Budget: India’s fiscal consolidation is well on track despite hurdles

We don’t think so. Not only does it remain on track, it has gathered significant momentum in the last few years, with commendable fiscal marksmanship and a particular focus on improving the quality of spending. Indeed, both the interim budget in February and the post-election budget in July exceeded expectations on the government’s fiscal deficit target, which is praiseworthy.

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We expect the government to target a fiscal deficit of 4.45% of GDP in 2025-26, down from a likely revised estimate of 4.84% in 2024-25. According to our estimates, there is scope for the 2024-25 fiscal deficit to end this year lower, as we don’t expect the full capital-expenditure allocation of ₹11.1 trillion to be spent, which will likely result in a lower fiscal deficit than the budget estimate of 4.9%.

Once the fiscal deficit has been brought under 4.5% in 2025-26, we expect the government to henceforth focus more on reducing the Centre’s debt-to-GDP ratio over the medium-term. We do not expect any yearly consolidation target as far as the central government’s debt-to-GDP path is concerned, but the endeavour will likely be to bring the Centre’s debt-to-GDP ratio down to about 50% of GDP by 2030-31 (closer to the pre-pandemic 2018-19 level). If this probable target is achieved over the next five-year period, then it should translate to the Centre’s fiscal deficit reducing further to 4% of GDP by 2030-31 (representing 10 basis points of consolidation each year between 2026-27 and 2030-31).

Assuming the fiscal deficit of states stabilizes at 2.6-2.7% of GDP, this can result in the combined government deficit falling to a low of 6.6-6.7% within the forecast horizon. As far as the consolidated public sector debt-to-GDP trajectory is concerned, our analysis of India’s debt sustainability indicates that by 2030-31, the ratio will likely fall below 75% of GDP, back to the pre-pandemic level, from about 79.4% estimated in 2025-26. A steady fiscal and debt consolidation path should open up room for a sovereign rating upgrade soon.

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We expect the central government to factor in nominal GDP growth of 10.5% in 2025-26, versus 9.7% likely in 2024-25. This will implicitly assume 6.5-6.7% real GDP growth and 3.8-4.0% average inflation, as measured by the GDP deflator. The Centre’s capital-expenditure allocation has increased considerably over the last few years, but this seems to have hit a peak. The target for 2025-26 is likely to be kept at ₹11.1 trillion (3.1% of GDP). This will constitute about 14.5% year-on-year growth from the likely revised expenditure of ₹9.7 trillion (3% of GDP), as opposed to the 2024-25 budget estimate of ₹11.1 trillion (17% year-on-year increase; 3.4% of GDP). In 2023-24, actual public sector capital expenditure was ₹9.5 trillion (3.2% of GDP), up 28.2% from 2022-23 ( ₹7.4 trillion; 2.7% of GDP). 

Over the last few years, the government has done a lot to crowd-in private sector and state government public investment. Now, it is the turn of the private corporate sector and various state governments to boost allocation for capital expenditure to support good-quality growth.

The quality of fiscal spending has improved significantly, but seems to have peaked, given that the Centre’s capital- expenditure allocation is reaching a peak and it may be difficult to reduce revenue expenditure further, as most of these outlays are by definition “committed expenditure.” We expect the authorities to aim at maintaining the revenue deficit-to-fiscal deficit ratio in the 35-40% range in 2025-26.

With India’s growth momentum having weakened, the budget is likely to act in support of private consumption. There could be some tax cuts for middle-income households, which could help increase disposable income and consequently provide an incremental boost to consumption. Allocations for agriculture, the rural employment guarantee scheme and rural development, urban development, affordable housing, health, education and social welfare are also likely to be increased by varied degrees. 

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Following through from the July budget, it is likely that the government will announce various tax reforms aimed at simplifying tax laws and providing incentives that benefit both the middle class and corporate sector.

But ultimately, monetary policy will have to do the heavy lifting to support growth in 2025 and beyond, while fiscal policy continues on the path of consolidation. Otherwise, the economy would face a non-trivial risk of falling behind the curve.

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We think the time has come for the Reserve Bank of India to cut its policy repo rate in February by 25 basis points and then another 25 basis points in April. In addition to rate cuts, a continuation of this week’s liquidity easing measures will be critical to support economic activity (such as another $5 billion of buy-sell foreign exchange swaps and more open-market-operation purchases in the period ahead). The sooner the rate cuts are delivered by the central bank, the lower will be the growth sacrifice.

The author is chief economist, India, Malaysia and South Asia, Deutsche Bank.