GS Paper: Indian Economy

Why in the News?

India’s inflation has remained mostly under the RBI’s target range of 2-6%, showing success in controlling price rise. However, many people still feel daily expenses are high because prices have increased over the years faster than incomes for many families. This has raised an important question: Does low inflation really mean things are affordable?

Why is inflation different from affordability?

1. Different Meaning: Inflation measures the rise in prices, while affordability measures whether people can still buy goods and services comfortably.
2. Different Basis: Inflation focuses on price increase, whereas affordability depends on income growth relative to prices.
3. Lower Inflation ≠ Lower Prices: A fall in inflation means prices are rising slowly, not that prices have reduced.
4. Cumulative Effect: Affordability depends on the total increase in prices over time, not only yearly inflation.
5. Real Purchasing Power: Even with low inflation, affordability declines if wages and incomes do not rise adequately.

How has RBI succeeded in controlling inflation but not affordability concerns?

1. Inflation Targeting Framework: RBI adopted formal inflation targeting in 2016, aiming to maintain retail inflation at 4% ±2%.
2. Policy Success: Retail inflation remained largely within the 2-6% comfort band, except during exceptional shocks.
3. Monetary Tightening: RBI increased repo rates to curb inflationary pressures arising from excess demand.
4. Structural Limitation: Monetary policy controls the rate of price increase, not already elevated prices.
5. Persistent Cost Burden: Even with lower inflation, consumers continue paying higher prices accumulated over previous years.

Data Highlight:

1. General price level increased by around 75% between April 2014 and March 2026.
2. Prices rose by 41% between March 2019 and March 2026.

How have rising prices affected different categories of workers?

1. Salaried Workers: Experienced relatively better affordability as income growth outpaced inflation in several periods.
2. Self-Employed Workers: Faced weaker affordability due to slower and irregular income growth.
3. Casual Labourers: Remained most vulnerable because of lower absolute earnings despite wage increases.
4. PLFS Classification: Periodic Labour Force Survey (PLFS) divides workers into:
   1. Salaried workers
   2. Self-employed workers
   3. Casual labourers
5. Data (2017-18 to 2023-24):
   1. Casual Labour Income: Increased by 43%, yet average monthly earnings remained only around ₹13,590.
   2. Self-Employed Income: Reached around ₹14,861/month.
   3. Salaried Workers: Earned around ₹22,690/month, showing relatively higher resilience.

Why does cumulative inflation matter more than annual inflation?

1. Limited Picture of Annual Inflation: Shows price increase only compared to the previous year and may hide long-term cost burden.
2. Rising Cost of Living: Cumulative inflation reflects the total increase in prices over several years, giving a clearer picture of household expenses.
3. Real Affordability: Affordability depends on whether incomes grow faster than total price rise, not yearly inflation alone.
4. Consumer Experience: Households feel the effect of accumulated increase in food, rent, transport, health, and education costs.
5. Example from Article: If the price index was 100 in 2014 and rose to 175 by 2026, even moderate yearly inflation still results in much higher everyday costs.

Why is affordability becoming a major policy concern?

1. Consumption Slowdown: Weak purchasing power suppresses domestic demand.
2. Growth Challenge: Lower household spending affects sectors dependent on mass consumption.
3. Income Inequality: Divergence in wage growth widens economic disparities.
4. Employment Quality Issue: Income growth depends on availability of stable and productive jobs.
5. Policy Dilemma: Excessive inflation control through higher interest rates may further suppress investment and employment.

Can RBI alone solve the affordability challenge?

1. Monetary Policy Constraint: RBI can contain inflation but cannot directly raise incomes.
2. Fiscal Policy Role: Government intervention through wage support, social protection, and targeted subsidies improves affordability.
3. Employment Generation: Productive employment raises real wages sustainably.
4. Supply-Side Reforms: Better logistics, food supply chains, and productivity reduce cost pressures.
5. Welfare Measures: Public provisioning in health, education, and food reduces household expenditure burden.

Conclusion

Inflation management and affordability are not synonymous. While India has achieved relative success in maintaining inflation within RBI’s target range, household well-being ultimately depends on real purchasing power rather than inflation statistics alone. Sustainable affordability requires a combination of price stability, faster income growth, productive employment generation, and reduced cost burden on essential services.

PYQ Relevance

[UPSC 2024] What are the causes of persistent high food inflation in India? Comment on the effectiveness of the monetary policy of the RBI to control this type of inflation.

Linkage: The PYQ tests understanding of inflation, RBI’s monetary policy, and limits of inflation control in improving economic outcomes. The article extends this debate by arguing that controlling inflation alone does not ensure affordability, as real income growth determines purchasing power.

Why in the News?

RBI’s Annual Report 2025-26 showed that India’s Balance of Payments (BoP) deficit widened sharply to $30.8 billion in 2025-26, compared to $5 billion in 2024-25. This marks a major reversal from the $63.7 billion surplus in 2023-24. This highlights rising pressure on India’s external sector due to weaker foreign investments and high dollar outflows for imports such as oil and gold.

What is Balance of Payments (BoP)?

The Balance of Payments (BoP) is a systematic record of all economic transactions between a country and the rest of the world during a specific period (usually a year). It tracks the flow of foreign currency (mainly dollars) into and out of the country. In simple terms, BoP shows whether a country is earning more dollars than it spends or spending more than it earns.

What are the components of BoP?

