Union Budget 2025: Balancing Fiscal Consolidation With Middle-Class Tax Relief To Spur Consumption

The Union Budget for 2025 has been presented at a time when addressing the cyclical slowdown early on is crucial. Among the various sectors, consumption stands out as the most vulnerable and requires immediate attention. This budget, being the first full-year budget of the current government's third term, provides an opportunity to introduce reform initiatives that will shape the economy in the coming years. In addition to these key priorities, the budget must also factor in the fluctuations in crude oil prices, global policy changes under the Trump administration, and India's long-term goal of reducing government debt. Moreover, rating agencies have recommended that the fiscal deficit should be kept below 7%, which is likely another important consideration for budget planners.

Based on an exclusive interview with Namrata Mittal, Chief Economist, SBI Mutual Fund, here is how the government targets growth through tax relief and fiscal consolidation and how the Union Budget 2025 will navigate fiscal discipline while boosting middle-class spending.

In striking a delicate balance, the Finance Minister has aimed to achieve fiscal consolidation while simultaneously lowering tax rates for the middle class to encourage consumption.

The Centre's target for the gross Fiscal Deficit in FY26 is set at 4.4% of GDP, a reduction from 4.8% in FY25. The fiscal deficit for the states is expected to remain around 2.9-3.0% in both FY25 and FY26. When adjusting for the CAPEX loan from the Centre to the states (approximately 0.4% of GDP), India's overall government deficit is expected to decrease from 7.3-7.4% in FY25 to 7% by FY26.

Income tax buoyancy helped offset other areas of revenue shortfall in FY25; Capex targets in FY25 were revised down by Rs. 900 billion.

Looking at the FY25 numbers, the government is set to surpass its fiscal consolidation target, reducing the fiscal deficit to 4.8% of GDP, compared to the initial goal of 4.9%. The capital expenditure (capex) target has been revised down to Rs. 10.2 trillion, from the original Rs. 11.1 trillion. Despite this reduction, capex spending will still need to grow by 21% in Q4 FY25 to meet the revised target. Overall receipts are expected to fall short of the budgeted plans by Rs. 600 billion, largely due to a shortfall in disinvestment targets (Rs. 330 billion vs. the budget estimate of Rs. 500 billion) and higher tax devolution to states (up by Rs. 400 billion).

However, the shortfall in corporate tax and other indirect taxes is more than offset by strong income tax collections. Income tax as a percentage of GDP in India has nearly doubled from 2.1% a decade ago to an expected 3.9% in FY25 RE. In summary, the FY25 government balance sheet reflects a significant miss in spending across several key sectors.

Weak government expenditure (with total expenditure expected to grow by just 6% in FY25-revenue expenditure by 5.8% and capex by 7.3%) has impacted tax buoyancy in indirect taxes and corporate taxes. However, the structural improvement in income tax collection, driven by better compliance, appears to be the main factor supporting fiscal consolidation in India, providing some fiscal space for future spending.

FY26 fiscal arithmetic looks credible

Looking ahead to FY26, nominal growth is projected at 10.1%, slightly higher than the 9.7% growth expected in FY25. Gross tax revenue is anticipated to grow by 10.8%, compared to a likely 11.2% in FY25, indicating a tax buoyancy of 1.1 in both FY25 and FY26, down from 1.4 in FY24. Aside from income tax, which is expected to grow by 20% despite tax rationalization, the growth assumptions for the other tax categories-corporate tax, customs, excise, and GST-seem reasonable.

The government expects dividend receipts to rise to Rs. 3.3 trillion in FY26, up from Rs. 2.9 trillion in FY25, suggesting an expectation of over Rs. 2 trillion in realized profits from the RBI. The disinvestment target for FY26 has been set at Rs. 470 billion, up from the revised estimate of Rs. 330 billion for FY25 (with the government having realized only Rs. 86 billion in disinvestment until January 2025). Telecom receipts for FY26 are projected at Rs. 824 billion, potentially reflecting lower receipts expected from BSNL, which is largely an accounting entry.

As tax buoyancy peaks, the government pares down its expenditure growth to achieve fiscal consolidation; the skew towards capex remains

The Centre's expenditure is expected to moderate to 14.2% of GDP in FY26, compared to an anticipated 14.6% in FY25. Capex through budgetary resources is budgeted to grow by 10%, an improvement over the revised 7% growth forecast for FY25 (3.1% of GDP), while revenue expenditure is projected to rise by 6.7% in FY25 (compared to a revised estimate of 5.8% year-on-year). At 11% of GDP, the Centre's revenue expenditure is among the lowest since the 1990s (excluding FY17-19).

