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As headwinds from a strong dollar and developed market yields recede, India is well-positioned to maintain its growth momentum into FY25. Adding to the lift is the Budget presentation in early February, which in our view, will emphasise an “inclusive and prosperous” policy push in the context of incremental progressive steps in the roadmap over the next 20-plus years toward India@100 (a century since independence).

In an election year, the government usually tables the vote-on-account or the Interim Budget. A vote-on-account seeks approvals for essential expenditure outlays until the polls, while the interim Budget broadly includes an assessment of the current state of the economy, current/ capex expenditures, and receipts, as well as revised estimates of the current financial year and estimates for the year ahead. After the polls in Apr-May 2024, the incoming administration will present the regular Budget around mid-2024.

Taking a leaf off the pre-election 2019 Budget, we expect this interim edition to propose modest pro-demand steps to address near-term risks. To recall, back in February 2019, the incumbent administration had announced fiscal concessions and benefits to the farm sector and other deserving parts of the society. This time, the ruling party dominated the recently held state elections, lowering the likelihood of aggressive competitive populism.

The fiscal fine print

We expect the FY24 fiscal deficit target at -5.9% of GDP to be met, despite an anticipated miss in the nominal GDP growth of 8.9% (according to the advance GDP estimate) vs the budgeted 10.5% (see table at the end of the report).

Strong tax revenue buoyancy. Gross tax collections collected by the central government are up 14.7% yoy in the first eight months of FY24 (Apr-Nov23). This suggests that full-year tax collections might be INR1.0-1.5trn above budget estimates. Direct tax revenues have been increasing at a faster-than-budgeted pace in FY24, as the next chart shows. Indirect tax collection, mainly GST (centre and states), is up 11.7% on a year-to-date basis, with the monthly average at INR1.66trn in FY24 vs INR 1.0trn pre-Covid in FY20 – see second chart.  Notably, gross tax to GDP ratios are higher than in the pre-Covid era. Tax revenue (gross taxes) buoyancy likely rose to 1.4x in FY24 from the budgeted 1.0.

Few misses. Receipts from divestments face the highest risk of a miss in FY24, with less than a fifth of the INR510bn having been collected through minority stake sales. New big-ticket proceeds in the rest of the year are unlikely as two-three of prospective asset sales face procedural and administrative delays. Nonetheless, a miss here is unlikely to derail the revenue math given the stronger run-rate of dividends from state companies, which is likely to make up for this miss. Dividend receipts might surprise at INR550-600bn vs budgeted INR 430bn. Indications are that the upcoming FY25 goal might be set at two-third of the FY24 goal, with a few delays also likely due to the election cycle.

Additional spending needs can be accommodated. Total expenditure was up 8.6% yoy by Nov23, meeting 59% of the budgeted target but lagging last year’s 62% in the comparable period. The pace of disbursements in revenue/ recurring expenditure is lower than capex, with the former up 4% yoy by Nov23, while centre’s capex is up 31%. We expect full-year capex to total INR9.8trn, slightly below the budgeted scale.

On the recurring expenses, additional requirements by way of higher food and fertiliser subsidies (~INR500bn), besides expenditure on cooking gas cut (~INR90bn) and higher allocation towards MNREGA (~INR300bn) will be accommodated. The states’ capital outlay is budgeted to rise 42.9% in FY24 to INR8.68trn.  In addition, the Centre had extended the Scheme for Special Assistance to States for Capital Investment with an enhanced loan allocation of INR1.3trn (+30% yoy). As of 1HFY24, ~40% of the full-year allocation was utilised.

FY25: Fiscal consolidation is likely to be prioritised (see table for breakdown)

For FY25, we expect the fiscal deficit to be pegged at around the -5.3% of GDP mark, working on a nominal GDP assumption of 10% yoy. A sharper pace of consolidation lies ahead if the FY26 goalpost of -4.5% of GDP is maintained. The ruling Bharatiya Janata Party (BJP) outdid its national and regional rivals at the recently held state elections, lowering the risks of outright populist measures.

Support measures to address near-term risks. While the vote-on-account will see the government seek permission from the parliament to cover crucial expenditures until the general elections, few measures might be proposed to support the rural/farming community, as the sector faces near-term challenges like poor weather conditions, the fallout of climate change, and inflationary pressures (food and fertilisers).

