The Problem with Low Inflation: Why Subdued Prices Challenge India’s Fiscal Math

Why in the News?

1. Retail inflation (CPI) has sharply fallen to 07% in August 2025, while Wholesale Price Index (WPI) inflation dropped to 0.52%, one of the lowest in recent years.
2. While low inflation is beneficial for consumers, it has emerged as a challenge for the government’s Union Budget 2025–26 assumptions, particularly regarding nominal GDP growth and tax revenue projections.

Key Highlights

1. A Phase of Subdued Inflation
   1. In recent months, both CPI inflation and WPI inflation have registered a steep fall.
   2. CPI averaged 4% in April–August 2025, compared to 4.6% in FY25.
   3. WPI averaged 1% in FY26 so far, compared to 2.3% in FY25.
   4. For households, this means lower food and commodity prices, which is a relief.
   5. However, this trend complicates the government’s budgetary assumptions, since fiscal projections depend heavily on nominal GDP rather than real GDP.
2. Link Between Inflation, GDP, and Government Finances
   1. Real GDP measures output after adjusting for inflation, while Nominal GDP includes the impact of inflation.
   2. The government uses Nominal GDP to calculate tax revenues, fiscal deficit, and debt ratios.
   3. In April–June 2025, India’s Real GDP grew at 7.8% (a five-quarter high), but Nominal GDP grew only 8.8% (a three-quarter low).
   4. The difference shows how low inflation drags down Nominal GDP, even when the economy is producing more goods and services.
3. Budget 2025–26 Assumptions vs Reality
   10. The Union Budget projected ₹357 lakh crore Nominal GDP for FY26, assuming a 1% growth from the previous year’s revised estimate.
   11. Tax revenue projections were based on this assumption, with net tax revenue expected to grow by ~11%.
   12. But in April–July 2025, gross tax revenue rose just 1% YoY, while net tax revenue actually fell 7.5%, exposing the risk of over-optimistic assumptions.
4. Fiscal Deficit and Debt Implications
   4. Fiscal deficit (targeted at 4% of GDP) and central government debt (estimated at 56.1% of GDP) are both measured relative to Nominal GDP.
   5. With 2024–25 GDP revised upward to ₹331 lakh crore, the required growth for FY26 is only 8%, making the absolute target achievable.
   6. However, growth momentum is weak, and economists expect Nominal GDP growth to stay around 3%, much below the Budget’s 10.1% projection.
   7. This divergence may still put pressure on fiscal management, especially if tax buoyancy does not improve.
5. Corporate Sector and Demand-Supply Dynamics
   1. A Reserve Bank of India (RBI) study highlighted an unusual trend:
      5. Sales of private companies grew only 5.5% in April–June 2025.
      6. Net profits, however, grew 17.6%, mainly due to lower input costs.

• In manufacturing, sales rose 5.3% but profits surged 27.7%.

1. This shows that low inflation is largely driven by falling global commodity prices rather than strong domestic demand.
2. Despite higher profits, private investment (capex) remains subdued, raising concerns about the sustainability of growth and job creation.

Implications

1. For Consumers
   1. Positive: Lower inflation keeps essential goods and services affordable, protecting household purchasing power.
   2. Confidence boost: Consumers enjoy price stability, reducing the risk of demand slowdown due to rising costs.
2. For Government Finances
   1. Negative: Lower inflation suppresses Nominal GDP, which directly reduces expected tax revenues.
   2. Budgetary stress: Lower revenue collection makes it harder to maintain fiscal discipline.
3. For Fiscal Indicators
   1. Dependence on Nominal GDP: Fiscal deficit and debt ratios are framed as a percentage of Nominal GDP.
   2. Risk: If Nominal GDP growth stays below assumptions, India may face slippage in deficit reduction targets.
4. For Investment and Growth
   1. Higher profits not leading to higher investment: Despite strong margins, companies remain hesitant to invest in capacity expansion.
   2. Weak capex cycle: This threatens job creation, wage growth, and overall demand revival.
5. For Policy Making
   1. Monetary policy challenge: RBI must balance between low inflation and ensuring it does not signal weak demand.
   2. Fiscal recalibration: The government may need to rely on disinvestment, non-tax revenues, or spending cuts to stay within fiscal limits.

