🎓 Cracking the IES Economics Paper (With a Smile & Strategy!) | Section A Solved & More!

IES/ISS 2025 ECONOMICS PAPER III SOLVED

So, you want to become an Indian Economic Service (IES) officer, huh?Welcome to the wild, wise, and wonderfully wordy world of economics, where your brain is taxed more than your income—and for good reason!

But first, let’s clear the dust off those UPSC dreams and dive into a paper that gave sleepless nights to many—Section A of the IES Economics Paper. We’ll not only solve all six questions (yes, all SIX!), but also add that extra touch—syllabus, salary, eligibility, and where to get coached without losing your sanity.

Spoiler alert: You’ll also find out why your cup of tea may cost more due to agricultural inflation!

1(a) What are the components of Human Development Index (HDI) in India? Why do these components remain stagnant over the years?

The Human Development Index (HDI), as constructed by the United Nations Development Programme (UNDP), is a composite indicator used globally, including in India, to assess a country's average achievements in three basic dimensions of human development:

1. Health – measured by life expectancy at birth, representing the ability to lead a long and healthy life.

2. Education – measured by mean years of schooling (for adults aged 25+) and expected years of schooling (for children entering school), reflecting access to knowledge.

3. Standard of Living – measured by Gross National Income (GNI) per capita adjusted for Purchasing Power Parity (PPP), capturing command over resources.

Despite India’s rapid GDP growth, HDI values have improved only marginally. This stagnation is due to several interlinked factors:

• Health outcomes remain poor due to low public healthcare spending (around 2% of GDP), rural-urban healthcare divide, and malnutrition among children.

• Education quality lags due to poor infrastructure, teacher shortages, rote learning, and exclusion of girls and marginalized communities, affecting both attainment and learning outcomes.

• Income inequality persists, with a large informal workforce, stagnant wages, and rising jobless growth limiting per capita income gains.

Moreover, regional disparities, weak human capital investment, and gender inequality impede equitable development. HDI stagnation thus reflects a paradox: high economic growth without parallel human capability expansion — calling for inclusive, rights-based development strategies.

1(b) Mention the major reasons for the rise in India’s current account deficit in the last decade.

The Current Account Deficit (CAD) reflects a country’s net outflow of foreign exchange due to excess imports of goods, services, and investment incomes over exports. For a developing economy like India, some level of CAD is expected. However, the sustained and rising CAD in the last decade has become a major macroeconomic concern. From structural weaknesses to cyclical shocks, several factors have contributed to this trend:

1. Persistent Dependence on Oil and Gold Imports

India is the world’s third-largest crude oil importer, meeting over 80% of its needs through imports. As international crude oil prices fluctuated dramatically—especially during periods like 2012–14, 2018, and post-Ukraine war in 2022—it directly ballooned India’s import bill. Additionally, gold, deeply embedded in Indian cultural and financial behavior, has remained a major import item despite various import restrictions. Together, these two commodities alone constitute over 35–40% of total imports in some years.

2. Slow and Stagnant Growth in Merchandise Exports

Despite the IT sector’s export performance, merchandise exports in sectors like textiles, engineering goods, and agriculture have remained largely uncompetitive in global markets. Factors include:

• Outdated technology and low R&D.

• Lack of economies of scale.

• Weak trade logistics and port infrastructure.

• Inconsistent trade policies.

India's inability to capture global value chains—especially in electronics and machinery—has widened the trade imbalance.

3. High Outflow in Primary Income Account

India faces a net deficit in primary income, primarily due to interest payments on external debt and profit repatriation by foreign companies. With increasing foreign direct and portfolio investments, the outflow under this head has grown significantly, adding pressure on the current account. In recent years, this outflow has crossed $30 billion annually.

4. Weak Import Substitution and Structural Rigidities

India’s manufacturing sector (especially MSMEs) continues to suffer from inadequate investment, power shortages, regulatory burden, and weak global integration. As a result, India remains dependent on imports of electronics, defense equipment, capital goods, and chemicals—sectors where domestic production hasn't met demand or quality benchmarks.

5. Global Disruptions and Supply Chain Shocks

The last decade witnessed multiple external shocks:

• The US-China trade war (2018–19).

