Union Budget 2025: Focusing on 3Cs – Consolidation, Capex and Consumption

Budget

The budget will be presented at a time when the economy is losing some steam on the twin engines of growth - capex and consumption. There is rising clamour that the budget boosts the disposable income of the urban consumer who is reeling under the pressure of rising inflation and slowing income growth. At the same time, capex cycle remains dependent on government support with private corporate capex remaining reticent. The Union Budget will need to provide all this support while remaining fiscally prudent, sticking to the stated fiscal deficit target of 4.5% of GDP for FY26.

Such high expectation come at time when state governments fiscal strategy is turning more towards targeted income schemes and less on capital expenditure. So can the Centre deliver on all three fronts of consolidation, capex and consumption? Are there hidden pockets of fiscal space, if so, where?

Starting with consumption, is there fiscal space to cut income tax and what is the efficacy? Over the last few years there has been a significant pick-up in income tax buoyancy, reflecting greater collection efficiency, formalisation and stock market gains. As a result,  We estimate income tax collection rising to 3.9% of GDP in FY25 and corporate tax collection reducing to 2.9% of GDP. In FY26 fiscal space for only a moderate cut in income tax cut exists, given need to support capex and remain fiscally prudent. The tax cut is likely to be provided under the new income tax regime. We have built-in moderation in income tax revenue growth in FY26, keeping collection as % of GDP flat at 3.9% of GDP.

How effective is income tax cut in boosting consumption? The reach of income tax is limited as only 2% of the population or 2.9% of the working age population pay tax. The reach of indirect taxes is much wider and will be more effective in boosting demand. The revenue collected from indirect taxes which includes GST, excise duties and custom duties is 6.6% of GDP in FY24. In FY25, indirect tax collection is estimated to rise to 6.8% of GDP. The Union Budget only has control over excise and custom duties, while the GST counsel has decides on GST rates.

Capex cycle is another engine of the economy which is showing signs of weakness as both Centre and state government expenditure declined in FY25. The decline was due to shift in focus during the elections. Central government capital expenditure has declined by 12.3%YoY in FYTD25 (Apr-Nov) and state government capital expenditure is lower by 6.1%YoY in FYTD25 (Apr-Nov). For the full year FY25, even after building-in pick-up in capital expenditure by the Centre, total capital expenditure is likely to be INR9.6tn, which is lower than the target of INR11.1tn.

Post Covid-19 the key support to the capex cycle has been the real estate sector and general government. Corporate capex has been tentative given the uncertainty on both domestic and external demand. This is reflected in rising capacity utilization in manufacturing sector despite slowdown in growth in H1FY25. This indicates that fresh capacities are being added at a slower pace. In FY26 Union Budget, focus on capital expenditure will need to be regained with capital expenditure target set at INR11.1tn which was the target for FY25.

Last but not the least, the focus on fiscal prudence needs to be maintained. The Centre has achieved significant fiscal consolidation with fiscal deficit reducing from Covid-19 peak of 9.2% of GDP in FY21 to 5.6% in FY24. In FY25, Central government fiscal deficit is likely to be lower than target levels at 4.7% of GDP (v/s Target of 4.9%). The outperformance is due to lesser capital expenditure. In FY26, the fiscal target should be retained at 4.5% which was the government’s medium-term target. The slower pace of fiscal consolidation opens space to support growth, which is essential as both consumption and investment engine of growth is slowing. Indeed, going forward the pace of fiscal consolidation (or reduction in fiscal deficit as % of GDP) is expected to moderate. Some clarity on this will be available in the Budget when the Centre unveils its medium-term fiscal consolidation plan. From FY27 onwards the fiscal deficit target will be set such that government debt to GDP reduces. This differs from the current practise of targeting reduction in fiscal deficit ratio (as % of GDP). This opens-up space for a more moderate pace of fiscal consolidation and still achieve a reduction in government debt to GDP.

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