Excessive austerity could worsen the economic situation that India is trying to escape

The impact of an oil shock is visible in higher petroleum and fertilizer prices in the global market, with other critical inputs for industry more costly as well. Supply chain disruptions for fertilizers and petroleum products like cooking gas, aviation fuel and so on are just part of the story.

The impact on macro-economic indicators is visible in a fast depreciating rupee, widening current account deficit and other indicators.

While the traditional macro view favours austerity as a fiscal response to such crises, the experience of many countries, developing ones particularly, would advise a degree of caution.

In a traditional framework, austerity works by reducing government debt via spending cuts that depress aggregate consumption. In most cases, such measures result in reduced economic activity in the short run, but have also caused recessions in some cases.

This risk is more serious in an economy already going through a demand deficiency amid weak overall investment, as is the case with the Indian economy. Any reduced spending reduces the economic activity associated with it. For example, millions involved in the manufacture and sale of gold jewellery may face a sectoral setback. Similarly for other goods and services that see consumption decline.

Other developing countries such as Sri Lanka and Pakistan have imposed restrictions on the consumption of import items. But most of these are already in a fragile economic situation, with fiscal austerity conditions imposed as part of structural adjustment programmes framed by the International Monetary Fund (IMF).

Austerity programmes employed after the 2008 financial crisis in Greece, Italy and other European countries led to long recessions in many of these countries. Similar experience was reported by Latin American countries that went for austerity after the commodity price collapse of 2014-15 fared poorly too.

Most of these countries were trying to control a balance of payments crisis and exchange rate devaluations, but faced prolonged distress.

Private spending cuts can have similar effects. Austerity that operates like a national-level programme can have unforeseen effects.

In Sri Lanka, food security and livelihoods were put at risk. In April 2021, it pushed for natural farming to save on foreign exchange but found itself in a worse crisis than what it tried to solve. It led to a decline of almost 30-50% in agricultural output, with rising inflation and hunger. The result was social unrest that led to a change in government.

In a year that we expect a deficient monsoon, we must be careful about employing any policy measure that may threaten food output. India’s latest retail inflation data shows a rise in food inflation from 3.9% in March 2026 to 4.2% in April 2026. This is likely to rise further and fertilizer adequacy will be a factor.

Given the track record of officially implemented austerity policies (in contrast with public exhortation) across the world, knee-jerk responses to today’s war-created crisis are likely to worsen our economic situation. The impact will not only be on aggregate demand for consumption and investment but perhaps also on food security.

So far, the PM has only suggested spending cuts. But a proper analysis of policy impact must precede any drastic measure that imposes hard restrictions.

Meanwhile, the government also needs to protect the livelihoods of millions who are likely to be impacted by rising costs. The poor need a cushion against their cost-of-living crisis. While several policy options exist, austerity, whether it is voluntary or mandated, is unlikely to be helpful in dealing with today’s economic circumstances.

The author is associate professor at Jawaharlal Nehru University and visiting fellow at the Centre de Sciences Humaines, New Delhi.