Fiscal Policy in India: Objectives, Instruments, Types and Role in Governance

Fiscal Policy is one of the most influential pillars of India’s economic strategy. It determines how the government spends, raises money, and borrows to guide the economy toward development and stability. In a country like India, where large populations depend on public services and markets are vulnerable to shocks, fiscal policy helps correct imbalances, support growth, reduce poverty, and promote equity.

What is Fiscal Policy in India?

Fiscal Policy refers to government actions related to taxation, expenditure, and borrowing that influence economic activity.
Its intellectual foundation lies in Keynesian economics, which suggests that the government must intervene when markets fail:

• During recessions → increase spending or reduce taxes to boost demand
• During inflation periods → cut spending or increase taxes to reduce overheating

Thus, fiscal policy functions as both a growth engine and an economic shock absorber.

Core Objectives of Fiscal Policy

India’s fiscal objectives balance long-term development with short-term macroeconomic stability. Major aims include:

Resource Mobilisation

Generating funds for infrastructure, health, education, and social security.

Economic Stability

Reducing fluctuations in output, unemployment, and inflation.

Price Stability

Using expenditure and taxation to curb inflation or deflation pressures.

Sustained Growth

Ensuring growth that is consistent, inclusive, and sustainable over time.

Improving Living Standards

Investing in welfare schemes, employment programmes, and public services.

Reducing Inequality

Implementing progressive taxation and redistribution.

Boosting Private Sector Activity

Providing incentives for investment, innovation and entrepreneurship.

External Balance

Reducing high foreign dependence and strengthening the balance of payments.

Instruments of Fiscal Policy

India uses three primary instruments, supported by supplementary methods:

Public Expenditure

This includes spending on:

• Infrastructure
• Energy
• Defence
• Health
• Education
• Welfare schemes

Changes in expenditure directly affect employment, production, and demand.
For example, increased capital spending on railways or rural roads generates jobs, stimulates private investment, and boosts income growth.

Taxation

Taxes determine how much income and profit individuals and firms retain.

• Lower taxes increase disposable income → higher consumption and investment
• Higher taxes reduce excess demand → help control inflation

India uses both direct taxes (income tax) and indirect taxes (GST) to influence economic activity.

Public Borrowing

When revenue is insufficient, the government borrows from:

• Banks
• Citizens
• Foreign institutions

Borrowing finances deficits, welfare schemes, and infrastructure, but excessive borrowing can increase debt burden and future interest costs.

Supplementary Measures

Fiscal policy may also use:

• Export incentives
• Subsidy reforms
• Price controls
• Welfare transfers
• Consumption duties

These fine-tune policy impact and correct market distortions.

Fiscal Policy vs Monetary Policy

Although interconnected, both policies differ:

Both sectors work together — fiscal policy boosts demand and investment while monetary policy ensures price stability and financial discipline.

Types of Fiscal Policy in India

Based on economic conditions, India adopts different approaches:

Expansionary Fiscal Policy

• Higher spending and/or lower taxes
• Used during recessions
• Aims to increase employment and GDP growth
• Risk: inflation

Contractionary Fiscal Policy

• Reduced spending and/or higher taxes
• Used when inflation is rising
• Aims to cool overheating and reduce deficit
• Risk: short-term unemployment

Neutral Fiscal Policy

• Revenue equals expenditure
• Used in stable growth conditions
• Aims to maintain equilibrium

Cyclical Nature of Fiscal Policy

Fiscal policy is shaped by the economic cycle:

Counter-Cyclical Fiscal Policy

Moves against the business cycle:

• More spending during downturns
• Less spending during booms

Example: India’s COVID-19 and 2008 crisis stimulus packages.

Pro-Cyclical Fiscal Policy

Moves with the business cycle:

• More spending during booms
• Austerity during recessions

This approach can worsen inequality and weaken recovery, therefore less preferred.

Key Concepts Linked to Fiscal Policy

Fiscal Deficit

Gap between spending and non-borrowed revenue, expressed as % of GDP.
A large deficit indicates higher borrowing needs.

Fiscal Consolidation

Efforts to reduce deficit through prudent spending and improved revenue.
India institutionalises this through the FRBM Act.

Fiscal Drag

When rising income pushes taxpayers into higher tax brackets without real income gain, reducing disposable income.

Fiscal Neutrality

Taxing and spending decisions cancel each other out → no net demand impact.

Crowding-Out Effect

Heavy government borrowing pushes up interest rates, making private investment more expensive and reducing its share.

Pump Priming

Government boosts economic activity through spending and incentives to jump-start growth — seen in efforts during major downturns.

Economic Stimulus

A broad framework of fiscal and/or monetary measures to revive demand and employment.
Example: Atma Nirbhar Bharat Package during the pandemic.