Budgeting for the future, while maintaining fiscal prudence

Nirmala Sitharaman with budget documents as she arrives to present the federal budget in the Parliament in New Delhi, India, Tuesday, July 23, 2024. (AP Photo)

The Union Budget announcements revealed significant positives for the Indian financial sector, with relatively larger share of benefits for the marginalized segment of the population. The budget proposals had focused on the growth of the informal sector of the economy by announcing various measures of skill enhancement of youth, credit flow to micro, small and medium enterprises (MSMEs) and the income enhancement measures for the rural sector.

The budgetary proposals shall augment the per capita income and further increase the financial inclusion. The proposals to incentivise domestic higher education though interest subvention and the incentives for addition of jobs in the formal sector could also enhance the growth of formal sectors of the economy. All these announcements are expected to improve the bankability of the population and improve the credit flow through the formal channels in the economy over the medium term.

Boost to MSME Sector

Given the significant employment generated by the MSME sector and with a focus on alleviating the stress in the MSME sector, a slew of announcements was made to increase the credit flow to MSME sector. The key ones included the Government of India (GoI) guaranteed credit support to overdue MSME borrowers, enhanced limits for MUDRA loans and reduction in turnover limit of the goods buyers from MSMEs for the mandatory onboarding on receivable discounting platform. Further, new credit guarantee scheme for MSMEs in the manufacturing sector for machine purchases and adoption of revamped loan underwriting models by public sector banks for lending to MSMEs are other key announcements which shall improve the credit flow while providing resilience the asset quality of the lenders.

To match the increased requirements of skilled labor for the industry, the announcements for youth skilling programme in collaboration with industry coupled with various financial incentives to provide formal employment to the youths are also positive, as they improve the formal jobs in the economy.

The housing sector has a multiplier impact on the economy and the continued thrust on PM Awas Yojna (PMAY) with sharp increase in allocations reinforces the housing push by the government. The announcements related to encourage states to reduce stamp duty for purchase of house shall also reduce the cost of ownership of the house. In addition, the announcements for land-related reforms in both rural and urban areas including the digitalization of rural land records and urban bylaws will support mortgage underwriting for the lenders. The reintroduction of the CLSS scheme after a hiatus of one year, which will improve affordability for end-borrowers, augurs well for affordable housing finance companies, as they are likely to see further improvement in demand.

Revision of Tax slabs

Buoyed by the increasing adoption of the new individual tax regime, the tax slabs have been revised, which will provide incremental relief provided to the income taxpayers. Supported by additional receipts, the overall gross and net borrowings for FY2025 have been further cut to Rs. 14.01 trillion and 11.63 trillion respectively. While the reduction is lower than our expectations, the announcements also augur well for the overall interest rates in the economy and not crowding-out the private sector fund raisings. The fiscal deficit, in line with our expectations, has been pared to 4.9% of GDP for FY2025 and reiterated at below 4.5% of GDP for FY2026. However, the new medium term fiscal consolidation path linked to reduction in debt/GDP ratio instead of a clear reduction in fiscal deficit/GDP ratio will remain monitorable.

PSU Banks Ignored

Given the strong performance of public sector banks as well as other government-owned financial institutions, there were no announcements related to capital infusion into these entities, which was entirely in line with our expectations. However, the three public sector general insurance companies getting overlooked once again for capital infusion came as a surprise, as these companies remain severely under-capitalized. With ambitious targets for insurance penetration over the medium term, a significant improvement in the financial health of these companies is the need of the hour.

To further strengthen the lenders, the announcements related to appropriate changes to be brought in insolvency and bankruptcy code 2016 and steps to be taken for reforms and strengthening of tribunals, debt recovery tribunals, and appellate tribunals along with establishment of more tribunals shall provide impetus to recoveries and is positive for the asset quality and profitability of the lenders.

With the heightened concerns on excess activity in derivatives trading, the increase in the securities transaction tax on future and options is not a surprise. Coupled with the increase in the capital gains tax rates with immediate effect, we can expect some moderation in the overall capital market activity levels.