Time for Modi govt to walk the talk on divestment, other reforms in Budget

The underwhelming growth rate of 5.4 per cent recorded by the Indian economy in the second quarter of the current financial year may not be the only challenge that Finance Minister Nirmala Sitharaman faces as she prepares to present Budget 2025-26 on February 1.

Along with the unpredictable "Trump tantrums"—which are better categorised as a “known unknown”—several headwinds have emerged in the financial landscape, making budget-making more difficult than usual this year. Economists suggest the domestic economy is in a cyclical downturn. 

Inflation is just shy of the upper threshold of 6 per cent, with food inflation (which significantly impacts households) hovering around 9 per cent. The Reserve Bank of India (RBI) has kept interest rates elevated, drawing criticism from the Union Commerce Minister. 

Meanwhile, private capital expenditure (capex) has been lacklustre, demand growth for consumer goods in urban India has been modest, bank credit expansion has lagged compared to the previous year, and forex reserves have declined recently by around $80 billion. The rupee has depreciated sharply over the last two months, and government expenditure has fallen short of last year's levels.

This situation has led some analysts to suggest that the slowdown could be a reflection of diminishing confidence in the government (Pratap Bhanu Mehta, Indian Express, January 14, 2025). However, international agencies have remained more optimistic. Morgan Stanley, which classified India as part of the “Fragile Five” in 2013, now expresses confidence in the country's future. The investment banker sees the current earnings slowdown as “a temporary 2-3 quarter phenomenon.”

Domestic manufacturing and mining sectors have also struggled to maintain vibrancy. Although government expenditure on capex has made some impact, less than 50 per cent of the budgeted capex expenditure for 2024-25 (Rs 11.11 lakh crore) has been utilised by the end of eight months this fiscal year.

The higher-than-usual allocations for infrastructure in the past three budgets have provided a substantial growth stimulus. The allocations for infrastructure in the last few budgets have been key drivers behind India’s growth outpacing that of other major global economies.

However, the fact that increased government spending has not led to a “crowding in” of private investment remains a concern. The government has also struggled with slower capex utilisation, which stood at just 37.3 per cent of the budgeted amount in the first half of this fiscal year, down from last year’s 49 per cent. This shortfall has been attributed to the impact of elections at the beginning of the financial year.

Nevertheless, there are some positive developments in the economy. Agriculture and allied activities grew 3.8 per cent, higher than the previous year's performance. Monthly GST collections up to December 2024 averaged Rs 1.81 lakh crore—the highest since the introduction of the GST. Based on the second-quarter GDP data, economic activity has not deteriorated as much as feared.

On the capital markets front, the primary market saw 91 companies raise Rs 1.6 lakh crore in the calendar year 2024, the highest in recent history. Foreign direct investment (FDI) grew nearly 26 per cent in the first half of the current fiscal year, reaching $42.1 billion, underscoring India’s rising appeal as a global investment destination, fueled by a robust policy framework and enhanced international competitiveness.

India’s external debt remains relatively low at Rs 5.74 lakh crore ($66 billion), comprising around 3 per cent of total debt and less than 2 per cent of the GDP. Meanwhile, forex reserves stand at approximately $625 billion, providing a solid buffer in relation to the government's foreign currency-denominated debt. This low external debt is a significant strength for the Indian economy, and its marginal increase over the past six years highlights its controlled external borrowing.

As of March 2025, the government’s rupee-denominated debt is expected to reach Rs 176 lakh crore. However, it is important to note that this debt is domestic and, therefore, not a major cause for concern. The Government of India’s external debt is estimated at a relatively low level of Rs 5,74,927 crore ($ 66 billion) at around 3% of total debt, as tabled below and less than 2% of GDP while the forex reserves are at about $ 625 billion.

On the trade front, India’s Current Account Deficit (CAD) for the first half of FY2024-25 stood at a manageable 1.2 per cent of GDP. The government has also succeeded in several initiatives, such as boosting exports of defence equipment and mobile phones, reflecting a qualitative improvement in the manufacturing sector.

Given this mixed backdrop—marked by considerable upside risks and strong macroeconomic stability indicators—the upcoming Budget must address several key questions. Should it maintain its focus on fiscal consolidation and play safe with regard to expenditure? Or should it take a counter-cyclical approach, unveiling measures to boost domestic demand and drive growth towards the potential 7-8 per cent range that India is capable of?

At a broader level, the Budget should focus on three key pillars: infrastructure investment, a renewed emphasis on welfare measures, and a pronounced push for structural reforms.

The government began its push for infrastructure development in 2021 with a goal of Rs 100 lakh crore in investments by 2025 under the National Infrastructure Pipeline (NIP). There are currently 12,701 projects within the pipeline, requiring a total investment of $2.3 trillion (as per NIP estimates).

Given the urgency of continuing to invest in public infrastructure, an increased allocation of approximately Rs 13 lakh crore in this Budget is essential to maintaining growth momentum. This will ensure that vital economic impulses are generated. While fiscal consolidation remains important, it should not be pursued at the cost of essential infrastructure development.

Last year, Union Finance Secretary TV Somanathan signalled a shift away from strict fiscal deficit targeting, which has been a conservative “holy grail”. Instead, the focus will be on reducing the government’s debt-to-GDP ratio, he said. The Budget should maintain this pragmatic approach, with infrastructure spending and welfare initiatives prioritised.

Welfare measures should remain a central focus, particularly for farmers, women, youth, and the economically disadvantaged. Historic initiatives such as the PM Kisan Samman Nidhi (Rs 6,000 per year for approximately 9 crore farmers), Ayushman Bharat health insurance, and Employment Linked Incentive schemes should see further expansion or innovative revision. The MSME sector, drinking water and housing missions, green energy, and electric vehicles should receive budgetary support.

Another area where the government could provide relief is the Income Tax Act of 1961. The Finance Minister promised a review of the tax code in her last Budget speech, and there is growing anticipation that further tax relief may be provided through a revised code.

Beyond infrastructure and welfare, the third pillar of the upcoming Budget should be a renewed emphasis on structural reforms. In recent years, the Budget has announced few significant reforms. Even the much-anticipated strategic disinvestment program has fallen short, with the government raising only Rs 8,625 crore this year against a target of Rs 50,000 crore.

Reforms in the farm sector are long overdue. Although the government has increased the Minimum Support Price (MSP) periodically, a comprehensive reform that would revitalise the sector is needed. The three farm laws introduced in 2020 were later rescinded. Agriculture requires consensus-based changes. 

In addition, the government could expedite strategic disinvestment, monetisation of PSU land assets, reforms to the Essential Commodities Act, and the introduction of a new Direct Taxes Code. These steps signify a clear commitment to structural transformation and enhance India’s economic potential.

We will have to wait and see whether the 2025-26 Budget unveils bold reform initiatives or settles for incremental allocations and routine announcements. If the government chooses the latter, it risks reducing the Budget to a mere accountant’s exercise. The current economic climate offers a unique opportunity for the government to go ahead with reforms that can unlock India’s growth potential for the next decade.
(S Adikesavan is a commentator on the economy and banking. Opinions expressed are personal.)