Sovereign budgeting is something that impacts every single country, and by extension, every investor in the stock market. While the revenues and expenditures of the government might seem irrelevant to you at the outset, these metrics do affect the overall economy, which in turn gets priced into the market.
In this article, we’re going to deep dive into what the budget surplus really means, what are the risks or advantages of having an Indian budget surplus, and whether this is a good thing for equity investors in public markets.
What is a budget surplus?
At its core, a budget surplus is a simple term. When a government is in surplus, it means that the government has more revenues than expenditure in that time period, meaning that it has ‘surplus’ funds in the end. On the other hand, if the government spends more than it raises (which is usually the case with the Indian government), it runs a ‘deficit.’
Government revenues most significantly come from taxes, fees, and asset sales, while government expenditures could be anything from infrastructure projects to public services.
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The government also, for instance, in the Union Budget that comes out every year, lays out how much money it will allocate to which sector in the following year. With reference to the latest Indian Union Budget 2023-24, here is a snapshot of different allocations for the upcoming fiscal year 2024-25:
How budget surpluses are generated
The road to a budget surplus comes in two ways – a reduction in government expenditure or an increase in government revenue. Usually, surpluses are generated by high tax revenues, coupled with prudent spending policies. It also depends on every particular year in the economy, and whether it suffered any unexpected shocks or not.
Surges in property prices, a high asset divestiture rate, or unexpectedly high tax rates could drive a government surplus. On the other hand, high expenditures due to a national disaster or another public health crisis like COVID-19 could drive government expenditures high while reducing tax revenues.
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What are the consequences of a budget surplus?
On the good side, a surplus could generate great effects for an economy:
- Reduced national debt: If the government doesn’t need to cover its expenses with debt, it won’t take on more. A lowering of debt could free up resources for future investments, potentially boosting economic growth.
- Lower interest rates: A smaller debt pile can also make the government a more creditworthy borrower, potentially leading to lower interest rates, which can stimulate borrowing and investment. Lower interest rates can also sometimes increase investment in private markets, leading to higher equity valuations and a booming stock market.
- Increased public spending: With more resources available, the government can invest in infrastructure, education, healthcare, and other areas, which could mean long-term betterment of the economy.
Even though surpluses might always seem like a good thing, there are several negative effects as well:
- Dampened economic activity: Excessive government saving can dampen economic activity since governments are usually the highest spenders on infrastructure and development, investment in which trickles down to other industries as well.
- Reduced social welfare programs: If spending cuts are the primary driver of the surplus, reductions could come with defunding of programs that actually increase well being in the economy.
- Personal taxes could go up: One of the ways of increasing revenue is increasing income taxes, which could mean that the price of lowering the government deficit (or creating a surplus) would be more money out of your salary.
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Calculating the budget surplus (or deficit)
Calculating whether the government is in deficit or surplus is actually pretty simple. All you have to do is look up the latest government Union Budget, scroll down, and find the overall expenses and revenues table.
With reference to the latest Union Budget 2024, this is it:
Deduct total revenues from total expenditure. If the answer is positive, the government is creating a surplus. If not, a deficit. In the latest Union Budget, while the Indian government is still in deficit, they have generated a significantly lesser deficit, decreasing it by 21.7%.
Conclusion
Ultimately, whether a budget surplus is good for equity investors depends heavily on the specific circumstances. A well-managed surplus used for productive investments can create a favourable environment for stocks. However, if it leads to economic slowdown, exacerbates inequality, or introduces policy uncertainty, it can pose risks.
Therefore, while the budget should be an important part of your fundamental analysis of the Indian economy, it shouldn’t be the only metric you judge the investing environment by.
