Overreliance on fiscal policy harms India’s economic growth prospects 

Part of the reason for economic slowdown as compared to expectations is the continuing global economic slowdown.

By DK Srivastava 

The year 2024 was characterised by the presentation of two union budgets: an interim budget in February and a final budget in July. In the interim pre-election budget, the Government of India (GoI) maintained fiscal discipline by not announcing any substantial fiscal giveaways. Its main intervention was to extend the ongoing Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) for another five-years.

However, since this scheme was already in operation, this did not imply any additional commitment beyond what was being spent, except for some inflation adjustment. The interim budget also continued the emphasis on GoI’s investment expenditure growth which has been the main growth driver for the Indian economy in the post Covid years. It also continued with an emphasis on fiscal consolidation by reducing fiscal deficit to a budgeted level of 4.9 percent of GDP.

Shortfall in meeting investment target hurt growth

This structure of priority continued in the final budget, except that it also contained a set of ambitious employment linked incentive schemes (ELI). While in terms of budgetary targets and allocations, these appeared to be consistent with the ongoing headwinds emanating from the global economy, the main disappointment arose from the implementation of these budget initiatives. First, instead of meeting the GoI’s investment growth target of 17.1 percent (over the CGA actuals for FY24), the first seven months witnessed a contraction to the extent of (-) 14.7 percent.

This became the main reason why the July-September 2024-25 quarter real GDP growth fell to 5.4 percent. The first half 2024-25 real and nominal GDP growth has been estimated at 6 percent and 8.9 percent respectively. The final budget had assumed a nominal GDP growth of 10.5 percent. The situation can now be recovered to some extent by accelerated growth in GoI’s investment expenditure in the remaining five months of the fiscal year. However, the likelihood is that we may fall short of the budgeted target since the required growth in this remaining period is more than 60 percent.

Overreliance on fiscal policy

Part of the reason for economic slowdown as compared to expectations is the continuing global economic slowdown. But it is partly also because only one policy driver has played an active growth supporting role namely the fiscal policy. On the monetary side, the repo rate has remained at the level of 6.5 percent for almost two years. The reason for this is a CPI inflation level which has remained at an average of 4.9 percent.

Underlying this average level is a core inflation of 3.4 percent but food inflation of 8.4 percent. Food inflation is a supply side issue and policy makers should find a more satisfactory solution to this continued problem. If this issue can be addressed, with core CPI inflation being less than 4 percent, monetary policy can also be aligned more to support growth.

2025 prospects

Going forward, we expect global economic headwinds to continue. India should target a real GDP growth of 6.5 percent to 7 percent in 2025-26 and in the medium term. The global crude price is expected to remain below US$75/bbl. which is satisfactory for India. The US is likely to encourage increased production of shale oil and gas easing the overall supply situation. Agricultural growth is likely to remain robust next year also.

The monetary policy authorities should now consider a 50-basis point reduction in the repo rate in two steps beginning February 2025. The GoI should aim for reducing fiscal deficit to a level of 4.5 percent of GDP in 2025-26 and maintain a healthy momentum in its investment expenditure growth.

With interest rates being reduced, there is a likelihood that private sector capital expenditure will also gather momentum while government capital expenditure can be targeted to grow at more than 15 percent. This will generate adequate domestic demand. At the same time, it is required that the nominal saving rate exceeds 30 percent of GDP which together with net foreign capital inflow of 2 percent of GDP can give an investible resource of 32 percent in nominal terms and 36 percent in real terms assuming a differential of nearly 4 percent points between implicit price deflator-based inflation of capital goods vis-à-vis all goods and services.

Employment guarantee is better than UBI

GoI should also be able to activate its ELI schemes. In fact, what is needed in India is a universal employment guarantee scheme by adding an urban component to the already existing rural counterpart (MGNREGA). This would be a better option as compared to a universal basic income guarantee scheme.

GoI’s fiscal deficit in the medium-term should be reduced to 3 percent of GDP and government debt to less than 40 percent of GDP. This would reduce the level of interest payments relative to revenue receipts of the GoI. In the next five years, the tax-GDP ratio should also be increased by about 100 basis points. Together these initiatives would help support a real GDP growth of 6.5 percent to 7 percent in the medium term.

(D.K. Srivastava is Chief Policy Advisor, EY India and formerly Director, Madras School of Economics.) 

Views expressed are personal and do not represent the stand of this publication.