India must set realistic growth aspirations

The Indian economy has grown at 7 per cent p;us for three years since the pandemic and is poised for a fourth year of growth of around 7 per cent. There are many who think that if growth of 7 per cent is possible on the present basis, why not aim for even higher growth on the strength of "big bang" reforms? Why not aim at a growth rate of 8 or 9 per cent? 

India has grown at 8 per cent or 9 per cent in short spurts in the past. What we are looking at is a sustainable growth rate over the next 20 years or so until 1947 by when we hope to become a developed country, which means reaching a per capita income of $14,000 at today's prices (which is the lower end threshold of developed country status).

Leave us aside the political feasibility of the "big bang" reforms. What is the track record of growth across economies? Very few economies have grown at 7 per cent plus over 20 years. Fewer still have grown at 7 per cent after reaching Middle Income Country (MIC) status. Now, factor in the reality that the world economy is becoming less open than it was in the decades following WW2. If you take all this into account, it seems that a growth rate of 6.5 per cent (that is, a compounded annual growth rate) of 6.5 per cent over the next 20 years would be a considerable achievement. 

More on this in my last BS column, Don't count on a growth miracle.

Don’t count on a growth miracle 

In a volatile global landscape, sustained growth rate of more than 7 per cent is quite a challenge   

T T Ram Mohan

The recent Budget has assumed real gross domestic product (GDP) growth of 6.5 per cent for FY24-25. The latest Economic Survey forecasts growth of 6.5-7 per cent.  Would-be reformers in India are asking for more. They urge the government to do whatever it takes to boost GDP growth to 8, 9 or even 10 per cent. Aiming for a higher growth rate has become a sort of test of the government’s machismo.

The gratifying part of current growth aspirations is that there is a sense all around that a long-term growth rate of 6.5 per cent for India is achievable. Yet, few had forecast such an outcome, least of all after the Covid pandemic struck India in March 2020.

For years, commentators warned us  that a growth rate higher than 5-6 per cent would not be possible unless the government summoned the will to push through “second-generation” reforms. The slowdown in growth during the three years preceding the pandemic seemed to confirm these apprehensions. 

None of those reforms have happened. Yet, the economy grew at over 7 per cent for three years after the pandemic and is now poised for a fourth year of growth close to 7 per cent. 

In FY 2024, as the Economic Survey points out, the Indian economy returned to the pre-pandemic growth trajectory. This is an impressive feat. The US returned to the trajectory even earlier, then veered off and returned to the trajectory a second time. Europe is yet to get back to the pre-pandemic growth trajectory. China got back very quickly to the pre-pandemic trajectory but has since departed from it. India’s recovery appears more sure-footed. That is something to celebrate. 

High growth rates after the pandemic have been driven by rising capital expenditure at the Centre. Critics said such increases were unsustainable. They said such increases would happen at the expense of fiscal consolidation and would cause the public debt-to-gdp ratio to rise. Unless private investment picked up, growth would sputter. 

They have been proved wrong on these counts as well. The central government’s capital expenditure as a proportion of gdp has doubled from 1.7 per cent in FY20 to 3.4 per cent in FY25. Yet, the gross fiscal deficit is projected to rise from 4.6 per cent to merely 4.9 per cent of GDP.   The total public debt –to-gdp ratio fell from FY21 to FY23 and rose marginally in FY24. Growth remains robust without the desired rise in private investment. Public investment-led growth has turned out to be more sustainable than analysts had thought. 

The reforms brigade now clamours for even higher gdp growth driven by further reforms- more fiscal consolidation, more privatisation, more labour reforms, more free trade. The clamour appears disconnected from reality. It is not just that the “second-generation” reforms have proved to be politically infeasible for nearly two decades and look even more remote in today’s setting. It is that growth miracles – growth of over 7 per cent for long periods- are rare for a Middle Income Country (MIC) and will become rarer still in the emerging global economic environment. 

That is the stark message from the World Bank’s World Development Report (WDR), 2024. The report focuses on the difficulties nations face in breaking out of the “Middle Income Trap”, that is, those with annual income per capita ranging from $1,136 to $13,845. India is now a lower MIC. It seeks to join the ranks of higher income countries by 2047 by growing at least 7 per cent for the next two decades. That would mean replicating the record of South Korea, which has the finest record of breaking out of the “Middle Income Trap”. 

The WDR pours cold water on such ambitions not only for India but for other aspirants as well. It states bluntly, “Given the changes in the global economy since the time that Korea was a middle-income economy, it would be fair to conclude that it would be a miracle if today’s middle-income economies manage to do in 50 years what Korea did in just 25”. 

 

The WDR report makes a point well known to students of economics from the Solow growth model:  Increases in investment can drive growth only up to a point. Thereafter, growth happens through increases in productivity. For productivity to grow, nations can induct technologies from elsewhere or they can innovate themselves. These steps are far more difficult than the initial one of simply raising the level of investment in the economy. That’s why becoming a MIC is easier than growing from that point into a high-income country. 

 

Growth in the MICs has already shown signs of slowing. Average annual income growth in these countries slipped by nearly one-third in the first two decades of this century—from 5 per cent in the 2000s to 3.5 per cent in the 2010s. Today, MICs face a whole set of adverse conditions: geopolitical tensions and fragmentation in the world economy, higher debt servicing obligations, and the costs of climate change.

The WDR 2024 report complements the findings of a study carried out by   the World Bank in 2008 under the leadership of Nobel Laureate Michael Spence.  That study that showed that growth of over 7 per cent for over 25 years from any starting point, not just from a MIC starting point, is a tall order- only 13 economies had been able to do so. Of these, nearly half were small economies. 

The economies that had grown rapidly had had the benefit of a post- WW2 world environment that was substantially open to free trade. 

If India can manage to sustain growth of 6.5 per cent over two decades starting from a MIC status in the bleakest international environment in two decades, it would be quite a feat. Those who would aim higher think that fixing several things in the Indian economy will automatically translate into a higher growth rate. 

They are mistaken. We have to reckon with serious constraints to growth and stability that emanate from outside. The sharp rise in geopolitical tensions in recent weeks and the sell-offs in financial markets in the past week only serve to reinforce this point. The Economic Survey’s conservatism about the growth rate for FY 24-25 may turn out to have been well-founded.