What's New

Budget Strategies to Reverse Economic Slowdown in India

Syllabus:

GS-3:

Growth & Development , Fiscal Policy

Focus:

The Indian government faces an economic slowdown, with private consumption and investment stagnating despite efforts like capital expenditure. The upcoming 2025 Budget is seen as a crucial opportunity to shift fiscal priorities toward social welfare and employment generation to stimulate economic recovery.

Understanding the Growth Decline: 2004-2011 vs. Post-2011 Period

• Sustained Growth in 2004-2011: The period from 2004 to 2011 witnessed consistent high growth and a reduction in absolute poverty. This phase stood out due to increased state interventions and welfare schemes.
• Social Sector and Welfare Schemes: State involvement in welfare, including rights-based legislation, led to improvements in rural wages and investments in agriculture, contributing to economic growth.
• Shift in Fiscal Expenditure: During 2004-2011, there was a marked increase in social sector and developmental expenditures. These included investments in agriculture, rural development, education, and welfare programs, which positively impacted consumption among the bottom 80% of the population.

Chart Insights:

• The rise in consumption among the bottom 80% during this period significantly outpaced the wealthiest 20%, demonstrating the effectiveness of targeted fiscal spending.
• The increase in social sector expenditure coincided with a notable increase in consumption of essential goods among lower-income groups.

Current Economic Predicament: Challenges and Slowdown

• Current Economic State: The latest provisional GDP estimates indicate a slower-than-expected growth rate, signaling economic challenges, particularly sluggish private consumption and investment.
• Government Response: The government has increased capital expenditure (Capex) to stimulate private investment. However, despite tax cuts and rising capital spending, private sector response has been lackluster, largely due to insufficient demand.
• Economic Shocks: The period since 2012 has witnessed shocks like demonetization, the introduction of GST, and COVID-19 lockdowns, which have further exacerbated economic challenges.

Chart Insights:

• The growth curves for GDP and private consumption show an inverted U-shape, reflecting an initial rise in growth followed by a significant downturn in recent years.

The Role of Fiscal Expenditure and Consumption Trends

• Impact of Fiscal Expenditure: The composition of fiscal expenditure, especially during the 2004-2011 period, was key to fostering consumption growth. State spending that targeted lower-income groups created a significant multiplier effect.
• Consumption Patterns: The propensity to consume is higher among lower-income groups, which means that spending in these sectors has a larger economic impact. Government spending, when directed towards wages, pensions, and welfare programs, leads to increased demand for goods and services, stimulating economic activity.

Hypothetical Scenarios:

• Capital Expenditure vs. Social Expenditure: When government spending focuses on capital projects (e.g., infrastructure or large-scale dams), the economic multiplier is weaker because the majority of the spending benefits capital owners. However, when the same amount is spent on social programs (e.g., NREGA wages), the multiplier is stronger, as it directly boosts consumption at the grassroots level.
• Leakage of Demand: Capital expenditure, particularly on imported goods like machinery, can result in a leak of demand outside the domestic economy, weakening the multiplier effect. In contrast, social expenditure is more likely to circulate within the domestic economy.

Strategies to Reverse the Economic Slowdown

• Increase in Revenue Expenditure: A shift towards higher revenue expenditure, particularly in the social sector, would create a virtuous cycle of higher incomes for workers. This would not only boost consumption but also stimulate private investment as demand for goods and services increases.
• Labour-Intensive Capital Expenditure: While capital expenditure is necessary, it should be focused on labor-intensive projects that have higher employment and income-generating effects. This approach ensures that the multiplier effect is maximized, benefiting the broader economy.
• Reversal of Fiscal Trends: The current trend of decreasing fiscal expenditure as a share of GDP should be reversed. The government should prioritize increasing fiscal spending, particularly on revenue expenditure, to boost economic activity.

Chart Insights:

• A rise in both total fiscal expenditure and revenue expenditure as a percentage of GDP is necessary to kickstart economic revival. This would represent a complete reversal of the current fiscal trends, which prioritize capital expenditure at the expense of social spending.

The Role of the 2025 Budget: What Can Be Done?

• Budget Priorities: The upcoming budget on February 1 will reveal whether the government will prioritize market demands by keeping fiscal expenditure low or whether it will focus on improving the living standards of the working class. A focus on increasing social sector spending could provide the necessary impetus to reverse the current economic slowdown.
• Long-Term Economic Strategy: To ensure sustained growth, the government must adopt a dual strategy: increasing both fiscal spending and focusing on revenue expenditure that directly impacts the working population. This approach would not only stimulate private consumption but also lay the foundation for long-term economic growth.

Challenges:

• Slowdown in Private Consumption: Despite efforts to boost capital expenditure, there has been a persistent sluggish growth in private consumption, which is the key driver of the domestic economy.
• Insufficient Private Investment: Private sector investment has not picked up, despite tax cuts and increased capital expenditure, as businesses are hesitant to invest amid low demand and economic uncertainty.
• Inadequate Fiscal Expenditure: The share of fiscal expenditure in the GDP has been declining, with a disproportionate focus on capital expenditure rather than social expenditure, which limits the multiplier effect in the economy.
• Global Shocks: Demonetization, the GST implementation, and COVID-19 lockdowns have caused significant disruptions in the economy, affecting supply chains, consumer confidence, and overall economic activity.
• Rising Inequality: While income inequality has grown, the share of consumption among the bottom 80% has not kept pace with the wealthiest, creating an imbalance in economic growth

Way Forward:

• Increase Revenue Expenditure: Shift focus towards social sector spending like NREGA, healthcare, and education, which can stimulate demand and improve living standards.
• Focus on Labour-Intensive Projects: Capital expenditure should be directed toward projects that generate more jobs and stimulate local economies.
• Boost Domestic Consumption: Ensure higher wages and employment opportunities for lower-income groups to enhance domestic consumption and economic activity.
• Reversal of Fiscal Trends: Increase overall fiscal spending, particularly in social sectors, to revitalize the economy through higher income multipliers.
• Sustain Long-Term Growth Strategies: Adopt a holistic approach that balances capital and revenue expenditure to ensure sustainable, inclusive growth.

Conclusion:

In conclusion, the 2004-2011 period highlights the importance of targeted fiscal spending, particularly in social sectors, to stimulate consumption and reduce inequality. To address the current economic slowdown, the government must shift its focus towards increasing revenue expenditure, particularly in the social sector, while ensuring that capital expenditure is directed toward labor-intensive projects with high multipliers. The upcoming budget offers a crucial opportunity to implement these strategies and reverse the economic decline.

Source: TH

Mains Practice Question:

Discuss the impact of revenue expenditure on economic recovery in India. How can the upcoming budget address the slowdown by focusing on social sector spending?