Budget 2024 | Government will continue on the fiscal consolidation path

Higher revenues will offset the higher spend on subsidies and NREGA.

With the general elections a couple of months away, Finance Minister Nirmala Sitharaman will table an interim budget on February 1.

Although an interim budget has only the ceremonial value, it will be watched keenly by the bond markets for three things: (1) How much slippage if any is expected for FY24? (2) What would be the government target for FY25? (A faster pace of consolidation would suggest that the government's fiscal deficit target of 4.5 percent by FY26 is more credible) and, last but not the least, (3) What are the expected net market borrowings for FY25 and thus what is the likely impact on 10-year yields.

We expect improvement in the tax-to-GDP ratio and believe budget estimates may prove conservative.

Gross taxes in FY24 revised estimate should be Rs 1 trillion, or 3 percent higher than the budget estimates, despite lower nominal GDP and, given better tax buoyancy. Large one-time increase in dividends would help as well. Income tax collections are estimated to grow at 22 percent on-year from FY23 revised estimate. FYTD, they have clocked 29 percent growth. The steady 5-bps annual improvement in personal income tax as a share of GDP from 2001 to 2019 has accelerated after Covid, rising 20bps per year.

The steady decline in corporate income tax as a share of GDP between 2008 and 2019 has also reversed. Corporate tax collections FYTD grew 20 percent on-year. We, however, expect only 12.3 percent annual growth for FY24. Indirect taxes have been relatively steady as a percentage of GDP, with volatility only due to changes in excise duty on fuel.

Gross central taxes as a proportion of GDP are thus the highest after 2008. We believe revenue receipts will grow faster than nominal GDP in FY25 but expect the government to make conservative assumptions.

Spending consolidation through big cuts are unlikely but the government will keep the spending growth below NGDP growth.

The government budgeted for the FY24 subsidy bill to fall 28 percent YoY, but they may fall only 19 percent YoY, as demand for supplementary grants point to subsidies being Rs 0.5 trillion higher than the budget estimate (food, fertiliser and even LNG). Added to higher than budgeted spend on NREGA and a few other heads, this means FY24 (revised estimate) revenue expenditure may be Rs 0.7 trillion higher than the budget estimate. For FY25, we estimate the subsidy bill to fall 14 percent (mainly due to lower global fertiliser prices), and expenditure ex-subsidies to grow 6.8 percent YoY (+13 percent in FY24 budget estimate), mainly as growth in interest costs slows (falling deficit ratios), and capex growth may slow to 15 percent (+37 percent FY24 budget estimate) , as a recovering economy needs less fiscal support.

Deficit financing likely to get easier

While the FY24RE deficit may be the same as budgeted, due to lower nominal GDP growth, the deficit ratio may be 6 percent. We expect the ratio to fall to 5.3 percent in FY25BE, with the primary deficit ratio of 1.7 percent close to FY20’s 1.6 percent. It needs to fall to 0.8 percent by FY26 to achieve the 4.5 percent fiscal deficit target. Government ‘crowding out’ of the private sector is progressively less of a concern (but some distance to go): an unchanged deficit for four years (FY23-26) makes it easier to finance it. FY25 should be particularly better as in addition to flows due to the JPM bond index inclusion (though some front-loading is visible in FY24), FY24 non-market borrowing (via small-savings) may be Rs 1-1.5 trillion higher than the budget estimate. An unchanged FY24 borrowing calendar, and current high cash balances suggest net issuance in FY25 could be Rs 2 trillion lower YoY.

In summary, we expect FY24 revised deficit to be largely unchanged vs. budget estimates, but lower nominal GDP may raise the ratio by 8bps to 6 percent. Higher revenues will offset the higher spend on subsidies and NREGA. For FY25, we expect government to stick to the consolidation path with fiscal deficit at 5.3 percent of the GDP. While an unchanged absolute deficit makes it easier to finance, higher-than-expected non-market borrowings point to net borrowing being Rs2tn lower vs. FY24.

Author is deputy managing director of Axis Bank. Views are personal