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Balancing Growth and Stability - A Critical Analysis of the Union Budget 2025-26

02-02-2025

03:37 PM

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Balancing Growth and Stability - A Critical Analysis of the Union Budget 2025-26 Blog Image

Context: The government’s first full budget in its third term had to balance two conflicting objectives: ensuring macroeconomic stability amid global challenges while supporting domestic growth.

The Global Economic Backdrop:

  • The global financial environment is tightening due to US exceptionalism, rising dollar value, and persistent high US interest rates.
  • A new trade war, with the US imposing tariffs on Mexico, Canada, and China, threatens to further destabilize emerging markets.
  • Given this backdrop, a conservative fiscal approach was needed to ensure India’s resilience.

Domestic Economic Challenges:

  • Growth in India has slowed, and the ongoing earnings season suggests a delayed recovery.
  • A global slowdown could further impact domestic growth, making fiscal support essential.
  • The trade-off was between fiscal prudence and allowing for increased government spending. 

Fiscal Consolidation:

  • Strategy:
    • The government opted for conservatism, setting the fiscal deficit at 4.8% of GDP, lower than expected.
    • The budget outlines a further reduction to 4.4% of GDP next year, continuing a trend of fiscal consolidation.
    • A buffer against external shocks should be provided by fiscal credibility, a healthy current account deficit and foreign exchange reserves, and inflation that is expected to return to 4%.
    • Strong fiscal discipline is expected to enhance macroeconomic stability and credibility.
  • Costs of fiscal conservatism:
    • Lower fiscal deficits constrain government spending in the coming months.
    • Public spending (excluding interest payments) grew by 23% last quarter but will have to slow to 8% in the last quarter of the fiscal year.
    • A reduction in government spending may negatively impact economic growth, shifting the responsibility to monetary policy.

Tax Cuts and Their Trade-offs:

  • The budget introduced a tax cut worth 0.3% of GDP to boost urban consumption.
  • However, fiscal consolidation largely relied on revenue expenditure compression rather than tax revenue augmentation.
  • Lower expenditure multipliers might impact overall economic stimulus.

The Role of Tax Buoyancy:

  • Tax buoyancy dropped from 1.4 in 2023-24 to 1.1 due to slower growth.
  • The budget assumes a higher tax buoyancy of 1.3, which may not materialize.
  • If tax targets are missed, policymakers should allow the deficit to widen rather than further cutting expenditures.

Public Investment and Growth:

  • Central capital expenditure has nearly doubled over four years but fell short of targets this year.
  • State capital expenditure is also lagging as states prioritize subsidies.
  • Maintaining public investment is crucial for sustaining growth and requires enhanced execution capacity.

Way Forward:

  • The need for structural reforms:
    • Fiscal stimulus has been the primary driver of growth over the last five years.
    • Future fiscal space will shrink, necessitating a shift toward private investment.
    • Policy measures must provide demand visibility and boost investor confidence ("animal spirits").
  • Reform agenda for sustainable growth:
    • The Economic Survey 2024-25 advocates for deregulation and liberalization to lower transaction costs and enhance global competitiveness.
    • Employment-focused reforms are needed, particularly in labour-intensive sectors.
    • Investing in health, education, and skilling is essential to boost labour-intensive growth and increase consumption.
    • Industrial policy should prioritize labour-intensive industries and rationalize labour laws.

Conclusion - A Reform Stimulus Over Fiscal Stimulus:

  • The budget signals that India lacks space for further fiscal stimulus.
  • The solution lies in a reform stimulus to attract private investment and sustain long-term growth.
  • Balancing macroeconomic stability with growth requires structural changes, especially in a volatile global economic environment.

Q1. What is the theme of the Economic Survey 2024-25?

Ans. The Economic Survey 2024-25 outlines the necessity for driving synergy between the government, private sector, and academia to create a societal infrastructure that harnesses the power of innovation for inclusive growth.

Q2. What is the key highlight of the Union Budget 2025-26?

Ans. Finance Minister Nirmala Sitharaman presented the Union Budget 2025-26, outlining what she called a roadmap for economic growth, social welfare, and technological advancement.

Q3. What do you mean by "animal spirits" in economy?

Ans. "Animal spirits" is an economic term that refers to the influence of human emotions on economic decisions. It was coined by British economist John Maynard Keynes in his 1936 book The General Theory of Employment, Interest, and Money. 

Q4. What is the significance of labour-intensive industries for the Indian economy?

Ans. Labour-intensive industries are highly significant for the Indian economy as they provide a major source of employment for the large, relatively unskilled workforce, and contribute to inclusive growth.

Q5. What are the government’s priorities to boost the Indian economy?

Ans. Speedy implementation of labour codes, providing social security to informal workers, especially gig and platform, and bringing transformative policies would be the government's priority in 2025 to empower all and boost the economy. 

Source:IE