A major takeaway from Prime Minister Narendra Modi’s address to the nation on Sunday was a clear confirmation that the government had changed its economic policy focus to revive and sustain growth. Of course, the primary reason for his address was to convey to the nation the likely impact of the decision of the Goods and Services Tax (GST) Council to bring down the number of main rates from four to two and thereby slash rates for over 450 goods and services. The so-called “Festival of Savings” that he believed the GST rate cut would usher in was the stated objective. But beneath that objective, a clear shift in the focus of his government’s economic policy was visible.
The post-Covid years saw the Modi government follow a two-pronged approach to reviving economic growth. At one level, the Union government embarked on a steady reduction in its fiscal deficit — from over 9.2 per cent of gross domestic product (GDP) reached in 2020-21 to 4.77 per cent by 2024-25. At another level, the government sought to achieve that fiscal consolidation through a better expenditure mix — a squeeze on revenue expenditure even as its capital expenditure rose steadily during this period.
The Union government’s revenue expenditure was sharply brought down from 15.5 per cent of GDP in 2020-21 to 10.9 per cent in 2024-25, even as its capital expenditure rose from 2.15 per cent to 3.18 per cent of GDP in the same period. Of course, revenue buoyancy was a big help, which contributed to the sharpest reduction in the Union government’s revenue deficit in recent decades — from 7.3 per cent of GDP in 2020-21 to 1.71 per cent in 2024-25. Thus, the government’s policy in the post-Covid years was to keep the fiscal deficit under check, rein in its revenue expenditure, and spend more on building infrastructure at a time when the private sector was not willing to invest.
That strategy seems to be changing, if the Prime Minister’s address to the nation is any indication. The “Festival of Savings” appears to be the new policy instrument to revive and sustain growth. The Prime Minister saw the GST rate rationalisation as part of the government’s broad strategy to provide more disposable money in the hands of consumers. The obvious expectation is that consumers will spend the money saved from tax cuts, instead of using it to bolster their savings, which have declined of late. And if consumers spend that money to buy goods and services, it would help revive demand, increase capacity utilisation, and encourage the private sector to increase its investments.
Mr Modi even noted that the GST rate cuts, taken together with the income-tax relief granted earlier in the Budget for 2025-26 by bringing down the effective tax rate to zero for annual incomes up to Rs 12 lakh, should provide annual savings of Rs 2.5 trillion. This amount is equivalent to about 0.75 per cent of GDP, which in other words should work as a demand stimulus for the economy.
Political messaging also could not be missed in the Prime Minister’s address. He hoped that industry would not hesitate from passing on the benefit of the rate cut in the form of lower prices for consumers. This was only an exhortation, as the GST regime no longer has the anti-profiteering rules that could be enforced on industries that do not pass on the benefits of the rate cut. So far, it appears that industry is using the GST rate rationalisation as an opportunity to boost its sales. The country’s largest automobile manufacturer has reduced prices of its vehicles at the lower end by margins that are more than what the rate cut benefit would have yielded. This shows its inclination to take full advantage of the rate cut to boost sales and increase market share.
There is also an appeal to the micro, small and medium enterprises to use the reduced rates and increase domestic manufacturing. The idea of Swadeshi or economic self-reliance has been endorsed once again by the Prime Minister. Even consumers have been urged to prefer goods produced within the country over those imported from overseas markets. The juxtaposition of a new form of Swadeshi in the backdrop of a significant cut in GST rates is a fresh approach that the prime minister has advocated through his address. Even states have been asked to encourage domestic manufacturing of goods.
Whether connecting tax reforms to Swadeshi and the country’s economic rejuvenation will yield the desired economic benefits or not, only time will tell. Whether such a Swadeshi drive will mean more protection for domestically produced goods, and, more importantly, whether the clarion call on Swadeshi will be accompanied by a much bigger policy push for enhancing competitiveness of domestic producers and improving government procedures to enhance the ease of doing business is still not clear.
But the shift towards creating a demand stimulus to boost growth is certainly an idea that will raise many questions on how the government wishes to pursue fiscal consolidation in the months to come. Note that the Modi government had consciously stayed away from providing demand stimulus in the immediate aftermath of the Covid pandemic and instead had opted for supply-side measures by raising its own investment in building infrastructure and reviving the economy. Many economists had criticised the government then for eschewing a demand stimulus through a tax cut. But four years after the Covid pandemic, the government seems to be embracing that approach to boost growth by spurring demand through tax concessions.
It is likely that the shift in this focus is an outcome of the policymakers’ realisation that concentrating only on higher investments after four years of successive increase in the government’s capital expenditure may not yield the desired outcome because of the public sector’s limited absorptive capacity. Economic growth decelerated to 6.5 per cent in 2024-25, and it is perhaps the urgency to both sustain and raise growth that could have influenced the government to reduce the burden of direct and indirect taxes on consumers.
Of course, these concessions are part of a larger game plan for tax rationalisation. But such a shift in strategy will have some short-term risks and challenges. Already, the Budget for 2025-26 has indicated how the path followed in the previous four years will be modified a bit. Fiscal deficit is to be brought down to 4.4 per cent of GDP, but revenue expenditure is rising as a percentage of GDP for the first time since the Covid pandemic and capex growth is set to slow slightly.
With the GST rate rationalisation expected to result in foregone revenues, and a likely rise in the demand for higher expenditure on support measures for export industries and defence projects, the task of achieving the planned fiscal consolidation target may face new challenges, particularly at a time when lower inflation could depress nominal GDP growth to below the projected 10.1 per cent for 2025-26. It is perhaps time, therefore, to recognise this significant policy shift to revive growth and prepare everyone, including the markets, for the likely challenges that the government might face in adhering to its fiscal consolidation programme.
AK Bhattacharya is the Editorial Director, Business Standard. He tweets @AshokAkaybee. Views are personal.