Growth, Taxes, and Investment: A Budget That is Mostly Good but With One Wrong Move

The Union Budget is a critical document that sets the financial agenda for the country, outlining the government's priorities and financial plans for the coming year. It plays a significant role in shaping the economic trajectory of the nation, influencing growth, investments, and the overall economic direction. The 2025-26 Budget aims to accelerate growth, improve tax structures, and promote fiscal consolidation, all while addressing emerging challenges in the economic landscape. In understanding this budget, it is essential to examine key aspects such as GDP projections, government expenditure, tax revenues, and fiscal transparency.

Key Aspects of the Budget

Economic Growth and Capital Expenditure

• Nominal GDP Growth Projection: The Budget projects a nominal GDP growth of 10.1% for 2025-26, which aligns with the Economic Survey's estimate of real GDP growth between 6.3% and 6.8%.
• Capital Expenditure: A key focus is on increasing capital expenditure, vital for economic development. The Budget allocates ₹11.2 lakh crore for capital expenditure, a slight increase from ₹11.1 lakh crore in the previous Budget. The goal is to sustain growth through infrastructure and industrial investments. However, to meet India’s aspirations of becoming a developed economy, the real GDP growth rate must rise to around 8%.
• Stimulating Economic Activity: While several measures are introduced to stimulate economic activity, some could have been implemented earlier for a more significant impact.

Tax Revenues and Structural Shifts

• Shift in Tax Structure: One of the standout features of the Budget is the shift from indirect taxes to direct taxes, with the share of direct taxes in Gross Tax Revenues (GTR) rising from 52% in 2021-22 to 59% in 2025-26.
• Declining Tax Revenue Growth: Despite this positive structural shift, tax revenue growth has shown a decline:
  • GTR Growth has slowed from 13.5% in 2023-24 to 10.8% in 2025-26.
  • GST Revenue Growth fell from 12.7% in 2023-24 to 10.9%.
  • Personal Income Tax growth has slowed from 25.4% in 2023-24 to 14.4% in 2025-26, partly due to new tax concessions.
  • Corporate Income Tax growth, which was 7.6% in 2024-25, is projected to recover to 10.4% in 2025-26.

Government Expenditure and the Need for AI Investment

• Fiscal Consolidation: The Budget focuses on fiscal consolidation, reducing government expenditure as a percentage of GDP from 14.6% in 2024-25 to 14.2% in 2025-26.
• Improved Quality of Expenditure: The total expenditure growth is 7.6%, which is lower than the projected GDP growth of 10.1%, but the quality of expenditure is improving.
• Investment in Artificial Intelligence: A critical investment area highlighted in the Budget is Artificial Intelligence (AI). The government recognizes the need to develop AI infrastructure to remain globally competitive. With countries like the US and China leading in AI investment, India needs to prioritize AI to stay ahead. The government should incentivize AI research and development through tax concessions and public-private partnerships.

Concerns Over Fiscal Transparency

Departure from the Fiscal Deficit Glide Path

• The Fiscal Deficit is a key indicator of the government’s financial health. In the 2024-25 Budget, the government set a target to reduce the fiscal deficit to below 4.5% of GDP by 2025-26.
• However, in the 2025-26 Budget, this explicit target is abandoned. The focus shifts to reducing the debt-to-GDP ratio annually, which creates uncertainty about the government's fiscal strategy.

Ambiguity in Debt Reduction Strategy

• The new approach involves three different scenarios for reducing the debt-to-GDP ratio, based on varying GDP growth assumptions (10.0%, 10.5%, and 11.0%) and different levels of fiscal consolidation (mild, moderate, and high).
• This uncertainty makes it difficult to evaluate the government’s fiscal performance. The reliance on optimistic GDP growth assumptions introduces the risk that debt reduction projections may not materialize if actual growth falls short.

Risks of High Government Borrowing and Crowding Out Private Investment

• One of the primary concerns is the potential for higher government borrowing, which can lead to the "crowding out" of private investment. When the government borrows more, it reduces the pool of funds available for private companies, resulting in higher borrowing costs.
• This could lead to reduced private sector investment, particularly in key sectors like infrastructure, manufacturing, and technology, thereby slowing economic growth.

Impact on India’s Credit Ratings

• Fiscal transparency is closely monitored by international credit rating agencies like Moody's, S&P, and Fitch. A lack of clear fiscal deficit targets can be seen as a weak commitment to fiscal discipline.
• If fiscal transparency is not reinstated, it could negatively impact India's credit rating, leading to higher borrowing costs for the government, businesses, and consumers, and could divert funds from essential expenditures like infrastructure, healthcare, and education.

Recommendations for a More Transparent Fiscal Policy

• Reintroduce a Clear Fiscal Deficit Target: The Budget should restore clear annual fiscal deficit goals, ensuring better accountability.
• Provide a Detailed Debt Reduction Strategy: Instead of presenting multiple uncertain scenarios, a clear plan for reducing debt levels should be outlined.
• Ensure Realistic GDP Growth Assumptions: Fiscal planning should avoid overestimation and be based on more conservative growth projections.
• Limit Government Borrowing: Prioritize fiscal consolidation and reduce excessive borrowing to avoid stifling private investment.
• Strengthen Transparency in Budgetary Disclosures: More detailed breakdowns of expenditure, revenue forecasts, and borrowing plans will enhance public trust and investor confidence.

Conclusion

The Union Budget for 2025-26 presents a well-thought-out approach to fostering economic growth, reforming the tax structure, and ensuring fiscal consolidation. While the GDP growth projections appear reasonable, the government must increase capital expenditure further to sustain long-term economic development. The departure from transparent fiscal deficit targets raises concerns about fiscal accountability. A more transparent fiscal policy, with clear targets and realistic assumptions, is essential for ensuring sustained growth and maintaining investor confidence.