Tax overhaul, populism: ICRA on proposals that Modi 3.0 budget must avoid

The Union Budget for fiscal 2024-25 (FY25) will be presented on July 23, 2024. A lot of ink will focus on what the budget should include. However, here we focus on what the Budget is can exclude / avoid, and rightly so.

Most crucially, the government must abstain from fiscal profligacy in the upcoming Budget. The fiscal deficit must not be allowed to widen beyond the original target of 5.1 per cent of GDP for FY25. As a corollary to the latter, the market borrowings should not be increased beyond the previously announced figure for FY25.

Raising the borrowing figure based on the presumption that it will get easily absorbed by the higher demand generated after India’s inclusion in global bond indices, would not be pragmatic, in our view.

Secondly, the budget should refrain from building unrealistic revenue assumptions. ICRA estimates revenue receipts to exceed the Interim Budget Estimates (IBE) by around Rs 1.2 trillion on account of the Reserve Bank of India (RBI) dividend as well as expectations of higher tax revenue targets. A higher revenue upside built into the July 2024 Budget with a view to expand the cushion for spending, would be imprudent.

This brings us to an associated point, the third in this long list. The budget should also avoid any major changes on the tax front, particularly on direct taxes. Although the number of individual income tax filers have increased substantially over the last decade, the increase in non-zero tax filers has been relatively low. Consequently, while there is the usual clamour to provide relief to the salaried class, the government must resist any measures that sharply reduce the income tax base.

With rural demand witnessing a sustained weakness since the last fiscal, amid the inadequate and uneven monsoon that was seen in 2023, there is admittedly a case to support the same via higher government expenditure.

The government can raise allocations for rural focused schemes and transfers by Rs 50,000-60,000 crore, while keeping the growth in non-interest non-subsidy expenditure in check. However, it must desist from announcing too many new schemes that typically continue to impinge upon budgets in the future. This is the fourth most important thing that the budget proposals should be devoid of.

The upswing in rural demand will, to a large degree, depend upon the turnout of the monsoon and the output of crops in the current fiscal. The catch up in cumulative rainfall vis-à-vis the Long Period Average (LPA) over the last two weeks as well as the India Meteorological Department’s (IMD) projections for above normal rainfall in July 2024 and development of La Nina conditions in the second half of the monsoon season augur well on that account.

The Fifth. On the capex front, we believe that raising the IBE of Rs 11.1 trillion would not be fruitful at the current juncture. Capex has contracted by 14.4 per cent YoY in April-May 2024, and the numbers are typically subdued during the monsoon months. This implies that substantial headroom would be left for capex for the second half of FY2025. Thus, any increment in the aggregate capex number in the upcoming budget is best avoided.

Sixth, the government must not shift its focus away from the quality of spending. The share of capex in total expenditure has continuously risen over the past decade, from 12.0 per cent in FY2014 to 21.4 per cent in the FY24 Provisionals. This has also led to an improvement in the quality of the deficit, with the share of the revenue deficit in the fiscal deficit falling below 50 per cent in FY2024 from over 70 per cent a decade ago, thereby touching the lowest level in 16 years.

Seventh, and lastly, the finance minister must refrain from shifting the fiscal consolidation roadmap further into the future; it must signal its adherence to the fiscal deficit target of sub-4.5 per cent of GDP for FY26, which was announced previously.

Moreover, it must not shy away from the disclosure of the fresh medium-term fiscal consolidation glide path. With FY26 just a year away, it must clearly articulate its intention to continue curtailing the fiscal deficit beyond the next fiscal. This would provide cues to assess the medium-term supply dynamics for G-secs and project the trajectory of the government debt. The end point of this glide path is eagerly awaited.

Overall, a continued focus on consolidation in FY25, and signalling towards the same for the medium term, would help strengthen India’s macroeconomic position. This would be key to prevent run-offs in the financial markets amidst lingering geopolitical risks over the near-to-medium term.