The Union budget shows remarkable fiscal restraint

First, that the ruling party does not need electoral goodies to enhance its electoral prospects or pump-prime the economy. A famous quip of an American president was “It’s the economy, stupid!" We are not sure if it is applicable universally, or even to the Indian voter. But artificially boosting the economy with fiscal dosage was clearly not needed, as per the assessment from the top quarters.

Or second, the other explanation is that the fiscal situation is indeed worrisome. The International Monetary Fund recently warned India that if the debt situation is not watched, its debt-to-gross domestic product (GDP) ratio could shoot up to 100%. The government rebutted that warning, saying that in fact it had come down from a covid high of 89% to the present 82%. And that most of the debt is denominated in domestic currency, which poses a much lower risk.

But the fact is that the fiscal situation is far from comfortable. Interest payments on outstanding debt alone takes up nearly 40% of all tax revenues. It is the single largest component of expenditures. The borrowing requirement in the present fiscal year was a whopping ₹18 trillion. This is a significant drag on the total supply of loanable funds from the banking system. It tends to keep interest rates high. And an expansionary budget can also be inflationary.

So, fiscal restraint is an imperative, and on this the budget has delivered very well. The fiscal deficit target for this year was 5.9%, but performance was better at 5.8% of GDP. Part of this success was due to the fact that the denominator, nominal GDP, grew only by 8.6%, almost 1.8 percentage points less than the target. Next year’s deficit target at 5.1% is quite ambitious, but sends the right signal of fiscal restraint.

And after that, finance minister Nirmala Sitharaman said she is aiming to go lower than 4.5% of GDP, which is very admirable.

Proposed expenditure in 2024-25 will rise by around 6%, lower than the expected increase in nominal GDP of 10.5%. Of this, revenue spending will rise only by 3%, leaving more room for capex enhancement, which will rise by 17%. The government’s capex-to-GDP ratio has been steadily rising for more than five years now. In the past three years, the compound average growth rate was a sizzling 31%, which was clearly not sustainable.

Longer term and more sustainable growth requires the contribution of private investment spending, consumer spending and exports. All three are energized by different factors. For instance, private investment requires a positive climate, lower uncertainty, policy continuity and predictability, and lower interest rates. In a world that is facing recessionary winds and geopolitical uncertainty, this is not easy for domestic policy alone to achieve. But by keeping corporate tax rates stable and showing fiscal restraint, it provides a positive signal. Consumer spending is affected by job prospects and the employment situation. Upper-income segments have done well and also benefited from the booming stock market. But consumption spending growth as a whole has lagged, mainly because of slower income growth in lower-income house-holds, real wage stagnation and still-high unemployment, especially among the educated youth. Welfare spending, like on free food and the rural employment guarantee, has ensured that households have escaped poverty. But only sustained all-round economic growth with more job creation can ensure income and consumption growth. On exports, the third important driver, India does very well on services. Earnings via software services or inbound remittances are very strong. But India’s share of global merchandise exports continues to stagnate. It can easily double. A recent piece by Arvind Panagariya, chairman of the 16th Finance Commission, advocated a sharp reduction in the policy protection given to the country’s automobile sector. If done, this will actually enhance the export prospects and competitiveness of this sector. The same holds true for most other industries in the manufacturing sector.

So, from a budgetary perspective, the promotion of manufacturing competitiveness calls for keeping taxation moderate, and maintaining the continuity, stability and predictability of policies. That seems to be on track. Job creation is a big challenge. This needs a big push to increase human capital via training, skilling and education. Our mix of public capital spending must skew much more towards human capital. One of the big priorities is to increase spending on higher education. No doubt enrolment has gone up and many new institutions have been set up, but budgetary spending is still barely 2% of GDP. Compare this with the huge outlay under just two heads, the fertilizer subsidy and free food scheme, which together exceed 2% of GDP. Clearly, priorities need to be re-aligned to beef up the human capital component of the total productive capital in the country. This should be the medium-term plan of all budgetary policies.