In economy's shifting sands, a budget to boost demand

First, the splendid economic recovery after the pandemic shock has begun to lose steam. Consumer spending in cities has been especially weak as a result of anaemic growth in labour incomes other than at the very top of the income pyramid. Meanwhile, corporate profits have soared. Companies sitting on piles of cash are not keen to invest in new capacity unless they see robust demand from fatigued consumers.

The income tax cuts that have been announced will leave more money with households, around ₹1 trillion according to the finance minister. That is around 0.3% of India's gross domestic product (GDP). The tax relief is an attempt to support weakening consumer spending, and hence hopefully stimulate wider economic activity.

Yet, personal income tax will continue to contribute more to the government exchequer than corporate tax. This was not the case before the pandemic. The latest budget numbers show that income tax is expected to account for ₹22 out of every ₹100 of receipts that will flow into the government treasury. Corporate tax will contribute ₹17.

The second major shift: In February 2021, the finance minister had announced a plan to gradually bring down the fiscal deficit of the Union government over five years, so that public finances could be repaired without harming economic recovery through a dramatic fiscal contraction. The government has credibly met its promise, with fiscal deficit expected to be 4.4% of GDP in 2025-26. It will now begin to pivot to a new fiscal strategy based on putting the ratio of public debt to GDP on a downward path. It is a fiscal framework that is untested in India.

Also read | India’s GDP growth shocker: Bad news can be good too

The new fiscal framework will give the government welcome flexibility in managing the economy rather than being chained to a single budgetary number--such as the fiscal deficit. However, an accounting item such as the fiscal deficit is a more transparent indicator of fiscal health compared to the slightly more hazy estimates of the trajectory of public debt over the years. These estimates will be open to debate based on how various people anticipate the trajectory of economic growth, inflation, interest rates and the primary deficit.

The budget is based on tenable numbers. However, its tax estimates are open to debate. Income tax collections are expected to increase by ₹1.81 trillion, despite the relief given to salary earners. Income tax collections are expected to grow faster in nominal terms than the underlying economy. The only way this circle can be squared is if either wage growth is unexpectedly rapid in the next financial year or more citizens are brought into the tax net. The finance ministry is perhaps taking a bet on higher income tax collection based on the buoyancy it has seen in the past three years.

The fiscal approach of the governments led by Narendra Modi has generally been conservative. The new budget continues along that path, with a tight control on expenses so that they do not run too far ahead of revenue. Given the coming switch to using the ratio of public debt to GDP as the new nominal anchor of Indian fiscal policy, the declining trend in the primary deficit is especially important. The primary deficit is calculated after taking out the interest payments on its debt, or the cost of past fiscal policy. It is thus an important indication of the future fiscal situation.

Also read | Why is the income tax department messaging political donors?

The finance minister announced the usual bag of new schemes to send signals to important interest groups, including the voters in Bihar. More importantly, in terms of the overall budget, the outlay on major schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme, the Pradhan Mantri Garib Kalyan Anna Yojana and the Pradhan Mantri Kisan Samman Nidhi—that provide rural jobs, free food and income support — have been more or less been held constant. Some schemes such as the Jal Jeevan Mission have received a sharp increase in outlays to correct for a sharp decrease in spending during the past 12 months.

The latest budget numbers confirm the fears being expressed for some time now that the government has struggled to spend on the creation of new capital assets such as roads. Effective capital expenditure has been ₹1.84 trillion less than was budgeted for 2024-25. The higher targets for 2025-26 merely reinstate what was planned at the beginning of last year.

Spending far less on new infrastructure than originally budgeted for is one reason why economic growth has faltered in recent quarters. There is an important lesson here. The government deserves credit for increasing spending on projects that have large ripple effects in the rest of the economy—or high multipliers, in economist-speak—but the baton has to be eventually handed over to the private sector.

The multiplier effect of a tax cut is usually assumed to be lower than that of government spending on infrastructure, as was shown in a paper by economists Sukanya Bose and N.R. Bhanumurthy in 2013. Either way, the overall fiscal impulse continues to be negative, as the government remains committed to lowering the fiscal deficit, the broadest measure of budgetary balances.

Also read | What's on the cards in Budget 2025: Income tax relief, farmer credit, insurance push

The corporate tax cut of 2019 has not delivered on its promise of triggering higher corporate investment. The indication given by the finance minister in her budget speech of extensive regulatory reforms, more ease of doing business, decriminalizing more parts of commercial law, and easing tax administration is welcome. These may have a more sustained impact on private sector investment rather than just a drop in the cost of capital through a reduction in corporate taxes.

The latest version of the eternal debate has been raging for some time now -- Is the ongoing economic slowdown cyclical or structural? Broadly, the latter needs to be tackled with a demand stimulus, while the latter needs economic reforms to address issues on the supply side. The new budget seems to lean towards the cyclical explanation by focusing on a stimulus to consumer demand.

And read | Income tax payers in India have good reason to feel neglected

Public attention will now shift to the six members of the monetary policy committee at the Reserve Bank of India. They will meet in a few days to decide the next course of action on interest rates. The fatigue in domestic demand, slowing economic momentum, core inflation under control, and a budget that has broadly stuck to its promised path should nudge them towards an overdue rate cut.

The author is executive director at Artha India Research Advisors.