Aiming beyond 7% growth

India is not the world's fastest-growing economy yet, but a revival of the animal spirits could propel it into that position

India’s gross domestic product (GDP) growth is now projected to be around 6.5 per cent for the financial year 2023-24, after recording 7 per cent in 2022. This is commendable, given global headwinds. The economy recovered sharply in 2021, growing by 9.1 per cent after a huge drop of (-) 5.8 per cent in 2020.

Where will it go over the medium-term? If India’s GDP continues to grow at 6.5 per cent on a sustained basis, it will become the third-largest economy soon. However, it is noteworthy that, on a per capita basis, it will remain a lower-middle income country well past 2030. Official statistics show that India’s GDP grew at around 6.8 per cent from 2001 to 2010, and then at 6.4 per cent from 2011 to 2019. During both periods, there were spikes in the GDP rate above 8 per cent, but were episodic and not sustained.

India’s economy has grown more slowly than that of China and even Vietnam (see charts on the right) but it has done better than Indonesia, another large Asian economy. These rankings are more pronounced if we look at GDP per capita growth rates due to their slower population growth. India is no slouch, but it is not the world’s fastest-growing economy yet, as some people claim. Can India grow faster at 7-8 per cent and attain upper- middle-income status by 2030, paving the way to an advanced economy by 2047, and rightfully become the world’s fastest-growing economy?

Some commentators incorrectly argue that India’s growth, unlike China’s, is led by consumption. Even if consumption drives growth for a year or so, sustained growth requires exports and investment, leading to employment, which, in turn, results in higher consumption. India saw a surge in private corporate investment in the period 2002–2008 (see chart below), but it then declined sharply, by over 10 per cent of GDP.

Household investment also surged after the global financial crisis stimulus, but has since remained steady at 11-12 per cent of GDP. In recent years, despite fiscal constraints and the needs arising from the pandemic, government capital expenditure has been maintained at high levels to crowd in private investment. However, overall public investment has still declined, given the fall in investment by public sector undertakings (PSUs). 

There is a view that India should be satisfied with 6 per cent growth. They argue that India is not China, and global conditions, which were favourable during China’s boom period from 1980 to 2010 when it grew at 10 per cent annually over three decades, have become more challenging now as global trade has slowed down, and geopolitical tensions have risen.  China was able to grow faster than India and other Asian countries even during the period 2011-19. But this growth has been driven by very high unsustainable debt-fuelled investment, which has averaged 44 per cent of GDP over the past decade, with a considerable portion allocated to the property sector. China’s incremental capital output ratio (ICOR), which measures how much capital is required to produce additional GDP, has doubled from 3.5 to 7 over the last decade, with a looming property crisis.

Some analysts claim that India’s ICOR has fallen to 4 and, therefore, India’s GDP growth will rise to 7-7.5 per cent annually even at the current gross investment rate of 30-32 per cent of GDP. If true, this is welcome news. But more realistically, India’s ICOR calculated over longer periods has been much higher at 4.9 from 2011-2019; 4.8 per cent from 2001-2010; 4.4 per cent from 1991-2000; and 4.8 per cent from 1981-1990.  This means that at today’s gross investment rate of 31 per cent of GDP, sustained growth of 6 per cent growth will be the likely outcome. If India wants over 7 per cent growth, investment must rise to 34-35 per cent of GDP, and further to 39-40 per cent of GDP to get above 8 per cent GDP growth.

Higher growth will, therefore, require a revival of private corporate investment, but not in an unsustainable way that China followed recently. Our research shows that the drivers of corporate investment are the capacity utilisation rate, credit to the private sector, and the real exchange rate. Given these, we should expect to see a revival in corporate investment, as capacity utilisation rates have risen in most sectors and are at a decadal high, according to the Reserve Bank of India’s latest survey. The real exchange rate has corrected to some extent after the fall in the rupee, and the banking sector clean-up has meant that banks can now finance much larger corporate investment needs. Corporate profits have also risen, corporate taxes are low, and they can plough back equity into investment as well. Our research also shows that government capex crowds in household investment, especially on housing. The efforts to keep government capex high have borne fruit, as household investment, which had fallen, has begun to recover.

Exports, too, played a key role in India’s growth story, as I have argued previously in this paper. India’s exports have consistently grown faster than world exports. As a result, India’s share in global exports rose from 0.5 per cent in 1990 to 2.5 per cent in 2022. Even if world export growth slows to 6-7 per cent annually, India’s exports of goods and services could grow at a healthy 12-13 per cent annually to $2trillion by 2030, accounting for 4 per cent of world trade. India must keep its focus on exports, especially as half of it will come from services where world trade is growing rapidly.

India can sustain a GDP growth rate of 7-8 per cent until 2030, if key reforms continue, and if we see a recovery in private corporate investment, which we hope comes through in 2024 and sustains. The stars are aligned for it unless geopolitical events spring a surprise.

The writer is distinguished visiting scholar, Institute for International Economic Policy, George Washington University, and co-author of Unshackling India, Harper-Collins, 2021 Best New Book in Economics, Financial Times