India’s Expansionary Policy Mix Amid Economic Slowdown Raises Questions of Coordination and Impact

India is currently experiencing a rare alignment of fiscal and monetary expansion, a policy stance typically adopted during severe economic slowdowns. However, despite the government’s income tax relief in early 2025 and the Reserve Bank of India (RBI)’s repo rate cuts in April and June, recent data reveals soft credit growth, rising unemployment, and low inflation — prompting debate over the effectiveness and timing of these measures.

In April 2025, the RBI cut the repo rate by 25 basis points, followed by a 50 basis point cut in June, bringing the benchmark rate down to 5.5%. These moves came alongside the February 2025 income tax cuts, aiming to boost disposable incomes and spur consumption. The central bank expects GDP growth of 6.5% in 2025–26, while inflation remains within the 4% ± 2% band, providing room for accommodative policy.

But while such dual expansionary efforts might seem appropriate in the context of sluggish demand, their simultaneous deployment raises critical concerns about economic coordination, inflation outlook, and fiscal sustainability.

A Tale of Two Policies: Expansion on Both Fronts

In economic theory, fiscal policy — which includes tax cuts or increased government spending — and monetary policy — generally focused on interest rates and liquidity — must work in tandem to achieve stable macroeconomic outcomes. When both are expansionary, the combined effect is an increase in aggregate demand, which can lead to inflation if not matched by a rise in output.

India’s case contrasts with what occurred in countries like the United Kingdom and the United States, where fiscal stimulus via tax cuts met resistance from monetary authorities concerned about inflation. Central banks in those economies refrained from cutting interest rates further, prioritizing price stability over growth.

But in India, the RBI’s willingness to ease policy, even in the face of fiscal loosening, suggests either confidence in inflation control mechanisms, or a greater concern about stagnating growth.

Muted Response from the Economy

Despite these policy measures, signs of a robust economic recovery remain elusive. A recent State Bank of India (SBI) report highlighted that credit growth fell to a three-year low of 9% in May 2025, down from 11.2% in February. The unemployment rate, meanwhile, climbed to 5.6% in May, up from 5.1% in April, signaling stress in the labour market.

These indicators suggest that the fiscal and monetary stimulus has yet to produce the intended multiplier effects. Consumption and investment, key drivers of aggregate demand, have not shown the expected revival. This raises two important questions:

1. Has the tax windfall failed to stimulate consumption?

2. Are households deferring spending despite higher disposable income?

Why Households May Not Be Spending Yet

One argument is that the effects of tax cuts and rate reductions take time to percolate through the economy. Households may only increase consumption after the full realisation of their increased take-home pay. However, this theory conflicts with a key assumption of modern macroeconomic models — that individuals are forward-looking and factor in expected future income when making spending decisions today.

If, instead, households are myopic, spending only when income materialises, then the result may be a delayed inflationary surge, as consumption and investment both rise simultaneously in the future. This could force the RBI to respond with aggressive tightening, negating earlier gains.

Is the RBI Underestimating Inflation Risk?

The current headline inflation rate dropped to a six-year low of around 3% in June, thanks to early monsoons, favourable agricultural output, and lower food prices. This has emboldened the RBI to adopt a more dovish stance. Yet, global risks loom large — including U.S. tariff escalations, Middle East conflict, and fluctuations in global energy prices following recent U.S. attacks on Iranian nuclear facilities.

If these factors spark a rise in imported inflation, or if consumption finally picks up, the RBI may be caught off guard, necessitating rate hikes that would stifle the fragile recovery.

The Fiscal Deficit Dilemma

One major concern of expansionary fiscal policy is its impact on government finances. Tax cuts reduce revenue, and unless matched by an increase in output, will result in a higher fiscal deficit.

The fiscal deficit for 2025–26 could widen significantly if economic growth underperforms. Maintaining fiscal prudence would then require cuts in government expenditure, possibly impacting welfare schemes, subsidies, and social spending.

This creates a moral hazard: Should the government cut spending at a time when the poor are already facing hardship, or allow deficits to grow?

If the state chooses to protect capital investment while trimming revenue expenditure, it could adversely affect social sectors and vulnerable populations. This might exacerbate inequality, especially as recent years have seen profit shares increase at the cost of wage shares.

Need for Inclusive Growth Strategy

Given the fragile global environment and domestic inequality, reliance solely on market mechanisms may not deliver optimal outcomes. The private sector may be reluctant to invest without clearer signs of demand revival.

Therefore, government-led interventions — including direct income support, employment programs, and wage-boosting policies — may be necessary to revive consumption at the base of the pyramid. Only with a broad-based rise in purchasing power can India sustainably lift aggregate demand.

Conclusion: Will the Twin Stimuli Work?

India’s simultaneous fiscal and monetary expansion may reflect a bold policy shift, but it also comes with significant risks. Without proper co-ordination and monitoring, these moves could:

• Spark inflation when demand returns suddenly

• Widen the fiscal deficit if tax revenues do not recover

• Force future policy tightening, undoing today’s gains

The success of these measures depends on whether they can reignite demand, stimulate private investment, and create sustainable employment. Policymakers must remain agile, ready to pivot strategies as data evolves, and ensure inclusive growth that doesn’t leave the vulnerable behind.

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