India: Embracing potential

India’s strong growth and macro stability reflect a newfound economic potential. Realising this potential will require sustained policy prudence. The fiscal imperative is clear – reduce the fiscal deficit and debt ratios, while upholding developmental spending.

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India’s pre-election budget for 2024-2025, released last week, underscored this ambition. The bond markets have cheered an unexpectedly strong commitment to fiscal discipline.

"The government has shown revenue spending restraint despite pressures in a pre-election year.”

The top five takeaways from the budget announcement:  

1. Fiscal promise

There were many positive surprises in India’s interim budget announcement.

The revised estimates showed that the central government is expecting to beat its FY24 (April 2023–March 2024) fiscal deficit target of 5.9 per cent of Gross Domestic Product (GDP) by ten basis points.

It now sees the budget deficit - the difference between government spending and revenues – for FY25 at 5.1 per cent of GDP. This is lower than the most optimistic market forecast.

A careful analysis of the details reveals a positively evolving fiscal story.

2. Expanding tax base

India’s fiscal problem is not excessive spending but a weak capacity to raise enough revenues, reflected in low tax collections relative to emerging markets.

The personal income tax as a share of GDP is 3.5 per cent in India, as only about five percent of the population pays up. At the same time, indirect tax collections suffer from weak compliance, although they cover a broad base of transactions.

However, these constraints are finally easing. India’s economic ascent has meant that the average income of taxpayers is rising, and the pool of compliant taxpayers is expanding. This means taxes can grow healthily.

For FY25, gross taxes have been pegged at 11.7 per cent of GDP, slightly higher than the revised estimate of 11.6 per cent in FY24, which was much higher than the 11.1 per cent figure that was budgeted last year.

The surge has been led by personal income taxes, which are benefitting from improving compliance and trends like digitalisation and formalisation.

The target for Goods and Services Tax collection may be slightly optimistic, however the targets for customs and excise tax seem underbudgeted, given expectations of an upturn in foreign trade.

The bottom line is that India’s fiscal parameters are improving, partly sharing the burden of fiscal consolidation alongside spending cuts.

3. Disciplined revenue spending

The government has shown revenue spending restraint despite pressures in a pre-election year. Revenue spending usually includes operational expenditures and welfare schemes that do not create any fixed assets.

For FY25, revenue spending has been slashed to 11.2 per cent from 11.9 per cent of GDP in FY24. This is the lowest since 2018 and is comparable to previous periods of sustained fiscal consolidation.

The subsidy spending is budgeted to be lowered by 20 basis points to 1.2 per cent of GDP, in line with the historical average for a ‘normal’ year that is not beset by commodity price shocks.

These subsidies include those on food grains under the National Food Security Act, fertilisers, and domestic cooking fuel, intended to shield economically weaker population from price shocks.

The residual savings in non-subsidy revenue spending look to be broad-based across ministries.

4. Strong capital expenditure

India has been driving growth through a healthy capital outlay. The allocation for FY25 at 3.4 per cent of GDP is the highest in decades.

A higher allocation for FY25 is on the back of a modest cut in FY24, which helped pay for the high subsidy bill.

For FY25 it has been scaled up to INR11.1trn, reflecting a solid 16.9 per cent rise over FY24 revised estimate. This will further the government’s push towards infrastructure and likely spur private investment.

5. Borrowing cut

The government announced gross market borrowing program at 14.3 trillion rupees, almost 7 per cent lower than consensus expectations. Bonds markets expectedly rallied while yields fell.

The net market loans (gross minus repayments) for FY25 were kept broadly unchanged from the FY24 level of 11.8 trillion rupees.

All of this was despite the government opting to fund 70 per cent of its total fiscal deficit from market loans, higher than the usual share of about 65 per cent.

Over to the Reserve Bank of India

Fiscal prudence aside, a sharp pullback in spending excluding interest payments will have a modestly negative impact on growth, especially with the backdrop of private consumption weakness.

However, the Indian economy has strengthened in recent years and can withstand a fiscal consolidation of this order, with an expected GDP growth of 6.2 per cent in FY25.

The fiscal retreat also coincides with decent progress on inflation. Although headline CPI inflation is still elevated, the underlying food inflation shock is easing, especially for items in which the price shock tends to persist and shape household inflation expectations.

More importantly, core inflation has slipped below 4 per cent as of December 2023 and can go even lower.

The RBI is likely to reduce the banking system’s currently large liquidity deficit and eventually embark on the rate-cutting cycle.

their is expected the RBI will cut its policy rate by a cumulative 100 basis points, starting early in the third quarter of 2024. But rate cuts could begin sooner if food CPI disinflation quickens.

The budget chose prudence over populism, deepening India’s fiscal credentials while paving way for balanced policy coordination. It has bolstered India’s medium-term growth promise, especially by ensuring lower borrowing costs.

Dhiraj Nim is Economist/FX Strategist with ANZ and Sanjay Mathur is Chief Economist, India and Southeast Asia with ANZ.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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