Macroeconomics

Union Budget 2025-26: Many small measures but lacks big ideas

  • Blog Post Date 05 February, 2025
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Rajeswari Sengupta

Indira Gandhi Institute of Development Research

rajeswari@igidr.ac.in

The Finance Minister recently presented the Union Budget for 2025-26. In this post, Rajeswari Sengupta notes that the most significant aspect of this Budget is the fiscal stimulus aimed at middle-class consumers through tax relief. However, she argues that the impact of this measure is likely to be limited and short-lived in the absence of substantial structural reforms to drive sustainable, long-term growth. 

The Union Budget for 2025-26 was presented at a critical juncture for the Indian economy. A few years ago, the economy was recovering strongly from the Covid-19 pandemic, with GDP (gross domestic product) growth running at 7-8%. This spurred optimism that the country might soon join the ranks of advanced economies. More recently, however, the economic momentum has faltered, prompting renewed questions about the country’s long-term growth trajectory. 

Against this backdrop, expectations from the Union Budget were twofold. First, the hope was that the projected budget deficit for 2025-26 would remain in line with the planned fiscal path, thereby safeguarding economic stability amidst a volatile global environment. Second, the expectation was that the Budget would include initiatives aimed at reviving rapid growth.

In certain respects, the Budget met these expectations. It announced a fiscal deficit target of less than 4.5% of GDP and included a modest tax relief for middle-income households, which is expected to stimulate consumption demand. However, in other areas, the Budget fell short. While the credibility of the fiscal projections is open to question, the absence of significant structural reforms was striking. More concerning still was the lack of clarity regarding a broader growth strategy. 

Economic backdrop

The Budget speech commenced with the Finance Minister reaffirming the government's commitment to achieving the goal of a Viksit Bharat – attaining developed country status by 2047. In this context, it is important to highlight that the most significant distinction between a developed and a developing economy is the disparity in per capita GDP. For example, the per capita GDP in the United States is approximately US $86,000, while India's per capita GDP, more than three decades after liberalisation, amounts to only US $2,600, lower than that of 140 countries. This is why raising per capita GDP has long been the focus of India's policymaking. 

The key question therefore is whether India is on course to achieve the ambitious goal of Viksit Bharat. More technically, it boils down to determining the country’s potential growth rate. If it lies in the 8-10% range, then the current slowdown might be of little concern; the economy could soon regain its former momentum, even without significant intervention from the government. However, if the true potential growth rate is much lower, then deeper structural reforms will be needed to push up the country’s growth trajectory. 

Answering this question is far from straightforward, not least because India's GDP data suffers from serious measurement issues. However, if one takes the data at face value, the trends are concerning. 

Consider recent and prospective developments. Real GDP growth has been declining in four of the last five quarters. In mid-2023, the economy was growing at a robust rate of over 8%. But, by the quarter ending in September 2024, growth had decelerated to below 5.5%. If this slowdown was merely cyclical, there would be some drivers on the horizon that could propel the economy back to a high-growth trajectory. But none are apparent. Consumption demand remains subdued, particularly in urban India. Despite healthy corporate balance sheets, investment levels have remained weak. Export prospects are not encouraging either, especially not with a feeble global economy and an exchange rate that has appreciated over the past few years in real terms thereby eroding India’s competitiveness on the global stage. 

Underlying the subdued GDP performance are festering structural weaknesses. These include a chronic shortage of adequate employment opportunities to absorb the millions of unemployed youth, an underperforming manufacturing sector whose share of GDP has declined from 17% in 2010 to 13% in 2023, and feeble growth in wages. A Federation of Indian Chambers of Commerce and Industry (FICCI) report released in December 2024 shows that the compounded annual growth rate of nominal wages across six major sectors of the economy ranged from 0.8% to 5.4% during the period 2019-2023. Given that the average annual inflation rate during this period was 5.7% this implies a contraction in real incomes. 

