The Double-Edged Sword: India’s Expansionary Policy Gamble

NATIONAL HERO — PETAL 001

🗓️ Post Date: June 24, 2025
📚 Thematic Focus: GS3 – Economy | Fiscal Policy | Monetary Policy

🪷 Opening Whisper

When the economy whispers for growth, the government and central bank often roar together—but too much of a good thing can still shake the balance.

🔍 Key Highlights

• India is in a rare phase where both fiscal and monetary policies are expansionary.
• The Union Budget 2025–26 focuses on infrastructure, agriculture, MSMEs, and tax cuts to boost demand.
• The RBI cut repo rate to 5.5%, balancing inflation control and growth push.
• Despite policies, demand remains muted, unemployment is rising, and growth is sluggish.
• Risks include inflation, fiscal deficit, and inequality, calling for tight policy coordination.

🧠 Concept Explainer

▸ What are Expansionary Policies?

Expansionary fiscal policy involves more government spending and lower taxes, while expansionary monetary policy refers to lower interest rates and liquidity injection to stimulate economic activity.

▸ Why Now?

• Growth slowdown in 2024–25
• Weak private demand and credit uptake
• Global cues encouraging domestic stimulus

🗺️ GS Paper Mapping

• GS Paper 3: Indian Economy and issues relating to Planning, Mobilization of Resources
• Keywords: Expansionary Fiscal Policy, Repo Rate, FRBM Act, Liquidity, Public Spending

🌠 A Thought Spark — by IAS Monk

“Stimulus without restraint is like rain without a riverbed—overflowing, aimless, and often destructive. Let us revive the economy not just by spending, but by aligning vision with velocity.”

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Policies in a Slowing Economy: Navigating the Tightrope between Growth and Stability

In the wake of a slowing global economy and tepid domestic demand, India has embarked on a bold economic journey: deploying both fiscal and monetary policies in an expansionary mode. This rare alignment, although aimed at reviving demand and investment, raises concerns around macroeconomic stability, inflation control, and long-term fiscal discipline. The key challenge lies in balancing short-term stimulus with long-term prudence.

Understanding Expansionary Policies

Expansionary Fiscal Policy refers to increasing public spending and/or cutting taxes to stimulate aggregate demand. On the other hand, Expansionary Monetary Policy, typically led by the central bank, involves reducing interest rates and increasing liquidity to encourage borrowing and investment. When both policies are expansionary at the same time, the multiplier effect can be powerful—but also risky if not carefully timed and coordinated.

The 2025–26 Union Budget reflects this approach clearly: a record ₹11.21 lakh crore allocated towards infrastructure, agriculture, MSMEs, and digital connectivity. Income tax cuts have been introduced to boost personal consumption. Simultaneously, the RBI has slashed the repo rate to 5.5% to revive borrowing and investment. These moves align with textbook Keynesian prescriptions for tackling demand-side slowdowns. But India’s complex economic landscape requires a more nuanced approach.

The Rationale: Stimulating a Sluggish Economy

India’s growth has been under pressure due to various global and domestic headwinds. Post-pandemic recovery has been uneven. Geopolitical disruptions, weak global trade, and inflation have dampened private sector confidence. Domestically, sluggish wage growth, high youth unemployment, and rural distress have constrained consumption.

With private investment reluctant and exports volatile, the government has stepped in with higher public capital expenditure to crowd in private investment. Infrastructure spending is expected to generate employment, enhance productivity, and build long-term assets. Tax cuts and consumption boosters aim to revive demand, especially among the middle class.

RBI’s dovish stance complements this effort. By lowering interest rates and injecting liquidity, it aims to reduce the cost of borrowing, encourage consumer loans (like housing and autos), and stimulate business investment.

Challenges and Emerging Fault Lines

Despite the boldness of this approach, several structural and short-term concerns remain:

1. Lack of Policy Coordination

While both fiscal and monetary policies are expansionary, there is little evidence of synchronized planning. This could lead to overstimulation and demand-pull inflation, especially if supply constraints persist. The government is injecting money through public spending while the RBI is loosening monetary policy. If demand shoots ahead of supply, inflation may rise again, forcing abrupt policy reversals.

2. Muted Consumer and Credit Response

Despite tax relief and lower interest rates, consumers remain cautious. The Rational Expectations Theory suggests that people may save rather than spend if they anticipate future inflation or job insecurity. Similarly, banks are wary of lending amidst poor credit demand, high NPAs, and global financial uncertainty. This indicates that expansionary tools alone may not be sufficient to trigger a full-scale recovery.