• COVID-19 pandemic (2020–21), leading to both demand and supply shocks.

• The Russia-Ukraine conflict (2022 onwards), which pushed up energy and food prices globally.

These disruptions hurt India’s exports while raising import costs, thereby worsening CAD.

6. Currency Volatility and Capital Flight

The Indian Rupee has depreciated over 40% against the USD over the last decade, making imports costlier. In periods of global uncertainty or monetary tightening (e.g., US Federal Reserve rate hikes), FII outflows spiked, leading to pressure on forex reserves and necessitating larger capital account financing to cover the CAD.

7. Rising Consumer Demand and Credit Expansion

With rising income levels, a surge in consumer demand for foreign goods, luxury products, and services (like education and tourism abroad) has caused a surge in invisible imports. India is also witnessing an increase in external borrowing by corporates, which eventually leads to higher foreign exchange outgo in future periods.

In essence, the rise in India’s current account deficit in the last decade is a complex interplay of global headwinds and domestic structural weaknesses. While occasional government interventions—like the Atmanirbhar Bharat scheme, Production-Linked Incentives (PLI), and export diversification efforts—show potential, deeper issues like low manufacturing productivity, high logistics costs, and policy unpredictability must be addressed. To ensure sustainable external balance, India needs a multi-pronged strategy focusing on export competitiveness, energy diversification, investment in technology, and trade diplomacy.

1(c) “Retail price inflation mainly stems from the agricultural and allied sectors, housing, textiles and pharmaceutical sectors in India.” Comment.

Retail inflation, measured through the Consumer Price Index (CPI) in India, has remained a persistent macroeconomic challenge. The quoted assertion rightly underscores the sectoral roots of inflation—emphasizing that inflation is not merely a monetary or demand-side phenomenon, but often deeply rooted in the structural inefficiencies and supply-side rigidities of specific sectors. Among these, the agricultural and allied sectors, housing, textiles, and pharmaceuticals have played a disproportionately large role in shaping the trajectory of India’s consumer inflation over the past decade.

Let’s examine each sector individually, and then tie them together within a macroeconomic and policy context.

I. Agriculture and Allied Sectors: The Structural Core of Food Inflation

India's CPI assigns over 45% weight to food and beverages, making it highly sensitive to food price changes. Inflation in this sector is largely supply-driven, due to several reasons:

• Climate Dependence: India’s agriculture is still highly dependent on the monsoon. Irregular rainfall, droughts, floods, and climate change-induced variability lead to frequent supply shocks.

• Low Productivity and Fragmented Holdings: A large percentage of farmers operate on small plots using traditional methods, leading to low yield and supply constraints.

• Inefficient Storage and Transport: Nearly 30–40% of perishable produce like fruits and vegetables is lost due to the lack of cold chains and warehousing.

• MSP and Government Procurement Policies: Hikes in Minimum Support Prices without matching productivity improvements often fuel inflation without adding real value.

• Global Price Transmission: Imported pulses and edible oil prices transmit global inflation to domestic markets, especially during geopolitical crises.

Thus, food inflation is often volatile, persistent, and geographically uneven, with rural populations often bearing the brunt of it.

II. Housing: Urban Demand, Supply Shortage, and Rent Inflation

Housing holds a significant weight in core inflation and directly influences CPI through House Rent Allowance (HRA) and rental prices in the urban consumer basket.

• Rapid Urbanization: With over 35% of India’s population now urban, pressure on urban housing markets has led to rising rents, especially in Tier-1 and Tier-2 cities.

• Supply Constraints: Lack of affordable housing, regulatory bottlenecks in land acquisition, and slow project clearances have led to inadequate housing stock.

• Speculative Investment: Real estate is used as a store of black money, artificially inflating prices without corresponding increase in supply or affordability.

• Post-COVID Work-Back Migration: After remote work ended, return to cities increased urban rental inflation significantly.

Housing inflation is thus both a cyclical and structural problem, intensified by speculative practices, rising input costs (cement, steel), and skewed demand patterns.

III. Textile Sector: Labour-Intensive Yet Vulnerable

The textile sector, a major contributor to employment, has experienced cost-push inflation, especially in post-pandemic years.

