CONTEXT

• The Indian economy is facing slowing growth, with signs of weak aggregate demand.
• Inflation fell to a 6-year low (~3%) due to early monsoons and good harvests.
• Unemployment rose to 5.6% in May 2025 from 5.1% in April.
• Credit growth fell to a 3-year low (9% in May 2025), reflecting sluggish private investment.

CONCEPT – EXPANSIONARY POLICIES

 Fiscal Policy

• Government cut income taxes (Feb 2025) to boost consumption.
• Aims to increase disposable income, spur demand, and drive growth.
• If demand doesn’t rise as expected, fiscal deficit may widen.

 Monetary Policy

• RBI cut repo rate in April (25 bps) and June 2025 (50 bps) to 5.5%.
• Aims to reduce borrowing costs and encourage private investment.
• Works well when inflation is low and credit demand exists.

CURRENT SITUATION & CO-ORDINATION

• Both fiscal and monetary policies are expansionary—a rare simultaneous move.
• Requires co-ordination; otherwise, can trigger high inflation or policy ineffectiveness.
• In UK/US, fiscal expansion was neutralized by monetary restraint due to inflation fears.

KEY ISSUES

• Despite tax cuts, consumption hasn’t risen significantly.
• Raises doubt on whether households are forward-looking (as per economic theory).
• Lag effect in response or loss of trust in policy signals could be reasons.

RISKS

• Rising fiscal deficit if revenue doesn’t increase.
• Government may need to cut welfare spending, impacting vulnerable sections.
• Future inflation spike possible if both consumption and investment surge later.

MAINS QUESTIONS

1. What are the potential consequences of a rising fiscal deficit in India, and how can the government manage its finances to mitigate these risks?
2. How can the RBI’s monetary policy decisions impact the overall economy, including inflation, growth, and employment?