Restoring the pace of execution and deployment of capital expenditure will be critical for reviving growth (Express illustration)
Jan 18, 2025 06:41 IST First published on: Jan 18, 2025 at 04:00 IST
In India, the process of budgeting perhaps takes up much more focus and energy than what it does in most other economies. This unusual focus on the budget is understandable, since it was through the budgets in the nineties that major industrial and financial reforms would get announced, and rather than being just an accounting process, the annual announcement is now almost synonymous with a “state of the economy” address that the government presents, as we approach the new fiscal year.
The expectations are no different this time. The budget for financial year 2025-2026 is being awaited, as the economy appears to have hit a rut, while global headwinds are rising. To be sure, government finances have been well managed, and are expected to reach a stable level post pandemic. Indeed, the 9.2% fiscal deficit recorded during the pandemic year is fading from memory, and the government which had laid down an ambitious target to achieve the glide path of fiscal deficit to 4.5% of GDP by FY26 is homing in on the target. This fiscal marksmanship has come while improving the quality of spending and strengthening the social security net despite multiple shocks. On the face of it, the ability to consolidate deficits while keeping growth and welfare considerations in mind is commendable and needs to be appreciated and acknowledged.
Still, there are risks ahead. As mentioned above, the cyclical state of the economy appears weak, and the government needs to manage the need for fiscal consolidation, while ensuring steady growth. One reason for the economic slowdown has been the lower pace of capital spending than what was budgeted, and while this slower pace puts the fiscal finances in good order, it does produce a negative impact on growth.
Restoring the pace of execution and deployment of capital expenditure will be critical for reviving growth. Indeed, the government can take a leaf out of its second term, where a significant highlight of its fiscal management was the surge in capital expenditure, which increased to 3.2% of GDP in FY24. We believe the government would be keen to restore this spending mix, and restart the spending momentum, as it pushes for greater infrastructure investments. As such, the government could consider front-loading capex to the first half of FY26 to ensure better planning, and with the revenue expenditure to capital expenditure ratio expected to go up from 3.7x to 4.0x in FY25 but fall to 3.25x in FY26, indicating a renewed focus on capex.
A major headwind comes in the form of slowing nominal growth. Indeed, just prior to the pandemic, the slowdown was causing fiscal headaches, and the return of sub-10% nominal GDP growth prints in consecutive years can do the same. In Q3 (July-September) 2024, nominal GDP growth slowed to a fifteen-quarter low of 8% annual growth, and if not addressed, this slowdown could have major implications for wage growth, tax buoyancy and debt consolidation going forward.
At 9.7%, the first advance estimate for FY25 is below the 10.5% nominal GDP growth that was factored into the July’24 budget. We believe to revive nominal growth along with real GDP growth, one needs to see both public capex spending and monetary conditions ease in coming quarters, which could improve the outlook for growth in FY2026. We continue to project GDP growth to be around 6.5% YoY in FY2025, with risks skewed to the downside, but expect a recovery to 7.0% YoY, contingent on conditions turning more supportive of both fiscal and monetary policy. If monetary policy remains entangled in dealing with a policy trilemma, then the heavy lifting of supporting growth will need to be done by fiscal policy.
Beyond the cyclical challenges, the bigger question remains – where do we go on fiscal management post the 4.5% of GDP deficit target?
Prior to the pandemic, the government had discussed a potential shift in the fiscal objectives away from deficits to debt, which may be restored, and can have several implications. While there will be an implied need for further fiscal consolidation, the expenditure mix and the pace of economic growth would also be key for this new approach to be successful. We believe the government is considering adopting a debt-driven fiscal framework, rather than one anchored on fiscal deficits, to approach the next stage of its medium-term fiscal framework.
As such, the primary deficit could become the de-facto operational parameter rather than the fiscal deficit as the government seeks to move away from debt financed consumption. However, it would also mean that the need to balance monetary conditions, which anchor borrowing costs, nominal growth which drives revenues and the denominator of debt, and fiscal prudence which reduces primary deficits, would be critical for the success of the new framework, which in the medium term can create fiscal space for the next crisis, as and when
it arises.
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