On 1 February, Finance Minister Nirmala Sitharaman will present the interim budget for the financial year 2024-25. Given it is a pre-election budget which is supposed to be a vote on account, the finance minister has said that there won’t be any “spectacular announcements”.
While people will still watch for big announcements, like the relief on income tax in the last interim budget, experts are keener on the announcements on capital expenditure and fiscal deficit.
The last few budgets of Prime Minister Narendra Modi’s government have seen a strong push for capital expenditure. From Rs 3.4 lakh crore in FY20 to Rs 10 lakh crore in FY24, the allocation for capex has grown by over 194 per cent in the last four financial years.
In the last budget, Sitharaman had noted, “This substantial increase in recent years is central to the government’s efforts to enhance growth potential and job creation, crowd in private investments, and provide a cushion against global headwinds.”
Due to the strong push by the public sector, India’s growth has remained resilient with the Q2 GDP growth for FY24 coming in at 7.6 per cent. The manufacturing sector’s growth has picked up again in this financial year as the capex push boosts industrial activity in certain segments.
But recent commentary over government finances suggests a shift towards consolidation in expenditure might be around the corner soon.
Moreover, the government’s own target of fiscal deficit at 4.5 per cent of gross domestic product (GDP) by FY2025-26 would entail a sharp brake as the target for this financial year is at 5.9 per cent.
Observers wonder what the impact of such a target would be on capital expenditure and India’s growth story.
Some global agencies have recently commented on Indian government’s fiscal targets. India’s fiscal performance was highlighted by the global credit rating agency S&P.
Kim Eng Tan, S&P managing director for APAC sovereign ratings was quoted as saying by Moneycontrol, “Unless, we see significantly more fiscal consolidation and bringing deficits down a lot more than what we have seen recently, we are unlikely to see further upside pressures on the rating." Several credit rating agencies have categorised India’s credit profile as BBB-, which the government has criticised time and again.
United Nation’s International Monetary Fund (IMF) staff paper had also noted that its directors recommended an ambitious medium-term consolidation target for the government. Its reasons included elevated public debt and contingent risks. The agency said that while the government ensured a boost in capex did not hinder fiscal tightening in the last budget, it needs to make sure the path government undertakes ensures a sustainable reduction in public debt level.
Data compiled by global investment bank Goldman Sachs showed that the central government’s spending on capex rose from an average of 1.5 per cent of GDP between FY18 and 20 to 3.3 per cent in FY24. This was accommodated by a cut in subsidy spending post the pandemic which fell from 4 per cent in FY21 to 1.4 per cent in FY24.
In its outlook for the interim budget, analysts at the bank noted, “Three key things for investors to look out for in the interim budget include the government’s commitment to the medium-term fiscal consolidation path, if capex growth can continue with fiscal consolidation, and the supply of government bonds that the market may be able to absorb.”
Since 2003, India has a law on fiscal responsibility in place, called as Fiscal Responsibility and Budget Management Act, which set the fiscal deficit target at 3 per cent of GDP. The path to the long-term target is still not clear as the government is currently looking to first reach 4.5 per cent. IMF’s baseline scenario suggests that the government will miss the target it has set.
What makes the target all the more important is the inclusion of Indian government bonds in global bond indices of JPMorgan and Bloomberg which is expected to attract attention on government finances in the coming years as inflows increase.
With global and domestic investors closely watching the announcement on fiscal deficit targets, attention would also be on whether the government slows down its capex push and the subsequent effects on India’s growth story.
In the last one year, India has seen strong infrastructure growth led by the massive rise in public capex. The index of Industrial Production (IIP) growth recently touched a 16-month high in October at 11.7 per cent before moderating to 2.4 per cent in November.
Throughout the current financial year, IIP growth has remained in the positive territory, a healthy sign for the industrial sector. However data suggests most of the growth is being seen in segments where public capex is acting as a catalyst.
Dr Sunil Kumar Sinha, Principal Economist at India Ratings and Research, suggests that the manufacturing sector has benefited from the economic momentum, but signs of a broad recovery are still elusive.
He says, “Close look in the IIP data shows that the index values of several categories have barely crossed the pre-pandemic level which shows that there is still some time left for a full recovery.”
Sinha adds, “Most of the growth being seen is in segments where public capex is playing a big role. In some pockets, private capex has picked up, but a broad-based capex cycle is still missing.”
MoSPI data on the index of value of 23 categories under the manufacturing segment in November 2023 shows that indices of only 7 components were higher than the level recorded in February 2020, the last full month before Covid-19 restrictions were announced in the country.
Moreover, the project completion and under implementation data compiled by CareEdge Ratings showed that 52.4 per cent of the total projects completed in the first half of the financial year belonged to the public sector.
The private sector lagged even further behind when it came to under implementation projects, where the share stood at 63.1 per cent for government while 36.9 per cent for private sector.
In such a scenario, the government could look to continue its capex push but slow down the rapid rise seen in the last few years. A Business Today report suggested that the capex budget could be hiked by 10 per cent to Rs 11 lakh crore in the upcoming budget.
With full recovery in domestic consumption still a bit further away, experts suggest that the economy needs support from government’s side.
Deepa Seshadri, Partner at Deloitte India, believes that government investment still has a big role to play in driving up growth as seen in the previous quarters. “This would need some stimulus from the government to support the rural demand, which is yet to recover sustainably. We expect the Government to reduce subsidies and divert the savings from subsidies towards spending that can aid in sustainable growth in the long-term income amongst rural households,” she says.
Will the government continue with significant hikes to capex budget or look to slow down? What will be the long-term strategy on fiscal deficit and how will the country achieve its medium-term target amidst slowing global economy? Analysts and investors are awaiting answers to these questions which will only be clear when the finance minister presents the interim budget on 1 February.
