Budget 2024: Exhilarant Growth Claims Of Budget Mask The Fiscal-Monetary Drags

The interim budget is pivoted on the assumption of a robust economy, in line with the latest advance estimates of CSO and the government's rosy assessment in their latest monthly assessment. The finance minister claims rising incomes, historical upliftment of people from poverty, a revival of private capex, and robust employment generation. The nominal GDP is projected to grow by 10.5% in FY25 (7% real and 3.5% inflation) versus 8.9% in FY24 advance estimates.

Their premise is that the economy is booming, and hence, people can fend for themselves. Thus, total expenditure grows just 6.1% year-on-year over revised estimates to Rs 47.8 trillion (2.6% YoY in real terms). Capital expenditure is budgeted to grow slower than last year at 16.9% to Rs 11.1 trillion. The government missed the Rs 10 trillion target in FY24 by Rs 500 billion.

Importantly, the total allocation under three major heads—roads, railways, and defence—is budgeted to grow 5.2% in FY25 budget estimate, significantly lower than 28.4% in FY24 revised estimate and a 27.5% CAGR during FY20-FY24. That's mainly due to a slowdown in roads and railways.

Revenue expenditure is seen rising by just 3.2% to Rs 36.6 trillion in FY25, mainly contributed by cut-back in subsidies and allocation under rural heads. The fragile rural economy does not get any respite from the budget as the total allocations of Rs 7.9 trillion under the heads of agriculture & allied activities, fertilisers, foods distribution, rural development, Panchayati Raj would see a contraction of 3% on top of 10.5% reduction in FY24 revised estimate. Net of interest payments, revenue expenditure is declining 0.8% at Rs 24.6 trillion, after contracting 3% last year. In real terms, it is projected to contract 4.3% year-on-year in FY25 vs a contraction of 4.6% in FY24 budget estimate.

Given their assumption that the strong economy is self-sustaining, they have decided to extract more taxes. Net tax collection is projected to grow 11.9% at Rs 26 trillion, much higher than the growth in expenditure budget.

Within the gross tax collections (Rs 38.3 trillion, 11.4%) the share of corporate tax is budgeted to rise 40 basis points to 27.2%, while that of indirect taxes is projected to decline by 80 basis points at 42.2%. This is indicative of the rising tax incidence on corporates. Conversely, the collective share of income and indirect taxes is declining by 40 basis points to 72.4%, indicative of some easing of tax incidence on households from the historical peak levels.

Overall, inclusive of tax receipts, non-tax revenue, and non-debt capital, the total non-debt receipts are projected to grow 11.6% to Rs 30.7 trillion.

So, less fiscal spending support for the economy, and higher taxes are expected to reduce the fiscal deficit by 2.8% year-on-year to Rs 16.9 trillion or 5.1% of FY25 GDP from 5.8% last year.

Overall, as it stands today, the fiscal structure of the interim budget FY25 will be a drag on the aggregate demand for the economy. This comes against the backdrop of declining global trade volumes and a major post-pandemic thrust for India’s recovery. This makes the role of private capex and household consumption spending very crucial for India’s outlook.

The real GDP data for first half of FY24 shows that, excluding the discrepancies, total expenditure across households, governments, and net exports grew just 2.3% year-on-year (vs headline growth of 7.7%), despite the heavy lifting by government capex (about 50% YoY in real terms). With an average capital formation growth of 9.5%, the implied residual of private capex would have still declined, contrary to the budget assumptions. 

We have also shown that after extracting the leveraged part, the leveraged consumption is estimated to have grown by 115% year-on-year in H1 FY24 in real terms, from the overall private final consumption expenditure growth of 4.5% in H1 FY24, the real non-leverage portion may have declined by 2.5% YoY, indicating a decline in real household income as well. The evidence is also reflected in the contraction in sales growth of non-finance companies (-1.5% in H1 FY24) and consumer companies continuing to deliver weak volume numbers in Q3 FY24.

Hence, the assumption of robust growth may be misplaced or is at the least ungrounded. If the household income fails to revive and private capex remains somnolent in response to weak demand conditions, the fiscal drag entailed in the interim budget can aggravate the growth scenario, leaving a considerable gap in the official growth projection to be buffered by the discrepancy component even in FY25.

Considering our analysis of the banking sector, and the implications of the decline in household savings and exuberant retail lending, the overall allocation of banks between credit, SLR investments, and cash holding has risen to over 113% of deposits, (ex HDFC merger)--that is close to the pre-GFC peak in May 2008. This has left little scope for banks to grow lending without aggravating the liquidity deficit scenario (currently at Rs 2.6 trillion or 1.3% of bank deposits). Our assessment also indicates that it would require the overall allocation-deposit ratio of banks to decline by at least 300 basis points to 110%, implying an adjustment of Rs 6 trillion. 

Hence, the space to accommodate government deficit also stands diminished. Ceteris paribus, there is an upside risk to the cost of government borrowings. Therefore, the imperatives of curtailing fiscal deficit by the government and the RBI’s intensifying regulatory tightening actions are aimed at ameliorating this structural logjam and ensuring that interest costs for the governments are contained much lower than the budgeted 25% of expenditure. The RBI’s regulatory tightening can heighten the fiscal drag unless private capex comes back strongly, which in our view is a low-probability scenario at this juncture. As this adjustment process evolves, the pressure on domestic liquidity may ease, thereby easing the G-Sec yields gradually.

Dhananjay Sinha is co-head of equities and head of research, strategy and economics, Systematix Group.

The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.