This article is based on the Editorial: Why the budget must prioritise incentives, not just resources that appeared in The Indian Express
India’s economic growth depends a lot on development and reforms. After the pandemic policies helped recovery but slower government spending and weak private investment need fixing. Important reforms like trade liberalization and better infrastructure can make us more competitive. A balanced fiscal policy, which focuses on public investment and growth driven by consumption is needed. Agricultural reforms, simpler regulations and tax incentives for investment can help long-term growth. The 2025-26 Budget should focus on efficiency, investment and supporting the middle class to keep the growth going.
Development and structural reforms are key to India’s growth. Post-pandemic policies helped tackle external shocks, leading to a strong recovery. But now we need to pay more attention to the quality of investment and making fiscal policies more efficient to keep the growth going.
Development and structural reforms are still really important for India's economic growth. After the pandemic, policies helped tackle external shocks and led to a strong recovery. Right now the economic situation needs a clearer focus on the quality of investment and making fiscal efficiency better to keep the growth momentum going.
Structural ReformsStructural reforms are policies that transform the economy’s framework to boost efficiency and competitiveness. They reduce government intervention by removing price controls, monopolies and trade restrictions. Reforms improve the business environment by addressing production obstacles and fostering innovation while resolving market failures like natural monopolies and financial distortions. Key examples include liberalizing trade and investment, enhancing infrastructure, reforming labor markets and strengthening social support systems. India’s LPG reforms—liberalization, privatization and globalization—in the 1990s marked a pivotal shift towards a market-driven economy. |
Slowing government spending has contributed to economic deceleration. By November 2024 only 46.2% of the Centre’s capital expenditure target was utilized compared to 58.5% the previous year. States also underperformed, spending just Rs. 0.88 trillion of the allocated Rs. 1.5 trillion for capital projects, highlighting the need for improved spending efficiency.
Capital expenditure (CapEx)Capital expenditure (CapEx) refers to government spending on machinery, equipment, buildings, healthcare, education and acquiring fixed assets like land. It includes investments yielding future profits or dividends. CapEx involves investment spending with long-term benefits, such as acquiring or upgrading assets, repairing assets, or loan repayment. It boosts production capacity, operational efficiency and labour participation, contributing to sustained economic growth. Loan repayment, reducing liabilities, also falls under CapEx. Difference from Revenue Expenditure: Governments must balance CapEx carefully to meet deficit targets, as seen in 2019-20, where it was 14.2% of Budget Estimates. |
India’s combined fiscal deficit remains above 7% of GDP with interest payments consuming 19% of the Centre’s expenditure. Lowering debt and deficit ratios is critical to enhancing fiscal flexibility reducing risk premiums and cutting interest rate spreads. A balanced fiscal approach is essential for long-term economic stability.
Fiscal Deficit: Indicator of Government BorrowingsFiscal deficit is the difference between the total revenue and total expenditure of the government, excluding borrowings. It reflects the borrowings needed by the government. The gross fiscal deficit (GFD) includes total expenditure, loans (net of recovery) and revenue receipts. On the other hand the net fiscal deficit excludes the Central government’s net lending. Fiscal deficits arise from revenue deficits or significant capital expenditure, which is incurred to create long-term assets like factories and infrastructure. Deficits are financed through borrowings from the central bank or by issuing instruments such as treasury bills and bonds in capital markets. |
Higher public investment yields stronger economic returns than revenue spending. Meeting capital expenditure targets and ensuring spending efficiency can drive growth. Conditional incentives that push states to enhance capital spending should continue to support infrastructure development.
Despite corporate tax cuts, private investment has not risen significantly. Fixed capital formation in the private sector declined averaging only 21.5% of GDP between 2015 and 2021. Policy measures like taxing non-business income and offering investment tax credits could incentivize greater private sector participation.
India underutilizes both domestic savings and foreign inflows. Domestic savings have grown, yet investment remains constrained. Foreign inflows consistently exceed the current account deficit, emphasizing the need to address investment bottlenecks rather than resource constraints.
CADA current account deficit (CAD) is when a country imports more goods and services than it exports, while a fiscal deficit is when a government spends more than it receives. Both are indicators of a country's financial health.
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NOTE: When foreign inflows consistently exceed the current account deficit (CAD), it indicates a surplus of capital inflows over the economy's external financing needs. This situation typically strengthens the foreign exchange reserves and stabilizes or appreciates the domestic currency.
Such inflows often take the form of foreign direct investment (FDI), foreign portfolio investment (FPI), or external borrowings. While beneficial for financing development projects and boosting liquidity, excessive reliance on foreign inflows may increase vulnerability to external shocks, such as sudden withdrawal of portfolio investments.
The expanding Indian middle class, especially in lower income brackets, drives consumption. Income tax cuts for lower slabs can boost spending, particularly in price-sensitive segments. Corporates should shift focus from the affluent to cater to a broader consumer base, leveraging this untapped demand potential.
Agricultural marketing reforms have advanced, with 26 states implementing private markets and direct farm-gate sales. Farmers who diversify production earn higher incomes compared to those dependent on MSP sales. Strengthening supply chains and developing a unified market will stabilize prices and improve farmer profits.
Simplifying business regulations remains a priority. Despite removing outdated laws, businesses continue to face challenges at local levels. Reforms must extend to second and third tiers of governance to enable smoother compliance and fostering investment.
Lowering interest rates can help boost demand as inflation slows down. Low real interest rates encourage purchases of housing and durable goods, especially among the youth. If fiscal and monetary policies are aligned well it can further encourage consumption and investment.
The Budget should focus on improving production conditions and cutting costs. Aligning resources with good incentives like investment tax credits and targeted public spending is key. Simplified regulations, strong agricultural supply chains and support for middle-class consumption should be at the core of the fiscal strategy.
NOTE: Investment tax credits (ITCs) are incentives given by the government to encourage businesses to invest in certain assets, like machinery, equipment, or infrastructure. The credit allows businesses to cut down their tax bill by a percentage of the money spent on the investment. This reduces the overall cost and encourages economic growth by promoting capital formation particularly in industries that need a lot of capital such as energy, manufacturing, or technology.
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