A Good Time to Stimulate

A WEEK AFTER THE Budget for 2025-26 took a bold bet and cut income tax to spur growth, the Reserve Bank of India (RBI) reduced its policy rate by 25 basis points, its first rate reduction in five years. To­gether, the two steps—taken nearly in tandem—are a bet on spurring the Indian economy. Economic growth had fallen to a seven-quarter low of 5.4 per cent in the second quarter of this fiscal year, prompt­ing steps to push the economy to a higher growth trajectory.

Softness in the Indian economy, especially on the consumption side, has been evident for a while now. Sales of vehicles—both two-wheelers and four-wheelers—along with FMCG goods have been muted and subdued for some time. A week after the Budget was presented, RBI released survey data that further highlighted these sources of weakness.

The Consumer Confidence Survey (CCS) that was released on February 7 showed that short-run confidence in the economy on the part of consumers, as measured by the Current Situation Index (CSI), remained in negative territory and had taken a slight dip from the previous edition of the survey in November last year. The CSI maps current perceptions of the Indian economy. At the same time, the Future Expectations Index (FEI) in the same survey was anchored in the zone of optimism even if it also showed signs of tapering off. Anything above 100 is considered a sign of optimism on the part of the consumers who are surveyed. The closest that CSI came to entering the zone of optimism was in March 2024.

Other surveys conducted by RBI gave a similar impression. The Survey of Professional Forecasters on Macroeconomic Indi­cators (SPF) showed a median forecast of GDP growth in 2025-26 at 6.5 per cent, just 0.2 percentage points more than the SPF fore­cast for 2024-25. What was worrying in this survey was that the median forecast for consumption growth in 2025-26 compared to 2024-25 was flat: 6.5 per cent. This tallied well with the CCS which showed weakness in the consumption economy. Anoth­er survey, the quarterly Order Books, Inventories, and Capacity Utilisation Survey (OBICUS), showed that seasonally adjusted capacity utilisation in the manufacturing sector had declined by 110 basis points between the first and second quarter of 2024-25.

The government, it is clear from the Budget pronouncements, had a good idea of the weakness of the Indian economy. But the Budget is not just an economic programme for the year: it is also a political statement in a noisy economy where the same set of rather limited resources has many demands on it. The plethora of schemes in every Budget geared to many sections of the popu­lation is usually like too little butter spread on too much bread. But amid these demands, the ultimate goal of higher growth has never been sacrificed. What changed this year were the tools used to spur growth. RBI’s decision to reduce the repo rate—the rate at which the central bank lends money to commercial banks— complements the steps taken by the government in the Budget.

RBI’S REASSESSMENT OF the economic situation for 2024-25 tells its own, rather different story, one that was at odds with developments in the Indian economy. But on February 7, the central bank corrected the course of its policy. In 2024, the focus of the RBI’s Monetary Policy Committee (MPC) was on inflation management even as it remained optimistic about India’s growth prospects. In its first meeting for fiscal 2024- 25 from April 3 to 5, MPC projected a GDP growth rate for 2024-25 at 7 per cent and for the second quarter of 2024-25 at 6.9 per cent. In June, when it held its meeting from the 5th to 7th of that month, it bumped up the annual GDP growth rate to 7.2 per cent and the second quarter growth for 2024-25 to 7.2 per cent, an increase of 0.3 percentage points. It maintained its optimistic projection for second-quarter growth through the year: in October, when MPC met from the 7th to 9th of that month, it assessed growth for the quarter at 7 per cent, just a tad below the 7.2 per cent forecast that was issued in June.

At the end of November, when the government released the GDP data for the second quarter of the year, the bottom fell through these projections and growth came to a seven-quarter low of 5.4 per cent: 1.5 percentage points less than RBI’s forecast at its first MPC meeting for 2024-25 and 1.8 percentage points below its most optimistic forecast of 7.2 per cent growth for the second quarter. But even at this late stage, when MPC met a week after the data was released at the end of November, the central bank asserted: “The MPC emphasises that strong foundations for high growth can be secured only with durable price stability. The MPC remains committed to restoring the balance between inflation and growth in the overall interest of the economy.” This rationale was used to keep the policy rate unchanged at 6.5 per cent and the monetary policy stance was kept “neutral”.

