A Budget That is Mostly Good but With One Wrong Move

Context

• The Union Budget plays a crucial role in shaping a country's economic trajectory.
• The 2025-26 Budget aims to accelerate growth, improve tax structures, and promote fiscal consolidation while addressing emerging economic challenges.
• It is important to examine the key aspects of the Budget, including GDP projections, government expenditure, tax revenues, and concerns regarding fiscal transparency.

Key Aspects of the Budget

• Economic Growth and Capital Expenditure
  • One of the most significant aspects of the Budget is its projection of nominal GDP growth at 10.1% for 2025-26, which is deemed reasonable given the Economic Survey's estimate of real GDP growth between 6.3% and 6.8%.
  • The government's strategy focuses on increasing capital expenditure, a critical driver of economic development.
  • For 2025-26, capital expenditure is estimated at ₹11.2 lakh crore, a slight increase from the ₹11.1 lakh crore allocated in the previous Budget.
  • While the increase is relatively modest, the government aims to sustain growth by boosting infrastructure and industrial investments.
  • However, given India’s aspiration to become a developed economy, a higher growth rate of around 8% in real terms is necessary.
  • The Budget introduces measures to stimulate economic activity, although some policies could have been implemented earlier for greater impact.
• Tax Revenues and Structural Shifts
  • A key feature of the Budget is the shift in the structure of gross tax revenues (GTR) from indirect taxes to direct taxes.
  • Over recent years, the share of direct taxes in GTR has increased from 52% in 2021-22 to 59% in 2025-26, which is considered a positive development.
  • However, despite this structural improvement, tax revenue growth has been declining:
    • GTR growth has fallen from 13.5% in 2023-24 to 10.8% in 2025-26.
    • GST revenue growth has similarly declined, from 12.7% in 2023-24 to 10.9% in 2025-26.
    • Personal income-tax growth has slowed from 25.4% in 2023-24 to 14.4% in 2025-26, partly due to new tax concessions.
    • Corporate income-tax growth was particularly low at 7.6% in 2024-25 but has been projected to recover to 10.4% in 2025-26.
  • Despite these declines, the assumptions about tax revenue growth appear realistic.
• Government Expenditure and the Need for AI Investment
  • The Budget also emphasises fiscal consolidation, leading to a reduction in government expenditure as a percentage of GDP from 14.6% in 2024-25 to 14.2% in 2025-26.
  • Although total expenditure growth at 7.6% is lower than the projected GDP growth of 10.1%, the quality of expenditure has improved.
  • One critical area for government investment is Artificial Intelligence (AI) infrastructure.
  • The Budget recognises that India needs to develop AI capabilities to remain competitive globally.
  • Countries like China and the United States have made significant strides in AI investment, with the US recently announcing a $500 billion AI infrastructure plan.
  • In contrast, India’s technology sector has lagged behind. The government should incentivise AI research and development through tax concessions and public-private partnerships to ensure India remains a leader in emerging technologies.

