Will Budget 2025 emerge as the growth Chyawanprash?  

Growth will take time to recover, as all policies come with varying transmission lags.

By Aurodeep Nandi

The Indian economy faces a trifecta of slumps.

First, urban consumption has slumped, hit by stagnating incomes, rising delinquencies, slowing credit growth, and tight policies – monetary, macroprudential and fiscal.

Second, private investment has slumped, despite years of concessional tax rates for new manufacturing firms, the ambitious Production Linked Incentive (PLI) schemes and aggressive public infrastructure spending. The private sector has largely underwhelmed in generating investments, jobs and salaries.

Third, public capex has slumped this year. While government departments admittedly had a late start due to the model code of conduct on general elections, even after the new government took charge in July, the pace of projects has struggled. Compared to an annual capex budget of 3.4 percent of GDP, we now expect the government to only be able to achieve 2.9 percent of GDP.

Backdrop to the budget

That said, there are other considerations beyond growth. The government has committed to achieving a fiscal deficit of below 4.5 percent of GDP in FY26 from 4.9 percent of GDP budgeted this year. This is particularly significant as it would mark the successful unwinding of the Covid-led fiscal expansion (when the fiscal deficit shot up to over 9 percent of GDP) and return it back to pre-pandemic levels. In view of India’s chequered past on fiscal discipline, this is a hard-won victory on fiscal credibility, and the low fiscal risk premia is an important factor to consider in the ongoing environment of currency weakness.

Also, the Budget gives the government the opportunity to do its bit in attracting capital flows and reducing the current account deficit, which in turn could limit pressure on the currency.

Finally, the Budget comes in the context of a Trump 2.0 world, where US-China trade tensions could create opportunities for manufacturing value chains to shift to India.

In this macro environment, with competing objectives, what can be reasonably expected from the Budget?

Plausible changes in the budget

On the headline fiscal deficit announcement, we expect the government to stick to its commitment and pencil in a target of 4.4 percent of GDP in FY26, down from a downwardly revised 4.8 percent in FY25. That said, we also do not think that fiscal discipline and support to growth are mutually exclusive objectives.

To support consumption, reports suggest that the government may tweak the personal income tax slabs and focus on increasing disposable income for the middle class. The marginal propensity to consume tends to be higher for lower-income households and this can provide a fillip to consumption in the near term.

With private capex still weak, we expect the public capex budget to increase by 12.5 percent y-o-y in FY26. This would lift capex to 3 percent of GDP in FY26 from our estimate of 2.9 percent in FY25. Additionally, the government could relax the conditions attached to loans given to states, to enable them to spend more. With the government facing what it calls institutional capacity constraints, we do not expect the prior-year run rates of ~20 percent y-o-y capex growth to recur.

To boost domestic manufacturing and attract global value chains to India, reports suggest a concessional corporate tax scheme for firms that use India as a hub for manufacturing, lower custom duties on intermediate inputs and higher import duties on products to counter China dumping.

Repetitive food price shocks have highlighted the importance of raising investment in cold storage and agriculture infrastructure to shield farmers from excessive food price fluctuations. The budget allocation for agricultural investment should, therefore, rise.

The Budget could raise the customs duty on gold imports (this was lowered in July 2024), as rising gold imports are weighing on the current account. Additionally, to encourage foreign capital inflows, it could increase the FDI limit in the insurance sector to 100 percent from the current 74 percent. Allowing public sector companies to tap more overseas funding could also be announced.

We are also keeping our antennae out for what will happen after FY26. Last year’s budget speech stated that from FY27 onwards, the “endeavor will be to keep the fiscal deficit each year such that the central government debt will be on a declining path as a percentage of GDP” (that is the government is looking to move from targeting the fiscal deficit to targeting debt). We expect more clarity on the medium-term fiscal rules to be provided in this Budget.

Growth cost is getting too high

More generally, we smell change in the policy air. India’s confluence of tight fiscal policy through disciplined fiscal consolidation, tight monetary and stable exchange rate policy through the tolerance of higher interest rates, and tight macroprudential policy to curb frothy retail credit – have exacted a growth cost. As that cost is becoming more evident in weaker growth readings, policymakers are starting to unwind.

The earliest sign was the new RBI Governor, Sanjay Malhotra loosening the RBI’s grip on the currency and sending in the cavalry to tackle the liquidity crunch through three bold measures (Rs 600billion in OMO purchases, Rs 500 billion for a long-dated VRR auction and $5bn for a buy/sell swap auction). We believe that a growth-targeted Budget will mark another shift in the policy trajectory. This should be followed by the RBI delivering its first policy rate cut in the February Monetary Policy Committee meeting in the forthcoming week, in our view.

Growth will take time to recover, as all policies come with varying transmission lags. But the change is important. After all, the first step to solving a problem is recognizing there is one.