A Budget Beyond Popcorn

In the Indian economy’s calendar, the two most important events are the Union Budget and the monetary policy of the Reserve of India (RBI). Over the next two weeks, we will have a ringside view of both. In some sense, they are two acts of the same play, typically staged in February. Along with many other things, the play explores the fiscal-monetary dynamics.

The Union Budget for financial year 2025-26 (FY26) is slated for February 1, and the three-day meeting of the RBI’s rate-setting body, the Monetary Policy Committee (MPC), the last one of FY25, will end on February 7.

It is certain that the government will hit the fiscal deficit?target of 4.9 per cent of gross domestic product (GDP) in FY25. In fact, no one will be surprised if it is at 4.8 per cent. This will ensure that Budget FY26’s aim is to meet the fiscal consolidation goal of?bringing the fiscal deficit to??under 4.5 per cent of GDP.

That’s a good story. The not-so-good story is that the economy isn’t shining at the moment. India’s GDP growth for the July-September quarter dropped to 5.4 per cent, much lower than all estimates and the lowest since the third quarter of FY23. Barring agriculture and services, all sectors reported deceleration in the quarter. The growth was 8.1 per cent during the same period in FY24 and 6.7 per cent in the April-June quarter.

Fiscal consolidation – from 9.2 per cent of GDP in the Covid pandemic-affected FY21 to a likely 4.8 per cent of GDP in FY25 – has been driven by improved tax collection, cut in expenditure, and high dividend flows from the RBI.

The pandemic period aside, this will be the toughest Budget for Finance Minister Nirmala Sitharaman. Indeed, the fiscal deficit target will be achieved, but going slow on capital expenditure and raising tax rates on multiple fronts can no longer be the key to this achievement. For the record, in the eight months between April and November 2024, capex spending stood at Rs 5.13 trillion, 46 per cent of the Budget estimates of Rs 11.11 trillion. A few analysts say that capex spending during FY25 is around 12 per cent lower than what the Centre?had?spent on capex in the previous financial year. Collectively, capex spending of the states, too, is around 5 per cent less this year compared with FY24. Had the spending matched the previous year’s, the September quarter growth would have been higher by at least half a percentage, they say.

This is the time to push the pedal on growth. Consumer demand has taken a beating, growth is slowing, forex reserves are shrinking (from $704.9 billion on September 27, 2024 to $623.98 on January 17,?2025), and the rupee is losing its value against the dollar. Another telltale sign of a slowing economy is the trajectory of bank credit growth. In percentage terms, till January 10, bank credit growth in the financial year so far has been 8.3 per cent, less than half of a year before, and year-on-year credit growth is 11.5 per cent versus 20.3 per cent a year ago.

Foreign direct investments are fraught with challenges (FDI inflows dropped from $42 billion in FY23 to $26.5 billion in FY24 before jumping to $16.17 billion in the April-June quarter of FY25)?and foreign portfolio investors are pulling money out of Indian markets.

Finally, there is the (Donald) Trump factor. And, the Chinese economy showing signs of revival, led by industrial output and exports. (The world’s second largest economy grew at 5.4 per cent year-on-year in the October-December quarter, far higher than the expected 5 per cent.)

A record Rs 2.11 trillion dividend by the RBI, higher tax collection and slower capex can help reduce the fiscal deficit, but it won’t bring back the momentum in growth. The Budget needs to unleash the animal spirit through reforms. How can this be done?

There is widespread speculation about a cut in income tax for individuals. A few years ago, the corporate rate was cut – from 30 per cent to 22 per cent for existing companies, and from 25 per cent to 15 per cent for the new ones. Has that led to massive investments by Indian companies and created millions of jobs? No. Most of the companies probably used the savings to deleverage their balance sheets. For some reason or the other, they are not comfortable to walk the talk on investment and capacity creation despite the government’s persuasion. The challenge is earning their confidence and making them comfortable.

During the current political regime, we have seen reforms in the form of the goods and services tax (GST), the Insolvency and Bankruptcy Code (IBC), and the setting up of the Real Estate Regulatory Authority (RERA). Now, it’s time for the second round. And, of course, the GST has to be streamlined. The authorities need to do this fast rather than spend their time differentiating among unpackaged and unlabelled popcorn with salt and spices, pre-packed and ready-to-eat popcorn and caramelised popcorn.

If growth falters, tax collection is bound to suffer. Empirically it has been found that if the nominal GDP growth falls below 10 per cent, tax buoyancy turns negative. The approach to taxation also needs to be finetuned. The current tax structure is not creating?"financialisation"?of savings; it is encouraging?"equitisation"?of savings. There is long term capital gains benefit for real estates, gold and equity but not for investment in bonds. How do we create a long term bond market as an alternative channel for financing corporations?

We have done well on the three Ds: Digitisation, direct benefit tax (DBT) and dividend. Digitisation is helping formalise the economy and leading to higher GST collections; DBT has plugged the loopholes to check government funds from being misused; and the RBI dividend has played a critical role in bridging the fiscal deficit. Now, it’s time to focus on the fourth D: Divestment.

On more than one occasion, Prime Minister Narendra Modi has said the government has no business to be in the business and has pitched for the privatisation of all public sector undertakings (PSUs). The government has missed the golden opportunity to make money and privatise at least some of the PSUs. Here’s one example: Between May 2020 and February 2024, Indian Overseas Bank’s share price rose 10-fold, from Rs 7.25 to Rs 71 a piece! At Rs 71, the bank’s share was trading at five times its book value, making it?probably the costliest bank?in the world. Did the government seize the opportunity to divest? No. It’s not just state-owned banks. Other sectors, too, rocked but the government didn’t make hay while the sun shone.

Speaking of divestment and privatisation, the finance minister had proposed to take up the privatisation of two public-sector banks and one general insurance company in 2021-22, besides IDBI Bank Ltd, which had featured on the privatisation wishlist even before this. In her February 2020 Budget speech, Sitharaman had said, “In the last few years, the government has taken concrete steps to bring our banking system to be robust. However, there is a need for greater private capital. Accordingly, it is proposed to sell the balance holding of the Government of India in IDBI Bank to private, retail and institutional investors through the stock exchange.”

What’s the latest on this? The government is silent on the privatisation of two PSU banks. Recent media reports say financial bids for IDBI Bank are likely to be submitted within the current financial year, ending March, but the privatisation exercise may be completed in FY26. Who says that we have junked the Five Year Plans?

The government needs to spend more on capex and allow consumers to have money in their pockets if it wants growth. Popcorn is popcorn which pops. How does it matter whether it is salted or caramelised? Let’s focus on the real issues.

?This column first appeared in Business Standard.

The writer, Consulting Editor with Business Standard and Senior Adviser to Jana Small Finance Bank, writes Banker's Trust every Monday in Business Standard.

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