Expecting an all-round budget

 Expecting an all-round budget

We expect the Union Budget in July to provide a combination of (1) higher capex targets, (2) higher allocation to the rural and agricultural sectors and (3) further fiscal consolidation—without shifting away from the existing prudent fiscal policy framework. In our view, (1) the RBI’s higher-than-budgeted surplus transfer (additional 0.4% of GDP) for FY2025 and (2) strong tax collections in 2MFY25 will allow the government to provide adequate support for capex and incremental support to consumption.

FY2025 GFD/GDP at 5%; lower if focus is only on capex

We estimate GFD/GDP at 5% (lower than 5.1% in the February interim budget), assuming (1) higher tax receipts, (2) higher transfer to farmers under the PM-KISAN Scheme, (3) Rs200 bn of additional allocation to rural development (housing, roads and employment) and (4) Rs777 bn of additional allocation to capex under roads, railways and loans to states. Without any relief on income tax or additional spends on agriculture and rural, GFD/GDP is likely to be lower.

Receipts should be revised higher; some scope for personal tax relief

We pencil in income tax growth rate of 16% for FY2025BE versus 11% growth (over FY2024P) assumed in the February interim budget. It is possible that the government may reduce the income tax rate for the low-income slabs, which may result in lower income tax revenues (similar to the budgeted amount in the February interim budget). The government may not change the divestment estimates, given the limited time frame, but strong market conditions for PSUs may spur it to prioritize stake sales, especially in low free-float companies. 

Continuing with the long-term capex focus

The July budget will have room to increase allocations to roads, railways and possibly, loans to states too. We pencil in overall capex growth versus FY2024P to be budgeted at around 25% (compared with 17% in the interim budget). The government may also (1) extend the 15% tax rate for new manufacturing entities, (2) expand PLI, especially to large employment-generating sectors and (3) notify labor codes and others. The interim budget had been quite conservative in allocations to railways and roads (3-4% growth).

Some retrained welfarism may not be a bad idea

It is possible that (1) continued weak consumption demand, especially for low-income households and (2) disappointing election results, beyond the usual math of caste, religion, candidate selection and others may prompt the government to consider incremental welfarism. Accordingly, the government may increase allocations toward (1) PM-KISAN (higher cash transfers to farmers), (2) rural housing under PMAY (already announced), (3) rural roads under PMGSY, (4) rural employment under MGNREGS by either increasing the number of working days or wage rates and (5) higher LPG subsidy for women.

More flexibility in fiscal management

Even though the government will officially use the FY2024RE as comparison, the Union Budget in July will need to, at least informally, consider (1) provisional FY2024 fiscal estimates, including GFD/GDP of 5.6% (revised estimate was at 5.8%) and (2) the RBI’s higher-than-budgeted surplus transfer (additional 0.4% of GDP) in the FY2025 budget estimates to be presented in July. The government can use the additional headroom for a mix of (1) higher capex targets, (2) higher allocation to the rural and agricultural sectors and (3) further fiscal consolidation. The government’s budgeted income tax growth seems quite low based on the actual FY2024 collections; the government will have space to either reduce tax rates at the lower income slabs or increase targets, which could help with additional spending and/or fiscal consolidation. The government will likely keep market borrowings unchanged in the July budget.

Details of FY2025 fiscal estimates

We assume that for FY2025E, (1) gross tax revenues would increase 12% versus the interim budget’s 11%, (2) net tax revenue would grow 13% versus the interim budget’s 12%, (3) non-tax revenues would grow 32%, helped by additional surplus transfer from the RBI (interim budget at (-)1%) and (4) divestment receipts would stay unchanged versus the interim budget at Rs500 bn. Overall, we assume receipts to grow 16% in FY2025E versus 10% assumed in the interim budget (over FY2024P). We pencil in expenditure growth of 10% versus the interim budget’s 7%, with revenue expenditure growth of 6% and capital expenditure growth of 25%.

We estimate FY2025E GFD/GDP at 5% (Rs­­16.5 tn) versus 5.6% in FY2024E (Rs16.5 tn), assuming a nominal GDP growth of 11.2%. We expect GSec borrowing to remain unchanged at Rs14.1 tn for gross borrowing and Rs11.8 tn for net borrowing. Exhibit 1 summarizes the fiscal details. We factor in higher expenditure, but the government may feel that it may not be feasible to undertake additional expenditure, given that the remaining 7-8 months of FY2025 may not be sufficient to undertake additional capital expenditure. In such a scenario, additional receipts will go toward reducing GFD/GDP toward 4.7%.