In emerging economies like India, the primary drivers of growth are typically private investment and exports. Hence it is worth examining the investment trends in some detail. Despite strong efforts by the government to boost private investment, such as major corporate tax cuts in 2019 and sizeable public investments in infrastructure, private investment growth has in fact been slowing. According to data from the Centre for Monitoring Indian Economy (CMIE), the nominal value of private investment projects under implementation grew at an average annual rate of 47% from 2005-06 to 2010-11. However, in the post-pandemic period (2021-22 to 2023-24) they grew at a far slower pace of only 15% annually. In calendar year 2024, this growth rate decelerated to 5.6%. 

The growth in new investment projects announced, a key indicator of business optimism within the private sector, has also been strikingly subdued, rising by only 1.3% in 2024. This is in sharp contrast to the remarkable average annual growth rate of 74% seen between 2004-05 and 2007-08, underscoring a significant decline in private sector confidence and domestic investment activity in recent times. 

Even as Indian firms have been scaling back their domestic spending, they have substantially increased their overseas investments, which have risen from US $20 billion in 2023 to US $36 billion in 2024. In other words, private firms are investing – but outside of India rather than within the domestic economy. 

Foreign firms are exhibiting a similar reticence. Despite initiatives to encourage firms to Make in India, including the flagship Production-Linked Incentives (PLI) scheme, foreign direct investment (FDI) into the Indian economy has been declining. The share of net FDI inflows in GDP has dropped sharply, from a peak of 3.6% in 2008 to 0.8% in 2023. Even more concerning is the contraction in net FDI since 2021-22, with an average annual decline of 34%. This lacklustre performance of FDI in India comes at a time when many multinationals are actively seeking to reduce their reliance on China. While countries like Vietnam have capitalised on this shift, India seems to have missed the bus. 

This also shows up in the underwhelming performance of goods exports. Over the past decade, the compound annual growth rate (CAGR) of goods exports has been a modest 3.3%, as a result of which India’s share in global goods exports remains a tiny 1.8%. While it is true that India’s share in global services exports stands at a respectable 4.3%, a more dynamic export-oriented manufacturing sector remains a necessity in order to raise the overall rate of growth and provide jobs for the country’s large pool of unskilled and underemployed labour. 

Where did the budget announcements fall short?

Against this economic backdrop, the most prominent growth-oriented measure in the Budget was the announcement of tax relief for middle-class salaried employees, particularly those earning up to Rs. 12,00,000 who will no longer be subject to income tax, along with some tax reductions for higher income earners. This measure has been widely praised as a stimulus intended to revive consumption demand. 

However, it is important to note a few points here. First, the measure leaves the bulk of the population unaffected, given that only 2.2% of Indians pay taxes. Second, the size of this tax relief is modest, amounting to only 0.3% of GDP. Finally, in a situation where growth is slowing down, jobs are not easy to come by, and the stock market boom has ended, the chances of an average middle-class household spending this additional money on consumption are relatively low. It is quite likely instead that this money will be saved or used to repay household debts. As a result, it is doubtful whether this measure will provide a significant boost to aggregate demand. 

More fundamentally, the underlying assumption behind the tax cut appears to be that the economic slowdown is merely cyclical, and that a modest boost to demand would suffice to reverse the slowdown. However as discussed, there are many reasons to suspect that the economic problems are much deeper and more structural in nature. This suggests that addressing the problems will require far more substantive, long-term measures than those proposed in the Budget. 

There are a few signs that the government has recognised some of the problems. For example, the Budget provides for establishing a high-level committee tasked with reviewing all non-financial regulations, while simultaneously directing the Financial Stability and Development Council (FSDC) to assess the impact of financial sector regulations. This reflects an understanding of the critical role that regulations play in shaping private sector economic activity. However, appointing committees is not the same as implementing reforms and it remains to be seen whether these initiatives will lead to tangible outcomes that alleviate the regulatory burden currently confronting the private sector. 

