As India moves through a changing global economic landscape, both monetary and fiscal policies have taken steps to support growth while ensuring stability. The Reserve Bank of India’s (RBI) decision to cut the policy repo rate by 25 basis points to 6.25% and the Union Budget 2025-26’s emphasis on private consumption and fiscal consolidation reflect a coordinated approach to economic management. However, the effectiveness of these measures depends on multiple factors, including liquidity conditions, private sector response, and external risks.
Monetary Policy: A Step Toward Growth Amid Liquidity Challenges
The RBI’s first rate cut in nearly five years signals a shift in focus toward economic growth. With inflation moderating—falling from 6.2% in October 2024 to 4.8% by early 2025—the central bank sees room to ease borrowing costs. The decision aligns with global monetary trends, where central banks in major economies are beginning to adopt a more accommodative stance.
However, liquidity constraints in the banking system remain a concern. Since late 2024, banks have been operating under a liquidity deficit exceeding ₹3 trillion, which could limit their ability to increase lending even as borrowing costs fall. If liquidity conditions do not improve, the transmission of lower interest rates into higher credit growth and investment activity could be delayed.
Another consideration is external economic conditions. The strength of the U.S. dollar and volatility in global commodity markets add uncertainty, which could influence capital flows and exchange rate stability. While India’s domestic economy remains resilient, external risks must be monitored.
Fiscal Policy: Encouraging Private Consumption While Maintaining Fiscal Discipline
The Union Budget 2025-26 introduces policies aimed at boosting household consumption and private investment. Key measures include:
- Income tax relief, making income up to ₹12 lacs tax-free, which is expected to increase disposable income and spur demand.
- A continued focus on capital expenditure, with an allocation of ₹11.2 lakh crore, though the rate of growth in government spending has slowed.
- A reduction in the fiscal deficit to 4.4% of GDP, signaling a commitment to long-term fiscal sustainability.
The government’s approach marks a shift from public sector-led growth to greater reliance on private sector investment. The assumption is that lower taxes and reduced government borrowing will create conditions for businesses to expand investment and job creation.
However, uncertainties remain. While higher disposable income can support consumption, the extent to which it translates into higher economic activity depends on consumer confidence and spending patterns. Also how much these disposable income will be in absolute terms given the benefit is more in the Rs 12 lacs and less bracket remains to be seen. Similarly, while the private sector is expected to drive investment, actual investment decisions will be influenced by factors such as global trade dynamics, credit availability, and business sentiment.
Aligning Monetary and Fiscal Policy: Opportunities and Risks
The simultaneous move toward monetary easing and fiscal consolidation presents both opportunities and challenges.
- Positive Impact: Lower interest rates and tax cuts together could stimulate demand and investment, providing a boost to GDP growth, which the RBI projects at 6.7% for 2025-26.
- Liquidity Concerns: If banking system liquidity remains tight, credit expansion could be slower than anticipated, reducing the effectiveness of the rate cut.
- Private Sector Response: The success of this strategy depends on how businesses respond—whether they increase investments, expand production, and generate employment.
- External Risks: Geopolitical tensions, commodity price fluctuations, and global financial conditions could impact India’s external trade and investment flows.
Conclusion: A Watchful Approach is Needed
Both monetary and fiscal policies in 2025 reflect a calibrated approach to supporting economic growth while managing risks. While the measures taken by the RBI and the government create an environment conducive to higher consumption and investment, their success depends on effective implementation, private sector participation, and external stability.
Going forward, policymakers may need to remain flexible. If liquidity challenges persist, additional monetary tools may be required. Similarly, if private investment does not pick up as expected, the government may need to adjust its capital expenditure strategy. A balanced and adaptive approach will be key in ensuring that India’s economic trajectory remains strong and inclusive.
Indian Political Debate 