What the Interim Union Budget Might Bring – and the Context in Which to Judge it

With the general elections around the corner, finance minister Nirmala Sitharaman will soon present an interim Union Budget on February 1.

In a political season of announcing and distributing freebies (what the prime minister calls revdis), the finance minister was seen conducting the traditional halwa ceremony recently. Interim budgets in an election year are usually seen as populist budget announcements that project larger-than-anticipated fiscal outlays on electorate-centred welfare schemes, mostly aimed at the poor.

In the Modi government’s own decadal tenure, though, there has been a conscious attempt to avoid populist announcements during the Union budget speeches while attempting to present budgets that appear growth oriented but remain indifferent to acknowledging or addressing key current economic challenges.

It also must be emphasised that the prime minister on his own has often announced electorally sensitive and popular fiscal measures – including the extension of schemes like PMGKAY –  throughout the last few years, with a goal to target poor-centred welfarism in states going to the polls.

In the Union Budget’s overall macro-outlays, however, amidst a larger proportion announced for capital expenditure over the last few Union Budgets, often coming at the cost of essential social/welfare spending, the Modi government has been repeatedly criticised by the opposition for its inability to fight rising inflation and high youth unemployment. Rather, the government does everything in its power to not even let these issues be highlighted in any of the Budget speeches or organised deliberations, with the support of government economists.

Managing ‘vanishing’ middle-class expectations

This author had earlier discussed some of the growing concerns with India entering into a middle-income trap while witnessing a deep, gradual erosion of the promise of upward income mobility for its broader middle-income class.

In terms of expectations, salaried individuals may expect an increase in the basic exemption limit and a higher HRA (House Rent Allowance) in both the old and new tax regimes that can offer troubled middle income classes some relief against the growing burdens of inflationary tax in a period of stagnating real wages and joblessness.

Most salaried classes haven’t seen a substantive rise in incomes (across both urban and rural areas) over the last seven years even though prices of essential consumer and capital goods have continued to rise. The value of the rupee has considerably fallen over time as prices of essentials have gone up, which has added to the fiscal purse of the average Indian household, contributing to greater than 35% household debt to GDP levels (see more on this issue discussed here).

In such a scenario, for those coming as part of the direct income tax base, providing a larger fiscal relief may be desirable for the government. The previous year’s Union budget granted income tax rebates for individuals earning up to Rs 5,00,000, creating expectations among the lower income spectrum, who would anticipate similar rebates in the upcoming interim budget.

There has been also a pending demand to increase the standard deduction limit after it was made part of the new income tax regime in 2023. This might be a much-needed relief for the salaried class that, on class-based vote considerations, has formed the core voter base of for the Modi government in urban India.

In addition to this, salaried individuals who receive House Rent Allowance (HRA) as a component of their salary and are currently residing in rented accommodation are anticipating an upward revision in the existing HRA exemption limit under Section 10(13A).

One may further see a possible extension the benefits of the National Pension System (NPS) to the New Tax Regime. If one looks at the Global Pension Index Rankings, it is observed that India has been poorly ranked across years, presenting a grim picture on the fiscal state of social security for its citizens – particularly for dependents and economically vulnerable sections of the demographic.

Against the needs and wishes of the vulnerable sections and affected-middle income classes in multiple crises shocks, what the Modi government has consistently done is followed a consistent fiscal policy of corporate friendly supply-side economics.

There has perhaps been no government in independent India that has so blatantly supported the elite, wealthy class during crises times with announcements on reductions in corporate tax rates, ad hoc aggressive push to promoting big capital manufacturing enterprises, with incentives for exports through “tax holidays”, responsible for a K-shaped economic growth trajectory.

What more can be on tax reform? 

As argued earlier, in terms of a few tangible fiscal measures, say on the fiscal tax side, a reduction in consumer (indirect) taxes may also help in at least increasing the disposable income of most under the tax base.

Slight tinkering with tax rates helps but more can be done to bring out the indirect tax cost burden on the low-income and middle class. It may also give a much-needed fiscal space for the low-income class to save-spend more on discretion, given how much this income group has struggled through subsequent cycles of high inflation and pandemic induced misery.

Additionally, to create more fiscal space for enhanced social (and welfare) spending, the government could have introduced a more structural, ‘bold’ tax proposal – as a ‘consumption tax’ on the top 1% wealth endowed consumption group.