• Raw Material Inflation: Cotton and synthetic fibre prices have surged due to global supply constraints, erratic rainfall, and export restrictions.

• Wage Pressures: Labour shortages due to reverse migration post-COVID increased wage rates, especially in unorganized segments.

• Import Dependencies: India imports dyes, chemicals, and high-end machinery for its textile industry. Rupee depreciation makes these inputs costlier.

• Compliance Costs: With increasing ESG norms and quality standards, small textile firms face higher regulatory burdens, increasing retail prices.

Clothing inflation is especially regressive—it disproportionately impacts lower-income groups, affecting their overall consumption.

IV. Pharmaceutical Sector: Essential Goods Facing Price Shocks

Despite being a global pharmaceutical powerhouse, India’s domestic healthcare inflation has risen steadily, especially in the wake of COVID-19.

• High Out-of-Pocket Expenditure: With only ~20% insurance penetration, most Indians pay for healthcare directly, making them more vulnerable to inflation.

• API Import Dependence: India imports over 65% of its Active Pharmaceutical Ingredients (APIs) from China. Any disruption or price increase in China gets passed directly to Indian consumers.

• Price Controls and Limited Coverage: While the National Pharmaceutical Pricing Authority (NPPA) controls prices of essential drugs, it leaves many critical and new-generation drugs outside its purview.

• Healthcare Services Inflation: Private hospitals, diagnostics, and specialist consultations have become increasingly expensive due to demand-supply mismatch and lack of regulation.

In this context, pharmaceutical inflation is not just economic—it has social and ethical dimensions, affecting access to life-saving treatments.

V. Broader Analysis: Cost-Push Inflation and Structural Bottlenecks

India’s inflation profile has gradually shifted from demand-pull to cost-push and supply-side inflation. These sector-specific pressures manifest as overall CPI inflation due to:

• Imported Inflation: India is a net importer of energy, capital goods, and healthcare inputs.

• Tax Structure: High indirect taxes like GST on essentials (e.g., textiles at 5–12%) pass on inflation to end consumers.

• Supply Chain Rigidities: Informal markets, poor logistics, and regulatory delays affect availability and pricing.

• Lack of Counter-Cyclical Policies: Monetary policy (via RBI) has limited impact on food or pharma inflation, which require fiscal and structural interventions.

1(d) Comment on the role of institutions in India for the effective functioning of a market economy.

A market economy is one where economic decisions—pertaining to production, consumption, pricing, and investment—are primarily determined by supply and demand forces, rather than centralized state control. However, for a market economy to function efficiently, equitably, and sustainably, strong institutional frameworks are indispensable. Institutions in this context refer not only to physical organizations but also to the formal rules (laws, regulations, policies) and informal norms (social conventions, trust systems) that govern economic interactions.

India, being a mixed economy with strong market orientation post-1991, depends heavily on its institutional architecture to regulate, facilitate, and balance economic growth and social welfare.

I. Legal and Regulatory Institutions: Upholding Rule of Law and Property Rights

• Judiciary: Institutions like the Supreme Court and High Courts ensure contract enforcement, protection of property rights, and resolution of commercial disputes. An efficient legal framework is vital for business confidence and FDI inflow. However, delays in judicial processes (e.g., pending cases in commercial benches) often raise the transaction cost of doing business.

• Competition Commission of India (CCI): Ensures fair competition, prevents monopolistic practices, and protects consumer interests. Its interventions in digital markets (e.g., Google Play Store case) demonstrate its evolving relevance in a tech-driven economy.

• Insolvency and Bankruptcy Board of India (IBBI): Established under the Insolvency and Bankruptcy Code (IBC), 2016, it has significantly improved the resolution of stressed assets, enhancing creditor confidence and improving capital efficiency.

II. Financial Institutions: Capital Allocation and Risk Management

• Reserve Bank of India (RBI): Plays a dual role—monetary authority and banking regulator. It maintains price stability, manages liquidity, ensures orderly credit flows, and promotes financial inclusion. RBI’s regulatory stance on NBFCs post-IL&FS crisis shows its growing institutional assertiveness.

