Unemployment and inflation call for revising budget priorities

While the government’s resource position appears to be robust with a buoyancy of the Centre’s gross tax revenues of ₹1.4 trillion in 2023-24 and the Reserve Bank of India’s (RBI) dividend of ₹2.11 trillion, some of the expenditure cuts in the interim budget may have to be re-examined.

On a trend basis, revenue expenditure growth in recent years was limited to 3.7%, 7.8% and 1.2% in 2021-22, 2022-23 and 2023-24, respectively, as per Controller General of Accounts (CGA) data. 

The interim budget’s growth was 4.6% over the 2023-24 actuals.

Such continued low revenue expenditure growth became possible by a steady reduction in major subsidies from ₹6.9 trillion in 2020-21 to ₹3.8 trillion in the 2024-25 interim budget.

Allocations under the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) also fell to ₹60,000 crore in the 2024-25 interim budget from ₹1.1 trillion in 2020-21. Further, the government may be inclined to accelerate filling vacant positions, which might also lead to increased revenue expenditures.

In light of these likely changes, the government may have to decide whether to maintain capital expenditure (capex) growth, which had averaged 29.7% from 2020-21 to 2023-24, or accelerate the reduction in fiscal deficit relative to gross domestic product (GDP) to show its commitment to fiscal consolidation.

While reasonable growth in government capex is critical for maintaining 7%-plus real GDP growth, a reduction in the fiscal deficit would have a positive impact on India’s credit ratings.

The government is likely to continue its emphasis on maintaining a high growth in capex, which was close to 17% of the interim budget.

The CGA actuals reflect an improvement in the Centre’s fiscal deficit to 5.6% of GDP in 2023-24 from the earlier revised estimate of 5.8%. In the final budget of 2024-25, it might be reduced to close to 5% of GDP.

Inflation challenges

Since September 2023, the RBI has successfully kept consumer price inflation within the target range of 2-6% as per the monetary policy framework. However, the structure of consumer price inflation is a problem.

Food inflation, in particular, averaged 7.5% in 2023-24 and 8.7% in April 2024. This is one major reason for household dissatisfaction, and is partly due to lower agricultural growth of 1.4% in 2023-24. Some support to rural incomes would be required by increasing the MGNREGS allocations, but the employment issue requires more broad-based policy attention.

Growth prospects

The new government has a solid take-off point in terms of GDP growth performance of 8.2% in 2023- 24. This aggregate growth has two notable features. First, real GDP growth is a full percentage point higher than growth in gross value added (GVA) of 7.2%. Such a large difference between these two rates is quite unusual.

This has been predicated by a sharp reduction in subsidies, which may not be replicated in the future. As such, it is the GDP growth which would come closer to the lower GVA growth.

The second feature is that the nominal GDP growth is 9.6% which is only 1.4% points higher than the real GDP growth. Such a small difference is also unusual. This is predicated on a relatively low implicit price deflator-based inflation of only 1.3%. This may also not be continued in the next few years. A more sustainable growth profile would be to target a real GDP growth of 7% and a nominal GDP growth of 10 to 11%.

Even for 7% real GDP growth, we require a real investment rate of 35-36% with an assumed incremental capital-output ratio of 5. In this context, for improving the private investment rate, the interest rate would have to be lowered. This is currently constrained by, among other factors, the recent fall in the household financial savings rate to close to 5% of GDP from its average level of 7%-plus in recent years.

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Lower interest rates and an improvement in consumption expenditure growth are critical for inducing private investment to pick up. Private final consumption expenditure growth was only 4% in 2023-24 while government final consumption expenditure (GFCE) growth was even lower at 2.5%. As government revenue expenditure growth increases, there would be some improvement in GFCE growth.

Robust growth in government and private investment expenditures is important for sustaining a 7%-plus real GDP growth rate in the medium term.

(D.K. Srivastava is chief policy adviser, EY India. Views expressed are personal.)