As explained before, such a tax wasn’t only needed for concerns of distributive equity (the rising gap between the rich and poor or the squeezing of the middle class) but more importantly, this would have given the government more fiscal revenue options on the direct tax end, subsequently reducing its ‘spending-dependence’ on increased government borrowing (which has been very high).

Let’s look at some of the other key macro-overheads reflecting the government’s fiscal outlook.

A backstory on the government’s failed attempt at driving private investment for growth

The present government has prioritised capital expenditure, with the CAPEX rising on a year-on-year basis, with a growth of 28.57% from 2022-23 to 2023-24. Further studies by organisations like Crisil and Jefferies predict that CAPEX as a percentage of GDP will reach nearly 30% in FY24, a decade-high, that will aid India’s resilience against a potential global slowdown.

However, this Capex-fuelled spending has yielded no positive dividends in boosting domestic private investment.

The Modi government has consistently exceeded its budgeted Capex targets in recent years. In FY22-23, the government expended Rs 7.36 lakh crore compared to the revised estimate of Rs 7.28 lakh crore. And for FY24, it has already crossed the 50% mark of the Rs 10 lakh crore that was announced in the budget. On FDI, the total foreign direct investment inflow into India dropped to $70.9 billion in the financial year 2023. There was a 16% decline from last year.

On government capex, the government has aimed to spent roughly Rs 10 trillion on longer term capital expenditure for 2023-24, in the hope of enabling a growth-push objective. The last allocation, announced for FY23 budget, was higher than the Rs 7.5 trillion budgeted for in the previous year and the highest on record.

The year-on-year increase of 33% is only marginally lower than FY22’s 35% jump. The ratio of capex-to-GDP, which rose to 2.7% in 2022-23, was estimated at 3.3% in FY23, as Sitharaman said in the last Budget speech. It is timely to mention, as argued earlier, how the Modi government’s obsessive capex drive push has so far yielded less positive dividends on both, driving macro-growth overall, or in terms of crowding-in private investment opportunities.

The robust 10.4% second quarter FY23 growth in real Gross Fixed Capital Formation (GFCF) reflection past government projects, camouflages the fact that real fixed assets of non-finance and manufacturing companies have actually contracted in real terms (-4.9%/-6.3% YoY), according to a recent policy brief. The share of private capital formation has also declined to roughly 7.8% of GDP (FY23E), while that of the public sector has risen to 10% or so.

My sense is that an increased government capex outlay going forward may actually do very little to change the underlying circumstances for the overall investment situation, where at 75% private sector capacity utilisation, most of the private firms remain reluctant to invest more or in new capacity.

The charts below reflect the full story in data. Margins for companies have plummeted despite high sales growth, and may remain low due to further deceleration in sales. Asset utilisation rations have remained below pre-covid levels and significantly lower than in FY12.

Any additional capex-spending may add more to a rising government debt position which fiscally may remain hidden in the short run but come out to haunt the government in its medium to long term fiscal situation later-imposing a higher revenue and borrowing burden (see here for a longer discussion on this).

There was a time up until when a higher supply side fiscal push that enabled more jobs and labour-intensive manufacturing helped the government ensure more growth and jobs. As per infographics sourced from a brief by SIE (Systematix Institutional Equities) below, observe how the effect of government expenditure on capital intensive projects was exceedingly positive till the decades of 1980s-1990s but post the financial crisis in 2008, greater government spending did not attract expected private capital Investment, which has been seen after the COVID-19 crisis as well.

The planned increase in capital or investment spending is set to continue, rising from the revised estimate of Rs 7.3 lakh crore in 2022-23 to Rs 10 lakh crore in 2023-24. The futility of a failed private investment crowding-in strategy may soon give way to crowding-out effects, which will be subsequently worse for growth prospects in a climate of global investment uncertainty.

Moreover, as the charts below show, many public and private projects under implementation have contracted over time due to several factors. Pace of projects (public and private) under implementation has been much flatter than, as seen in the 2006-2011 period.

Also, as argued before, there is also an increased discrepancy in the overall planned expenditure and the unplanned expenditure ratios when one reviews the revenue vs. capital expenditure account side.

