India’s CapEx Growth

Why Budget 2025 should focus on restoring India’s capex growth momentum

Related topics

The government may boost infrastructure spending in Budget 2025 to counter slowing growth.


In brief

  • India’s real GDP growth is revised down to 6.4%, on account of lower growth in capital and investment expenditure.
  • Budget 2025 should focus on reviving domestic demand, boosting private consumption, and increasing capital expenditure by at least 20%.
  • EY India estimates FY25 fiscal deficit at 4.8% of GDP, marginally lower than the budget estimates due to capital expenditure growth falling well short of the budgeted target.
  • EY India projects FY26 fiscal deficit at 4.4% of GDP.

The 2Q FY25 real Gross Domestic Product (GDP) growth data at 5.4% released on 29 November 2024 by the National Statistics Office (NSO) came as a surprise to many. It led to a downward revision of India’s GDP growth forecast for FY25 by most multilateral organizations and rating agencies. The IMF, in its January 2025 update of World Economic Outlook, projected India’s real GDP growth at 6.5% for FY25, a 0.5% points downward revision from its growth forecast in October 2024. The RBI also reassessed FY25 real GDP growth at 6.6% in December 2024 as against its October 2024 projection of 7.2%. The First Advance Estimates (FAE) of National Accounts by the NSO has assessed India’s real GDP growth at 6.4% for FY25. 

One of the key reasons for this slowdown is the unexpected contraction in Government of India’s (GoI) capital expenditure at (-)12.3% in the first eight months of FY25, as against a budgeted growth of 17.1% over the Controller General of Accounts (CGA) actuals for FY24. This led to a fall in the growth of gross fixed capital formation (GFCF), that is, investment expenditure. The GFCF growth is estimated at 6.4% in FY25 as compared to 9.0% in FY24. However, on the external front, the estimated contribution of net exports to real GDP growth is positive at 1.7% points, partly reflecting lower crude prices even as global economic headwinds continue to beset the economy. 

On the output side, data shows major weaknesses in the Gross Value Added (GVA) in non-agriculture sectors, except for public administration et al. sector. In particular, manufacturing, mining, and quarrying showed sluggish growth in FY25. In addition, construction and electricity, gas and water supply sectors and the two major services sectors – namely trade and hotels, and financial services and real estate – showed lower than expected growth rates. 

With regard to inflation prospects, in its December 2024 monetary policy review, the Reserve Bank of India (RBI) projected CPI inflation to remain moderate at 4.5% in 4QFY25 as compared to 5.6% in 3QFY25. In fact, in December 2024, CPI inflation moderated to 5.2% from 5.5% in November 2024 as inflation in vegetables eased to a four-month low of 26.6% in December 2024. Core CPI inflation remained steady for the third successive month at 3.7% in December 2024. If this downward trend in overall CPI inflation continues, the situation would be conducive to a downward revision in the policy rate in FY26. We expect that a 50-basis points reduction in the repo rate may happen during the year, possibly in two installments. This would provide some support to private investment expenditure. As per the NSO’s FAE, the implicit price deflator (IPD) based inflation is estimated at 3.2% in FY25, increasing from 1.3% in FY24.

As per NSO, nominal GDP is estimated to grow by 9.7% in FY25, well below the 10.5% growth assumed in the July 2024 budget. We expect that the budget may assume a 10.5% nominal GDP growth for FY26 consisting of 6.5% of real GDP growth and near 4% of IPD-based inflation.

FY25 revised estimates

In view of the shortfall of the nominal GDP growth to 9.7% in FY25 instead of the budgeted level of 10.5%, the FY25 revised estimates for tax revenues may be only marginally different from the budgeted magnitudes relative to GDP. In spite of the lower nominal GDP growth, EY considers that the impact on GoI’s Gross Tax Revenue (GTR) will be minimal. Accordingly, we estimate GoI’s GTR and net-tax revenues would be lower than BE only marginally, amounting to 11.76% and 7.91% of GDP respectively (Table 1). This slight difference is likely to be made-up by marginally higher non-tax revenues so that as a percentage of GDP, revenue receipts would remain unaffected.

However, there will be some improvement in the fiscal deficit to GDP ratio from 4.9% to 4.8% of GDP in FY25 primarily because of the tangible shortfall in capital expenditure relative to GDP alongside a marginal increase in revenue expenditure as compared to respective budgeted expenditure. Revenue expenditure is likely to grow at a rate higher than the budgeted rate, resulting in an increase in revenue deficit from 1.78% (BE) of GDP to 1.99%. 

