In a surprising move, the Reserve Bank of India slashed the policy repo rate by 50 basis points to 5.5 per cent on June 6, marking the largest cut since March 2020.

This decision, aimed at stimulating growth, comes amid a sharp decline in inflation and persistent global uncertainties. The RBI’s Monetary Policy Committee (MPC) also shifted its stance from ‘accommodative’ to ‘neutral,’ signalling limited room for future rate cuts.

While this move is expected to inject liquidity into the system and boost credit demand, the real challenge lies in addressing the lack of consumer demand that has been plaguing the economy.

Despite the RBI’s efforts to infuse liquidity, with a cumulative injection of approximately ₹9.5 lakh crore this year, transmission has remained muted. The banking system has moved from a liquidity deficit to a surplus of ₹2.9 lakh crore, yet the anticipated boost in credit demand has not materialised.

Demand components

Analysing the components of aggregate demand provides clarity on the underlying issue. Using the long-term trend estimates after removing short-term fluctuations, a recent article by C Rangarajan and DK Srivastava highlights that Private Final Consumption Expenditure (PFCE) has stabilised at around 57 per cent of GDP, while Government Final Consumption Expenditure (GFCE) has averaged approximately 10 per cent of GDP over the last decade.

Gross Capital Formation (GCF) has stabilised around 35 per cent, and Gross Fixed Capital Formation (GFCF) is about 33 per cent. These stable ratios indicate insufficient dynamism in consumption and investment to drive economic growth.

Additionally, recent trends in capacity utilisation rates, per the RBI Order Books, Inventories, and Capacity Utilisation Survey (OBICUS), show stability at around 74 per cent in the most recent quarters, reflecting a balanced yet cautious approach to production amidst weak demand and muted capital expenditure. Therefore, merely increasing liquidity without addressing the underlying demand constraints may not be sufficient to revive economic activity.

Government expenditure and investment are key to stimulating demand in the short and medium term. However, to effectively stimulate growth, it is crucial to focus on the components of aggregate demand that exhibit significant transitory variations. Investment expenditure, both private and government, along with government consumption expenditure, shows higher variability compared to private consumption from 1991-92 to 2024-25.

This indicates that these expenditures are more autonomous and can be utilised as instruments for raising demand in the short and medium term, signalling that an investment-led growth strategy should be prioritised.

Several factors are influencing investment decisions beyond the cost of credit. Demand uncertainty remains a significant barrier, as companies are hesitant to invest in new projects without confidence in future demand. The focus on maintaining high Return on Capital Employed (ROCE) further deters businesses from making investments that might temporarily lower this metric.

Additionally, global uncertainties and geopolitical tensions create an environment of caution among enterprises. Let’s explore each of these to understand further.

First, insights from a recent survey on private sector capital expenditure (Capex) intentions by the Ministry of Statistics and Programme Implementation (MoSPI) reveal a cautious approach by enterprises. There has been a significant Capex increase from ₹3.95 lakh crore in 2021-22 to ₹4.22 lakh crore in 2023-24, reflecting a 7 per cent growth.

However, the intended Capex for 2025-26 is expected to decline by 25 per cent compared to 2024-25, reflecting cautious planning amid global uncertainties. This caution is evident in investment strategies, where 40.3 per cent of enterprises plan to focus on core assets, while 28.4 per cent aim to add value to existing assets.

Insipid investment

Second, the private sector’s reluctance to invest is evident, as companies prioritise protecting their ROCE over expanding capacities, which has seen a steady increase from 27 per cent in 2010 to 31 per cent in 2024 and is expected to rise further in 2025. This efficiency in capital management has been recognised by the stock market, with the Nifty50 up 20 per cent annually over the same period.

Third, investment trends vary across sectors. Sectors such as healthcare and manufacturing have seen increased capital expenditure, driven by visible demand and the need for capacity expansion.

On the other hand, sectors such as real estate and trade have experienced a decline in investment rates. This is partly due to high pent-up demand tapering off and structural challenges such as regulatory hurdles and market saturation.

Additionally, some companies face idle capacities due to insufficient demand, further deterring investment in those segments.

To truly stimulate economic growth, it is imperative to address the demand side of the equation as well. The government must focus on policies that boost consumer confidence and spending. This could involve targeted fiscal measures, such as tax relief for consumers, increased public spending on infrastructure, and initiatives to support small and medium enterprises (SMEs).

Moreover, addressing structural issues such as unemployment and income inequality could help increase disposable income and, in turn, consumer demand. The government should also consider measures to enhance the ease of doing business, thereby encouraging private sector investment and job creation.

In conclusion, while the RBI’s rate cut is a step in the right direction, it is not a panacea for the economy’s woes.

An investment-led growth strategy should also be prioritised. By focusing on increasing investment, particularly in infrastructure and other capital-intensive projects, the government can leverage the multiplier effect to stimulate broader economic activity.

This approach not only addresses immediate demand constraints but also lays the foundation for long-term growth by enhancing productive capacity and technological advancement. Only by boosting consumer demand can the economy truly recover and thrive in the long term.

Bhaduri is Professor at Madras School of Economics (MSE) and Anand is a Ph.D scholar at MSE

Published on June 14, 2025