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26th June 2025 (28 Topics)

India’s Expansionary Fiscal and Monetary Policies

Context

In 2025, India is facing slowing economic growth, declining inflation, and rising unemployment. To revive the economy, the government and the Reserve Bank of India (RBI) have both taken expansionary steps—through tax cuts and interest rate reductions. However, this simultaneous expansion by both fiscal and monetary arms has raised concerns about policy coordination and long-term macroeconomic stability.

The expansionary steps

  • Monetary Policy: The RBI cut the repo rate in two successive policy meetings: April 2025: -25 basis points, June 2025: -50 basis points to boost private investment, increase credit growth, and support GDP growth (forecast at 6.5% for 2025–26).
    • Reason: Inflation has fallen (3% in June 2025), giving the RBI space to cut rates and stimulate demand.
  • Fiscal Policy: In February 2025, the government announced income tax cuts to increase household disposable income, raise consumption demand and stimulate growth.

Why is this Policy Mix Problematic?

Expansionary Policies Need Careful Coordination

  • Fiscal and monetary policies both influence aggregate demand.
    • Fiscal expansion means more spending or investment by the government or consumers.
    • Monetary expansion makes loans cheaper, encouraging more private investment.
  • If both policies are expansionary at the same time, they risk the following:
    • Overheating the economy
    • Rising inflation
    • Higher fiscal deficits if the economic growth does not keep pace
  • Global learning: In US & UK, tax cuts were neutralised by central banks refusing to cut rates fearing inflation. This shows how uncoordinated policies can cancel each other out or create imbalances.
What are the current concerns in India?
  • Muted Economic Response: Despite tax cuts, credit growth fell to 9% in May (lowest in 3 years). Unemployment rose from 5.1% in April to 5.6% in May. This suggests:
    • Weak aggregate demand
    • Income tax cuts have not yet stimulated spending
  • Time Lag vs. Forward-Looking Consumers: Economic theory assumes people adjust their spending based on expected gains (forward-looking). But the delay in response raises doubts:
    • Are people waiting for actual income before spending?
    • If so, a delayed inflation spike could come once spending picks up.
What Happens If Growth Doesn’t Rise?
  • Fiscal deficit may widen if GDP doesn't rise, tax collections fall, and deficit rises. To control deficit:
    • Government may cut spending (especially revenue expenditure).
    • That could hit vulnerable populations, as welfare programs may be downsized.
  • If both consumption and investment spike later, RBI may be forced to reverse its rate cuts, tightening monetary policy sharply.
Structural Risks
  • Weak Demand Structure: Even with expansionary policies, demand isn’t picking up. This points to larger structural issues:
    • Inequality in income distribution
    • Rising corporate profits, stagnant wages
    • Weak wage-led demand for goods/services
  • Role of the State: In such cases, relying solely on markets may not work. Sustained state intervention is needed to:
    • Boost wages and consumption
    • Strengthen public infrastructure
    • Protect social spending from fiscal consolidation pressures
Fact Box:

Expansionary Policies

  • Expansionary fiscal policy: Government spends more or cuts taxes to push demand.
  • Expansionary monetary policy: Central bank (RBI) cuts interest rates so businesses and consumers borrow and spend more.
  • Together, these are used when the economy is slow, unemployment is rising, and people aren’t spending enough.

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