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Budget 2025: Insights on macro-fiscal implications
In this latest episode of our post Budget 2025 podcast series, we decode some of the most relevant macro-economic themes for FY26, implications of tax reforms and fiscal policies of the government with Dr. D. K. Srivastava, Chief Policy Advisor, EY India. Join as he shares insights on the budget’s potential impact on consumption, investment, and long-term growth of the Indian economy. Will these measures propel India beyond 7% GDP growth? Tune in to find out.
Rationalization of personal tax rates will increase disposable incomes, driving both consumption and savings in the economy.
Capital expenditure remains strong, with state support and new technologies mitigating diminishing returns for sustainable economic expansion.
Achieving 7% GDP growth will depend on global economic conditions, efficient government spends, and private sector investments.
Achieving sustainable growth requires a strategic balance—enhancing capital expenditure while ensuring fiscal prudence to maintain long-term economic stability and resilience.
D.K. Srivastava
EY India Chief Policy Advisor
For your convenience, a full text transcript of this podcast is available on the link below:
Muralikrishna : Welcome to the EY India Insights podcast. I am your host, Muralikrishna Bharadwaj (Murali), and in this episode, we will decode the Union Budget for FY26 to highlight key macroeconomic messages. To facilitate this discussion, we are joined by Dr. D. K. Srivastava, a distinguished economist, member of the Advisory Council to the 16th Finance Commission, Honorary Professor at the Madras School of Economics, and EY India's Chief Policy Advisor.
Sir, a very warm welcome to you.
Dr. Srivastava: Thank you, Murali. Thank you very much.
Murali : The big question on everyone's mind is that the Finance Minister has rejigged personal income tax rates, providing significant relief to taxpayers. While she mentions a revenue foregone of INR1 lakh crore, does that mean the entire amount will go into boosting private consumption? What kind of impact is this measure expected to have on the overall economy?
Dr. Srivastava : The implication is that the INR1 lakh crore will add to the disposable income of households benefiting from this rate rationalization and reduction. When disposable income increases, it impacts both consumption and savings.
Suppose the marginal propensity to consume is about 0.7; consequently, the marginal propensity to save would be 0.3. Therefore, a portion of this increase will boost consumption, adding to overall demand, while another portion will contribute to savings, which in turn finances investment. Both effects are beneficial: savings enhance investment opportunities, and increased consumption stimulates demand across various sectors.
The impact can be further analyzed by considering the subsets of households likely to benefit. The household sector in India comprises lower middle-income, middle middle-income, and high middle-income groups. Most beneficiaries will belong to the lower middle-income and middle middle-income groups, which have relatively higher marginal propensities to consume. This would create a stimulating effect on demand, triggering a multiplier effect across different sectors based on their demand structure and the consumption patterns of these groups.
If these sectors have underutilized capacity, the multiplier effect will be immediate, directly benefiting the economy. However, if they are already operating at full capacity, the impact may initially push inflation rather than increase output. Currently, capacity utilization stands at around 75%, suggesting that a portion of this increased demand will drive higher consumption, while another portion will facilitate investment.
Murali: That is an interesting perspective, particularly considering the budget's focus on boosting consumption. Thank you, sir, for this insight. While the government has not reduced capital expenditure, this budget appears to prioritize putting money in people's hands over increasing infrastructure spending. Has capital expenditure reached a state of diminishing returns? What are the pros and cons of the government's approach in this budget?
Dr. Srivastava: This is not a fundamental shift; rather, it is a marginal adjustment. The government stimulates demand through its overall expenditure, and in this case, there has been a slight shift from direct capital expenditure by the Government of India (GoI) to stimulating demand through tax concessions.
However, capital expenditure growth has not been significantly reduced. Instead, there has been a shift in the channeling of capital expenditure, with state governments being co-opted to supplement GoI’s efforts. A concept called "effective capital expenditure" accounts for both GoI’s capital expenditure and grants provided to state governments for capital asset formation. In this budget, this amount is substantial, with INR4.3 lakh crore allocated for capital formation grants. Additionally, an interest-free loan of INR1.5 lakh crore has been provided to state governments for 50 years to further support capital investments.