Receipts: Providing fiscal flexibility

4 Corporate taxes. We budget corporate tax growth at 12% in FY2025E (10% growth in FY2024P), keeping in view our nominal GDP growth estimate of 11.2% (FY2025E KIE coverage universe earnings growth is 10%, pulled down by lower profits for the oil marketing companies from very high levels of FY2024).

4 Personal income tax. We factor in 16% growth in personal income tax revenue in FY2025E (after 25% growth in FY2024P). The income tax estimate in the interim budget translated to 11% growth over FY2024P (against 13% in FY2024RE). There are two possibilities—(1) if there are no changes to the tax rates/slabs, the government will need to revise the estimates higher (2MFY25 growth is at 42%), or (2) reduce the tax burden at the lower income slabs, which will also increase disposable income in the segment, with relatively higher propensity to consume. We assume the government would leave income tax rates unchanged. Nonetheless, we believe the tax slabs should be rationalized to reduce the tax burden, particularly at the lower end of the income pyramid.

The market will be focusing largely on any changes to the capital gains tax structure. We are not sure if the government would want to introduce changes in the July budget without additional consultation and on this sensitive issue. We assume that there would be no changes to the capital gains framework.

4 GST. We expect the government to stick with the interim budget figures in the July budget too. The interim budget had assumed a CGST + IGST target of Rs9.2 tn (12% growth over FY2024P) or a run-rate of around Rs760 bn per month. We believe that this target is achievable and any slippage will be manageable. For the first two months, the run rate has been around Rs740 bn.

4 Non-tax revenues. Without changing any other heads in non-tax revenues, there is an upside of around Rs1.3 tn due to the RBI’s surplus transfer of Rs2.1 tn versus the government’s assumed figure of Rs800 bn in the interim budget. The government will have to account for this and non-tax revenues target should be at Rs5.3 tn (February interim budget: Rs4 tn, FY2024P: Rs4 tn). Dividends from PSUs could also be higher than budgeted in the interim budget, but it is unlikely that the government will change those estimates.

4 Divestments. The government will likely keep the divestment target unchanged at Rs500 bn, given that it has only around eight months to achieve the target. Given the buoyancy in the markets and the demand for PSU companies’ (at least in the secondary markets), the government should be aggressive in stake sales even though outright strategic sales/privatizations may not be politically palatable. Exhibit 2 summarizes the hypothetical amounts the government can raise by divesting stakes in the PSUs down to 51%.

Expenditure: Higher capex and additional focus on the agriculture and rural sectors

We expect the government to continue focusing on budgetary capital expenditure as its plank for boosting economic growth. In fact, with the additional fiscal space compared with the interim budget, we expect allocations on capital expenditure to increase significantly in the July budget. However, given the recent election results and the continued demand for job creation (more specifically quality of jobs), the focus has to be more on the non-urban areas to prop up incomes/demand. This does not imply that the government has to move away from its supply-side focus. In our view, allocations to PM-KISAN, rural housing, rural roads and rural employment could be pushed up, which will provide welfare support and infrastructure improvements.

4 Revenue expenditure. We estimate revenue expenditure in FY2025E at around Rs36.9 tn (growth of 6% over FY2024P). We pencil in additional spends of Rs400 bn split between (1) Rs200 bn for the agriculture sector through higher transfers to farmers under PM-KISAN to Rs7,500 per year from Rs6,000 per year currently and (2) Rs200 bn in rural development spread across rural housing (PMAY-G), rural roads (PMGSY) and rural employment (MGNREGS). Alternatively, allocations can also be increased to health infrastructure, keeping in line with the aim of higher coverage under health insurance. Overall, the government will have around Rs400-500 bn to allocate under various schemes, unless it focuses fully on consolidating GFD/GDP from the FY2025BE estimate. The interim budget had pegged revenue expenditure at Rs36.5 tn (growth of 5% over FY2024P).

