India is often described as being in a “Goldilocks” phase — strong growth without inflationary pressure. Official data suggests real GDP growth of around 8%, while headline inflation remains subdued. Yet recent fiscal and monetary decisions point to a more fragile reality beneath the surface.
The government’s move to raise the basic excise duty on cigarettes, shortly after a round of GST rationalisation, has surprised markets. The hike is expected to generate about ₹400bn annually. Around the same time, the Reserve Bank of India (RBI) announced additional open market purchases of government securities worth ₹2tn, alongside $10bn of dollar-rupee swap operations — despite having already committed to large liquidity injections weeks earlier.
These actions appear counterintuitive for an economy supposedly enjoying strong growth and price stability. Since mid-2025, monetary policy has turned sharply accommodative, with deep cuts to the repo rate and cash reserve ratio, liquidity infusion of nearly ₹8tn, and fiscal support via tax reductions — measures more commonly associated with crisis management.
Yet financial markets tell a different story. Government bond yields have climbed to around 6.6–6.65%, the rupee has weakened beyond 90 to the dollar, and banking system liquidity has slipped into deficit. These developments have revived concerns about “crowding out”, where government borrowing pushes up interest rates and limits private investment.
Ordinarily, such risks emerge when public spending overheats the economy. However, government expenditure has in fact lagged nominal GDP growth for much of the past five years. In FY26 so far, spending growth has been modest and driven largely by interest payments rather than fresh investment or welfare outlays.
The bigger concern lies in weak tax collections. Net tax revenues have fallen year-on-year, even as nominal GDP has grown by nearly 9%. This points to unusually low tax buoyancy, suggesting that private sector momentum may be weaker than headline growth implies. GST collections, in particular, slowed sharply in the December quarter, undermining expectations that tax cuts would quickly revive consumption and revenues.
As revenues disappoint, fiscal pressures are mounting. Interest costs now absorb more than half of tax revenues, while public debt has doubled over seven years. To meet deficit targets, capital spending may have to be cut sharply in the final months of the year, potentially weakening future growth.
The result is a fiscal gridlock. Monetary easing struggles against structural constraints in the banking system, fiscal space is shrinking, and household demand remains subdued. Policymakers now face a difficult choice: prioritise fiscal discipline at the risk of slowing growth, or loosen the purse strings further and accept higher deficits in an already stretched system.