Targeted support by way of transfers to make up for output losses due to weather, higher farm insurance outlays, boost to disbursements towards rural employment schemes, irrigation facilities, etc., might be tapped. Administrative measures via export restrictions or sops on fertiliser purchases and farm inputs could also be part of the mix to relieve purchasing power. Besides these, more durable initiatives like further encouraging the development of the food-processing industry, skill development, social spending (education, health), and boosting rural infrastructure are other avenues that might get attention. These measures might be detailed at the mid-2024 budget, assuming the incumbent government retains power at the centre.

From a structural perspective, the emphasis on capital expenditure is bound to continue, though rising at a more measured ~9-10% yoy. Road construction slowed in FY24 but will likely be prioritised for next year. The Railway and National Highway of Authority of India (NHAI) budget will continue to be fully financed by the books, preserving transparency. Long-term interest-free capex loans to states might persist in FY25. In recent years, the quality of spending has improved with a rising share of capex disbursements on relative terms, even if revenue/recurring expenses still account for ~80% of the total. While the slower pace of capex spending will weigh on growth, the moderation will enable the authorities to undertake the required scale of consolidation towards the near-term FY26 target. Wider progressive steps to push towards indigenising manufacturing activity are bound to continue, though these announcements are not restricted to the Budget presentation.

Gross borrowings are likely to stay at INR15.1trn, with redemptions at INR3.7trn. Netting out the latter, we expect the net bond borrowings to be in the range of INR11.3-11.5trn, not far from INR11.8trn budgeted for FY24. For states, we expect net borrowings to stand at INR7.3trn, taking the general government total to INR 18.6trn. On the demand end of the bond supply, inclusion into two of the global benchmark bond indices (India rates: Bloomberg seeks to include India's local currency bonds in its EM benchmark index) will prove to be an additional tailwind to absorb the incremental increase in supply, besides the committed domestic buyers. At the same time, the inclusion will also necessitate prioritising fiscal discipline. We assume RBI will have no net presence in FY25.

Implications for monetary policy

Despite the headline CPI inflation being vulnerable to volatile food prices – rising from 4.3% yoy in May23 to 7.4% in Jul before retreating to 4.9% in Oct, steady disinflation in core readings was the highlight of India’s inflation trajectory last year. In December 2023, the core reading (ex-food and fuel) stood at 3.9% yoy (lowest print since lates-2019) vs 5.2% at the start of the fiscal year. Core-core (core ex transport and precious metals) hovered around 4% by December 2023.

Disaggregating the core components, housing (which faces data quality issues that might reverse out next year) makes the biggest sub-part, followed by clothing and health. Even though personal care items, specifically bullion prices, have added to the core measure, disinflation in other sub-components has helped to keep a cap on the momentum. Base effects have also been adding to the downside pressure on the headline core readings, some of which will diminish into FY25.

Our FY25 CPI inflation forecast at 4.5% yoy and core ~4% make for a favourable mix of price pressures. A key risk to our view is poor weather and the further impact on farm output, coupled with exogenous shocks, primarily oil prices. Encouragingly, proactive government intervention (export restrictions, higher imports, intra-state supplies, etc.) has limited the intensity of the food price shock as well as limiting the spill over onto inflationary expectations.

Meanwhile, the upcoming Budget is unlikely to alter the direction of monetary policy materially. The next brewing debate is on the timing of a shift in the RBI’s policy direction. While few market participants have brought forward expectations of a shift in the policy stance, we expect a calibrated approach by the RBI policy committee to begin with a) ease up the liquidity tightness with higher VRR auctions in 1Q24, which will take the system liquidity to neutral rather than sharp deficit, b) followed by a shift to the neutral stance by April/June and c) start rate cuts from 3Q24, with an eye on the US FOMC rate decision and commentary.

After a period of low volatility, the Indian rupee has gained slightly at the start of the year. To recall, the IMF, in its Article IV consultations, suggested that the economy had shifted from a “floating exchange rate regime,” i.e., the rupee's movements were left to the market, to “a managed regime.”

In addition, the agency also observed that FX intervention was more than was deemed necessary. This likely refers to a sharp fall in the rupee’s volatility in recent months, whilst sharp portfolio inflows into the debt, as well as the equity markets, failed to push the currency far from the 83.0-83.40 range. The country’s FX reserves stood at $616bn as of Jan 5^th, after consistently rising for the past four weeks.


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