– By Dr Partha Chatterjee
Each Union Budget has to be seen in the context of the times they were presented in. The most obvious is the budget presented during Covid – it had to account for that shock. Similarly, in 20011-12, the eurozone debt crisis dictated the cautious fiscal approach. What sets the context for the Union Budget to be presented in 2025? Both internal and external factors are at play. According to recent data, India’s GDP growth rate is estimated at 6.4% for the fiscal year 2024-25, which is lower than most forecasts. Inflation eased to 5.22% in December, falling for two consecutive months after breaching the upper limit of the inflation band and rising to 6.21% in October. The external factor that looms large above all is the return of Donald Trump as the president of the United States of America. In his second presidency, though, arguably, he is a little more known factor, there is no doubt that his second term brings a high degree of uncertainty globally. All countries, including India, must prepare for it. Given all of these, the budget must find a way to balance growth and macroeconomic stability.
A growth rate of 6.4% for any country is commendable. However, India has about a quarter of a century to take advantage of its demographic transition. For India to become a developed nation within that period, it would need to grow above 8% every year. This, along with the fact that the estimated growth rate is below expectation, is causing anxiety. The finance minister has to take steps to boost the growth rate and build back confidence in the Indian economy. The general prescription is to do a countercyclical fiscal policy. That would entail cutting taxes and increasing government spending. The finance minister has to be circumspect on both these fronts.
The latest data shows that the direct tax to GDP ratio is the highest in almost a quarter of a century. Yet, that number remains very low at 6.64%. The combined direct and indirect tax ratio is 11.7% in India, which is much lower than the next biggest economies, UK, France, and Italy, in which it is closer to 25%. The OECD average is above 30%. So, while the temptation may be there to cut tax rates, the focus should be on increasing the tax net. Maybe changing some of the slabs for income tax can help boost the sentiments and spur consumption growth. While this is not part of the budget, simplifying GST should be high on the agenda. That will have an impact on both the demand side and the supply side. Moreover, reducing tax rate will also have implications for macro stability. So, what would benefit is tax reforms, not tax cuts.
So, given the uncertainties of our times, what can there be in the budget to ensure that both growth gets a fillip and macroeconomic stability is maintained? The government should focus on two aspects that will increase growth rates and ensure macroeconomic stability – capital formation and productivity enhancement. One important thing to note here is that while growth and macroeconomic stability can sometimes be in conflict, they are necessary for each other. If a country grows at a fast clip, servicing debt is easier, and macroeconomic stability is ensured. Similarly, without macroeconomic stability, it is hard to sustain a high growth rate.
To increase growth rate, the government has to look at how government spending can be increased without jeopardizing macroeconomic stability. In that, the government can probably look back at the Covid period, when it increased government spending while maintaining the debt within sustainable levels. In particular, what the government can focus on is increasing capital formation. This can be done by bringing in concessions and subsidies for investment like the PLI scheme. Yet, as we have seen from the PLI scheme, the effect of this type of intervention has been limited. The government can consider creating an investment arm, maybe in the way NARCL was formed, which can take up equity positions in small to large firms. This will help the firms not only get the required funds to expand their businesses but also manage risks during these uncertain times. The deepening of capital will help the country grow faster and ensure the sustainability of government finances.
To increase productivity, the government should focus on reforms that will relax constraints for businesses. For example, in our research, we found that the Indian labor market is not that dynamic, the chance of getting a job is not particularly high and mobility across jobs is low. A combination of labor market reforms and employment generation at a higher rate, including by firms boosted by government investment, can push the labor market to become more dynamic and increase productivity. The government also needs to increase investment in education to ensure that the current demographic edge we have can be fully utilized by increasing the productivity of the labor force.
While the context of the budget is often determined by factors outside the control of the government, the choices the finance minister will make in the budget will determine the path the economy takes.
(Dr Partha Chatterjee, Dean of Academics and Professor of Economics, Shiv Nadar University, Delhi NCR.)
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