The Budget for FY26, followed by the RBI’s February monetary policy, needs to be seen together at least on two counts. First, can they surmount immediate problems confronted by the economy? Second, do they have the firepower to steer the economy towards the aspirational goal of becoming a developed country by 2047?
According to the IMF, global GDP growth at 3.3 per cent in 2025 and 2026 would be below the historical average of 3.7 per cent (2000-19). Geopolitical risks remain unresolved disrupting global supply chains. The recent resurgence of tariff war has accentuated the prevailing anti-globalisation attitude. Global uncertainties harm cross-border merchandise trade and capital flows to emerging market economies.
Amidst this scenario, India’s real GDP growth is expected to be 6.5 per cent in FY25 (according to NSO’s second advance estimates released on Friday) compared to an average GDP growth of 8.8 per cent in the previous three years. Both consumption and private investment continue to remain sluggish. The manufacturing sector’s growth has been unimpressive for quite some time. Certain segments of the services sector have also shown signs of weakness. The only silver-lining is the agriculture sector which may witness robust growth in FY25. The stock market is passing through a bearish phase due to global headwinds. Policymakers are increasingly intrigued by persistent inequality and unemployment. Both, fiscal and monetary policy authorities have to act in concert to meet a complex set of objectives.
To achieve the aspirational goals by 2047, the asking rate of real (nominal) GDP growth is over 8 per cent (12 per cent), assuming 2.5 per cent annual average rupee depreciation. As against India’s potential growth of 7-7.5 per cent, the Economic Survey projects sub-optimal growth of 6.3-6.8 per cent in FY26. Despite several structural reforms pursued in the last decade, what is preventing India from achieving its potential rate of GDP growth?
In the post-Covid period, India’s growth has been mostly public-capex driven and expected to crowd in private investment. Employment was expected to grow commensurately with high growth. Moreover, high growth and transfer payments were expected to reduce income inequality. Earlier Budgets attempted to generate quality employment through PLI (production-linked incentive) scheme and ELI (employment-linked incentive) scheme. These expectations were not fulfilled, at least to the desired extent. Growth was jobless due to the impact of modern technology. A cyclical slowdown started well before a virtuous cycle, possibly due to inadequate consumption/investment demand following the high cost of funds.
Fiscal policy
These developments led to a course correction in this year’s Budget, accompanied by a change in monetary policy trajectory. Priority was shifted towards promoting MSMEs, agriculture, rural prosperity, private investment, and exports to achieve inclusive growth and high employment. Moreover, large income tax breaks and other Budget proposals wanted to leave more money in the hands of middle-class people who would consume more, and thereby help attract private investment.
The packaging looks attractive as the government is perceived to be doing something different to improve the standard of living of the common people. The Budget has something for all sections of society, from farmers to fishermen, weavers, and gig workers. Rural prosperity is being promoted to reduce the urban-rural divide. Have we changed direction from capex-led growth to employment-led growth? There is no harm in doing so, as the market economy cannot ensure equitable growth. Moreover, India would gradually transform from an investment-driven to a consumption-driven economy with high-mass consumption emerging from the growing middle-class.
It may seem that Budget proposals to address the immediate requirements of the economy have overshadowed the medium-term strategy of structural reforms, that can serve as fuel for reaching the Viksit Bharat destination. Effective public capex, including grants-in-aid to the State government for creating capital assets, is expected to remain elevated at ₹15.5 trillion in FY26. Investment in people/economy/innovations carries immense potential for medium-term growth acceleration. To improve productivity through ease of doing business, the High-Level Committee for Regulatory Reforms proposed in the Budget and the Prime Minister’s recent announcement for a Deregulation Commission assume importance.
The Budget is non-inflationary and growth-positive. Fiscal profligacy is eschewed by keeping the gross fiscal deficit to GDP ratio at 4.4 per cent in FY26. Systematic reduction of the debt-GDP ratio would now be the guiding principle of fiscal policy with GFD-GDP ratio as the operating target.
Coordinated move by RBI
Fiscal discipline opened up avenues for monetary policy to stimulate growth through a lower repo rate. Post-Budget, the MPC decided to unanimously reduce the repo rate by 25 basis points in February, in anticipation of CPI inflation gradually converging to the target. MPC minutes also highlighted concern about growth slowdown. Policy coordination is best achieved through capex-heavy fiscal consolidation and a low interest-rate scenario. Will a virtuous cycle kick-start and cut short the prevailing cyclical slowdown?
The writer is the former Head of the Monetary Policy Department of RBI. Views expressed are personal
