Jefferies in its 2025 India outlook note said that the Modi government's commitment towards an aggressive fiscal consolidation path -- to bring fiscal deficit down to 4.4 per cent in FY26, lowers the spending headroom. The weak government expenditure growth in H1FY25 will drive a higher growth in H2FY25 but that improvement will be short-lived, it warned, as it feels the Union Budget 2025 in February may not boost investor sentiment.
In its note, Jefferies expects total spending growth in FY26 at 6-7 per cent YoY with capex growth slower as compared to that in the recent past. In addition, possible increase in taxes -- capital gains on equities or communication to that effect under the DTC could disappoint. Overall, equity markets could give a buying opportunity post Union Budget 2025, it said.
Jefferies noted that the government raised the capital gains on equity by 5 percentage points to 20 per cent (short-term) and 2.5 per cent to 12.5 per cent (long-term) in its July 2024 Budget.
"We believe the movement of short-term capital gains tax rate to marginal (30 per cent + surcharge) is underway, and as such another hike cannot be ruled out. As and when it gets effected, it will then equalise rate of taxation across other asset classes viz. debt, gold and property. The govt may defer this possible increase to a later date but a possibility of the same finding a mention in the DTC (Direct Tax Code) exists. If this happens, the sentiments of the equity market investors will be impacted," it said.
Jefferies said the unwinding of the post pandemic fiscal response started in FY24 and FY26 would likely see the continuation of the trend. It estimated FY26E fiscal deficit at 4.4 per cent of GDP against a likely 4.7 per cent in FY25. This would be against a target of 4.9 per cent for the ongoing financial year.
The government has also highlighted its aim to target future years fiscal deficit with a broad aim to bring down government debt to GDP ratios every year.
"Partly, the fiscal consolidation is driven by a desire for a Sovereign bond rating upgrade. Notably, S&P had upgraded India's rating outlook to positive, from stable in May24. S&P has said that fiscal deficit below 7% of GDP on consolidated (centre + state) basis will be a trigger for rating upgrade to BBB (from BBB-). With the state FD at ~3%, centre's FD consolidation to 4.0% is needed for the upgrade," it said.
Jefferies said FY26 could see some revenue slowdown against base, partly as a large RBI dividend received by the government in FY25 (Rs 2.1 lakh crore) is likely to see a decline (Rs 1.5 lakh crore), impacting revenues by 20 bps of GDP. Also, the tax revenue growth, particularly for income taxes (26 per cent CAGR over FY21-25E) has a relatively high base.
"Nonetheless, we assume tax revenue growth at 10 per cent (vs 11 per cent in FY25E). The total expenditure growth would have to be limited to 6-7 per cent, same as FY25E. There will be some comfort on expenditure as the GST cess collections are likely to run into a surplus - though excess collections will likely get shared with the state govt's," it said.