This pace of growth, though twice that of global GDP, may not be enough to achieve India’s aspirations of becoming a middle-income country and creating meaningful jobs for its youth.
Can India sustain more than 7% growth over a long period? In the past, the answer to this question would have depended on when it was asked:
- In the 1980s, the hopeful answer would have been 5%.
- In the ’90s, after liberalisation, there were hopes of a sustainable 6% growth rate.
- During the ‘Goldman Sachs – BRIC’ mania of 2004-2011, it seemed to be India’s birthright to grow at 9%.
- Morgan Stanley’s ‘Fragile Five’ in 2013 smothered it to below 8%.
- ‘Achhe Din’ in 2014 raised hopes of 8% growth again.
- Amid talk of ‘atmanirbharta’ and ‘Amrit Kaal’, many seem to be settling for around 6%.
My long-term assumption of 6% to 6.5% real GDP growth comes from a very simple analysis. Assuming India’s gross domestic savings (GDS) of around 30% of GDP and the incremental capital-output ratio (ICOR) – the capital required to get a unit of growth) of around 5, the potential growth (GDS/ICOR) works out to 6%. Negative aspects such as inefficiency in the government sector and household savings are balanced by positives such as attracting excess foreign savings into India.
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Technically, India should be growing faster than this. Efficiency is improving (India’s ICOR is lower), Indians are saving more in risk assets, and the country is attracting capital through foreign direct investments (FDI), foreign portfolio investments (FPI), foreign borrowings, and from the Indian diaspora through remittances and deposits. However, these have not resulted in sustained growth above 7%.
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Expectations are everything
For the September 2024 quarter, year-on-year growth rates were as follows: real GVA at 5.6%, real GDP at 5.36%, and nominal GDP at 8.04%. This represents a decline of more than 1.5% in both real and nominal terms compared to September 2023. This has sparked a debate on whether India is experiencing a cyclical or structural slowdown.
Some attribute the slowdown to tight fiscal and monetary policies, while others point to the incomplete recovery from the lack of income and job growth both before and after covid. A prominent economist and former executive director at the IMF described the slowdown as‘surprising and inexplicable,’ attributing it to‘India’s deep-state inspired policy’ of high taxation on income, trade and capital.
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All the above explain the current slowdown, which seems to be due a mix of cyclical and structural reasons.
However, the debate on whether the slowdown is cyclical or structural hinges on one’s growth expectations. If one expects sustainable growth above 7%, then India appears to have been in a structural slowdown for many years. Conversely, if one believes India’s sustainable growth potential is between 6% and 6.5%, the current decline may be seen as cyclical.
But considering India’s young population and low per-capita GDP, achieving 6% growth should be relatively straightforward. Therefore, a decline below this level, as seen in 2019 and now, is indeed a cause for concern.
Short-term fixes
There are some short-term remedies, of course. Fiscal policies at the state level, across all parties in power, have turned towards supporting incomes and providing subsidies. Various studies estimate that close to 1% of state GDP is spent only on women through bank transfers and other schemes. This should alleviate some of the income concerns that seemed to have held back demand.
This is the harsh reality, and politicians are the first to react to it. They know that over the past decade, growth has been weaker, incomes have been modest, and job growth hasn’t kept pace with the labour force. The only way to maintain social stability and political relevance is to provide cash transfers and income support. But consumer sentiment and overall employment, which were already on an upswing and back above pre-covid levels, should improve further, driving demand.
Monetary policy may have sent the first signals of choosing domestic goals over a steady exchange rate. Allowing the Indian rupee to move freely and weaken against the US dollar is indicative of this stance. This needs to be followed up with a rate cut in February and a liquidity infusion, which would further weaken the rupee and ease economic conditions. I would expect these measures to address the ‘cyclical’ headwinds.
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For India to grow at more than 7%, according to the ICOR formula, we need gross savings or investments to be at 35% of GDP, up from the current level of around 30%. This increase needs to come from higher domestic capital investment, an increase in the global share of exports, and a higher share of global savings as capital flows.
We saw this happen for close to two decades, from 1991 to 2011, when investments rose due to an increase in domestic capacity creation, a rise in export share, and global capital flows. This does not need ‘big bang’ reforms now. India and its ‘deep state’ may know what it takes to try and drive growth above potential. It was a combination of receding government control, simplification of taxation, freer goods and services trade, and a recognition of treating risk capital in a fair, transparent, and consistent manner that lifted India’s potential growth from 5% to more than 6%.
Arvind Chari is CIO at Q India UK, an affiliate of Quantum Advisors Pvt Ltd. The views expressed here are of the author is solely that of the author and does not necessarily reflect the views of the author’s employer, company, institution or other associated parties.
Arvind has 22 years of experience in investment management in Indian capital markets. He began his career in 2002, gaining experience in macro, credit and fixed-income portfolio management. He has multi-asset exposure by helping launch the Gold ETF, Equity Fund of Funds and multi-asset funds at Quantum. As CIO, Arvind guides global investors on their India asset allocation.
