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Photographic portrait of D.K. Srivastava
D. K. Srivastava

EY India Chief Policy Advisor

6 minute read 22 Feb 2024

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The FY25 Interim budget has struck a fine balance between sustaining growth and achieving fiscal consolidation. 

In brief

  • The FY25 Interim Budget refrained from making any major budgetary commitments.
  • De-emphasizing current expenditure created fiscal space to prioritize growth-stimulating capital expenditures.
  • The Government of India (GoI) has shown a strong commitment towards fiscal consolidation with its fiscal deficit relative to GDP budgeted to fall to 5.1% in FY25 from 5.9% in FY24. 

Over the past decade, India has made significant strides, marked by improvements in the tax-GDP ratio of the GoI as well as on the consolidated account of central and state governments, a shift in the structure of GoI’s expenditure towards capital expenditures, and a sustained reduction in GoI’s subsidy burden. The February 2024 edition of Economy Watch delves into these reforms, and how GoI’s fiscal policy has navigated the country towards stability, growth, and a renewed commitment to fiscal consolidation.

Improvement in tax-GDP ratio

The 10-year period under review can be considered in three distinct parts: (1) FY15 to FY20, (2) FY21 and FY22, and (3) FY23 to FY25 (BE). Starting from a relatively low level of 10% in FY15, GoI’s gross tax revenue (GTR) to GDP ratio increased on a consistent basis to 11.2% by FY18. This improvement in the post-demonetization period was largely due to improved compliance linked to increasing digitalization and formalization of the Indian economy. In the latter part of the first phase, two major tax reforms took place namely, transition to the GST and comprehensive CIT reforms leading to revenue underperformance in the initial years. Consequently, GoI’s GTR-GDP ratio was back to 10% in FY20, the pre-COVID year. In FY21, this ratio remained subdued at 10.2%. In FY22, it increased to 11.5% reflecting a sharp economic recovery. After that, in more normal years, the GTR-GDP ratio incrementally rose from 11.2% in FY23 to 11.6% in FY24 (RE) and is projected to further increase to 11.7% in FY25 (BE).

Chart 1 alt tag: Trends in GoI’s gross tax revenue (GTR) to GDP ratio (%)

The net tax revenue (NTR) relative to GDP indicates the share of GoI’s GTR that accrues to the GoI. The excess of GTR over NTR mainly indicates tax revenues that are shared with the states . GoI’s NTR-GDP ratio increased notably after FY20. The share of states in GoI’s GTR relative to GDP fell from 4% in FY19 to 3% in FY21. This was due both to a fall in the GoI’s GTR to GDP ratio and an increase in the non-sharable central cesses and surcharges. If we look at the share of states in GoI’s GTR, it fell from 36.6% in FY19 to 29.4% in FY21. However, the share of states in GoI’s GTR relative to GDP is estimated to increase from 3.5% in FY23 to 3.7% in FY24 (RE) and FY25 (BE). This translates to an improvement in the share of states in GoI’s GTR from 29.4% in FY21 to 31.1% in FY23 and further to 31.9% in FY24 (RE) and 31.8% in FY25 (BE).

 

GoI’s expenditure structure

 

A second major outcome of fiscal reforms during the last 10 years relates to an improvement in the structure of government expenditures. Considering FY15 to FY25 (BE), the share of GoI’s revenue expenditure in total expenditure has fallen from 88.2% to 76.7%, a margin of 11.5% points. Correspondingly, there is an increase in the share of capital expenditure from 11.8% to 23.3% over this period. Within capital outlay, there is a further trend of increase favoring non-defense expenditure, which implies expenditure on infrastructure.

It is notable that the FY25 Interim Budget steered clear of any significant voter-oriented giveaways. As a percentage of primary expenditure, allocation for major social sector schemes is budgeted at 12% in FY25, close to the average for the last four years.

GoI’s major subsidies

 

One part of revenue expenditure reforms relates to subsidy reforms. The GoI has been able to show a steady reduction in major subsidies which were at its peak relative to GDP at 3.57% in the COVID year of FY21. Since then, this ratio has steadily fallen to 1.16% in FY25 (BE). In fact, the period from FY15 to FY20 witnessed a steady reform aimed at reducing the share of subsidies in GoI’s revenue expenditure primarily by better targeting and delivery to the intended beneficiaries by using India’s substantially improved public digital infrastructure.

 

Recasting fiscal consolidation path

 

A major thrust of the Interim budget was to signal that the GoI has been committed to restoring fiscal consolidation after the COVID shock. In fact, in FY19, the GoI’s fiscal deficit was reduced to 3.4% of GDP with a view to eventually reaching 3% as per the Fiscal Responsibility and Budget Management (FRBM) norms. However, in FY21, GoI’s fiscal deficit to GDP ratio increased to 9.2%, its highest level at least since FY1991. It took concerted effort from then onwards to put GoI’s fisc back on the path of fiscal responsibility in incremental steps. The FY25 interim budget projects FY26 fiscal deficit to GDP ratio at 4.5%. It may take three more years of

incremental reductions of 0.5% points each to reach the level of 3% of GDP. 

 

Finding space for growth supporting capital expenditure expansion

 

It is useful to understand the adjustments in the fiscal aggregates that enabled the creation of adequate fiscal space for the reduction in the fiscal deficit. The first positive element is the improvement in GoI’s GTR which rose from 11.2% of GDP in FY23 to 11.7% in FY25 (BE), providing additional fiscal space to the extent of 0.48% points and 0.24% points of GDP considering GoI’s gross and net tax revenues in FY25 (BE) vis-à-vis FY23. The lower margin in the latter reflects an increase in the share of states’ in GoI’s GTR. The second component of adjustment relates to reduction in revenue expenditures relative to GDP which has fallen from 12.68% in FY23 to 11.94% in FY24 (RE) and 11.15% in FY25 (BE). Comparing FY23 to FY25 (BE), there were additional non-debt receipts to the extent of 0.39% points of GDP and saving in revenue expenditures of 1.52% points. This fiscal space, amounting to 1.91% points of GDP, was utilized for two purposes: (1) reduction in fiscal deficit of 1.24% points and (2) increase in capital expenditures of 0.67% points of GDP. This is why we can consider the FY25 budget as sustaining growth while succeeding in achieving fiscal consolidation.

Table 2 alt tag: Budget arithmetic: FY25 (BE)

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Summary

In the presence of continuing global economic slowdown, India may have to rely largely on domestic growth drivers. In this context, GoI’s strategy to proceed on the path of fiscal consolidation by relatively de-emphasizing revenue expenditures and creating fiscal space for capital expenditure growth aimed at supporting infrastructure development is the most desirable strategy for sustained growth in the medium term.

About this article

Photographic portrait of D.K. Srivastava
D. K. Srivastava
EY India Chief Policy Advisor
A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.

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