However, much of the increase is due to the government absorbing some vintage oil and fertilizer bonds into the budget. Excluding interest payments, revenue expenditure is expected to grow by 4.2% in FY26, down from 5.3% in the FY25 revised estimate. Therefore, as revenue buoyancy appears to be peaking, government expenditure growth is being moderated to align with the fiscal consolidation agenda.

13% growth in rural schemes comes on the back of a sharp miss in FY25 targets; Housing and tap water are the focus

In FY25, there was a significant shortfall in actual spending on key rural-oriented schemes such as the Jal Jeevan Mission and Pradhan Mantri Awas Yojna (PMAY Rural). With a 4% y-o-y decline in spending in FY25, FY26 is expected to see a 13% increase in funding for rural-oriented schemes.

Infrastructure budget sees weak expansion for the second year now; focus towards urban development

Infrastructure spending, including both budgetary support and extra-budgetary resources, is expected to grow by a modest 8% y-o-y, compared to a likely 3% growth in FY24. As a result, infrastructure spending has been moderating for two consecutive years. However, there seems to be a shift in focus sectors, with budgetary allocations for core sectors like roads and railways remaining largely flat, while urban development sees a significant 33% increase in allocation. The defence budget has risen by 13% y-o-y. Rural-oriented infrastructure also sees a healthy increase, largely driven by expectations of better outcomes in FY26, particularly in the Jal Jeevan Mission and the housing sector.

The highlight of the budget was an attempt to boost consumption by reducing the tax incidence on the middle class.

The income tax structure has been revised in such a way that income below Rs. 12 lakh per annum will be taxed at nil (vs. Rs. 7 lakh previously). The tax structures have also been revised in a way that individuals with income above Rs 12 lakhs see a lower annual tax incidence ranging from an annual savings of Rs. 80000-Rs.1.1 lakh per person. This is expected to result in an aggregate tax saving of Rs. 1.1 trillion (0.3% of GDP) with most of the benefits accruing to households with income ranging from Rs. 10-50 lakhs creating a positive impetus for discretionary consumption demand.

Other areas of reform and focus

Beyond the numbers, deregulation and improving the ease of doing business have been central themes of the Budget. It highlights the importance of simplifying permissions, documentation, certifications, and licenses, especially for MSMEs, which is expected to boost employment as well. The budget also appears to be favourable for the solar sector, with increased allocations for solar rooftop projects.

The focus on power sector reforms continues, with states that undertake these reforms being incentivized through additional borrowing limits. Building on the success of the first round of the asset monetization plan, where the government likely exceeded its target of Rs. 6 trillion in monetizing operational assets across sectors like roads, mining, power, petroleum, and airports, the government has announced a second asset monetization plan for 2025-30, aiming to raise Rs. 10 trillion for new projects. Additionally, the push for lithium-ion batteries and other critical minerals needed for electric vehicles and electronics remains a key priority.

Future path for fiscal consolidation

In its FRBM document, the government has emphasized that it will prioritize the debt-to-GDP ratio as the key fiscal anchor, aligning with global trends. Additionally, it has set a target to reduce the debt-to-GDP ratio to about 50+1% by March 31, 2031. Working backwards, we estimate that the government's debt reduction goals can be achieved with a 4% fiscal deficit between FY27 and FY31, coupled with a 10.5% nominal growth rate. If the country achieves slightly stronger growth of 11% in the coming years, the debt reduction target could be met without the need for further fiscal consolidation by the Centre.

Gross G-sec supply is marginally higher than expected; but RBI's OMO will provide a support

Leading into the Budget, the key expectations from the Fixed income perspective were for the continuation of the fiscal consolidation path. At the same time, expectations on the gross borrowing numbers were anchored around Rs 14.0 trillion with some aggressive estimates being even lower. This was contingent on assumptions of RBI doing switches with the GoI with respect to its maturing Government securities in the coming year. Seen from this angle, the eventual outcome today can be seen as underwhelming from a market positioning perspective.

While the government has targeted the FY26 FD estimate at 4.4% in line with the anticipated range, with net borrowings stable at Rs 11.53 Trillion, the gross numbers have been budgeted higher at Rs 14.82 trillion. A higher gross borrowing number may be seen marginally negative vis a vis expectation. However, the demand-supply balance remains favorable on a broader level.

This will also be bolstered by the requirement for the RBI to conduct OMO purchases in the near term given the pressures on core liquidity. The focus from the market perspective would be more on potential RBI actions going forward. While the possibility of repo rate reduction would be debated, the sequencing of the same would be subjective, with any rate actions likely to remain ineffective if liquidity conditions remain tight and persistent pressures on the currency continue.