• Securities and Exchange Board of India (SEBI): Protects investor interests, enhances transparency in stock markets, and prevents insider trading. It ensures that capital markets remain efficient and fair.

• Public Sector Banks, Cooperative Banks, and Microfinance Institutions: These serve diverse economic agents, from big corporates to marginalized borrowers. Institutional health of banks is crucial, especially in a credit-driven economy.

• Insurance Regulatory and Development Authority (IRDAI) and Pension Fund Regulatory and Development Authority (PFRDA): Promote long-term savings, risk coverage, and social security—key pillars of market stability.

III. Market-Facilitating Institutions: Infrastructure, Trade, and Innovation

• NITI Aayog: As a think tank, it advises on long-term policy planning, ease of doing business, and sustainable development—building a market-friendly governance architecture.

• Goods and Services Tax Council (GST Council): A federal body institutionalizing tax harmonization. It reduces distortions in product markets by replacing cascading taxes with a unified indirect tax structure.

• Start-up India, SIDBI, and incubators: These foster innovation and entrepreneurship, enhancing market dynamism. However, funding gaps and regulatory uncertainties still hinder early-stage start-ups.

• Digital India & Aadhaar infrastructure: These institutions have enabled financial inclusion, DBT (Direct Benefit Transfers), and e-governance, bridging the gap between markets and citizens, especially in rural India.

IV. Social and Developmental Institutions: Balancing Equity and Efficiency

• PDS, MNREGA, and Social Welfare Boards: While not traditionally ‘market’ institutions, they play a crucial role in correcting market failures, addressing inequality, and enhancing demand in distressed regions.

• Labour Courts and Industrial Tribunals: Ensure industrial peace, mediate in employer-employee conflicts, and support inclusive labor market functioning.

• Environmental Institutions (like CPCB, NGT): Regulate externalities, promote green business practices, and safeguard intergenerational equity—a critical aspect in sustainable market systems.

V. Challenges in Institutional Functioning

Despite the impressive institutional network, several challenges dilute their effectiveness:

• Regulatory Overlap and Turf Wars: Conflicts between SEBI and IRDAI or RBI and Finance Ministry dilute accountability and increase uncertainty for market players.

• Capacity Constraints: Many institutions lack technical manpower, financial autonomy, or digitized systems (e.g., debt recovery tribunals, tax appellate tribunals).

• Corruption and Political Interference: Undermine credibility and independence of institutions—especially in land markets, mining regulation, and licensing.

• Access Disparities: Small and informal players often find it difficult to navigate institutional complexities, limiting their market participation.

• Slow Judicial Enforcement: Though laws exist, delays in execution of contracts and resolution of disputes erode the very trust that institutions aim to uphold.

VI. Way Forward: Reforming Institutions for a 21st Century Market Economy

To enhance the institutional robustness of India’s market economy, reforms should include:

• Judicial and Tribunal Reforms: Fast-track benches for economic disputes, digitization of filings, and alternate dispute resolution mechanisms.

• Autonomy and Accountability: Institutions like RBI, SEBI, and CCI must be granted full operational independence while maintaining transparency.

• Capacity Building: Greater investment in training, digital platforms, and human capital within regulatory bodies.

• Inclusive Institutional Design: Encourage representation of MSMEs, women entrepreneurs, and regional players in policy forums.

• Public-Private Institutional Partnerships (PPIPs): Leverage corporate capabilities in governance (e.g., self-regulatory organizations for digital finance or sustainability disclosures).

1(e) Inflation targeting has been an effective policy tool in controlling inflation in India. Critically examine.

Introduction: Defining Inflation Targeting and Its Purpose

Inflation targeting (IT) is a monetary policy framework wherein the central bank commits to achieving a publicly declared inflation rate, typically over the medium term. The aim is to anchor inflation expectations, stabilize the macroeconomy, and promote long-term growth. In this system, price stability becomes the primary objective of monetary policy.

Globally, this model was pioneered by New Zealand in the 1990s and later adopted by economies ranging from the UK and Canada to South Africa and Brazil. The core logic is that low and stable inflation enhances investment, consumption planning, and real wage stability.

