
When consumption push and fiscal consolidation go hand in hand

Summary
- The budget has delivered on changing the narrative on weak consumption demand while continuing on the path of fiscal consolidation and giving a roadmap of reducing India’s debt to GDP to 50% (+/-1%) by FY31, thus setting the base for a likely upgrade of India’s sovereign rating.
The budget this year came in the background of an economic slowdown led by weak urban consumption and lower government capex. Hence, finance minister (FM) Nirmala Sitharaman was expected to stimulate growth while continuing on the path of fiscal consolidation. The budget has delivered on this by incentivizing urban consumption through tax cuts while continuing on the path of fiscal consolidation.
More importantly, by shifting the anchor of fiscal consolidation from fiscal deficit to debt to GDP, the FM has created room for stimulating capital spending from next year. Hence, the budget has addressed both near-term and medium-term growth concerns while continuing on the path of reducing debt to GDP over the long-term.
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The biggest announcement in the budget was for 8 crore income tax filers who on an aggregate basis will save ₹1 trillion in the budget (0.3% of GDP). Assuming a marginal propensity to consume of 0.77, it implies a 0.2% increase in growth in FY26 from FY25. In addition, it should lead to increase in capacity utilization and thus drive investments in the long-term. Given the reduction in income tax, next year’s personal income tax collections are estimated to increase by 14.4%, slower than 20.3% in FY25.
Corporate earnings should rise
Given the pick-up in demand, corporate earnings and tax collections should also see an uplift from an increase of 7.6% in FY25 to 10.4% in FY26. Hence, overall direct tax collections are estimated to increase by 12.7% in FY26 from 14.4% in FY25, which seems achievable on a low base for corporate taxes even as income tax collections may be slightly lower. On the non-tax revenue front, the budget has assumed a buoyant dividend from RBI and public sector enterprises, which is in the backdrop of a depreciating rupee, higher US yields and hence higher income on foreign holdings and higher FX activity undertaken by the central bank.
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On the indirect tax front, the increase is estimated to be 8.3%, which is marginally higher than a 7.1% increase seen in FY25 and is driven by higher goods and services tax. Given the push for urban consumption, higher GST collections are inevitable. On the customs front, collections are estimated to increase by only 2.1% over FY25, with the endeavour being reducing customs duties which should effectively neutralize the impact of a weaker currency and thus is positive for inflation outlook. There is a push towards domestic manufacturing and investments with reduction in custom duties on input and capital goods.
Fiscal conservatism on
On the expenditure side, the budget has continued the path of fiscal conservatism with overall expenditure rising by only 7.4% in FY26 compared with a 6.1% increase seen in FY25. However, capital spending is projected to increase by 10.1% in FY26 compared with 7.3% in FY25. Notably, the budget has projected a much larger increase in effective capital expenditure of 17.4% once grants given to state governments are included. Hence, the budget is incentivizing states to spend on capex, given that this year states too haven’t spent on capital formation.
As has been the case over the last few years, the budget this year too has outdone itself on fiscal target by reducing fiscal deficit to 4.8% as against 4.9% projected last year. The lower actual revised nominal GDP growth at 9.7% from 10.5% assumed in the budget has led to a lower absolute amount of fiscal deficit of ₹15.7 trillion as against ₹16.1 trillion projected in the budget. For next year, fiscal deficit is estimated at 4.4% of GDP, implying absolute fiscal deficit at the same level as FY25. Hence, net market borrowing is estimated at ₹11.5 trillion, which is slightly lower than ₹11.6 trillion in FY25.
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However, gross borrowing number is on the higher side at ₹14.8 trillion as against ₹14 trillion in FY25, and has room to go down if RBI switches some of its holding of government securities. This is also the need of the hour since it would allow RBI to expand its balance sheet and inject much-needed durable liquidity into the economy when balance of payments surplus is muted. In terms of financing of the deficit, the budget has reduced the extent of borrowing from small savings schemes, which tells us the broader direction of deposit rates in the country.
Non-inflationary
The budget is non-inflationary, with government spending estimated at 14.2% of GDP compared with 14.6% of GDP in FY25, which is driven by revenue spending falling to 11% of GDP from 11.4% in FY25 with capital spending being maintained at 3.1% of GDP. Thus, even as urban consumption is being incentivized, it is not at the expense of the quality of fiscal consolidation, which gives room for a monetary impulse by the RBI's monetary policy committee (MPC) by cutting policy rate on 7 February by 25 basis points (bps). We believe that a shallow rate cut cycle of 50 bps at the minimum is possible and the cut in Feb might be followed by another cut in April of 25 bps.
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To summarise, the budget has delivered on changing the narrative on weak consumption demand while continuing on the path of fiscal consolidation and giving a roadmap of reducing India’s debt to GDP to 50% (+/-1%) by FY31, thus setting the base for a likely upgrade of India’s sovereign rating.
B. Prasanna is the head, treasury, and Sameer Narang is head-economic research group, with ICICI Bank.