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Informist, Saturday, Feb. 1, 2025

 

By Shubham Rana

 

NEW DELHI – With the sharp increase in capital expenditure in the last four years failing to revive private investment, Finance Minister Nirmala Sitharaman seems to have put her bets on large income tax breaks to revive growth in the Indian economy, which has hit a four-year low of 6.4% this year

 

There is no denying the virtues of capital expenditure as a driver of growth. Ever since the Narendra Modi government first came to power in 2014, it has bet big on capital expenditure because of its high multiplier effects in terms of promoting economic activity, creating jobs, and crowding in private investment. Tax cuts, on the other hand, give the government relatively a lesser bang for its buck.

 

It is no wonder that since the start of the decade, the government increased capital expenditure sharply in a bid to revive the economy, which was left battered by the COVID-19 pandemic. Capital expenditure as a share of GDP is projected to rise to 3.1% in 2025-26 (Apr-Mar) from 1.7% in FY20.

 

But this reliance was unlikely to sustain forever with government capital spending seen running into capacity constraints over the last two years. Government capital expenditure was lagging last year's spending until December and the Budget has lowered FY25 allocation by nearly INR 1 trillion. This is the second consecutive year in which the government failed to complete the targeted amount of capital expenditure.

 

Economists have said that the government has hit a peak on how much capital expenditure can be increased every year, necessitating a change in the growth strategy. Many economists have been for some time advocating a cut in income tax rates to boost consumption, but the government chose to continue putting its money on capital expenditure instead.

 

But now, matters seem to have come to a head because of the rising risks to growth and glaring limitations to increasing capital expenditure. The government could no longer afford to block fiscal space for such spending, only to see it unutilised at the end of the year, resulting in greater-than-intended fiscal contraction. It has understandably opted for a less potent, but perhaps more reliable growth lever in the form of tax cuts. Next year's capital expenditure target is seen growing 10% to INR 11.21 trillion, in what would be the slowest growth in allocation since the pandemic.

 

At the same time, Sitharaman has chosen to target urban consumption, one of the biggest reasons behind the growth moderation this year. Once again, in the several pre-Budget meetings that Sitharaman held with various stakeholders, the common demand was to cut income tax rates. This time, she listened and how.

 

Sitharaman announced that there will be no tax on personal income of up to INR 1.2 million, a move aimed at reducing the tax burden and increasing disposable incomes. Sitharaman also tweaked the income tax structure to aid savings and investments of individuals across the income strata. The revised tax slabs will lead to the government forgoing revenue to the tune of INR 1 trillion per annum.

 

At a post-Budget press conference, Finance Secretary Tuhin Kanta Pandey said the government is hopeful that income tax rate cuts will return to the economy as spending and investments.

"The budget has tried to balance the twin objectives of fiscal discipline and supporting growth. At the margin, there is a tilt towards supporting consumption through tax cuts for middle class households, relative to the public capex push seen over the last four years," said Sonal Varma, chief economist, India and Asia ex-Japan at Nomura.

 

Notably, the government has been able to provide tax breaks without compromising on the quality of its fiscal metrics. The government has targeted a fiscal deficit of 4.4% of GDP for FY26 and has also lowered this year's target to 4.8% of GDP from the 4.9% of GDP. It has also projected a lower revenue deficit of 1.5% for FY26, down from the revised estimate of 1.9% for the current year, showing mindfulness about the quality of deficit.

 

Economists are divided on the efficacy of tax breaks to boost consumption--some had suggested more capital spending to revive demand.

 

According to Nomura's Varma, the growth impulse from the Budget should be marginally positive for FY26. Shilan Shah, deputy chief emerging markets economist at Capital Economics, said the tax breaks should provide some support to household consumption but, "overall, the measures fall some way short of constituting major stimulus."

 

"Incorporating today's fiscal announcement and recent measures by the RBI (Reserve Bank of India) to ease inter-bank liquidity deficit, likely shallow monetary easing, inclination towards greater exchange rate flexibility and focus on persistent structural reforms, should help to boost India's growth towards 6.5% in FY26-27," UBS India Chief Economist Tanvee Gupta Jain said in a report. Sitharaman will be extremely disappointed if the tax breaks end up in just a 10-basis-point increase in GDP growth over the next two years.  End

 

Edited by Saji George Titus

 

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