The Indian Context: Adoption and Framework

In India, inflation targeting was formally adopted in 2016 with the passage of the Finance Act (2016), which amended the Reserve Bank of India Act, 1934. This shift institutionalized a Flexible Inflation Targeting (FIT) regime based on the recommendations of the Urjit Patel Committee (2014). The key features include:

• Target: CPI inflation at 4%, with a tolerance band of ±2% (i.e., 2% to 6%).

• Time horizon: Medium-term (typically 2 years).

• Operational framework: Implementation via the Monetary Policy Committee (MPC), a six-member panel with independent and government-appointed experts.

• Accountability clause: If inflation exceeds the tolerance band for three consecutive quarters, the RBI must submit a report to the government explaining the reasons and remedial actions.

I. Achievements and Strengths of Inflation Targeting in India

1. Anchoring Inflation Expectations

Prior to 2016, India was plagued with double-digit inflation, especially between 2009 and 2013 (averaging around 9–10%). Inflation targeting has been instrumental in anchoring expectations, leading to:

• Greater price predictability for consumers and firms.

• More stable wage-setting behavior and contract negotiations.

• A shift in public perception—from inflation being a persistent norm to a manageable risk.

2. Enhancing RBI’s Credibility and Policy Transparency

With a codified inflation target and the formation of the MPC:

• The RBI became more transparent, publishing minutes of meetings, rationale for decisions, and individual votes.

• Policy-making became rule-based rather than discretionary, reducing volatility from ad hoc political interference.

• India’s sovereign risk profile improved, boosting foreign investor confidence.

3. Improved Monetary Transmission

A low and predictable inflation environment facilitates better monetary transmission. Between 2016 and 2019:

• Policy rate cuts led to corresponding reductions in lending rates.

• Government bond yields became more stable, lowering the cost of borrowing.

• Inflation risk premium embedded in long-term interest rates declined.

4. Lower Volatility in Core CPI

Core CPI (excluding food and fuel) also became more stable under FIT. This enhances long-term planning for sectors like housing, consumer durables, and financial services.

5. External Stability

Price stability has spillover benefits for:

• Exchange rate stability.

• Current account balance, by making exports more competitive and reducing gold imports (used as inflation hedges).

• Improved sovereign credit ratings.

II. Criticisms and Limitations of Inflation Targeting in India

While inflation targeting brought macroeconomic discipline, it has faced growing criticism in recent years—both theoretical and operational.

1. Structural Nature of Inflation in India

Unlike developed economies, inflation in India is heavily influenced by supply-side shocks, particularly in:

• Food prices, which are volatile and account for nearly 46% of the CPI basket.

• Fuel and transport costs, which fluctuate with global crude oil.

• Imported inflation through commodities and the exchange rate.

Since the RBI has limited influence over supply-side dynamics, interest rate hikes in such contexts may be ineffective or even counterproductive, suppressing demand without addressing root causes.

2. Trade-off with Growth and Employment

India’s economy is demand-constrained, and excessive focus on inflation may lead to:

• High real interest rates, which deter private investment.

• Lower credit growth, hurting MSMEs and rural consumption.

• Crowding out of fiscal policy responses in downturns.

For instance, in 2018–19, despite slowing GDP growth, the MPC maintained a cautious stance due to transient inflation risks—delaying counter-cyclical rate cuts.

3. Incomplete Fiscal-Monetary Coordination

Inflation targeting assumes a neutral or disciplined fiscal policy. However, in India:

• High fiscal deficits and MSP hikes often counteract RBI’s deflationary stance.

• Administered prices (e.g., fuel, power tariffs) remain tools of political signaling, undermining monetary stability.

Thus, without tight fiscal-monetary coordination, the efficacy of inflation targeting remains partial.

4. Measurement Issues: Headline vs. Core Inflation

India targets headline CPI, which is more volatile and less controllable via interest rates. Some experts argue that:

• Policy should give more weight to core inflation for setting interest rates.

• Use of food inflation buffers, like dynamic minimum export prices (MEPs), could supplement monetary tightening.

5. Financial Market Frictions and Transmission Lags

Despite reforms, India’s financial markets still face:

• Weak corporate bond market penetration.

• Sticky deposit and lending rates in the banking system.

