📰Spending-led Growth

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Market Update.

What’s Next for India’s Spending-led Growth?

India’s economic story over the past decade has been shaped as much by how the government spends as by how fast the economy grows. From sweeping fiscal reforms to a post-pandemic infrastructure boom, public expenditure has played a defining role in the country’s trajectory. But has that spending been effective? By analyzing key trends from 2013-14 to 2024-25 and applying the RBI’s metrics, we can gauge what worked, what didn’t, and—most importantly—how India should pivot to sustain its growth momentum.

Mid-2010s structural reforms saw India implement transformative policy initiatives aimed at strengthening fiscal federalism and streamlining indirect taxation. The 14th Finance Commission significantly increased the share of divisible tax revenue devolved to states, rising from 32 percent to 42 percent. This move was intended to empower states financially, enabling them to undertake greater developmental projects. Simultaneously, 2017’s GST marked a historic shift in India’s taxation structure by replacing a fragmented system with a unified indirect tax regime. While these reforms were to improve efficiency and transparency, their implementation posed transitional challenges for states adjusting to new revenue-sharing mechanisms.

At the central level, capital outlay during this phase remained stable at 1.3 percent to 1.6 percent of GDP, reflecting a measured commitment to infrastructure development. However, development expenditure declined as more funds were transferred to states under the reformed fiscal framework. While this redistribution enabled states to enhance social sector spending and capital outlay — helping maintain overall development expenditure at 10-12 percent of GDP — there were concerns about widening disparities in spending priorities between states and the central government.  

Interest payments, which ranged between 3.0 percent and 3.3 percent of GDP, continued to consume a substantial portion of government expenditure. However, the relatively stable debt profiles of states and the central government suggested prudent borrowing practices. 

Infrastructure-led pandemic recovery: The COVID-19 pandemic triggered large-scale fiscal interventions. In response, there were direct cash transfers, emergency health allocations, and liquidity measures to support distressed sectors. The government, recognizing the need for long-term economic revival, strategically increased capital outlays, rising from 1.6 percent of GDP in 2020-21 to an estimated 2.8 percent in 2024-25. Furthermore, effective capital expenditure — including grants-in-aid for capital asset creation — reached 4.6 percent of GDP in 2024-25, signaling a decisive shift toward investment-driven fiscal policy.  

This shift aimed to harness infrastructure’s multiplier effects, boosting employment, industrial growth, and long-term economic resilience. While pandemic-induced borrowing initially raised fiscal deficits, higher debt-servicing costs remained manageable, preventing significant deterioration in fiscal health.  

At the state level, fiscal decisions were shaped by expanded borrowing limits and revenue shortfalls. Many states prioritized healthcare, social protection, and capital works, ensuring that pandemic mitigation efforts were complemented by medium-term developmental objectives. This led to a reduction in the revenue expenditure to capital outlay (RECO) ratio, indicating a relative increase in productive spending. RECO reductions are positive since spending should be for driving long-term growth and infra development, not basic government revenue rises. Despite rising debt burdens, most states maintained stable interest obligations, reflecting prudent financial management and favorable interest rate environments until 2022.  

Creating a spending index: The evolving nature of India’s public expenditure necessitates an assessment of its effectiveness in fostering economic and social development. To achieve this, a Quality of Public Expenditure (QPE) Index was constructed, utilizing key fiscal indicators such as:  

• RECO

• Capital outlay to GDP (COGDP) ratio  

• Development expenditure to GDP (DEGDP) ratio  

• Development expenditure to total expenditure (DETE) ratio  

• Interest payments to total expenditure (IPTE) ratio  

By employing a dynamic factor model, the QPE Index aggregates these variables into a single measure that captures the efficiency of government spending. The methodology ensures comparability across years, revealing trends in fiscal quality over time.  

The QPE Index for both the Centre and states shows a strong correlation with economic growth and human development. Notably, periods of a rising QPE Index align with higher GDP growth and improvements in health and education.  

