Government spending and the challenge of fiscal consolidation in FY25

Interim budgets tend to be tame affairs confined to making tax and expenditure provisions only until a new government is in place and ready with its own budget. The finance minister has recently put paid to expectations that the February interim budget would somehow deviate from this protocol. Thus, instead of dwelling on the budget itself, it might be worthwhile to assess how the fiscal books have fared in 2023-24 and how 2024-25 is likely to pan out.

For 2023-24, the fiscal deficit is likely to be in line with the target of 5.9% of gross domestic product (GDP) with the government taking one more step toward getting back to a sustainable fiscal path after deviating sharply in the pandemic period. There has been some overrun in expenditure—higher spends on Mahatma Gandhi National Rural Employment Guarantee Scheme and fertilizer subsidies are examples. However, healthy tax collections, higher dividends from public sector companies and some cuts in expenditure for ministries that have fallen behind the curve in absorbing budget allocations should ensure that the fiscal gap does not exceed the target amount. Moreover, some savings from lower capital expenditure are likely, particularly as states are unlikely to spend the entire allocation for interest-free loans by the Centre this year.

What are the challenges and supports for 2024-25? First, it is imperative that fiscal consolidation continues and crosses the next milestone for the deficit of 5.3% of GDP set by the finance minister for 2024-25. Going by any metric, deficits over 5% are extremely high and saddle the government with a growing interest bill that potentially crowds out more productive expenditure. Besides, in an increasingly crisis-prone world, fiscal interventions might be needed to counter unexpected turbulence. It is prudent to create fiscal space by pruning the budget gap as much as possible in more clement times.

However, consolidation means less borrowed money that the government has to fund expenditures. The question then is: how can the government fund critical spends without compromising the deficit? This brings us to the key challenge—ramping up the disinvestment and asset monetization programmes that have lagged their targets substantially over the last few years.

There might be another buffer though. With several of the Centre’s flagship welfare schemes near completion, the incremental capital expenditure required for them will go down. The rural Awas Yojana scheme (with an allocation of ₹54,000 crore in fiscal year 2024), for instance, has a completion rate of 85% and is scheduled to end by this year. Similarly, the bulk of the work under the rural drinking water (Har Ghar Nal Se Jal) mission and urban housing (Pradhan Mantri Awas Yojana—Urban) schemes has been done. While more allocations might be needed to enter the second phase of these schemes, the amount is likely to be small and this might provide some space to fit in other spending heads.

What should the government spend on in 2024-25 and beyond? Over the past few years, the government has successfully changed the so-called “expenditure mix” with capex improving relative to revenue spends. This has helped in three ways. First, filling the gap that patchy private investments has created. Second, capex multipliers are known to be much higher than revenue spending multipliers. Thus, this switch to investment spending has helped spur growth. Third, it has helped address the infrastructure deficit, both physical and digital, to enable a more competitive business environment.

However, while growth has picked up and measures like the Niti Aayog’s multidimensional poverty index (a composite of benefits both from higher income as well as the myriad welfare programmes such as access to potable water) show a significant improvement in the standard of living in the more backward states, more needs to be done to improve the quality of the workforce. Health, nutrition and education spending is imperative. They often involve spending under revenue heads. A healthier, more skilled workforce is necessary for a pivot toward labour-

intensive manufacturing and better paid services.

Besides this, two major groups deserve attention. First, small and marginal farmers who have not entirely benefitted from the spectacular growth in Indian agriculture over the last decade (averaging 4%) need more support. Second, greater participation of women in the workforce can be a force multiplier for long-term growth and fiscal policy needs to work toward this. The success of schemes like Ladli Behna Yojana in Madhya Pradesh and the Kalaignar Magalir Urimai Thittam in Tamil Nadu might provide a template for a more pan-national programme for women’s welfare.

Finally, fiscal strategy must take note of the global environment that it is likely to face. India might face headwinds from slowing global growth. However, globally and locally, inflation is likely to fall, taking interest rates down with it. Coupled with the fact that Indian sovereign bonds will be included in a key global bond index, this means that the government could narrow its fiscal gap with much cheaper loans.

The biggest risk in 2024-25 probably stems from geopolitics. There is a chance of escalating tensions in West Asia and more muscle-flexing by China over Taiwan. However, these are not the only wars to fret over. The fear of tariff wars might escalate with their invariable consequences for economies, should the likelihood of a Trump presidency in the US increase.

Abheek Barua is chief economist at HDFC Bank.