Lowering Inflation Expectations to Safeguard India's Long-Run Employment Amid Surging Government Spending.....

In the bustling economic landscape of India as of February 20, 2026, the recent Union Budget for 2026-27 has ignited debates on how ambitious government spending plans intersect with persistent inflationary pressures and the quest for sustainable job creation. Finance Minister Nirmala Sitharaman unveiled a budget emphasizing fiscal prudence with a deficit target of 4.3% of GDP, while ramping up capital expenditure to 12.2 trillion rupees—a 11.5% increase from the revised 10.96 trillion rupees in 2025-26—to fuel infrastructure and domestic manufacturing. This comes against a backdrop of nominal GDP growth projected at 10% for the fiscal year, with real growth estimates hovering between 6.8% and 7.2%. Yet, as consumer price index (CPI) inflation ticked up to 2.75% in January 2026 under the new base year series, economists are cautioning that the real battle lies not in current price levels but in managing inflation expectations to protect long-term employment gains. With unemployment edging to 5% in January from 4.8% in December 2025, the political economy narrative underscores a critical choice: prioritize anchoring expectations over reactive measures to current inflation spikes, ensuring that India's growth story translates into enduring job security for its youthful workforce.

The interplay between government spending, inflation, and employment in India reveals a complex political economy where fiscal stimulus meets monetary discipline. The Reserve Bank of India (RBI), under its inflation-targeting framework adopted in 2016, has maintained the repo rate at 5.25% since its last cut in December 2025, signaling an end to easing amid revised inflation forecasts. For fiscal year 2025-26 ending March 2026, the RBI now projects average inflation at 2.1%, up slightly from earlier estimates due to precious metal price surges, with the fourth quarter expected at 3.2%. Projections for 2026-27 anticipate a climb to 4.3%, driven by normalizing food prices and base effects, though core inflation remains subdued at around 3.9%. This moderation follows a period of ultra-low inflation averaging 1.7% from April to December 2025, aided by easing food and fuel costs. However, the budget's push for higher spending—total outlay rising to 53.47 trillion rupees from 49.65 trillion in the previous revised estimate—raises questions about potential demand-pull pressures. Government initiatives like the Purvodaya scheme for eastern industrial corridors and enhanced public infrastructure via entities such as InvITs and REITs aim to boost productivity and create jobs, but without careful calibration, they could inadvertently stoke inflation if expectations remain unanchored.

At the heart of this discourse is the distinction between current inflation and inflation expectations, a nuance often overlooked in political rhetoric but pivotal for long-run employment. Current inflation, as measured by headline CPI, stood at 2.75% in January 2026, returning to the RBI's 2-6% tolerance band for the first time since August 2025. This uptick was largely due to a 19.02% surge in personal care items influenced by gold and silver prices, while food inflation, now weighted at 36.8% in the revised CPI basket (down from 45.86%), rose to 2.13% from -2.71% the prior month.Yet, economists argue that focusing solely on these figures misses the bigger picture. Inflation expectations, as captured in RBI's household surveys, have historically exceeded actual inflation by 2-4 percentage points, with recent data showing three-month-ahead expectations at around 8-9% despite low realized rates. This gap persists because headline shocks, like food price volatility, feed into public perceptions, influencing wage negotiations and spending behaviors. Studies on India's Phillips curve—a relationship linking inflation and unemployment—indicate that unanchored expectations can lead to persistent inflation, necessitating tighter monetary policy that temporarily elevates unemployment.

From a long-run employment perspective, lowering inflation expectations emerges as more crucial than addressing transient current inflation spikes. Historical data reveals India's unemployment rate has trended downward, averaging 7.87% from 2018 to 2026 but dropping to a low of 4.7% in November 2025 before rising to 5% in January 2026. The Periodic Labour Force Survey shows rural unemployment at 4.2% and urban at 7.0%, with female joblessness notably higher at 9.8% in urban areas. Long-term trends are encouraging: the rate fell from 6% in 2017-18 to 3.2% in 2023-24, reflecting structural reforms like labor codes that boosted formalization and added over 10 lakh manufacturing jobs in FY24. However, research underscores a negative long-run link between inflation and growth in India, with thresholds around 5.5% where elevated inflation erodes output by 0.1-0.2 percentage points annually. High expectations amplify this: if households anticipate 7-8% inflation, they demand higher wages, pushing up costs and reducing firm hiring. This creates a vicious cycle, as seen in the 1970s global stagflation, where unanchored expectations led to wage-price spirals, ultimately harming employment.

In India's context, evidence from the RBI's inflation-targeting era shows that better-anchored expectations enhance policy flexibility. For instance, during the COVID-19 shock, anchored outlooks allowed aggressive stimulus without spiraling prices, supporting a rebound in employment from pandemic highs of 20.8% in 2020. Conversely, ignoring expectations risks "jobless growth," where GDP expands at 7% but unemployment lingers due to investor caution amid perceived instability. The budget's fiscal consolidation—debt-to-GDP targeted at 55.6% for 2026-27, down from 56.1%—complements this by avoiding overheating, but political pressures for populist spending, like rural guarantees, could undermine it. Analysts note that supply-side bottlenecks, exacerbated by global trade frictions, make expectation management vital; a 1% rise in inflation expectations could shave 0.5% off long-run growth, translating to 2-3 million fewer jobs annually in a labor force of over 560 million.

Politically, this pits short-term gains against long-term stability. The government's focus on "Viksit Bharat" envisions 7-8% growth creating 8-10 million jobs yearly, but opposition critiques highlight youth unemployment at 14.3% in Q4 2025. RBI Governor Sanjay Malhotra has emphasized that excluding volatile items like gold (adding 60-70 basis points to inflation) reveals "benign" underlying pressures, yet proactive liquidity measures are needed to preempt fluctuations. International comparisons bolster the case: economies like the US in the 1980s tamed inflation by credibly anchoring expectations, unlocking decades of job growth. In India, where inflation persistence is high— a 1% deviation from expected inflation adjusts expectations by only 0.1% quarterly—policy must prioritize communication and forward guidance over reactive rate hikes.

As India navigates this juncture, the imperative is clear: while current inflation at 2.75% demands vigilance, the true lever for containing it lies in lowering expectations through consistent policy. This not only prevents cost-push spirals but fosters an environment where government spending on capex yields multiplicative employment effects. With projections of 4% inflation in 2027 and unemployment trending toward 5.4%, anchoring expectations could add 1-2% to long-run growth, creating millions of jobs. In the political economy of a rising power, this strategy ensures that today's fiscal ambitions secure tomorrow's workforce prosperity, turning economic resilience into inclusive advancement.