1. Current Account (Trade and Income Flows): It records transactions related to:
   1. Goods Trade: Exports and imports of merchandise (e.g., crude oil, machinery).
   2. Services Trade: IT services, tourism, consulting, shipping.
   3. Remittances: Money sent by Indians working abroad.
   4. Investment Income: Interest, dividends, profits.
   5. Example: India imports crude oil and exports IT services.
2. Capital Account: Investments and Capital Flows: It records:
   1. Foreign Direct Investment (FDI): Long-term investments in industries.
   2. Foreign Portfolio Investment (FPI): Investment in stocks and bonds.
   3. External Borrowings: Loans from abroad.
   4. Banking Capital and Other Transfers
   5. Example: A foreign company investing in India or FIIs buying Indian shares.

How is BoP interpreted?

1. BoP Surplus: Dollar inflows exceed outflows, strengthens forex reserves.
2. BoP Deficit: Dollar outflows exceed inflows, RBI may use foreign exchange reserves to bridge the gap.
3. In 2025-26, India recorded a BoP deficit of $30.8 billion, meaning the country spent more foreign currency than it received, raising concerns about external sector stability.

Why has India’s Balance of Payments deteriorated sharply in 2025-26?

1. Balance of Payments Deficit: India recorded a BoP deficit of $30.8 billion in 2025-26, compared to $5 billion in 2024-25, showing a sharp deterioration in external sector stability.
2. Sharp Reversal: India moved from a BoP surplus of $63.7 billion in 2023-24 to a large deficit in just two years, indicating weakening capital inflows.
3. Foreign Exchange Pressure: RBI had to finance the deficit through foreign exchange reserves, leading to reserve depletion.
4. Investment Slowdown: Net foreign investment inflows into India witnessed a sharp decline, worsening the external financing gap.

How do the current account and capital account shape India’s external position?

1. Current Account: Captures trade in goods and services, remittances, and cross-border income flows.
2. Capital Account: Includes foreign direct investment (FDI), foreign portfolio investment (FPI), external borrowings, and assistance.
3. Persistent Current Account Deficit (CAD): India generally imports more than it exports, making CAD a structural feature of the economy.
4. Trade Deficit: India’s merchandise trade deficit stood at $251.6 billion in 2025–26, improving from $286.9 billion in the previous year, but still remaining substantially large.
5. Services Surplus (‘Invisible Trade’): India earned a services surplus of $221.4 billion in 2025-26, lower than $263.9 billion in 2024-25, reducing the cushion available against merchandise deficits.

Why did the capital account weaken despite India’s growth story?

1. Capital Account Contraction: Capital account surplus declined sharply to $72 million in 2025-26, compared to $16.6 billion in 2024-25. This indicates weak external financing.
2. Funds Held Abroad: Indians parked larger amounts abroad through delayed export receipts, advance import payments, and overseas holdings. This creates a deficit of $22.6 billion, compared to $7.4 billion previously.
3. Geopolitical Impact: Trade disruptions linked to the West Asia crisis increased payment uncertainties and external pressures.
4. Foreign Portfolio Investor (FPI) Outflows: FPIs withdrew $4.3 billion more than they invested in 2025-26, reversing the previous trend where inflows exceeded outflows.

Why is the government especially concerned about oil and gold imports?

1. Oil Dependence: India imports nearly 90% of its crude oil requirement, making external balances highly vulnerable to global oil price shocks.
2. Gold Demand: India produces negligible gold domestically despite large consumer demand, increasing pressure on dollar reserves.
3. Dollar Outflow: A substantial portion of India’s foreign exchange outflow is used to pay for oil and gold imports.
4. Policy Response: The government raised import duty on gold and silver from 6% to 15% and restricted imports of several silver categories to reduce external pressure.
5. Consumption Advisory: Prime Minister Narendra Modi urged citizens to moderate fuel consumption and gold purchases, reflecting concern regarding dollar outflows.

What are the broader macroeconomic implications of a worsening BoP deficit?

1. Forex Reserve Depletion: Persistent BoP deficits force RBI to utilise foreign exchange reserves, reducing external buffers.
2. Currency Pressure: Sustained dollar outflows may weaken the Indian Rupee, increasing imported inflation.
3. Inflationary Impact: Higher oil import costs raise transportation and manufacturing expenses.
4. External Vulnerability: Reduced capital inflows increase dependence on volatile external borrowing.
5. Investor Sentiment: Weak BoP signals may affect foreign investor confidence and macroeconomic stability perceptions.

Can India reduce structural vulnerability in its external sector?

1. Export Diversification: Strengthens merchandise exports beyond traditional sectors.
2. Manufacturing Expansion: Supports Make in India and production-linked incentives to reduce import dependence.
3. Energy Transition: Accelerates renewable energy and domestic energy security to reduce oil import dependence.
4. Financial Stability: Enhances resilience through stable FDI rather than volatile portfolio flows.
5. Gold Monetisation: Encourages financialisation of savings through sovereign gold bonds and monetisation schemes.

Conclusion

RBI’s latest data highlights a growing imbalance in India’s external sector marked by widening dollar outflows, weakening foreign investments, and structural dependence on imported commodities. While India’s strong services exports continue to provide resilience, sustaining external stability will require export competitiveness, reduced import dependence, stable capital inflows, and prudent macroeconomic management.

PYQ Relevance

[UPSC 2019] How would the recent phenomena of protectionism and currency manipulations in world trade affect macroeconomic stability of India?

Linkage: India’s worsening Balance of Payments (BoP) and rising dollar outflows directly affect macroeconomic stability, exchange rate management, foreign exchange reserves, and external vulnerability. The issue links external trade dynamics with rupee stability and capital flows.