3. Widening Fiscal Deficit and Debt Risks

A heavy reliance on public spending without adequate revenue growth risks widening the fiscal deficit. If growth does not accelerate significantly, tax collections will lag, forcing the government to borrow more or cut welfare spending. This would hurt vulnerable sections and reverse the redistributive goals of fiscal policy. Already, India’s debt-to-GDP ratio hovers around 84%, leaving limited room for fiscal adventurism.

4. Inequality and Disproportionate Gains

Corporations, especially in tech and capital-intensive sectors, have reported robust profits. Yet real wages for informal and rural workers remain stagnant. If expansionary policies disproportionately benefit capital owners over labor, inequality will deepen. This reduces the efficacy of consumption-led recovery, since the marginal propensity to consume is higher among lower-income households.

5. Global Headwinds and Imported Inflation

India remains vulnerable to global shocks—rising oil prices, Fed rate hikes, and currency volatility. If imported inflation creeps in due to a weaker rupee or global commodity price surge, RBI may be forced to raise rates, thereby undoing its current expansionary stance.

Lessons from the Past

The world has seen the dual deployment of expansionary policies during major economic crises:

• The New Deal (1930s) in the US saw large-scale public works to counter the Great Depression.
• Post-2008 Financial Crisis: Central banks cut rates to near zero; quantitative easing injected liquidity.
• Japan’s Abenomics (2012–2020) combined fiscal stimulus, monetary easing, and structural reforms.
• India during COVID-19: A ₹20 lakh crore Aatmanirbhar Bharat package combined with RBI’s liquidity support helped stabilize the economy, but the long-term debt burden increased.

These episodes underline that expansionary policies work best when targeted, time-bound, and accompanied by structural reforms.

Benefits in the Indian Context

Despite concerns, the expansionary stance has several advantages for India:

1. Boosting Aggregate Demand

Public spending on infrastructure generates direct and indirect employment, while income tax relief increases disposable income. Together, they can nudge households and businesses to spend more, thereby reviving demand.

2. Supporting Job Creation

Schemes like PM Gati Shakti, Jal Jeevan Mission, and MSME credit guarantees can catalyse rural employment. Public works programs generate jobs even when private sector hiring slows down.

3. Encouraging Investment

Lower borrowing costs incentivize private firms to invest in capacity expansion, provided there’s visibility of demand growth. Infrastructure development also improves ease of doing business and reduces logistics costs.

4. Stabilizing Financial Systems

Liquidity injections prevent NBFCs and small banks from collapsing under stress. This sustains credit flow and avoids financial contagion.

5. Building Productive Assets

Unlike consumption subsidies, infrastructure spending creates long-term assets (roads, ports, digital connectivity) that improve productivity and competitiveness.

Way Forward: A Balanced and Calibrated Approach

To ensure that expansionary policies achieve their intended objectives without creating long-term risks, the following steps are necessary:

1. Strengthen Institutional Coordination

Set up a Monetary-Fiscal Council for regular policy alignment. This ensures that inflation targeting does not clash with growth objectives.

2. Adopt Targeted Transfers

Rather than across-the-board tax cuts, boost Direct Benefit Transfers (DBTs) and rural wage schemes to stimulate consumption among those with high marginal propensity to consume.

3. Implement Countercyclical Measures

Create buffers during boom years (such as sovereign wealth funds or budget surpluses) to fund fiscal stimulus in downturns.

4. Reform Tax Structures

Rationalise GST rates to improve compliance and revenues. Re-examine corporate tax concessions that have not led to commensurate investments.

5. Enhance Data-Driven Monitoring

Use real-time economic indicators (employment, credit flow, inflation expectations) to dynamically adjust policy levers. Avoid lag-based responses.

Conclusion: Walking the Tightrope

India’s simultaneous use of expansionary fiscal and monetary policies is bold and contextually justified. In times of distress, the state has a moral and economic responsibility to stimulate demand and protect vulnerable populations. However, stimulus must not be mistaken for a permanent growth engine. The real test lies in exiting expansionary policies gracefully and transitioning to a sustainable, productivity-led growth model.

While the sails of stimulus are catching the winds of recovery, the rudder of coordination and structural reform must steer India safely through the waves of global and domestic uncertainty. As history has shown, the journey from crisis to stability is not merely about spending more, but about spending wisely.

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Topic: Policies in Slowing Economy