Interim Budget accelerates on the path of fiscal prudence

The FY25 interim budget was a vote on account, with prior indications that it would be more “a blueprint of intent” and a facilitator of fiscal operations over the next five months. Yet, there was also a very strong signaling of a continuity in the fiscal thinking and strategy of the Government, particularly in the event of a political continuity after the general elections. First, this continuity is evident in an acceleration in the path of fiscal consolidation. The revised Fiscal Deficit for FY24, despite a lower nominal GDP, is estimated to be lower at 5.8% of GDP; this was contrary to expectations of a mild slippage from the earlier Budget Estimate of 5.9%. In addition, the FY25 estimate has been sharply reduced to 5.1% of FY25 GDP. This will boost investor sentiment, both domestic and foreign, on India’s macro-financial stability.

After 3 years of 7%+ growth, a Viksit Bharat dream will need to sustain 10-15 years at these levels, a large part of which is likely to emerge from last mile reforms at the ground level, which will largely be the domain of States

Global investor sentiment on India is important, particularly at a time when in a first, India will be integrated into a global bond index, formalising a financial markets link. The second signal was the continuing focus on the quality of expenditure. The outlay for capital expenditure was further increased from the FY24 revised estimate of Rs 9.5 lakh crores (l.c.) to Rs 11.1 l.c. in FY25 (although the revised estimate is lower than the earlier budget estimate of Rs 10.0 l.c.). This is an increase of almost 17% year on year (yoy) over the revised FY24 outlay. Revenue expenditure, on the other hand, is budgeted to rise only 3.2% yoy in FY25 (although the outlay is substantially larger at Rs 36.5 l.c). Overall, total expenditure growth is 6.1%.

The FY25 forecast growth is reasonable, assuming a 6.5% real GDP growth and 4.0-4.5% inflation

The main takeaway from this interim Budget messaging is macroeconomic guidance, specifically regarding implications on revenue, building on the comprehensive Finance Ministry Review of the Indian Economy 2024. At a time of high global uncertainty, investors will focus on key macroeconomic fundamentals. 

Top level nominal GDP growth is assumed to be 10.5% yoy (relative to the revised estimate), the same as budgeted earlier for FY24. As noted above, though FY24 nominal growth is revised down to 9.5% (although the official Advance Estimate is 8.9%). The FY25 forecast growth is reasonable, assuming a 6.5% real GDP growth and 4.0-4.5% inflation. The budget however does assume a higher buoyancy in tax receipts, around 13% yoy for both direct taxes and Centre GST, higher than the earlier budget rates for FY24. 

Although rate cuts are likely to start much later than the timelines markets are expecting, and be offset to an extent by quantitative tightening and reduced liquidity, markets are likely to start buying bonds in anticipation of expected easing in policy interest rates

This presumably is based on the experience of actual tax collections in FY24, which have been much higher than budgeted, particularly personal income tax. This is a metric which needs to be monitored, since non-tax revenue receipts are unlikely to have robust growth. In particular, the RBI FY24 dividend (to be paid out in April) is likely to be lower than for FY23, due to lower notional and realised profits from accounting for Rupee exchange rates. Realisation of the aggressive reduction in the fiscal deficit target will depend to a large extent on this. 

Sovereign debt denominated in foreign currency (i.e, external sovereign debt) is negligible, and hence there is virtually no risk of default

A consequence of the lower fiscal deficit was the much more restrained market borrowing programme required to finance it. Bond markets rallied strongly, with the yield on the benchmark 10-year Government security falling to 7.06% from the prebudget 7.17% levels. Over the course of FY25, these yields are expected to fall further as Central banks, both G7 global and RBI, transition to monetary policy easing. 

Although rate cuts are likely to start much later than the timelines markets are expecting, and be offset to an extent by quantitative tightening and reduced liquidity, markets are likely to start buying bonds in anticipation of expected easing in policy interest rates. In addition, the expected inflows into government bonds following the inclusion into a global bond index will increase demand from foreign investors. 

There was also a very strong signaling of a continuity in the fiscal thinking and strategy of the Government

This is good news for the Centre’s expenditure compression and the government’s focus on this should be lauded. India’s Centre and State government debt is estimated to be 83% of GDP in FY23 and entails a large interest payout. This is budgeted at Rs 11.9 lakh crores for FY25, a significant jump from the revised Rs 10.6 l.c. for FY24. 

The FY25 interest liability is almost 39% of the total receipts of the centre, post devolution to states. Other committed expenditures like salaries and pension add another 13%. Quasi-committed expenditures like subsidies add another 12-14%, adding up to almost two thirds of the Centre’s net receipts. This leaves very little for other development and capital expenditures, which are met through borrowings. India’s sovereign debt is amongst the highest in comparison to its emerging market peers, with only Brazil among the larger countries having a slightly higher level. The good news is sovereign debt denominated in foreign currency (i.e, external sovereign debt) is negligible, and hence there is virtually no risk of default. 

Global investor sentiment on India is important, particularly at a time when in a first, India will be integrated into a global bond index, formalising a financial markets link

The final salient point is the continuing initiative to incentivise States to increase their capex spends, in large part through linking big financial resources transfers (Rs 1.3 lakh crores in FY25) to milestone-based reforms. After 3 years of 7%+ growth, a Viksit Bharat dream will need to sustain 10-15 years at these levels, a large part of which is likely to emerge from last mile reforms at the ground level, which will largely be the domain of States.
 

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