Context:
Recently released inflation data for India's economy presents a curious scenario. The Consumer Price Index (CPI) fell to 2.07% in August 2025, one of the lowest levels in recent years. Meanwhile, the Wholesale Price Index (WPI) showed a modest increase of only 0.52%. This situation may seem like a relief to consumers, as prices of essential commodities remain stable and households' purchasing power is secure. But if we analyze it deeply, the picture is not that simple. Extremely low inflation challenges the government's fiscal strategy, as tax collection and budgetary balance depend on nominal GDP growth. While households have received relief from inflation, the risk of worsening fiscal balances is increasing. This paradox poses a difficult question for policymakers: is extremely low inflation actually beneficial for a developing economy like India?
Inflation: (in the box)
· Inflation is the sustained rise in the general level of prices of goods and services such as food, housing, fuel, education, healthcare, and clothing. · A moderate level of inflation is essential for a healthy economy. If prices rise slightly year after year, people are encouraged to spend or invest rather than hoard money. This circulation of money drives demand, which in turn fuels production and job creation. · Excessively high inflation reduces purchasing power, making essential goods unaffordable. But extremely low inflation or deflation can be equally damaging as it signals weak demand, discourages businesses from investing, and slows economic momentum. |
How Has the Macro Picture Changed Since Last Year?
1. From high to low inflation
o In 2024, inflation was a pressing concern. CPI averaged 4.6%, eating into household budgets, while WPI averaged 2.3%.
o In contrast, during the first five months of 2025–26, CPI has averaged just 2.4% and WPI an almost negligible 0.1%.
2. From sluggish to robust growth
o Real GDP growth in April–June 2025 surged to 7.8%, the highest in five quarters.
o This is a sharp turnaround from the slower pace of growth seen last year, showing that production and consumption are picking up momentum.
3. Growth–inflation differential widened
o In 2024, the gap between real GDP growth and inflation was 2.1 percentage points.
o In 2025, this gap has widened dramatically to 5.5 points, highlighting strong growth amid mild inflation.
4. Comparability of data
o Concerns about the reliability of official data existed last year as well, so the year-on-year comparison remains valid. The relative improvement is genuine and not an artifact of data quality.
Low Inflation and Fiscal Problem:
· Nominal GDP drives revenue:
The Union Budget is based on nominal GDP, since tax collections depend on the actual money value of economic activity. Excise duties, GST, and income taxes all scale with nominal incomes and prices.
· Budget assumptions for 2025–26:
o Nominal GDP was projected at ₹357 lakh crore, about 10.1% higher than the revised estimate of ₹324 lakh crore for 2024–25.
o Net tax revenues were expected to grow by nearly 11%, aligned with this nominal GDP assumption.
· The reality so far:
o Nominal GDP growth in April–June 2025 was only 8.8%, its lowest in three quarters.
o Tax revenues are already faltering: gross tax revenue rose just 1% year-on-year in April–July, while net tax revenue actually fell 7.5%.
· The base effect cushion:
The GDP for 2024–25 has since been revised upward to ₹331 lakh crore (a 2% increase). This means that to reach the Budgeted figure of ₹357 lakh crore, nominal growth of only 8% is needed, not 10.1%. Still, economists are skeptical that this will be comfortably achieved.
Global and Domestic Factors at Play:
1. Russian oil purchases
o India has been importing large volumes of discounted Russian crude, which helped contain fuel inflation over the past two years.
o Even if geopolitical pressures force India to cut back, global crude prices are already subdued. Thus, the inflationary shock would be limited.
2. GST rate cuts
o From September 22, 2025, GST rates on multiple items will be reduced.
o This policy move will lower consumer prices further, directly feeding into CPI but also weakening nominal GDP growth since transaction values fall.
3. RBI’s cautious stance
o The Reserve Bank of India (RBI) now faces a unique combination of low inflation and high growth, which supports the case for a rate cut.
o However, global economic uncertainties may delay this move, with December 2025 seen as the more likely timeline for monetary easing instead of September.
Is Low Inflation Always Bad?
· Positive scenario: If low inflation arises because of abundant supply — better harvests, lower global commodity prices, or efficiency gains — it supports growth.
· Negative scenario: If low inflation reflects weak demand, it signals an economy struggling to expand.
India’s present condition offers mixed signals:
· Corporate sales grew 5.5% in April–June 2025, but profits surged 17.6%.
· Manufacturers saw sales rise only 5.3%, while profits skyrocketed 27.7%, largely due to falling input costs globally.
· Despite these healthy margins, companies are not reinvesting significantly. Capital expenditure (capex) sentiment remains weak, which raises concerns about sustaining growth momentum.
The Growth Angle: Real vs. Nominal GDP
Understanding the difference between real GDP and nominal GDP is critical:
· Real GDP adjusts for inflation and reflects how much more the economy is producing in terms of goods and services.
· Nominal GDP includes price changes, capturing the economy’s total monetary value.
From the government’s perspective, nominal GDP matters more because taxes are levied on actual incomes and prices, not just on production volume.
The challenge today is that while real GDP is strong at 7.8%, low inflation has pulled nominal GDP growth down to 8.8%. This gap reduces tax buoyancy — the ability of revenues to grow in line with GDP.
Significance of Nominal GDP:
Two fiscal indicators hinge directly on nominal GDP:
1. Fiscal deficit ratio
o The target for 2025–26 is 4.4% of GDP.
o If nominal GDP is lower than expected, this ratio worsens even if the government keeps the absolute deficit unchanged.
2. Debt-to-GDP ratio
o Estimated at 56.1% in the Union Budget.
o A smaller nominal GDP base automatically raises the ratio, affecting India’s fiscal credibility in the eyes of credit rating agencies and investors.
Conclusion:
India today finds itself in a paradoxical situation: robust economic growth paired with very low inflation. For households, this is a rare period of relief as purchasing power improves. But for the government, it complicates the Budget math — slowing nominal GDP growth reduces revenues, risks fiscal deficit slippage, and raises concerns about debt ratios.
| UPSC/PSC Main Question: India’s current economic condition presents a paradox: strong growth but very low inflation. Critically evaluate whether low inflation is always desirable for a developing economy like India. |
