Expansionary Policy in India, Types, Advantages and Risks

Learn about Expansionary Policy in India, a fiscal or monetary strategy used by the government or RBI to stimulate economic growth through increased spending or reduced interest rates.

Table of Contents

Context: The Reserve Bank of India (RBI) has cut key lending rates in two successive meetings, indicating a significant expansionary shift.

Instances of RBI Lending Rate Cuts in 2025

April 2025: The RBI reduced the repo rate by 25 basis points (bps).
June 2025: A further 50 bps cut was announced.
- Current repo rate: 5.5%

What is Expansionary Policy in India?

Expansionary policy refers to the use of fiscal and monetary tools to stimulate economic growth, especially when the economy is facing low demand, low growth, or recessionary trends.

Types

Expansionary Monetary Policy (RBI):
- Reducing repo rates to lower the cost of borrowing.
- Encourages investment and consumption by making loans cheaper.
- Also includes increasing liquidity in the banking system.
Expansionary Fiscal Policy (Government):
- Cutting income taxes (as done in Feb 2025).
- Increasing public expenditure to boost aggregate demand.
- Providing incentives/subsidies for specific sectors.

Advantages of Expansionary Policy

Boosts Aggregate Demand: Lower interest rates and tax cuts encourage households and firms to spend and invest more.
Revives Investment Activity: Helps the private sector, especially MSMEs, to access cheaper credit and restart production.
Reduces Unemployment: Rising demand for goods and services increases the demand for labour, thereby reducing joblessness.
Counteracts Economic Slowdown: Especially useful during low inflation and low credit growth (like in 2025), to revive economic momentum.
Supports Growth Projections: Aims to maintain or enhance GDP growth (RBI projects 5% for FY 2025–26).

Cons and Risks of Expansionary Policy

Inflationary Pressure: Increased demand may lead to higher prices, especially if supply doesn’t rise proportionately.
- Could breach the RBI’s targeted inflation band of 4% ± 2%.
Fiscal Deficit Widening: Tax cuts may reduce revenue without a proportional increase in GDP, causing the fiscal deficit to rise.
- It may force the government to cut spending, especially on welfare schemes.
Policy Coordination Risk: If both fiscal and monetary policies are expansionary without coordination, it may destabilise macroeconomic balance.
Delayed Impact: Time lags in the transmission of monetary signals or implementation of fiscal measures may lead to slow or uneven outcomes.
Dependence on External Conditions: Global headwinds (e.g. Trump’s tariff wars, Middle East conflict) may offset domestic policy gains.
Uneven Benefits: Expansionary policies may disproportionately benefit corporations and high-income groups, while vulnerable sections may lose out if the government cuts revenue spending.