Decoding the Budget: Two Cheers, the third depends on Trump effect

The middle class swooned with delight at the tax cuts in the budget, but the stock markets barely moved. Why so? Because finance minister Nirmala Sitharaman's speech about a bright future was silent on the sharp, continuing fall of Indian stock markets and the rupee ever since it became clear that Donald Trump was going to become US President and disrupt global relations.

He is expected to announce high tariffs on Mexico, Canada and China on Saturday night, and on steel, aluminium, chips, oil and gas soon after. His words will matter more for markets than anything Sitharaman said, showing how large his shadow falls on India. This is just his first tariff barrage: nobody knows how far he will go.

His unpredictability is killing animal spirits in the world economy, and in India too. Global money is rushing to the ultimate safe haven, the US, leaving emerging markets like India stranded. The schemes announced by the FM to spur growth may be more than nullified by the Trump effect.


Remarkable Achievement
The best thing in her budget is the reduction of the fiscal deficit to 4.4% of GDP, fulfilling a promise of reduction from 9.2% made five years ago. To have combined that with rising capex and GDP growth of 7% is a remarkable achievement, even if it owes a lot to record RBI dividends.

Yet one cannot give three cheers because India's fiscal problems are far from over. Interest payments for the second year in a row will be 44.9% of the Centre's tax revenue, an outrageously high ratio. It is far higher than the 39.7% ratio in 2018-19, before Covid. If Trump's belligerence slows the world economy and India with it, Sitharaman's growth and revenue expectations will be seriously impaired.

Many analysts make the mistake of thinking that her budget will stimulate consumption thanks to tax cuts of ₹1 lakh crore. Yes, but these tax cuts are offset by a stagnation of capex, which will barely rise from ₹11.1 lakh crore to just ₹11.2 lakh crore this year. Consumer goods companies may gain at the expense of capital goods and infrastructure companies. But remember that a cut in the fiscal deficit is anti-stimulus, not pro-stimulus. At the macro level, the fiscal contraction is larger than and matters more than income tax cuts for the middle class. This is not a boom budget. It marks a milestone in fiscal consolidation, which, however, has a long way to go.

In many countries the tax exemption limit is around the per capita income. India's per capita income is ₹2.3 lakh, so the tax exemption limit of ₹12 lakh is five times higher. In the US, the per capita income is $82,000 but tax exemption limit is $14,600, almost one-sixth of the per capita level. Okay, the USA may not be the best comparator. But India's exemption limit is now by far the highest in South Asia. Pakistan's tax exemption limit is the equivalent of ₹1.87 lakh, one tenth India's rate. It is another matter that Pakistan is far worse than India in checking tax evasion.

Year after year, official documents speak of the need to expand the tax base. But raising the tax exemption limit from ₹7 lakh to ₹12 lakh will contract the tax base substantially. In numbers, the bottom of the taxpayer pyramid is far larger than the peak, and it is the base that the budget has eroded. This may be good politics but not good economics.

It is also good politics for Sitharaman to show much she wants to do for Bihar, which has a state election later this year. So her budget speech promised new greenfield airports for the state apart from expanding Patna airport, help for the West Kosi Canal, a tourism focus on Buddha (which must include Bodh Gaya), a National Institute for Food Processing, a Makhana support mission for a product Bihar is famous for, and an expansion of Bihar's IIT.

She promised a new income tax bill next week, puzzlingly close to her budget. Why was it not included in the budget? We will soon know. Its focus will apparently be in procedures and simplification, to reduce disputes and litigation. Sitharaman announced the elimination of seven tariff rates in addition to the seven eliminated last year, leaving only eight rates. This is still too many, but fewer is better than more.

She also promised "trust-based" regulatory reforms. A committee will review all regulations of permits, licences and clearances in all non-financial areas, to overhaul those that currently assume guilt unless otherwise proved. The Jan Vishwas Act 2023 decriminalised more than 180 legal provisions, and Sitharaman promised a new Bill to decriminalise 100 more.

These are solid long-term measures. They will not immediately excite investors or the middle class. But they will ultimately have more impact than mere tax cuts.