‘Compared to the interim Budget, the Centre’s revenue position is expected to improve on account of both higher tax and non-tax revenues’
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The final Budget for 2024-25, to be presented on July 23, would be the first Budget of the new government. It is an opportunity for the government to provide its medium-term growth and employment perspective along with its policy priorities. Given the continued global economic slowdown, India will have to rely largely on domestic growth drivers. The short-term objective could be to ensure a minimum 7% growth, while the medium-term objective may be to sustain the real GDP growth rate in the range of 7%-7.5%. This would be facilitated by bringing down the fiscal deficit relative to GDP from the current levels to the Fiscal Responsibility and Budget Management (FRBM) consistent level of 3% in the next three to four years. The employment objective is not independent of the growth objective except for an additional emphasis on the relatively more labour-intensive sectors in the composition of output.

Investment and savings prospects

To ensure a 7% plus growth on a sustained basis, we require a real investment rate of 35%. As in the latest available data for 2023-24, the real investment rate measured as gross fixed capital formation (GFCF), as percentage of GDP, was 33.3 for 2022-23 and 33.5 for 2023-24. Although gross capital formation (GCF) is marginally higher, we need to ensure a level of GFCF at 35% or so in the medium-term to sustain a growth of 7% plus, assuming an incremental capital output ratio of five. The saving to GDP ratio in nominal and real terms were 30.2% and 32.8%, respectively, in 2022-23. Assuming these trends continue, marginal upward adjustments are required in the savings and investment rates to ensure reaching and sustaining a level of 35% of GDP for the GFCF. One point of concern is the recent fall in household sector financial savings which, as per available information for 2022-23, had fallen to 5.2% of Gross National Disposable Income. Since this provides the investible surplus in addition to inflow of foreign capital, it is critical to increase the household financial savings rate to facilitate access to investible surplus at reasonable rates for the private sector.

On the demand side, the contribution of net exports to GDP growth has remained negative or low in recent years due to subdued export prospects. It was at 0.5% points in 2022-23 and (-)2.0% points in 2023-24. Indian service exports are expected to continue to do better than goods exports, which contracted in 2023-24. Until export demand picks up and private investment gathers momentum, India will have to rely on government investment demand to provide support to growth.

Budgetary options

Compared to the interim Budget, the Centre’s revenue position is expected to improve on account of both higher tax and non-tax revenues. The base number for gross tax revenues (GTR) for 2023-24 at ₹34.65 lakh crore, according to the Controller General of Accounts (CGA) actuals, turned out to be higher than the revised estimates (RE) of the interim Budget by a margin of ₹27,581 crore. We expect a nominal GDP growth for 2024-25 to be at least 11%, made up of 7% real growth and 3.8% implicit price deflator (IPD)-based inflation. The rise in the IPD-based inflation as compared to the 2023-24 level of 1.3% is on account of expected higher Wholesale Price Index (WPI) inflation which was (-)0.7% in 2023-24. With a buoyancy of 1.1 and a GTR growth of 12.1%, we expect a GTR magnitude of ₹38.8 lakh crore. This would translate to a net tax revenue for the Centre at ₹26.4 lakh crore after providing for States’ share in central taxes, a shade higher than ₹26 lakh crore provided in the interim Budget.

Non-tax revenues are also expected to be higher, as compared to the interim Budget estimates, due mainly to the Reserve Bank of India (RBI)’s augmented dividends of ₹2.11 lakh crore. We expect the Centre’s non-tax revenues to exceed ₹5 lakh crore. It may be noted that any transfer from the RBI is going to be expansionary since it will have a liquidity effect. This transfer is similar to an extension of credit by the RBI to the government without being treated as debt. Thus, it has implications for monetary policy. However, the improved revenue situation of the central government would facilitate meeting the government’s fiscal consolidation target.

Assuming that the government adheres to the 5.1% fiscal deficit to GDP ratio, as announced in the interim Budget, total expenditure that can be financed amounts to ₹49 lakh crore after taking into account some non-debt capital receipts. This will have to be allocated between revenue and capital expenditures. With the interim Budget expenditure magnitudes, revenue expenditure growth in 2024-25 turns out to be 4.6% over the CGA actuals for 2023-24. This growth may have to be increased to accommodate higher revenue expenditures on account of increased subsidies, increased health expenditures and increased allocations for the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) to support and provide relief largely to the rural population.

Some improvement in rural incomes is expected in the current year with the expectation of it being a normal monsoon. Our estimates indicate that even if the revenue expenditure growth is enhanced to 8%, this would provide additional revenue expenditures close to ₹3 lakh crore over 2023-24 actuals. This would still leave fiscal space to provide for capital expenditure growth of 19.2% in 2024-25 which would be required for supporting investment demand resulting in infrastructure expansion that is consistent with the government’s medium-term objectives. Some tax rationalisation measures may be undertaken as long as they do not imply any significant revenue sacrifice. Some expansion of the ongoing Production Linked Incentive (PLI) scheme, particularly if it supports employment generation, may be considered.

