This is an exciting time for people as budgets always create a buzz, particularly around taxation, but there are broader aspects such as fiscal deficit management, inflation, and geopolitical uncertainties. These are crucial for sustaining economic momentum and financial stability.

India’s GDP growth has slowed, inflation concerns persist, and global uncertainties, including geopolitical tensions, pose challenges. SABYASACHEE DASH speaks to the former Governor of the Reserve Bank of India, Dr. D SUBBARAO, to get insights on taxation, public spending, investment revival, and structural reforms. Dr. Subbarao is an Indian economist and former civil servant who served as the 22nd Governor of the Reserve Bank of India (2008- 2013). He previously served as Finance Secretary and played a key role in managing India’s policies during the 2008 Global Crisis. He is an alumnus of IIT Kanpur, Ohio State University, and MIT Sloan School of Management.

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Q: Post-COVID, India’s recovery plan has been praised. However, the economic slump to a seven-quarter low of 5.4 per cent GDP growth in Q2 has raised concerns. What, in your view, are the main causes of this slowdown?

A: The slowdown in GDP growth to 5.4% in Q2, down from 6.7% in the previous quarter, is concerning. The NSO projects full-year growth at 6.4%, down from 8.2% in FY24. Opinions are divided on the causes of this slowdown. Some experts attribute it to cyclical factors, including a reduction in public infrastructure spending due to elections and global uncertainties that have impacted export demand and increased import prices. According to this view, the slowdown is temporary, and once elections are over and global conditions stabilize, growth will rebound. Others argue that the slowdown is structural in nature. The rapid growth seen over the past few years was largely a result of post-Covid recovery, which has now plateaued. This growth relied heavily on government expenditure, which is unsustainable in the long term. Sustainable growth requires strong private consumption, private investment, and net exports. Current consumption is growing at only 4%, which suggests that the benefits of growth are not reaching all segments of the population. I believe the slowdown is more structural than cyclical and that it calls for significant reforms to ensure inclusive and sustainable growth.

Q: That’s insightful. What, in your view, can the budget do to revive growth?

A: The budget should focus on accelerating growth while ensuring its benefits are broadly shared. Private consumption, especially among the lower-income segments, plays a crucial role. Higher incomes for these groups lead to increased spending, which drives demand, production, and job creation. This cycle is vital for achieving sustainable high growth. To achieve these goals, the budget must prioritize structural reforms. With four-and-a-half years of governance ahead, this is an opportune time for the government to implement politically challenging but necessary reforms. These reforms include addressing issues in labour laws, land acquisition, and taxation, all of which are critical to improving the investment climate. India has an opportunity to position itself as a key player in the Chinaplus-one strategy and creating a favourable investment environment is essential. Additionally, supporting labour-intensive industries and the MSME sector will help create jobs and stimulate growth.

Q: Moving to taxation, do you think there is room for tax cuts to revive consumption and encourage investment?

A: While there is widespread demand for tax cuts to boost consumption and investment, I believe such measures are not feasible at this time due to fiscal constraints. Tax cuts could provide short-term relief but are not a sustainable solution for longterm growth. Structural reforms are far more critical in addressing the underlying issues. Furthermore, the government cannot afford to lose revenue when fiscal challenges persist. A more prudent approach would be to focus on creating an environment that fosters investment and growth without compromising fiscal stability.

Q: Many feel that taxes are nonreciprocal and don’t directly benefit taxpayers. However, during Covid, the government’s support to vulnerable segments demonstrated the importance of social spending. On fiscal deficit, the target is 4.9 per cent this year. Is it still a concern?

A: Achieving a fiscal deficit target of 4.9 per cent is indeed commendable, but it would be premature to declare victory. India’s debt-to-GDP ratio remains high at 80 per cent, far above the FRBM target of 60 per cent. High debt levels lead to substantial interest payments, which reduce the government’s ability to allocate funds for productive expenditure. This, in turn, fuels inflation and crowds out private investment. Fiscal consolidation is essential, and both the central and state governments need to work collaboratively to reduce the debt-to-GDP ratio and ensure long-term fiscal stability.

Q: The FRBM Act is under review. What are your thoughts on it, and how do you view India’s public debt compared to advanced economies?

A: The FRBM Act has played a crucial role in promoting fiscal discipline, but there is scope for improvement. The focus should shift to addressing revenue deficits and reducing the debt-to-GDP ratio. While advanced economies have higher debt ratios, India’s low revenue-toGDP ratio makes high debt unsustainable. Additionally, India’s reliance on foreign capital, despite minimal sovereign external debt, makes the economy vulnerable to external shocks. Fiscal responsibility is critical for ensuring economic stability and growth.

Q: Competitive populism in states often leads to unsustainable freebies. How does this impact longterm growth?

A: Competitive populism, characterized by indiscriminate freebies, imposes a significant fiscal burden and undermines long-term growth. While targeted transfer payments for vulnerable segments are necessary, unrestrained spending on non-productive freebies is unsustainable, especially when financed through borrowing. A political consensus on a code of conduct for fiscal responsibility is essential to curb this trend. Governments must focus on empowering citizens through skill development and job creation rather than temporary handouts. Q: Moving to the role of the RBI, what can the central bank do to revive growth? A: The RBI’s primary responsibility is to maintain price stability. Low and stable inflation is a prerequisite for sustainable growth as it enables informed decision-making by consumers and investors. While some advocate for rate cuts to stimulate investment, the real constraint on investment today is weak demand rather than high interest rates. The RBI must focus on controlling inflation and maintaining financial stability, which are essential for fostering long-term growth.

Q: Private investment remains sluggish. Is monetary policy to blame?

A: No, the sluggish private investment is not due to monetary policy or high interest rates. The real constraint lies in the lack of demand. Investors base their decisions on long-term growth prospects, and addressing weak demand will naturally lead to increased private investment. Structural reforms and measures to boost consumption will play a crucial role in reviving private investment.

Q: The Economic Survey 2023- 24 pitched for an inflation targeting framework that targets an inflation rate excluding food. What is your view on this?

A: I disagree with the Economic Survey’s argument that the MPC should exclude food prices from headline inflation when setting targets. Food prices form a significant part of India’s consumption basket, influence inflation expectations, and impact people’s daily experiences. Ignoring food inflation could harm the credibility of the MPC and RBI. While monetary policy primarily affects demand and is less effective against food-driven inflation, this argument is valid only if food inflation is temporary – not if it has become a persistent trend, as seen in India. However, there’s a case for reviewing the consumption basket, as some suggest that food’s share has declined over time.

Q: Lastly, the Indian rupee has weakened significantly. Should the RBI intervene to stabilize it or leave it to find its level?

A: The RBI should allow the rupee to align with economic fundamentals. While a weaker rupee can be inflationary, artificially propping it up would hurt exports and economic growth. The RBI’s role should be to prevent excessive volatility rather than target a specific exchange rate. Allowing the rupee to reflect market fundamentals will enhance competitiveness and support growth in the long run.

Q: As we conclude, what broader priorities should the government focus on to meet its aspirations?

A : Alongside accelerating growth, reducing inequalities must be a priority. Policies should aim to ensure the benefits of growth are widely shared. Creating productive jobs is critical to addressing unemployment and underemployment. Additionally, skill development initiatives must focus on enhancing employability and preparing the workforce for the demands of a rapidly evolving economy. Balancing growth with inclusivity will be key to achieving India’s long-term aspirations.