• Delayed transmission of repo rate changes to actual loan products.

Thus, changes in the policy rate do not always translate into expected macroeconomic outcomes.

III. Empirical Overview of Inflation Under Targeting Regime

Fiscal Year	CPI Inflation (%)	Repo Rate (%)	GDP Growth (%)
2013–14	9.4	8.0	6.4
2015–16	4.9	6.5	8.0
2017–18	3.6	6.0	6.8
2020–21	6.2	4.0	-6.6 (COVID)
2022–23	6.7	6.5	7.2

While inflation was tamed during normal years (2016–2019), exogenous shocks (COVID-19, Russia-Ukraine war, global supply disruptions) have challenged the RBI’s capacity to meet the target without harming growth.

IV. Reforming the Inflation Targeting Framework: A Way Forward

Rather than abandoning inflation targeting, a flexible and adaptive overhaul is the need of the hour:

1. Dual Mandate Model

Like the U.S. Federal Reserve, India could formally adopt growth and employment as secondary goals, alongside inflation.

2. Core-CPI Anchoring Strategy

While headline inflation must be monitored, the MPC can shift emphasis toward core inflation trends for interest rate decisions.

3. Food Inflation Buffering

Integrate agricultural policies (e.g., warehousing, crop insurance, storage) with monetary policy to address food inflation volatility.

4. Strengthen Fiscal-Monetary Coordination

Revive formal institutional dialogue mechanisms between the RBI, Ministry of Finance, and sectoral regulators.

5. Data-Driven Monetary Policy

• Use nowcasting models, AI/ML tools, satellite data, and big data to forecast inflation more accurately.

• Integrate inflation at regional/state levels to design more calibrated policy responses.

1(f) Examine the importance of Gross Fixed Capital Formation (GFCF) in the process of economic growth in India.

Introduction: Understanding GFCF and Its Theoretical Significance

Gross Fixed Capital Formation (GFCF) is a critical component of the expenditure side of GDP. It measures net investment in fixed assets such as infrastructure, plant and machinery, equipment, buildings, and intangible assets (excluding land purchases). In simple terms, it reflects how much the economy is adding to its productive capacity.

From a macroeconomic perspective, GFCF is a proxy for physical capital accumulation, one of the key drivers of long-term economic growth in classical and neoclassical growth theories. According to the Solow Growth Model, long-run output growth depends on capital accumulation, labor force growth, and technological progress. Higher GFCF increases the capital stock, which enhances productivity, output, and employment.

In India’s development trajectory—especially as a capital-scarce, labor-abundant economy—GFCF plays an indispensable role in infrastructure creation, industrial development, employment generation, and overall capacity building.

I. Importance of GFCF in India’s Economic Growth Process

1. Capital Formation as a Driver of Productive Capacity

India’s journey from a largely agrarian economy to a diversified one has required vast investments in:

• Roads, railways, airports, and logistics.

• Power generation and transmission infrastructure.

• Urban infrastructure like housing and sanitation.

• Manufacturing plants, storage facilities, and R&D centers.

GFCF in these sectors enhances productive capacity, facilitates crowding-in of private investments, and improves supply-side efficiency, thereby sustaining higher growth rates.

2. GFCF and Multiplier Effects on Employment and Demand

Capital formation leads to a multiplier effect:

• Direct effects through construction and equipment industries.

• Indirect effects via forward and backward linkages (e.g., cement, steel, transport).

• Induced effects through increased incomes leading to higher consumption.

For a country like India, where unemployment and underemployment are persistent issues, investments in infrastructure and capital goods create labor-intensive job opportunities, especially in rural and peri-urban regions.

3. Attracting Private Investment and FDI

A strong trend in public and private GFCF boosts investor confidence and sends signals about macroeconomic stability. It reduces the “cost of doing business” and increases the rate of return on private investment.

India’s initiatives like:

• Make in India

• Production Linked Incentive (PLI) Schemes

• National Infrastructure Pipeline (NIP)

...are designed to stimulate GFCF, with the goal of creating a virtuous cycle of public-private investment convergence.

4. GFCF and Sectoral Development

• In agriculture, capital formation in irrigation, cold storage, and warehousing enhances productivity, reduces post-harvest losses, and stabilizes food prices.