This interest-free loan facility has been in place for the past three to four years and continues this year as well. When we combine GoI’s direct capital expenditure with grants for capital formation, the total capital expenditure in the system reaches INR15.5 lakh crore, resulting in a growth of 17.4%—similar to FY25’s capital expenditure growth rate.
Although there is a shift toward increasing personal disposable incomes, the focus on capital expenditure remains intact.
Regarding diminishing returns, this concept does not apply uniformly across time. As capital stock ages and new technologies emerge, diminishing returns may apply to older investments. However, adopting new technologies, such as AI and GenAI, shifts the production function upward, mitigating the adverse effects of diminishing returns. The more rapidly new technology is adopted, the greater its positive impact on overall growth.
A balanced strategy for growth involves augmenting capital expenditure while also supporting personal disposable incomes to drive demand, encouraging private sector investment in response to increased capacity utilization.
Murali: In your view, sir, are the steps taken in the FY26 budget sufficient to push India's GDP growth above 7% in the medium to long term, or will they merely sustain growth between 6% and 6.5%?
Dr. Srivastava : The budget estimates nominal GDP growth at 10.1%. The Economic Survey, however, projects real GDP growth in the range of 6.3%–6.8% for FY26, down from the FY25 estimate of 6.5%–7%.
If global headwinds persist, growth may trend toward the lower end of this range—potentially below 6.3%. However, external factors such as declining global crude and gas prices could positively impact India’s economy, potentially pushing growth higher.
Although the budget provides some demand stimulus, the overall government expenditure trajectory has slowed in recent years—from 10.5% growth in FY23 to 6% in FY24 and a projected 7.4% in FY26. Sustaining nominal GDP growth of 10.1% will require a focus on expenditure quality. Notably, the share of capital expenditure within total expenditure has increased steadily from 18.7% in FY21 to 28% in FY25 (RE) and is budgeted at 30.6% in FY26 (BE). This improvement in capital expenditure quality helps counterbalance the lower overall expenditure growth.
India’s ability to achieve 7% growth will depend on both domestic and global economic conditions. A target of 6.5% is reasonable, but pushing beyond that to 7% would be highly desirable and attainable in the medium term.
Budget itself has provided some uplift to demand, but if we look at India's total expenditure, not just the capital expenditure, then we find that there is an interesting pattern that has emerged. FY23 onwards, progressively, the total expenditure undertaken by GoI has been languishing; it fell from 10.5% to 6% in FY 24 to 6.1%, and if FY25 and it is slated at 7.4% in FY26. Such a low growth rate cannot actually sustain and nominal GDP growth even up 10.1%, which has been indicated in the budget.
Murali: Thank you, sir, for your insightful response. The budget has shifted its fiscal consolidation target from the fiscal deficit to government debt relative to GDP. What are the implications of this move for achieving a sustainable fiscal balance post-Covid?
Dr. Srivastava: Fiscal sustainability is analyzed by considering both the debt-to-GDP ratio and the fiscal deficit as a pair. Typically, a nominal GDP growth projection is set, and a corresponding fiscal deficit level is determined to ensure that the debt-to-GDP ratio remains sustainable.
Focusing solely on the debt-to-GDP ratio is insufficient; the operational target should remain the fiscal deficit. A sustained high debt level increases interest payment burdens, reducing the government's fiscal space for primary expenditure—expenditures that directly impact demand and economic growth.
India's fiscal deficit surged from 3.4% of GDP in FY19 to 9.2% during the Covid period. While some reduction has occurred, returning to pre-Covid levels of 3%–3.4% (as per the 2018 FRBM Act) requires sustained commitment. The current gradual adjustment trajectory may not be optimal for long-term fiscal sustainability.
Murali: Thank you so much, sir. These are extremely insightful perspectives. Thank you so much for joining us in this session and providing us your invaluable views.
Dr. Srivastava : Thank you, Murali.
Dr. Srivastava : Thank you to all our listeners. Stay tuned for more captivating discussions on EY India Insights do not forget to subscribe to the latest updates. Until next time, this is Murali signing off. Thank you.
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