4 Capital expenditure. We assume FY2025E capital expenditure at Rs11.9 tn (growth of 25%) compared with Rs11.1 tn in the interim budget (growth of 17%). One of the impediments to higher allocations will be that spending has to be completed within 7-8 months and an already weaker-than-usual spending in 1QFY25 due to the general elections (2MFY25 capex growth was at (-)14.4%). The interim budget had budgeted 17% growth (over FY2024P) in capital expenditure, with only 3-4% growth in allocation for railways and roads sectors. With the available headroom from the RBI’s surplus transfer, we pencil in higher allocations of around Rs780 bn across (1) railways with growth of 15% (FY2025BE was pegged at 4%), (2) roads with growth of 15% (FY2025BE was pegged at 3%) and (3) loans for capex to states, which can be increased by Rs200 bn conditional on certain reforms being undertaken (possibly linked to power, labor, digitization and others).

A judicious blend of capex and welfarism

We expect the Union Budget to continue with its focus on investment-led capacity creation as the primary growth driver. We believe the government may set specific medium- and long-term targets for its core focus sectors such as (1) defense, (2) electricity, (3) railways, (4) roads and (5) urban infrastructure. Given a comfortable fiscal position, we expect the government to increase allocation to specific rural sector schemes such as (1) income support to farmers, (2) MNREGA, (3) rural housing, (4) rural roads and (5) water and irrigation. The government may also seek to further support income generation through (1) extending the tenure of the 15% tax rate for new industries, (2) PLI for employment-generating sectors and (3) easing compliance for start-ups, among others. On the revenue side, we do not expect much change in capital gain tax rates in this budget.

Investment-led growth likely to remain the core pillar of government agenda 

We expect the central government to continue to focus on capacity building and thereby, remaining committed to higher capex spending (see Exhibit 3). The increased fiscal room compared with the interim budget may allow the government to increase FY2025BE capex by Rs800 bn. As a result, we may see increased capex and the government setting medium-term targets in key sectors such as (1) defense, (2) housing, (3) railways, (4) roads, (5) urban infrastructure and (6) water. At the same time, renewed focus on the electricity sector, coupled with high near-term growth targets, suggests that there may be a decent increase in allocation for the sector. Given that PSUs will be the major driver of capex in electricity, we expect the same to reflect in IEBR. We also expect the government to incentivize affordable housing, while further strengthening RERA.

We also expect the government to detail its medium- and long-term capex objectives for various sectors. We note that the government already has a strong pipeline of over Rs100 tn under the National Infrastructure Pipeline (see Exhibit 4), which was unveiled in FY2022. The government may further ramp up long-term targets in certain sectors.

Increased allocation to specific rural sector schemes 

We expect the central government to increase its allocation to rural-centric schemes and sprinkle targeted welfarism. In our view, the weaker-than-expected political outcome for BJP in key states in the Lok Sabha elections may spur the government to increased welfarism (see Exhibit 5). Nonetheless, we expect the government to be balanced in increasing allocation, which may provide economic support, but may not provide a large-scale stimulus. We note that private consumption growth has been weak over the past few years (see Exhibit 6), with demand at the lower end of the pyramid particularly weak.

Exhibit 7 shows the budgeted allocations to major central social sector schemes in the interim budget of FY2025. We expect the increased fiscal room to allow the government to increase allocations to specific rural-focused schemes such as (1) PM-KISAN (income support to farmers), (2) MNREGA, (3) PMAY (rural housing), (4) rural roads and (5) irrigation. We also expect the government to increase allocation to women-centric schemes such as increasing subsidy on LPG.

Continued support for job creation in manufacturing and services

We expect the central government to continue with its business-oriented policies and further incentivize job creation through a further thrust on manufacturing. To that end, we expect the government to (1) extend the tenure of the 15% tax rate for new manufacturing capacities, (2) expand PLI to employment-generating sectors (see Exhibit 8), (3) notifying labor laws, (4) encouraging entrepreneurship, (5) supporting startups and (6) promoting tourism, among others. In our view, the government has already executed the bulk of the investment-linked reforms (see Exhibit 9). We do not expect any progress in land acquisition for now, while further reforms in the electricity sector may be driven by states’ fiscal compulsions and strategic priorities. The government may also seek to increase MSME participation in domestic manufacturing.

No tinkering in capital gains tax yet; protecting small investors may be a priority

We expect the central government to maintain a stable policy related to capital gains tax, even as there seems to be a view of rationalizing taxation across asset classes over time (see Exhibit 10). There is a decent probability that the government may express its views and seek broader consultation in the same. Meanwhile, the increased participation of small investors in derivatives, coupled with large losses (see Exhibit 11), may result in the government dis-incentivizing participation in these instruments; this is outside the purview of the budget though. According to press articles, the market regulator SEBI has already suggested various measures to tackle the sharp increase in retail participation in the F&O market.