Fitch Ratings announced that India's post-election budget confirms the new administration's commitment to reducing the fiscal deficit for FY25 and FY26 despite the coalition government's demands. The FY25 budget lowers the Centre's fiscal deficit target for the year ending March 2025 to 4.9% of GDP, down from 5.1% in February's interim budget. This target is significantly below the 5.4% anticipated by the rating agency when it affirmed India's 'BBB-' rating with a stable outlook in January 2024.

Commitment to Fiscal Deficit Reduction

Fitch noted that the sustained focus on supporting economic growth through high public capital expenditure indicates continuity in key areas. Additionally, the government's recent record of achieving or outperforming its budget deficit targets has improved its fiscal credibility. The deficit in FY24, at 5.6% of GDP, was well below the original target of 5.9%. Furthermore, using the RBI dividend reinforces a preference for fiscal consolidation over additional spending.

Public Finance Metrics and Credit Profile

Public finance metrics remain weak in India's credit profile, with fiscal deficit, interest-to-revenue, and debt ratios still high compared to the 'BBB' category peers. Sustained fiscal consolidation that supports a downward trajectory in the government debt ratio over the medium term would support India's credit profile and could potentially lead to a rating upgrade, especially with positive momentum in macroeconomic performance and external finances.

Priority Areas and Reforms

The budget highlighted several other priority areas, including agricultural development, job creation, labour skills improvement, and manufacturing strengthening. Proposals addressing India's skills gap, particularly in manufacturing, will ultimately depend on implementation. Additionally, measures to review customs duties and reduce the foreign firms' corporation tax rate to 35% from 40% should positively impact manufacturing investment. However, land and labour regulations remain significant constraints. They will remain under state governments' purview, with the central government incentivizing reforms. This aligns with expectations, as advancing such reforms is challenging, especially at the national level, and has become more politically difficult following the return to a coalition government.

Fiscal Deficit Target and Economic Growth

The FY25 budget has set an ambitious target for reducing the fiscal deficit to 4.9% of GDP, which demonstrates a strong commitment to fiscal discipline. This reduction from the previously projected 5.1% in the interim budget is a significant step towards fiscal consolidation. Fitch Ratings has recognized this effort and highlighted that the government's recent track record of meeting or surpassing its deficit targets has enhanced India's fiscal credibility. The fiscal deficit for FY24 was 5.6% of GDP, which was below the initial target of 5.9%.

Importance of Public Capital Expenditure

The government's focus on high public capital expenditure is crucial for supporting economic growth. This strategy ensures that investments in infrastructure and other key areas continue to drive economic development. Fitch Ratings has acknowledged this approach, noting that it indicates continuity in key areas that are essential for sustainable growth.

Utilizing RBI Dividend for Fiscal Consolidation

One of the notable aspects of the budget is the use of the RBI dividend for fiscal consolidation rather than additional spending. This move underscores the government's preference for maintaining fiscal discipline and reducing the deficit. By prioritizing fiscal consolidation, the government aims to improve its financial stability and credibility.

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Addressing Public Finance Metrics

While there have been improvements, public finance metrics remain a challenge for India's credit profile. The fiscal deficit, interest-to-revenue ratio, and debt ratios are still high compared to other 'BBB' category peers. Sustained efforts towards fiscal consolidation that support a downward trend in the government debt ratio over the medium term would enhance India's credit profile. Positive momentum in macroeconomic performance and external finances could also contribute to a potential rating upgrade.

Focus on Key Priority Areas

The budget has highlighted several key priority areas, including agricultural development, job creation, labour skills improvement, and manufacturing strengthening. Addressing the skills gap, particularly in manufacturing, is crucial for India's economic growth. The government has proposed measures to review customs duties and reduce the corporation tax rate for foreign firms, which should positively impact manufacturing investment.

Challenges in Land and Labour Regulations

Despite these efforts, land and labour regulations remain significant constraints. These areas fall under state governments' purview, and the central government is incentivizing reforms. However, advancing such reforms at the national level is challenging, especially given the political complexities of a coalition government.

Conclusion

Fitch Ratings' announcement that India's post-election budget confirms the administration's commitment to reducing the fiscal deficit is a positive development. The budget's focus on high public capital expenditure, fiscal consolidation, and key priority areas demonstrates the government's dedication to sustainable economic growth. However, addressing public finance metrics and overcoming challenges in land and labour regulations will be crucial for achieving long-term financial stability and economic development.

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