View: Prudence triumphs over populism before polls

Budgets are about the choice between prudence and populism. This choice becomes starker in a pre-election year. Hence, the government’s choice to set the FY25 fiscal deficit target at 5.1% of GDP is an unexpected positive surprise. The pace of consolidation at 0.7 percentage points is steep and sends a very strong signal that prudence triumphs populism, even ahead of elections.

One could argue that this is just an interim budget, and the final numbers will be different. That’s not true. Our analysis of the fiscal deficit targets set in the interim budget and the final budget in the last two election cycles (in 2014 and 2019) shows that the interim targets are usually retained.

So, why is the government opting for faster consolidation? We see this as the government’s signal to five constituents: private sector, foreign investors, rating agencies, the RBI and politicians.
First, the government has followed a well thought-out fiscal strategy over the years. After the big fiscal slippage during the pandemic, the pace of consolidation was slow, and spending was initially focussed on support measures (since lockdowns meant lower capex multipliers), but this pivoted towards public capex after 2021-up 25-30% y-o-y, on average-in order to crowd-in private investments. The faster consolidation now reflects the government’s confidence that the private sector is investing, and is a signal to them to invest more.
Of course, the government is not stepping back completely. Capex is budgeted to rise by 16.9% y-o-y in FY25, and as a share of GDP, capex will still rise to 3.4% in FY25 versus 3.2% in FY24.Second, the decision to lower gross borrowing to INR14.1trn will reduce bond supply at a time when there will be more demand from foreign investors due to India‘s bond index inclusion. The favourable demand-supply gap, the stable currency and expectations for a turn in the monetary policy cycle sometime in FY25-is a signal to investors to invest more in India.Third, despite India’s strong growth recovery, positive medium-term growth prospects and stable external sector fundamentals, rating agencies see India’s high fiscal deficit (and public debt) as its weakness when compared with similarly rated peers. The government’s faster consolidation strengthens its commitment to attain a fiscal deficit narrower than 4.5% of GDP by FY26, and is a signal to rating agencies to revisit their framework.Fourth, fiscal prudence is a signal to the RBI that fiscal policy will complement monetary policy in its aim to achieve high growth, sustain low inflation, while prioritising macro stability.

Finally, the budget is also a political signal of the government’s confidence regarding the upcoming elections, due to its focus on inclusive growth, success in recent state elections, the consecration of the Ram temple in Ayodhya and signs of fractures in the opposition alliance.

But are the assumptions behind the aggressive consolidation credible? We believe there will be some hits and misses. The nominal GDP growth assumption of 10.5% appears achievable, given the expected pickup in WPI inflation. Tax buoyancy-the ratio of growth in tax collections to nominal GDP growth-is assumed at 1.1x in FY25, which looks more likely, after the surge to 1.4x in FY24. We do see a risk that revenue expenditure growth will be higher than budgeted, and do not believe that a broad-based private capex cycle is underway, which are potential risks to monitor, but a rejigging of expenditure components might still enable meeting the fiscal deficit target.

Ultimately, the interim budget was a platform to signal intent. By choosing a faster pace of fiscal consolidation, the government has signalled confidence.