By February, when MPC held another meeting, this position had become untenable. For one, there was plenty of data to show the softening of growth in the Indian economy; for another, the government reducing taxes for the middle class in the 2025-26 Budget was a cue that it was time to shift gears in the inflation-growth dynamic. RBI did what was necessary and on February 7 it reduced the policy rate by 25 basis points even as it maintained a “neutral” monetary policy stance.

MPC’s rationale for reducing the policy rate factored in the changing dynamic between inflation and growth. “The MPC not­ed that inflation has declined. Supported by a favourable outlook on food and continuing transmission of past monetary policy actions, it is expected to further moderate in 2025-26, gradually aligning with the target. The MPC also noted that though growth is expected to recover from the low of Q2:2024-25, it is much below that of last year.” This is probably the most realistic assessment of the Indian economy by the central bank in the past year.

SINCE 2019, THE Narendra Modi government has been criticised routinely for not ensuring economic growth at a pace that is requisite for what India needs. Much of this criticism was unfair even as it was obvious that India needed faster growth.

At any point, any government has two levers to speed up growth. It can boost consumption or it can increase investment. These are like the two engines of a plane that can be used to push up its altitude and increase its speed. The government can spur growth quickly through fiscal means, either by undertaking higher expenditures or by reducing taxes and leaving more mon­ey in the hands of citizens. Both options have trade-offs that need to be understood and factored in carefully. Higher expenditures on subsidies and government consumption are less preferred to higher spending on public investment. The latter creates assets and infrastructure that encourage growth in the medium to long term while the former give short-run growth spurts that are ac­companied by inflationary risks. In India, the two options are not ‘perfect substitutes’.

For political reasons, farmers and other interest groups have to be given subsidies on fertilisers and by increasing procurement prices. These ought to be seen as ‘stability costs’ that are necessary to maintain political equilibrium.

The other option, to increase public sector expenditures, es­pecially capital expenditure, is more fruitful. This has been the favoured option of the Modi government for the past seven years. In 2019-20, capital expenditure stood at 1.7 per cent of GDP. When the grants-in-aid for the creation of capital assets were added to this expenditure, it rose to 2.6 per cent of GDP. The overall figure, dubbed as “effective capital expenditure”, rose over the next six years to a high of 4.3 per cent budgeted for 2025-26. In money terms, too, these expenditures nearly tripled from ₹5.2 lakh crore in 2019-20 (for effective capital expenditure) to ₹15.6 lakh crore in 2025-26 (Budget estimate). In 2019-20, this amounted to nearly 31 per cent of the Centre’s revenue receipts that fiscal. This expendi­ture is estimated to go up to a scorching 45.26 per cent in 2025-26.

It is interesting to note that in 2025-26 grants-in-aid for the cre­ation of capital assets to states as a percentage of GDP will increase more as compared to the Centre’s own capital expenditure. There is a good reason for this. Constitutionally, the Centre’s ability to spend is more limited as compared to states that have a wider am­bit. That the upper limits on Centre’s capex were fast approaching was obvious for a while now. While these expenditures have laid the foundations for medium-run growth—by massive invest­ments in infrastructure—what was needed next was something different, something that could spur growth quickly.

That was the rationale behind the ₹1 lakh crore cuts in income tax announced by Finance Minister Nirmala Sitharaman in the Budget for 2025-26. When seen along with RBI’s policy rate re­duction, the combination is a bet on a new fiscal and monetary stimulus to the Indian economy. This complements the large doses of money injected into India’s rural economy through vari­ous welfare measures over the past years. Those measures have their importance, especially as they take care of farmers and other sectors of the rural economy that are not as productive as the lead­ing sectors of the economy. What RBI and the government have done in the past fortnight is to renew focus on economic growth, something that is essential for all Indians.

economic stimulusFinance Minister Nirmala SitharamanIndian economyOpenomics 2025Union Budget 2025