Union Budget | Cut this Gordian knot to revive animal spirits of India’s economy

As the Narendra Modi government 3.0 moves towards presenting its first full year budget, the economy faces multiple domestic and external challenges. A slowdown has been recorded in the second quarter of the current fiscal (FY2024-2025) leading to growth projections being scaled down to around 6.5% from the robust 8.2% recorded last year. The outlook is expected to be brighter in the second half, but overall growth is now set to be moderate.

The external horizon is also uncertain as geopolitical tensions continue to impact global economies. The tentative truce in the Israel-Hamas conflict is welcome but it remains fragile for the time being. As for the advent of Donald Trump as US president, it raises the spectre of higher tariffs with the world’s biggest economy turning protectionist.

On the domestic front, there had been concerns last year over sluggish demand with inflation especially impacting food products. But there is now a pick-up in rural areas. In fact, rural consumption is now actually outpacing urban areas owing to multiple factors like record foodgrains output, direct benefit schemes, and expanding financial inclusion. Market research agency NelsonIQ has found that rural demand has risen at the rate of 6% in the second quarter compared to only 2.8% for urban segments. At this rate, the traditional gap between urban and rural spending may be bridged sooner rather than later. In fact, the worries are now more about urban rather than rural demand.

The other concern about slower infrastructure spending may be set to rest during H2 FY2025. The relatively muted level of government capital expenditure in the first half was clearly a fall-out of the general elections. The lacuna is likely to be made up in the subsequent quarters. The Budget is bound to bring more clarity but hopefully should also outline a sustained rise in capex in FY2026.

As for growth, the first advance estimates of national accounts pegged real growth at a realistic 6.4% for FY2025, lower than the 6.6% forecast made by the Reserve Bank of India (RBI). Other agencies have downgraded growth projections including Moody’s which pegged it at 7% from 8.2% earlier. For FY2026, however, the World Bank and the International Monetary Fund (IMF) still expect India to be the fastest growing economy with forecasts of 6.7% and 6.5% respectively.

External headwinds are one of the major factors behind the pessimism for this year. Geopolitical stress continues in both the Ukraine and West Asia despite the latest peace agreement in the latter region. For India, it is imperative that conflicts do not disrupt stability of oil markets. These have been facing fluctuations in the new year. Prices of the benchmark Brent crude crossed $80 per barrel for the first time since October. The reasons include last minute additional sanctions imposed by the outgoing Joe Biden administration as well as the extremely cold climatic conditions over the Atlantic Ocean.

It must be recognised that the energy sector remains one of the biggest policy challenges before Finance Minister Nirmala Sitharaman as she formulates the Budget. An economy that relies for over 85% of its fuel needs from abroad must closely monitor global oil markets. If crude oil goes beyond the range of $75-80 per barrel in FY2026 it would create pressure on the current account deficit as well as push up inflation. On the plus side, Trump’s declaration of ‘drill baby drill’ at his inauguration means that the US oil production is set to rise. This could soften world prices which have been bullish in recent weeks.

Another factor that could impact the domestic economy would be Trump’s proposed new tariff regime. The details of the new trade policy have not been outlined but higher import levies are certainly on the anvil for a slew of countries. This includes neighbours as well as China. For India, which has been described as a tariff king by Trump, there has been a veiled warning that reciprocal levies are on the way. So, exports to the huge US market could soon face daunting tariff walls.

While navigating both domestic and external headwinds, the upcoming Budget must seek to create a more conducive environment for private investment to push growth. The issue appears to be a major challenge for policymakers. Despite claims that much has been done to remove regulatory cholesterol, investors continue to find red tape enmeshing new projects. The result is that smaller countries, like Vietnam and Indonesia, with less bureaucracy are attracting higher investments. The Budget will have achieved a large measure of success if it can cut this Gordian knot and thus revive the animal spirits of the economy.

(Sushma Ramachandran is a senior journalist.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.