• In industry, GFCF enables technological upgradation, economies of scale, and global competitiveness.

• In services, especially IT and financial services, capital formation in digital infrastructure enhances outreach, efficiency, and employment.

Thus, GFCF is sectorally inclusive and transformational.

5. Enhancing Total Factor Productivity (TFP)

While capital accumulation is essential, the quality of capital also matters. GFCF directed toward research and development, education, and digitization enhances total factor productivity, making the economy more resilient, dynamic, and future-ready.

II. Trends in GFCF in India: A Mixed Performance

Let us analyze the GFCF trends in India over the last two decades:

Year	GFCF (% of GDP)	Growth Rate (%)	Remarks
2007–08	~35%	9.3	Peak investment-led boom
2011–12	~32%	6.6	Global crisis aftershocks
2015–16	~29%	8.2	Modest recovery post policy reform
2020–21	~27%	-6.6	COVID-19 pandemic contraction
2022–23	~30.5%	7.2	Recovery aided by infrastructure push

While GFCF has rebounded post-COVID, it is still below the pre-2008 highs, suggesting the need for sustained investment growth to reach double-digit GDP expansion.

III. Challenges to Capital Formation in India

Despite its importance, GFCF in India faces several structural and policy-related hurdles:

1. Investment Stagnation and Risk Aversion

• Private sector capex has been subdued since 2013 due to balance sheet stress, corporate deleveraging, and global demand slowdown.

• Investment in capital-intensive sectors like steel, cement, and telecom saw delays due to regulatory and land acquisition bottlenecks.

2. Twin Balance Sheet Problem

As identified by the Economic Survey (2016–17), the twin balance sheet problem—stressed corporate and bank balance sheets—led to reduced credit growth and investment hesitancy. Non-performing assets (NPAs) in public sector banks constrained lending to infrastructure and capital-intensive industries.

3. Policy Uncertainty and Regulatory Hurdles

Frequent changes in taxation policies (e.g., retrospective taxation), delays in environmental clearances, and judicial overreach in commercial matters often increase project costs and risks, discouraging large-scale capital investment.

4. Low Public Spending on Productive Assets

A significant portion of public spending is revenue expenditure (e.g., subsidies, salaries). Capital outlay on infrastructure, though increasing, still lags behind the ideal 7–8% of GDP target necessary for high-growth outcomes.

5. Skewed Regional Distribution of Capital Formation

GFCF is heavily concentrated in certain states (Maharashtra, Gujarat, Tamil Nadu, Karnataka), while BIMARU and North-Eastern states lag behind, leading to regional inequality in infrastructure and employment opportunities.

IV. Government Initiatives to Boost GFCF

To revive and accelerate capital formation, the Government of India and RBI have taken several initiatives:

1. National Infrastructure Pipeline (NIP)

Announced in 2019, this is a ₹111 lakh crore initiative across 7,400+ projects, spanning roads, ports, energy, and digital infrastructure.

2. PM Gati Shakti Master Plan

A digital platform for integrated infrastructure planning among 16 ministries to ensure synchronized project execution.

3. PLI Schemes

Targeting 13+ sectors (electronics, textiles, solar panels), PLI incentivizes private players to build production capacity and expand exports.

4. Credit Support to MSMEs and Infrastructure

Schemes like ECLGS (Emergency Credit Line Guarantee Scheme) and development finance institutions (DFIs) such as NABFID are intended to improve long-term project financing.

5. Simplification of Regulatory Frameworks

Labour codes, GST reforms, and faster environmental clearances are aimed at improving the ease of doing business, thereby promoting fixed capital investments.

V. Way Forward: Making GFCF the Engine of Inclusive Growth

To further enhance the role of GFCF in India's economic growth, policy must focus on:

• Public-private partnerships (PPP) for long gestation infrastructure projects.

• Skill development to ensure that capital investment translates into productive employment.

• Green and digital infrastructure investments to align with global climate goals and future demand.

• Greater inclusion of Tier 2/3 cities and backward states in capital allocation.

• Reduction in logistics and energy costs to enhance return on capital deployed.

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