenge of slowing household consumption, while exercising fiscal prudence, which bodes well for macroeconomic stability.

 

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The author is senior fellow, Centre for Social and Economic Progress, New Delhi