How can the Budget arrest growth decline? | Explained

Union Budget 2025: Analysis of Indian economy's growth patterns, fiscal spending, and impact on consumption trends, highlighting need for policy changes.

The Indian economy is going through a rough patch as was evident from the recently released provisional estimates of its Gross Domestic Product (GDP). The underlying growth rate is lower than what was expected and estimated by the government earlier. What is surprising is that, as noted in the last Economic Survey, this slowdown is despite the rising capital expenditure in various budgets under this regime. To understand the current predicament of the government, it may help to take a longue duree of the Indian economy. In particular, we focus on private consumption since that is the ultimate driver of the domestic market.

Also Read: Will the FY26 Budget reverse the decline in social sector spending?

We divide the post reform period into three parts — 1991-2004, 2004-2011, and 2011-2023. The period from 2004 to 2011 stands out as the one with sustained high growth rate accompanied by a reduction in absolute poverty. This period also saw some revival in state interventions in welfare through rights-based legislations as well as new national schemes.

In contrast, the most recent period starting from around 2012, but especially since 2019, has seen a slowdown in growth rates with the current concerns in the Indian economy being related to sluggish private consumption as well as private investment. This period also saw some major shocks to the economy including demonetisation, the introduction of the Goods and Services Tax (GST), and the lockdowns during the COVID-19 pandemic. Chart 1 shows the rate of growth of GDP and private consumption over these three periods; and we get inverted U-shaped growth curves in both.

Something unique happened during the high growth phase of 2004-2011. While income and wealth inequality were rising for over a decade, this is the only phase in the post-reform period when the share of consumption (out of the total private consumption demand) of the richest 20%, after having risen since 1990, fell significantly. This means that the consumption of the bottom 80% was rising at a faster pace than the richest 20%. But how was this possible when the growth of income was the opposite?

We believe that state policy played a key role in this unique composition of consumption demand. It is not just the amount of fiscal expenditure that matters but its nature as well. Those at the lower end of the income spectrum have a higher propensity to consume as compared to the richest. If state spending tilts in favour of the working class, the income and employment multiplier effects of such spending would be much larger.

To understand this point, let us consider a hypothetical scenario where the government has a choice of spending ₹100 on (A) capital expenditure in commissioning a large scale dam/nuclear project or (B) providing it as National Rural Employment Guarantee Act (NREGA) wages or pension to the elderly. Let us, for simplicity, assume all wages are consumed and all profits saved.