19 January 2025
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The Economy Observer
Budget Preview: Spending growth likely to remain subdued in FY26
Expect fiscal deficit target at 4.5% of GDP in FY26
The Government of India (GoI) will present its Budget 2025-26 on Saturday, 1st Feb’25. The first full-year Budget of the
new government comes against the backdrop of slower domestic economic growth, a weakening currency, and a highly
uncertain global geopolitical situation (especially the Trump-led US administration). Not surprisingly then, the
expectations are running high. In this note, we present our five key expectations from the Union Budget 2025-26 and also
discuss the fiscal math.
Five key expectations from the Union Budget 2025-26:
1.
Make interest-free capex loans to states conditional: One of the most worrying trends in public finances for the past 2-3
years has been the increasing number of welfare schemes. The Union Government announced the PM-KISAN scheme in
the interim Budget 2019, which was followed up with free food grains to about 813.5m citizens in Dec’22 for one year
and was extended to five years in Nov’23. Notwithstanding the prospering India, several states have announced
unconditional monthly stipends to various groups (women, students, unemployed, etc.) without any economic criteria or
statistical reasoning, which is a bit confusing. If states have the resources to announce cash transfers or other welfare
schemes, then the need for interest-free loans for capex to states by the central government must be reviewed. It would
be useful to link such capex loans with some conditions, such as a) the achievement of capex by each state vs. its budget
estimate, and b) the ratio of welfare schemes/cash transfer/current expenditure to capital expenditure of each state. The
higher the former and the lower the latter, the more the state deserves capex support from the central government.
Such conditions would help bring some fiscal discipline.
2.
Lower/simplify indirect taxes and change dividend income tax policy: There is no doubt that personal income tax rates
are high, but the burden of indirect taxes is more widespread and concerning. Based on the central government’s gross
taxes data, direct taxes (personal and corporate income taxes) account for ~57% of total taxes now, the highest share in
15 years. Nevertheless, if we include states’ taxes, the indirect taxes still account for ~60% of all tax receipts in the
country, the same as it was a decade ago
(Exhibit 1).
We recommend that: a) double taxation on dividend income be
abolished by either making it tax deductible for companies or by reverting to the old system of including it only in the
corporate income taxes, and b) the government needs to articulate its intention of making GST simpler by reducing tax
slabs and interventions and lowering the burden of indirect taxes.
3.
Focus on boosting household income, not consumption: It is widely believed that urban consumption growth has slowed
down, while the rural economy has improved in FY25. There is, thus, a lot of expectation from the government to boost
consumption. This, we believe, is unwarranted. The government needs to focus on improving household income growth
rather than consumption. Apart from simplifying and lowering indirect taxes, any support to the construction sector (the
second-highest employer industry in India) would be highly effective. Further, while the formalization of the economy is
beneficial, it is not advisable to completely overlook the huge informal sector (e.g., MSMEs). Therefore, any non-
inflationary support to the micro and small enterprises would be welcome.
4.
Remain on the path of fiscal consolidation and focus on capex: It is very likely now that the government will miss its FY25
capex target by about INR1t. Further, the first batch of supplementary demands for grants for FY25 included proposals
involving a net cash outgo of INR441b. Total spending, thus, is anticipated to be lower than the targets this year, even
though total receipts could meet the budget estimates (slightly better tax receipts, offset by lower non-debt capital
receipts). Therefore, the central government will probably overachieve its fiscal deficit target this year. We recommend
that the government continue on the path of consolidation and target a deficit of 4.5% of GDP next year, with a clear
preference for capex. We expect 10-15% growth in capex in FY26, following +/-5% change this year (FY25). At the same
time, if the government chooses to target the debt-to-GDP ratio from the subsequent years, it needs to clearly outline its
target range (or point target) over a longer period.
Nikhil Gupta – Research Analyst
(Nikhil.Gupta@MotilalOswal.com)
Tanisha Ladha–
Research Analyst
(Tanisha.ladha@motilaloswal.com)
Investors are advised to refer through important disclosures made at the last page of the Research Report.
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