Key Terms

1. Nominal GDP
   1. Definition: Nominal GDP is the total market value of all goods and services produced in an economy during a specific period, measured at current prices without adjusting for inflation.
   2. Deals with: It reflects both production growth and changes in price levels in the economy.
   3. Significance: Nominal GDP provides a snapshot of the economy’s size in monetary terms at prevailing prices.
   4. Implication: It can give a distorted picture of growth if inflation is very high or very low, as changes in prices influence the total value.
   5. Use in policy: It is used to plan government budgets, assess fiscal health, and compare revenue targets with actual receipts.
2. Real GDP
   1. Definition: Real GDP is the total value of goods and services produced in an economy after adjusting for inflation or deflation.
   2. Deals with: It captures the actual growth in production by removing the effect of price changes.
   3. Significance: Real GDP is a better indicator of an economy’s productive capacity and long-term growth trends.
   4. Implication: Policymakers rely on real GDP to design interventions for sustainable economic growth, independent of price volatility.
   5. Use in policy: It is essential for international comparisons, evaluating living standards, and formulating long-term development plans.
3. Fiscal Deficit
   1. Definition: Fiscal deficit occurs when the government’s total expenditure exceeds its total revenue, excluding borrowings, in a financial year.
   2. Deals with: It measures the government’s dependence on borrowing to finance its spending.
   3. Significance: Fiscal deficit is a key indicator of fiscal prudence and sustainability of public finances.
   4. Implication: Persistent fiscal deficits can lead to higher interest rates, crowding out private investment, and long-term debt accumulation.
   5. Use in policy: Monitoring fiscal deficit helps governments design corrective measures such as expenditure rationalization or revenue mobilization strategies.
4. Tax Buoyancy
   1. Definition: Tax buoyancy measures the responsiveness of tax revenue to changes in nominal GDP.
   2. Deals with: It assesses how efficiently the government collects taxes relative to the growth of the economy.
   3. Significance: High tax buoyancy indicates a tax system capable of generating revenue faster than economic growth, providing fiscal flexibility.
   4. Implication: Low tax buoyancy can create revenue shortfalls even during periods of growth, increasing pressure on borrowing.
   5. Use in policy: It is used to evaluate tax policy effectiveness and to plan sustainable fiscal strategies.
5. Wholesale Price Index (WPI)
   1. Definition: WPI tracks the average change in prices of goods sold in bulk by producers or wholesalers.
   2. Deals with: It reflects price trends in the supply chain before products reach retail consumers.
   3. Significance: WPI serves as an early indicator of inflationary pressures in the economy.
   4. Implication: Rapid changes in WPI can signal future movements in retail prices, helping policymakers anticipate inflation.
   5. Use in policy: WPI is monitored to guide monetary and trade policies and to forecast cost pressures for industries.
6. Consumer Price Index (CPI)
   1. Definition: CPI measures changes in the price of a representative basket of goods and services consumed by households.
   2. Deals with: It reflects the actual cost of living for consumers.
   3. Significance: CPI is widely used as a standard measure of inflation affecting households.
   4. Implication: Rising CPI indicates that the cost of living is increasing, while a falling CPI suggests reduced consumer expenses.
   5. Use in policy: CPI informs monetary policy, wage adjustments, and social welfare programs to protect household purchasing power.
7. Capital Expenditure (Capex)
   1. Definition: Capex refers to spending by governments or companies on acquiring, upgrading, or maintaining long-term assets like infrastructure, machinery, or factories.
   2. Deals with: It focuses on creating productive capacity and long-term growth potential.
   3. Significance: High capex enhances economic productivity, job creation, and industrial expansion.
   4. Implication: Low capex, despite profitability, signals weak investment confidence and may slow future economic growth.
   5. Use in policy: Capex decisions guide economic development strategies, infrastructure planning, and private sector investment incentives.

Challenges and Way Forward

Conclusion

India’s current phase of low inflation is a double-edged sword. While it benefits households by reducing the cost of living, it undermines the government’s budgetary arithmetic, weakens tax revenues, and complicates fiscal deficit management. Moreover, subdued inflation driven by weak demand and low capex is worrying, as it signals structural bottlenecks in growth. For long-term stability, India must balance consumer welfare, fiscal health, and investment revival.