Commit to FRBM targets

In conclusion, the Budget needs to aim at combining growth with stability. Stability includes both price stability and fiscal stability. It is important to signal commitment to the FRBM targets in the short to medium term. If the fiscal deficit to GDP ratio is brought down to 5.1% in 2024-25, it may take another three to four years to bring it down to 3% of GDP. As the fiscal deficit to GDP ratio is reduced and nominal GDP growth is kept in the range of 11%-11.5%, the debt GDP ratio and the interest payment to revenue receipts ratio would also come down, facilitating the reduction in fiscal deficit, thereby creating a virtuous cycle.

C. Rangarajan is former Chairman, Prime Minister’s Economic Advisory Council, and former Governor, Reserve Bank of India. D.K. Srivastava is former Director, Madras School of Economics, and former Member, Twelfth Finance Commission. The views expressed are personal

For representative purposes
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The story so far: The failure of private investment, as measured by private Gross Fixed Capital Formation (GFCF) as a percentage of gross domestic product (GDP) at current prices, to pick up pace has been one of the major issues plaguing the Indian economy. Private investment witnessed a steady decline since 2011-12 and the government has been hoping that large Indian corporations would step in and ramp up investment. In fact, in 2019, the Centre slashed corporate taxes from 30% to 22% hoping that the move would encourage private investment.

What is GFCF and why does it matter?

GFCF refers to the growth in the size of fixed capital in an economy. Fixed capital refers to things such as buildings and machinery, for instance, which require investment to be created. So private GFCF can serve as a rough indicator of how much the private sector in an economy is willing to invest. Overall GFCF also includes capital formation as a result of investment by the government.

GFCF matters because fixed capital, by helping workers produce a greater amount of goods and services each year, helps to boost economic growth and improve living standards. In other words, fixed capital is what largely determines the overall output of an economy and hence what consumers can actually purchase in the market. Developed economies such as the U.S. possess more fixed capital per capita than developing economies such as India.

What is the trend seen in private investment in India?

In India, private investment began to pick up significantly mostly after the economic reforms of the late-1980s and the early-1990s that improved private sector confidence. From independence to economic liberalisation, private investment largely remained either slightly below or above 10% of the GDP. Public investment as a percentage of GDP, on the other hand, steadily rose over the decades from less than 3% of GDP in 1950-51 to overtake private investment as a percentage of GDP in the early 1980s. It, however, began to drop post-liberalisation with private investment taking on the leading role in fixed capital formation.

The growth in private investment lasted until the global financial crisis of 2007-08. It rose from around 10% of GDP in the 1980s to around 27% in 2007-08. From 2011-12 onwards, however, private investment began to drop and hit a low of 19.6% of the GDP in 2020-21.

Why has private investment fallen?

Many economists in India have blamed low private consumption expenditure as the primary reason behind the failure of private investment to pick up over the last decade, and particularly since the onset of the pandemic. Their reasoning is that strong consumption spending is required to give businesses the confidence that there will be sufficient demand for their output once they decide to invest in building fixed capital. Hence these economists have advised that the government should put more money into the hands of the people to boost consumption expenditure, and thus help kick start private investment.

Historically, however, an increase in private consumption has not led to a rise in private investment in India. In fact, a drop in consumption spending has boosted private investment rather than dampening it. Private final consumption expenditure dropped steadily from nearly 90% of GDP in 1950-51 to hit a low of 54.7% of GDP in 2010-11, which was a year prior to when private investment hit a peak and began its long decline. And since 2011-12, private consumption has risen while private investment has witnessed a worrying fall as a percentage of GDP. The inverse relationship between consumption and investment is likely because the money that is allocated towards savings and investment, either by the government or by private businesses, comes at the cost of lower consumption expenditure.

Other economists believe that structural problems may likely be the core reason behind the significant fall in private investment as a percentage of GDP over the last decade or so. They have cited unfavourable government policy and policy uncertainty as major issues affecting private investment. The rise in private investment in the 1990s and the 2000s correlated with the economic reforms programme started in 1991. The drop in private investment, on the other hand, correlated with the slowdown in the pace of reforms in the last two decades under both the UPA (second term) and NDA governments. Further, policy uncertainty can discourage private investment as investors expect stability to carry out risky long-term projects.

What about low private investment?

The biggest cost of low private investment would be slower economic growth as a larger fixed capital base is crucial to boost economic output. The push by the government to increase government investment is also seen as a negative by some who believe that it crowds out private investment.

Others, however, think that government investment compensates for the lack of private investment. It should be noted, however, that private investors are considered to be better allocators of capital than public officials, helping avoid wasteful spending. Further, taxes imposed to raise money for public spending can be a significant drag on the economy.