Policy choices that deepened the slowdown demand urgent course correction

For years, India has been one of the world’s fastest-growing major economies, attracting global investors eager to capitalise on its potential. Today, the story is less flattering. Growth has decelerated sharply, with gross domestic product (GDP) expanding by 6.1 per cent in April-December FY25, down from 9.5 per cent during the same period last financial year. Inflation remains stubbornly above the Reserve Bank of India’s (RBI’s) 4 per cent target, markets are jittery, and foreign investors are pulling out. And just when things couldn’t look worse, there’s the looming spectre of Donald Trump imposing higher tariffs on Indian exports.

 

What’s troubling is that this slowdown is unfolding despite a broadly stable global economy—no financial crisis, no commodity shock. The International Monetary Fund’s latest World Economic Outlook projects resilient global growth, with the US exceeding expectations. Markets reflect these concerns, with the stock market down over 10 per cent since September 2024—far more than in other emerging economies. The issue isn’t external; it’s domestic. And it’s serious.

 

India’s growth slump isn’t just a blip — it stems from deeper structural challenges, worsened by policy missteps. A key factor: The simultaneous tightening of fiscal and monetary policies, which has exacerbated the slowdown.

 

Take fiscal policy. In the first half of FY25, capital expenditure contracted by 15 per cent, leading to a fiscal tightening of a whopping 200 basis points. While elections and post-Covid fiscal adjustments played a role, they don’t fully explain the extent of this unusual contraction.

 

Monetary policy added to the squeeze. The RBI’s exchange rate strategy — effectively pegging the rupee to the dollar since late 2022 — has led to aggressive forex interventions, tightening liquidity, raising interest rates, and eroding competitiveness.

 

To be fair, corrective measures have been introduced. The RBI has eased its grip on the exchange rate and injected liquidity through rate cuts, cash reserve ratio reductions, and bond purchases. The February Budget also provided tax relief for the middle class to stimulate demand.

 

But quick fixes do not deliver sustained growth. The real problem dates back more than a decade. After the 2008 financial crisis, two critical engines—private investment and exports—collapsed and never recovered. Even consumption weakened in subsequent years, with GDP growth falling to a multi-year low of 3.9 per cent in FY20.

 

Post-pandemic, pent-up demand and fiscal support offered a temporary boost, but that momentum is fading. With capacity utilisation stuck in the low 70s, firms see little reason to invest, despite corporate tax cuts and banking reforms. Weak demand and sluggish investment reinforce each other, increasing the risk of a prolonged low-growth equilibrium.

 

If domestic demand remains weak, foreign demand provides a potential escape route from this stagnation. True, the era of hyper-globalisation is over, but India still has a strong case for export-led growth. Three factors stand out. First, India’s share of global manufacturing exports remains below 2 per cent — trailing even smaller economies like Vietnam, highlighting untapped potential. Second, China’s retreat from low-skill exports and the global shift away from overreliance on China create new openings. Third, US tariffs on Chinese goods present India with an opportunity to step in.

 

Yet, India has failed to seize the moment. For instance, since 2013, China has ceded $40 billion in global apparel exports, with Vietnam and Bangladesh stepping in. India’s share, however, continues to shrink.

 

One major reason: India’s increasingly inward-looking trade policies. While the government talks about boosting exports, its own protectionist measures have hurt competitiveness. Between 2017 and 2021, tariffs increased on over 3,200 products, covering 70 per cent of imports. Labour-intensive industries were hit the hardest—textile and apparel tariffs alone jumped by 13 percentage points, far exceeding those of India’s competitors. Higher input costs have made Indian goods less competitive in global markets

 

To its credit, the government seems to recognise its mistake, rolling out significant cuts since 2023, including in the latest Budget. But rising non-tariff barriers—such as disruptive quality control orders—have erased any gains, highlighting a deep policy inconsistency. As a result, India remains an expensive and unpredictable manufacturing destination, making it harder to integrate into global value chains.

 

The investment climate is equally troubling. Foreign direct investment (FDI) is a critical driver of export growth, bringing capital, technology, and global market access. Yet, India has failed to position itself as a viable alternative to China. Investors remain wary, deterred by protectionism, regulatory uncertainty, and high tariffs on intermediate goods. FDI inflows are declining—not just due to global monetary conditions, but also domestic policy missteps. Estimates suggest that India may have already lost up to 60 per cent of potential FDI due to these policy gaps.

 

So, what’s the way forward? India must change course — urgently. It needs a clear, outward-looking trade strategy, one that leverages global opportunities while ensuring a stable, predictable business environment. Protectionist barriers must come down, FDI must be actively encouraged, and exports must become a central priority. Without these fixes, India risks falling further behind.

 

The choices are clear. The question is whether policymakers will act—before it is too late.

 

The author is visiting fellow, Madras Institute of Development Studies