India's economy is likely to grow by 6.5 per cent in the current and the next financial year, an EY report said, attributing lower than anticipated expansion in the September quarter to fall in private consumption expenditure and gross fixed capital formation.

Real GDP growth eased to a seven-quarter low of 5.4 per cent in July-September -- the second quarter of the current 2024-25 fiscal year.

This was compared to 6.7 per cent in the preceding quarter.

This was primarily because two domestic demand components -- private final consumption expenditure and gross fixed capital formation -- together accounted for a fall of 1.5 percentage points.

"One outstanding feature of demand is the slowdown in investment, as reflected in the growth of gross fixed capital formation. This growth is estimated at 5.4 per cent in 2QFY25, which is a six-quarter low. Apart from the fact that private investment demand has not picked up, there was a contraction in government of India's investment expenditure growth, which has remained negative at (-)15.4 per cent in first half of FY25," the report said.

It continued to be negative even in October 2024 at (-)8.4 per cent, implying that in the first seven months government's investment expenditure growth has remained negative at (-)14.7 per cent. "In fact, to meet the budgeted target of Government of India's capital expenditure growth of 17.1 per cent over CGA actuals for FY24, we now require a growth of 60.5 per cent in the remaining five months of the fiscal year FY25." The EY Economy Watch December 2024 forecasts India's real GDP growth at 6.5 per cent for FY25 (April 2024 to March 2024 fiscal year) and FY26.

It also highlights the importance of reforming India's fiscal responsibility framework to achieve the Viksit Bharat vision by 2047-48. A recalibrated approach is vital for sustainable debt management, eliminating government dissavings, and driving investment-led growth, paving the way for India's transformation into a developed economy, it said.

"With global conditions remaining uncertain and global trade likely to be fragmented, India may have to continue to rely largely on domestic demand and services exports. In the medium-term, India's real GDP growth prospects can be kept at 6.5 per cent per year provided the Government of India (GoI) accelerates its capital expenditure growth in the remaining part of the current fiscal year and comes up with a medium-term investment pipeline with participation from the GoI and state governments and both their respective public sector entities, and the private corporate sector," it said.

It would be appropriate to recast the earlier 2019 National Infrastructure Pipeline (NIP) for a period extending up to 2030 with revised targets for the priority sectors including roads, smart cities, railways, power, and renewable energy.

"Investment targets for all the three major investors namely GoI and state governments and their respective public sector undertakings, and private corporate sector should be recast after evaluating their performance in financing the earlier NIP," it said, adding, together, the GoI and the state governments should ensure a minimum capital expenditure allocated towards infrastructure growth of 6 per ent of GDP each year over a five-year period. This implies driving their revenue deficits to near zero.

The latest edition of EY Economy Watch suggests that the total debt of the central and state governments combined should not exceed 60 per cent of the country's nominal GDP, with each taking an equal share of 30 per cent.

It also emphasizes the need for both levels of government to balance their current/operating income and spending, which would boost national savings. This would lead to a savings rate of about 36.5 per cent of GDP in real terms. Adding another 2 per cent of GDP from foreign investments would bring the total real investment level to 38.5 per cent, helping India achieve steady economic growth of 7 per cent per year.

D K Srivastava, Chief Policy Advisor, EY India, said, "The proposed revisions to the Fiscal Responsibility and Budget Management (FRBM) Act are essential for enabling India to pursue sustainable growth while maintaining fiscal prudence. The updated framework would help eliminate government dissaving, increase investment, and create a more resilient economy that is well-equipped to meet the challenges of the future. The changes will not only address current challenges but also pave the way for India's transition to a developed economy, achieving its Viksit Bharat aspirations."

Economy Watch suggests that a major reform is required in the FRBM Act to ensure fiscal responsibility while supporting India's ambitious growth goals. One of the recommendations is to reinstate the revenue account balance as a key target for both the central and state governments.

This would eliminate government dissavings, which are currently a drain on resources, and create space for productive investments that are vital for economic growth.

The report also suggests that both the central and state governments should aim for a fiscal deficit target of 3 per cent of GDP each. However, to handle unexpected challenges like economic slowdowns, the central government should have some flexibility, allowing the deficit to range between 1 per cent and 5 per cent of GDP.

In case the crisis is much bigger, such as the Covid crisis, suitable variation in GoI's and states' fiscal deficit beyond the above range may be considered by an appropriate body such as a fiscal council. This approach balances fiscal discipline with the ability to address extraordinary situations.

Another key recommendation is to eliminate revenue deficits entirely. This would free up funds for productive investments, with combined government investments expected to reach 6 per cent of GDP by FY2048.

"Overall, investments in the economy, including contributions from households, businesses, and the public sector, are expected to grow to 38.5 per cent of GDP in real terms, driving sustained growth and development," the report added.

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