Why India faces three balancing acts—and why they are tough to achieve

Policy making usually involves trade-offs. Monetary policy has to choose between inflation and growth. Fiscal policy must balance prudence with deficit spending. Currency policy faces a choice between supporting the exchange rate and protecting foreign exchange reserves. The more uncertain the times, the harder it becomes to balance competing objectives. Today, more than ever, policy making is as much art as science, and policies must remain flexible and adaptable to changing circumstances.

Among the many challenges facing India, three difficult trade-offs stand out: reconciling affordability with efficient, free-market price determination; balancing the interests of savers and borrowers; and attracting foreign capital inflows without compromising fiscal health.

Affordability vs market forces

The reconciliation between affordability and free-market price determination has become difficult since the West Asia war, especially in the context of fuel prices. The government has kept the retail price of petrol and diesel down to insulate households from soaring fuel prices.

Holding prices artificially low distorts price signals in the market: there is less incentive to reduce fuel consumption when prices are controlled. On the other hand, it lowers the cost of living, improves affordability and maintains consumer confidence. Of course, price controls cannot keep inflation down forever—they can only delay the inevitable. The West Asia war is now over six months old, and businesses paying higher bulk prices for crude oil and its derivatives are already passing on some price rises to consumers. The July-September quarterly results illustrate such pressures.

Leading fast-moving consumer goods companies have reported margin compression despite robust sales volumes and selective price hikes. The cement sector saw sharp margin contractions despite price adjustments. Meanwhile, growth in domestic air passengers slowed in September as rising aviation fuel prices and higher airfares weakened demand. At this point, restrained price hikes by producers have led to a rise in inflation, but government interventions have ensured prices are not yet out of control.

However, households and businesses are fully aware of incipient price pressures. Inflation based on the wholesale price index (WPI) is now at 11.4%, and the impact of a super El Niño is apparent in changing rainfall patterns. Expectations of inflation are building up, approaching the highs last seen during the 2022 inflationary period.

This means either the Reserve Bank of India hikes interest rates to curb inflation and thereby bring down inflation expectations, or retail fuel prices must be raised. The former has already started, and energy experts are of the view that retail pump prices may be raised post-Diwali, if international crude prices remain elevated.
Savers vs borrowers

The second one is a trade-off between optimizing for savers and borrowers: savers benefit from high interest rates, while borrowers prefer low rates. Households are the largest net savers in the economy, but their savings have been depleted—first by the pandemic, and then by inflationary shocks in the following years. Bank deposits, the largest individual component of household financial assets, have given declining real returns over the past year.

The government is the largest borrower in the economy, followed by the corporate sector. If the RBI hikes rates, it could deliver both lower inflation and better returns to households. However, higher rates would raise the government’s interest burden, putting further pressure on its fiscal health. Higher rates may also moderate the otherwise robust growth in bank credit to industry.

Foreign flows vs fiscal health

The final challenge is to strike a balance between attracting foreign capital inflows and maintaining fiscal health. On the external front, dwindling capital inflows are India’s main problem.

Until 2023-24, we received an annual average of $50 billion in net capital flows. In the following years, flows dropped steeply to a net inflow of just over $1 billion in 2025-26, and a net outflow of $5.5 billion in Apr-Jun 2026.

Not surprisingly, the rupee has depreciated by about 6% against the US dollar since the start of 2026. India’s stock markets have underperformed its peers in recent months- gross return on the MSCI India index during Jan-Sept 2026 was -9.1%, compared to 32% for the MSCI emerging market index. We also have among the lowest real policy rates in the emerging market universe.

Given that safe US Treasury bond yields are 5% or higher, it is hard to find reasons for hot portfolio flows to stay in India. This signals why the government has shown openness to making the tax regime favourable for foreign investors. From April 2026, foreign portfolio investors (FPIs) were exempted from withholding income tax and capital gains tax on investment in government securities. It may be time to do for equities as well.

Some of the ideas being floated include dollar taxation of FPI incomes (to eliminate capital gains created due to rupee depreciation), reduction of long-term capital gains tax on equity from 20% to 12.5% (to match domestic investors), short-term capital gains tax rate on equity, and securities transaction tax (STT) rate. Market analysts argue that reducing taxes on sale, purchase, and profits from equity could increase the returns on FPI investments.

A tax cut may or may not bring FPI inflows back, but it would certainly reduce the government’s revenue receipts. In 2024-25, long-term capital gains tax receipts (across domestic and foreign investors) amounted to ₹1.29 trillion, around 10% of personal income tax receipts. STT collections are also growing strongly, particularly after rates were hiked in April 2026. Total STT receipts are budgeted at ₹737 billion in 2026-27. While neither tax is a major source of revenue, they are crucial to supporting revenue in a year when expenditure is likely to go up on multiple fronts. Higher fertilizer prices are expected to push up fertilizer subsidies, El Niño-related agricultural distress may increase rural spending and food assistance, and excise duty cuts on petrol and diesel could bring down excise collections. In sum, the fiscal deficit may be higher than budgeted, which would mean higher government borrowing.
These concerns are particularly relevant given the recent run-up in government yields: the benchmark 10-year rate has gained 82 bps in ten months, the steepest rise in recent years. With interest outgo at 38% of revenue receipts, a rise in borrowing rates would add to fiscal pressures.

These three challenges highlight that policymaking is all about competing priorities. Keeping prices low, attracting foreign capital, maintaining fiscal discipline, protecting the interests of savers, and creating a credit-positive environment are all important objectives, but focusing on one can come at the cost of another. The real challenge is to manage these trade-offs with practical and balanced policies.

The author is an independent writer in economics and finance.