The state-wise analysis further underscores the importance of effective fiscal spending. States that demonstrated higher QPE Index values tended to exhibit better overall outcomes. The critical role of well-targeted public expenditure in improving social indicators is also proven through regression Analysis validated this relationship, with the QPE Index positively influencing HDI components, even after controlling for variables such as per capita income and the share of agriculture in Gross State Domestic Product. Controlling for per capita income is just to normalize income while a larger prevalence of agriculture can suggest rural areas which could have less infrastructure. 

Recommendations using QPE: We would want to minimize RECO and IPTE while increasing DEGDP and DETE. There are a few different strategies to do so but this would involve privatization while boosting infrastructure and company subsidies to improve job creation. Privatization is a nascent movement but would help drive down unnecessary expenditure while increasing competition in the private sector which would lead to faster growth. A lack of wasted rupees also helps with reducing a future debt burden to avoid high-interest payments. Infrastructure and forced private sector growth would drive long-term economic resilience and job creation.

Other fiscal policies would be to balance states’ fiscal checkbooks to give them the autonomy to improve their own social and physical infrastructure. To do so, the government would likely have to sharpen tax policies to be more revenue-earning in the future.  

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Gupshup.

Macro

• The RBI's short dollar book hit a record $77.5 billion (₹6.7 trillion) in an effort to reduce rupee depreciation. Most of this is being done through forwards since the bank can sell dollars now but buy them back in the forward market. The use of derivatives is to limit losses since naked dollar shorts are extremely risky with weekly tariff changes.  

• GDP grew 6.2 percent in the December quarter which met most economists’ expectations and rose above the 5.4 percent reading in the previous quarter. There was a pickup in public spending which was up 8.3 percent y-o-y that quarter after national and state polls started closing. There were also private spending increases but that mostly came from seasonality since there was the festive season. 

• India's infrastructure output rose 4.6 percent y-o-y in January. This was backed up by growth in cement and refined petroleum products. Industrial outputs like coal, electricity, and cement all rose except for crude and natural gas. India is currently finding new oil and LNG partners due to sanctions and tariffs from the US which likely contributed to the slowdown.  

• Heat waves could threaten wheat production and a weak electricity network. Hotter temperatures would cause food supply-side inflation to keep rising plus a 40 percent import duty could be scrapped. India also expects 270 gigawatts of needed electricity this summer — up 8 percent y-o-y — which would be strained under the heat as well. 

• India's oil imports from Russia plunged by 15 percent monthly after sanctions and the required shipments have now been sourced from Iraq (8.3 percent growth) and smaller African and LatAm countries. Sanctions have led to a drop in fleet availability and cargo sellers.

• RBI adds $10 billion (₹870 billion) via currency swaps to each cash crunchwhich brings the sum of intervention to $47 billion (₹4.1 trillion) in the past month. Markets are still waiting to see other provisions that the RBI could try out to remedy the cash crunch.  

Equities

• Ikea could post an Indian profit by 2028 after investing $1.2 billion (₹105 billion). The company is mostly concentrated in north India with two more arriving in Delhi soon. The company only has 4 stores with competition arising from cheap, unorganized furniture makers and the conglomerate Reliance.  

• Indian grocery store BigBasket eyes IPO in 2 years due to rapid growth. The company will expand to 70 cities from 35 by 2026 since there is high double-digit sales growth. The grocer right now relies on other delivery apps which have proliferated its growth, but is going to start its own in-house delivery this year as well.

Alts

• India is building a $1.3 billion (₹113.1 billion) liquified gasoline pipeline. The pipeline will be the largest in the world and account for 25 percent of India’s gas flows, limiting accidents and transportation costs. The pipeline will travel from the south to the west coast all the way north.  

Policy

• Tuhin Kanta Pandey replaced Buch as head of SEBI. Buch’s term ended today leading to Pandey, a financial bureaucrat being nominated. He is known for engineering the sale of Air India while bringing reforms to other state enterprises. Analysts expect him to continue removing regulations and red-taping as SEBI chair.  

• India-EU is pushing for a trade deal this year. For perspective, negotiations have stalled every time they have been ignited since 2007. The two sides will also start space talks, do joint research on EV batteries, and cooperate on counter-terrorism and cyber security

See you Monday.

Written by Yash Tibrewal. Edited by Shreyas Sinha.

Disclaimer: This is not financial advice or recommendation for any investment. The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.