Apart from announcing new committees, the Budget included many small, piecemeal measures, which might help at the margin. For instance, the decision to raise the credit guarantee limits for the micro, small and medium enterprises (MSMEs) is a positive move, especially considering that this policy played a crucial role in facilitating significant credit flow to MSMEs during the pandemic (Sengupta and Vardhan 2023). This move is expected to provide much-needed financial support to the sector, which continues to face challenges in accessing capital, and could help stimulate growth and job creation in this vital part of the economy. 

In the end, the Budget discourse sidestepped the challenges at hand. The first missing element was a diagnosis of the current situation. This diagnosis should then have been followed by a clear articulation of the government’s medium-term growth strategy. 

The irony is that in previous years, the government had indeed provided such a vision. Its growth strategy, based on a variation of the “China model”, aimed to create a conducive environment for the private sector by building infrastructure and providing incentives for firms to invest. But in this Budget these measures were conspicuous by their absence. There was no mention of the PLI scheme in the Budget speech nor any substantial increase in infrastructure spending. 

Where does this leave the growth strategy? The question is all the more pressing, since the previous strategy has not yet paid the anticipated dividends. What alternative growth strategy could the government then have announced? 

Briefly, it could have announced a set of reforms aimed at spurring private investment by reducing the risks that firms are facing. For example: a systematic reduction of import duties thereby signalling a clear intent to move toward trade liberalisation; removal of Quality Control Orders (QCOs) to facilitate greater market competition; more effective and transparent system of fiscal devolution to states in place of the current, complex structure of cesses and surcharges which often distorts resource allocation; tax administration reforms to ease the burden on businesses, simplify compliance, and accelerate the resolution of tax disputes; reforms in the power sector; as well as incentives for states to implement land and labour market reforms. These reforms could have played a crucial role in unlocking India’s potential for growth and also reigniting the ‘animal spirits’ of the private sector. 

Regarding fiscal consolidation, the Budget announced a target to reduce the fiscal deficit to 4.4%of GDP in 2025-26, marginally below the previously set target of 4.5%, signalling the government’s commitment to fiscal discipline. This is undoubtedly a significant development, as fiscal stability is a crucial precondition for long-term, sustained economic growth. However, the reduction in the fiscal deficit is based on assumptions that warrant closer scrutiny. Specifically, the Budget anticipates a 14.4% year-on-year growth in personal income tax revenues. This assumption becomes questionable in light of the new tax relief measures, which effectively reduce the pool of income taxpayers. In addition, the government may not benefit next year from copious capital gains taxes, now that the stock market boom has ended. Projections for corporate income tax and even the Goods and Services Tax (GST) also look pver optimistic given a slowing economic momentum. 

If revenues fall short of target levels, then two risks arise. There could be more aggressive tax enforcement. This is certainly something to watch closely, as any missteps in tax administration or overreach could undermine the very growth the government is trying to stimulate. The other risk is that spending will need to be cut – and that means even lower capital expenditures. 

Conclusion

In summary, the most significant aspect of the Union Budget for 2025-26 is the fiscal stimulus aimed at middle-class consumers through tax relief. This measure comes at a time when the Indian economy is facing a noticeable slowdown. While fiscal policy can offer short-term relief, the deeper economic challenges – such as declining private investment, weak goods exports, and sluggish job creation – require more than temporary fixes. They call for substantial structural reforms to drive sustainable, long-term growth. Without addressing these core issues, the impact of the fiscal stimulus is likely to be limited and short-lived.

For India to achieve sustained high growth and raise its per capita GDP, a reinvigorated growth strategy is necessary. The Budget was an opportunity to lay out such a framework, but while a few isolated steps were taken, the overall approach lacked a coherent plan to tackle the fundamental issues hindering India’s growth. The absence of a more candid acknowledgment of these challenges suggests that the government may be underestimating the scale of reform required. Thus, this Budget, like several before it, represents yet another missed opportunity.

The views expressed in this post are solely those of the author, and do not necessarily reflect those of the I4I Editorial Board.

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