Betting on the middle class: Budget fuels growth with consumption boost

This Union Budget was presented at a time of considerable macroeconomic uncertainty. Growth has slowed domestically in recent quarters. The future path of world trade — and thus Indian exports — as well as of energy prices — and thus inflation and wealth — is also uncertain. The lingering effects of the pandemic might not be visible in economic activity, which has recovered to pre-pandemic levels, but is certainly evident in the higher levels of public debt in India.

 

It may not be possible to address all these sources of uncertainty at this stage. The government, therefore, settled on a particular diagnosis of the fundamental growth slowdown, and attempted to address that. Much has been said in the recent past about a squeeze on consumption demand being the reason why growth was failing to take off. This Budget, through its focus on income-tax relief and urban issues, has attempted to address the problem.

 

 

If all goes well, the reworking of tax rates — meant to ensure that those earning about a lakh rupees a month no longer pay income tax, and also that those earning at higher levels pay less thanks to updated tax slabs — will create a wealth effect among the middle class. This will then turn into greater household consumption demand and ideally into private-sector investment and growth.

 

It should be recognised that this is a different mechanism for the revival of growth as compared to those the government has preferred since the pandemic. In recent years, capital expenditure (capex) by the public sector has received big increases in successive Budgets. While public capex has been retained at its elevated level, it appears that the finance ministry believes that without a more direct push to household demand, growth will subside to unacceptable levels.

 

The Budget’s big bet on the middle class has been made despite the general macro numbers not necessarily spelling out the same level of malaise as is heard on corporate-earnings calls. Personal income-tax receipts have increased handily year after year, and are projected to increase 14 per cent in the coming year even after the Rs 1 trillion given away in tax cuts. According to the latest figures for gross domestic product (GDP), private final consumption expenditure will grow 7.3 per cent in 2024-25 in real terms as compared to 4 per cent in the previous fiscal year. The big message of the Budget is that a consumption stimulus will revive growth.

 

Comfortable growth in personal income tax in recent years will have emboldened the finance ministry in taking the course of a consumption stimulus, since it allows for the fiscal impact of tax cuts to be controlled. This government has had two major achievements when it comes to handling the fisc: First, it has improved the quality of spending by sharply controlling revenue expenditure; and, second, it has demonstrated a commitment to fiscal transparency and consolidation.

 

Both these continue to be visible in this Budget. The only large variable when it comes to fiscal mathematics is the future path of personal income tax once these tax cuts have been implemented. Revenue expenditure has been compressed in the past year by reducing spending on housing subsidies and the Jal Jeevan water programme, as well as big reductions in some heads of capex compared to what was in the July 2024 Budget. The estimate of 4.8 per cent of GDP as fiscal deficit for the ongoing year and 4.4 per cent in the coming year are seen as credible, given the government’s past performance.

 

The longer-term path of fiscal consolidation is, however, a little unclear. The broad requirement for the Budget is that it specify how it intends to achieve the long-term target for the fiscal deficit of 3 per cent. On this occasion, the Budget instead provided a glide path for the deficit that was based on the ratio of Union government debt as a proportion of GDP, which it said would be within a percentage point of 50 per cent by 2031. Such a target is welcome. But markets would also appreciate a more old-fashioned thorough view of what happens to the fiscal deficit and thus market borrowing in the medium term.

 

The politics of this Budget was also unusually transparent. The big Assembly election in the second half of the year is in the swing state of Bihar, ruled by an ally within the national coalition. Naturally, some sops had to be offered to the state, but these were signalled transparently and were fiscally far less impactful than they could have been. The income-tax cut was clearly considered enough when it came to the upcoming elections in Delhi; in general, getting the middle class back on side will have been a major political priority for a party that rode to power a decade ago on the back of urban dissatisfaction.

 

There will be some less happy political fallout over the coming years when it comes to other Budget trends, however, including the increasing demands on state governments. With the deceleration in  capex at Union level, state governments will have to bear a greater burden. The Budget also made clear that some funds being sent to the states for centrally sponsored schemes are not being utilised; these schemes have become political flashpoints in recent years. States will be allowed to borrow more provided they conduct power-sector reforms. They will also be ranked on investment-friendliness.

 

Overall, this is a Budget that bet on the middle class while setting aside the concerns, such as capex, that dominated the last few Budgets. Tax reform, including comprehensively rationalising direct taxes, has long been hoped for. If it succeeds in reviving growth in 2025, it will have been delivered at just the right time.