A Major Contention in the Budget Announcement: Concerns Over Fiscal Transparency

• Departure from the Fiscal Deficit Glide Path
  • Fiscal deficit, the gap between government revenue and expenditure, is a crucial metric for evaluating a country's financial health.
  • In the Medium-Term Fiscal Policy Cum Fiscal Policy Strategy Statement of the 2024-25 Budget, the government had outlined a clear glide path to reduce the fiscal deficit to below 4.5% of GDP by 2025-26.
  • However, in the 2025-26 Budget, the government abandons this explicit target, instead stating that the focus will be on reducing the debt-to-GDP ratio annually.
• Ambiguity in Debt Reduction Strategy
  • The new approach focuses on alternative debt-to-GDP reduction paths rather than specific fiscal deficit targets.
  • The Budget document presents three different scenarios for debt-to-GDP reduction, based on varying GDP growth assumptions (10.0%, 10.5%, and 11.0%) and different levels of fiscal consolidation (mild, moderate, and high).
    • This method introduces greater vagueness into the fiscal planning process:
    • The government does not specify a clear fiscal deficit target for each year, making it difficult to evaluate progress.
    • The alternative scenarios do not provide a definitive commitment to how quickly the government will reduce its debt burden.
    • The reliance on optimistic GDP growth assumptions (up to 11%) increases the risk that debt reduction projections may not materialise if actual growth falls short.
• Risks of High Government Borrowing and Crowding Out Private Investment
  • One major consequence of unclear fiscal deficit targets is the potential for higher government borrowing, which could lead to the ‘crowding out’ of private investment.
  • When the government borrows more from domestic financial markets, it reduces the pool of available funds for private companies to borrow at affordable interest rates.
  • This can lead to higher borrowing costs for businesses, discouraging private sector investment in critical sectors such as infrastructure, manufacturing, and technology.
  • Reduced private investment can slow economic growth, which contradicts the Budget’s objective of achieving high and sustainable GDP expansion.
• Impact on India's Credit Ratings
  • Fiscal transparency plays a crucial role in determining India’s sovereign credit rating.
  • International credit rating agencies, such as Moody’s, S&P, and Fitch, closely monitor fiscal deficit trends and debt sustainability.
  • If fiscal deficit targets are unclear or absent, rating agencies may perceive this as a weak commitment to fiscal discipline.
  • A downgrade in India’s credit rating would increase borrowing costs for the government, businesses, and consumers.
  • Higher interest payments on government debt could divert funds away from productive expenditures like infrastructure, healthcare, and education.
  • To maintain investor confidence and creditworthiness, the government should reinstate a transparent fiscal deficit target framework, providing a clear roadmap for achieving both deficit reduction and long-term debt sustainability.

Recommendations for a More Transparent Fiscal Policy

• Reintroduce a Clear Fiscal Deficit Target: Instead of relying solely on debt-to-GDP projections, the Budget should restore annual fiscal deficit goals, ensuring better accountability.
• Provide a Detailed Debt Reduction Strategy: The government should outline a step-by-step plan to reduce debt levels, rather than presenting multiple alternative scenarios that create uncertainty.
• Ensure Realistic GDP Growth Assumptions: Fiscal planning should be based on conservative growth projections, avoiding overestimation that could lead to fiscal slippage.
• Limit Government Borrowing to Avoid Crowding Out Private Investment: Fiscal consolidation efforts should prioritize reducing the fiscal deficit, preventing excessive public sector borrowing that could hinder private sector growth.
• Strengthen Transparency in Budgetary Disclosures: The Budget should provide more detailed breakdowns of expenditure, revenue forecasts, and borrowing plans, improving public trust and investor confidence.

Conclusion

• The Union Budget for 2025-26 presents a well-structured approach to economic growth, tax reforms, and fiscal consolidation.
• While GDP growth projections are reasonable, capital expenditure needs to be increased further to sustain long-term economic expansion.
• The move away from transparent fiscal deficit targets raises concerns about accountability.
• Fiscal policy should remain clear and specific, ensuring that the government meets its targets without creating uncertainty in financial markets.

Q1: What fiscal indicator did the 2025-26 Budget move away from?
Ans. The Budget moved away from using the fiscal deficit as a key indicator of fiscal health.

Q2. What has replaced the fiscal deficit as the primary focus in the Budget?
Ans. The Budget now focuses on reducing the debt-to-GDP ratio annually.

Q3. Why is the shift from fiscal deficit to debt-GDP ratio concerning?
Ans. It introduces ambiguity and reduces transparency, making it harder to track fiscal progress and set clear targets.

Q4. What risk does higher government borrowing pose?
Ans. Higher government borrowing could crowd out private investment, leading to higher borrowing costs for businesses.

Q5. What should the government do to ensure fiscal transparency?
Ans. The government should reinstate clear fiscal deficit targets and provide a structured debt reduction plan. 

Source:The Hindu