2025 Budget and Inflation

The 2025 Budget is a critical response to ongoing economic challenges. As India navigates a complex landscape, the Finance Minister Nirmala Sitharaman aims to tackle inflation while encouraging growth. The Reserve Bank of India (RBI) strives to maintain inflation within a 2-6 per cent range. Recent data shows a decline in inflation rates, dropping to 5.22 per cent in December. This follows a peak of 6.21 per cent in October, primarily due to moderating food prices. However, inflation remains above the RBI’s medium-term target of 4 per cent, indicating persistent economic pressures.

Current Economic Context

• India’s economic growth for FY 2026 is projected at 6.7 per cent.
• This growth forecast comes amidst fluctuating inflation rates.
• The recent easing of inflation is a positive sign. However, challenges such as currency depreciation and global economic conditions threaten further reductions. P

Inflation Management Strategies

The RBI’s target is to keep inflation within a specified range. Former RBI Governor Shaktikanta Das emphasised the importance of aiming for a 4 per cent inflation target. Achieving this target requires a gradual and sustainable approach. Policymakers must balance growth and inflation management to encourage economic stability.

Fiscal Policy Considerations

Experts suggest that a countercyclical fiscal policy is necessary for the 2025 Budget. This involves cutting taxes and increasing government spending to stimulate growth. However, caution is advised to avoid fiscal risks. The current direct tax-to-GDP ratio stands at 6.64 per cent, a 25-year high but still below global averages.

Tax Reforms and Economic Activity

Instead of implementing tax cuts, the focus should shift towards broadening the tax base. Simplifying the Goods and Services Tax (GST) can enhance consumer spending. Tax reforms are essential to boost economic activity. Experts advocate for a strategy that prioritises reforms over reductions to ensure long-term growth.

Future Economic Outlook

The economic outlook hinges on effective policy measures. The 2025 Budget must address inflation while encouraging a conducive environment for growth. Ensuring that fiscal policies are sustainable will be crucial. Policymakers must remain vigilant to external and internal economic pressures.

Questions for UPSC:

1. Examine the impact of inflation on economic growth in India. How can fiscal policies mitigate these effects?
2. Discuss the significance of the Reserve Bank of India’s inflation target. What challenges does it face in achieving this goal?
3. Critically discuss the role of tax reforms in enhancing economic activity in India. Provide suitable examples.
4. With suitable examples, discuss the relationship between currency depreciation and inflation in emerging economies.

Answer Hints:

1. Examine the impact of inflation on economic growth in India. How can fiscal policies mitigate these effects?

1. High inflation can erode purchasing power, leading to reduced consumer spending and lower economic growth.
2. Fiscal policies, such as increasing government spending, can stimulate demand in the economy.
3. Countercyclical fiscal policies can help stabilize the economy during inflationary periods.
4. Tax reforms aimed at broadening the tax base can increase government revenue for public spending.
5. Effective management of inflation can restore consumer confidence, encouraging investment and growth.

2. Discuss the significance of the Reserve Bank of India’s inflation target. What challenges does it face in achieving this goal?

1. The RBI’s inflation target of 4% is crucial for maintaining price stability and economic confidence.
2. Achieving this target supports sustainable economic growth and protects savings from inflationary erosion.
3. Challenges include external factors like global commodity prices and domestic issues such as supply chain disruptions.
4. Currency depreciation can lead to imported inflation, complicating the RBI’s efforts.
5. Balancing inflation control with growth objectives requires careful policy calibration.

3. Critically discuss the role of tax reforms in enhancing economic activity in India. Provide suitable examples.

1. Tax reforms can simplify compliance, encouraging businesses to operate within the formal economy.
2. Broadening the tax base increases government revenue, enabling more public investment in infrastructure.
3. For example, the implementation of GST streamlined multiple indirect taxes, enhancing economic efficiency.
4. Lowering compliance costs through reform can boost small business growth and job creation.
5. Tax incentives for sectors like renewable energy can stimulate investments and drive economic activity.

4. With suitable examples, discuss the relationship between currency depreciation and inflation in emerging economies.

1. Currency depreciation often leads to higher import costs, contributing to inflation in emerging economies.
2. For instance, in India, a weaker rupee increases prices of imported goods, including oil and food items.
3. Inflation can erode consumer purchasing power, leading to reduced economic growth.
4. Countries like Turkey have experienced high inflation rates following currency depreciation.
5. Effective monetary policy is essential to manage the inflationary pressures resulting from currency fluctuations.