Capital expenditure (plan vs. non plan) also follows a different pattern with actual and budgeted expenditure mapping throughout the years, but, for revenue accounts, when we look at which of it was planned and unplanned, there is still a wide divergence in trend across the years-indicating a large increase in non-plan expenditure overheads (especially prior to 2015).

Aimless capex-bloat coming at the cost of key upward mobility-based welfare spending

To fuel a bloated capex-driven fiscal budget and fiscally afford this amidst weaker than anticipated revenues, the last few Union Budgets not only trimmed social spending but did so in a year when capital expenditure rose substantially. The Modi government has also been responsible for squeezing state governments, inhibiting their fiscal space for supporting welfare schemes.

The most significant reduction in the Union government’s own social spending was observed in the budgeted allocation for the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) scheme, seen below.

Consistent reductions in government budget allocations contributed significantly to the scheme’s inability to create promised employment for job seekers across India, at a time when MGNREGA’s demand in rural areas had significantly gone up (particularly during Covid years). The graph depicts an 18% decrease in budget allocation on MGNREGA.

On the subsidy Bill, during a time of escalating fertiliser prices and dwindling average farmer incomes, the reduction in fertiliser subsidies has gone from Rs 2.25 lakh crore to Rs 1.75 lakh crore. The Ministry of Food and Public Distribution saw a reduction of 30.6% in its allocated budget for the fiscal year 2023-24 compared to the allocations made in 2022-23. The allocations for health and education show minimal increases, even in nominal terms, without adjusting for inflation.

Looking more closely at subsidy-based expenditure, present financial year saw a considerable expenditure on subsidies with Rs 1.97 lakh crore for food and Rs 1.75 lakh crore for fertilisers. The poll-bound year will necessitate an increased subsidy for food, approximating Rs 2.2 lakh crore in the interim budget to facilitate and account for the higher food inflation.

Increased subsidy costs would account for the fluctuations in the minimum support price and the distribution of free food grains under the Pradhan Mantri Garib Kalyan Anna Yojana. Indian economists suggest that the capital expenditure push of the Modi government might slow down in FY2024-25 amidst their focus towards fiscal consolidation and to bring down the fiscal deficit to 4.5% of the GDP by FY26 from the present 5.9%.

What about jobs and job security? 

This is one area, apart from many in the social sector spending outlay, where the current Budget disappoints gravely. This author had earlier argued how vital this Budget was for the government’s effort to intervene on the crisis of joblessness gripping across India.

The finance minister, much like what she has done in the past four to five budget speeches, failed to mention/acknowledge the job creation crisis ripping through sectors across India. Token announcements, like every year, were made with limited effect on ensuring good, decent jobs for the young.

If the government’s effort to ensure upward social and income mobility amongst the youth is centred largely on establishing skill centres for international outreach, then we might sit on the largest ‘brain drain’ of educated, young Indian aspirants abroad than ever seen before. Allocative outlays for targeted job creation across sectors has been avoided by past and current budgets.

In terms of providing job security, an urban version of the MGNREGA programme, that has been the need of the hour for quite some time and advocated for by many policy economists, failed to receive any attention or mention. Even MGNREGA’s own allocation for this year, announced at Rs 60,000 crore, is the lowest made in comparison to what was announced in all of previous years during this term of the Modi government.

In retrospect, 10 years of Modi Government’s failed supply side interventions have led to ‘no gain’ in creating good employment opportunities for the young -at a time when India’s demographic potential has been on a sweet spot, or, in driving private investment opportunities (despite all the fiscal carrots provided), while barely spending on key social-welfare schemes.

The interim budget may do very little to band-aid these structural concerns even if some soaps and candies maybe anticipated in the Government’s projected fiscal outlay announcement and vision before the 2024 Lok Sabha Elections. What’s needed amidst all the noise created over the next week is a careful review of the final details that lie in the published budget documents as against any rhetorical speech that the finance minister may give.

This is part of data-based explainers undertaken every year in a pre and post budget analysis by the InfoSphere team of Centre for New Economics Studies, O.P. Jindal Global University. Team Credits: Amisha Singh, Aditi Desai, Aryan Govindkrishnan, Aman Chain, Jheel Doshi. For reviewing Team InfoSphere’s work, please see its website here.