Table 1. Fiscal aggregates in FY24 and FY25: broad contours

Expectations from FY26 budget: Balancing fiscal stimulus and consolidation

Union Budget for FY26 needs to be formulated keeping in view the signals from recent national income accounts data as well as prospects of medium-term growth for India, in the context of the evolving global scenario. While sluggish export demand can be linked to the global economic headwinds, the focus of the GoI should be to revive domestic demand through both fiscal and monetary instruments.

On the fiscal side, capital expenditure may be supplemented by some push to private consumption through reforms of personal income tax (PIT) which can put additional disposable incomes in the hands of lower and lower middle-income groups. We expect that global energy prices, including that of crude oil, will remain moderate in FY26 and with the new regime, the US would augment supplies to the global market through additional shale oil and gas supplies. This may lead to some easing of pressure on the CPI inflation in India and facilitate reduction in the policy interest rates.

Another emerging concern relates to pressure on the INR vis-à-vis the US$ which is depreciating faster than expected. Financial resources are flowing back into the US economy as the it is perceived to do well under the new regime. There is also demand for US$ from India’s importers. The budget may examine the structure of import tariffs with a view to increasing protection for domestic industry, particularly domestic manufacturing. This may reduce demand for imports and therefore also that for the US$ and incentivize domestic manufacturing.

Column 6 of Table 1 summarizes the broad fiscal aggregates projected for FY26 relative to GDP, highlighting the underlying growth as compared to FY25 estimates. We consider that a reduction in fiscal deficit from 4.8% to 4.4% of GDP in FY26 may be feasible. We also project the capital expenditure growth at a minimum of 20% in FY26 over the FY25 estimates (column 8). This amounts to 3.35% of the estimated GDP. Till private investment shows a tangible improvement, government capital expenditure may have to do the heavy lifting. The debt to GDP ratio is estimated to marginally fall to 55.9% in FY26. 

Fiscal consolidation prospects in the medium term

With the announcement of the implementation of the recommendations of the Eighth Pay Commission, which will be in effect from FY27, there is a possibility that the momentum towards achieving fiscal consolidation targets may be delayed. The fiscal deficit and debt targets, as per the GoI’s 2018 amended FRBMA, are 3% and 40% of GDP, respectively. However, achievement of both of these targets is likely to be delayed because of the additional pressure on revenue expenditures due to revised salaries and pensions of government employees. A similar impact would also be felt by the states. Chart 1 shows that the fiscal deficit glide path is likely to be moderated FY27 onwards.

Chart 1: GoI’s fiscal deficit relative to GDP – glide path

In FY26, the main fiscal policy intervention required would be an attempt to restore infrastructure expansion momentum to support real GDP growth. There would be some positive movement on fiscal consolidation both in FY25 and FY26. Some other changes in the FY26 budget may relate to the revision of import tariffs and some rationalization of personal income tax rate and its deduction structure.

In the medium-term, in view of the impact of Eighth Pay Commission recommendations, the path of fiscal consolidation would lose momentum. We consider that, in the medium-term, real GDP growth can still be maintained at 6.5% and nominal GDP growth at 10.5% with some inter-year variations. A combination of slower nominal GDP growth in FY24 and FY25 and pressure on the INR may push the US$5 trillion Indian economy milestone from FY28 to FY30. To address this, nominal GDP growth must recover to at least 10.5% beyond FY25, and INR depreciation against the US$ must be moderated.

Download the full pdf

Related articles

Recasting fiscal responsibility framework: Roadmap to achieve Viksit Bharat

Discover India's new fiscal framework for Viksit Bharat: aiming for 30% debt, 3% deficit norms, and zero revenue deficit to ensure economic stability.

23 Dec 2024 D. K. Srivastava

How India can frame its fiscal architecture to realize Viksit Bharat

Discover the roadmap to Viksit Bharat. Learn about the necessary government size, tax reforms, and fiscal discipline to achieve India's development goals.

27 Nov 2024 D. K. Srivastava

BRICS+ to pave the way for a multipolar currency era

BRICS+ group's rising trade share challenges G7 dominance. Explore the shift towards a multipolar economic system and implications for global currencies.

30 Oct 2024 D. K. Srivastava

    Summary

    In the medium-term, it is possible to maintain India’s real GDP growth at 6.5% and nominal GDP growth at 10.5% with some inter-year variations. The primary fiscal policy intervention required in FY26 is the restoration of infrastructure expansion momentum, along with some positive movement in fiscal consolidation. 

    About this article

    You are visiting EY in (en)
    in en