Context: The government’s first full budget in its third term had to balance two conflicting objectives: ensuring macroeconomic stability amid global challenges while supporting domestic growth.

The Global Economic Backdrop:

• The global financial environment is tightening due to US exceptionalism, rising dollar value, and persistent high US interest rates.
• A new trade war, with the US imposing tariffs on Mexico, Canada, and China, threatens to further destabilize emerging markets.
• Given this backdrop, a conservative fiscal approach was needed to ensure India’s resilience.

Domestic Economic Challenges:

• Growth in India has slowed, and the ongoing earnings season suggests a delayed recovery.
• A global slowdown could further impact domestic growth, making fiscal support essential.
• The trade-off was between fiscal prudence and allowing for increased government spending. 

Fiscal Consolidation:

• Strategy:
  • The government opted for conservatism, setting the fiscal deficit at 4.8% of GDP, lower than expected.
  • The budget outlines a further reduction to 4.4% of GDP next year, continuing a trend of fiscal consolidation.
  • A buffer against external shocks should be provided by fiscal credibility, a healthy current account deficit and foreign exchange reserves, and inflation that is expected to return to 4%.
  • Strong fiscal discipline is expected to enhance macroeconomic stability and credibility.
• Costs of fiscal conservatism:
  • Lower fiscal deficits constrain government spending in the coming months.
  • Public spending (excluding interest payments) grew by 23% last quarter but will have to slow to 8% in the last quarter of the fiscal year.
  • A reduction in government spending may negatively impact economic growth, shifting the responsibility to monetary policy.

Tax Cuts and Their Trade-offs:

• The budget introduced a tax cut worth 0.3% of GDP to boost urban consumption.
• However, fiscal consolidation largely relied on revenue expenditure compression rather than tax revenue augmentation.
• Lower expenditure multipliers might impact overall economic stimulus.

The Role of Tax Buoyancy:

• Tax buoyancy dropped from 1.4 in 2023-24 to 1.1 due to slower growth.
• The budget assumes a higher tax buoyancy of 1.3, which may not materialize.
• If tax targets are missed, policymakers should allow the deficit to widen rather than further cutting expenditures.

Public Investment and Growth:

• Central capital expenditure has nearly doubled over four years but fell short of targets this year.
• State capital expenditure is also lagging as states prioritize subsidies.
• Maintaining public investment is crucial for sustaining growth and requires enhanced execution capacity.

Way Forward:

• The need for structural reforms:
  • Fiscal stimulus has been the primary driver of growth over the last five years.
  • Future fiscal space will shrink, necessitating a shift toward private investment.
  • Policy measures must provide demand visibility and boost investor confidence ("animal spirits").
• Reform agenda for sustainable growth:
  • The Economic Survey 2024-25 advocates for deregulation and liberalization to lower transaction costs and enhance global competitiveness.
  • Employment-focused reforms are needed, particularly in labour-intensive sectors.
  • Investing in health, education, and skilling is essential to boost labour-intensive growth and increase consumption.
  • Industrial policy should prioritize labour-intensive industries and rationalize labour laws.

Conclusion - A Reform Stimulus Over Fiscal Stimulus:

• The budget signals that India lacks space for further fiscal stimulus.
• The solution lies in a reform stimulus to attract private investment and sustain long-term growth.
• Balancing macroeconomic stability with growth requires structural changes, especially in a volatile global economic environment.