Focus on economy’s basics for 8% growth

There is no need to change India’s economic model to step up growth, aggressively deploying the existing advantages of the economy should do the job

India’s growing clout in the world was on display at the recent Delhi G20 summit. In our view, India’s increasing importance in geopolitical terms is a manifestation of its growing economic heft. Over the next three to five years, it is reasonable to expect India to achieve at least 6% Gross Domestic Product (GDP) growth per annum, driven by the inherent advantages of its economy. However, even at a pace of 6% growth over the next five years, the International Monetary Fund’s projections (6.3% is the forecast for 2023-24) show that India will remain behind China in terms of contribution to global GDP growth, even though the latter’s economy is set to grow more slowly than India’s. Hence, it is reasonable to ask if India, while being an important piston of the global growth engine, can become its strongest driver of growth?

The government needs to persist with fiscal consolidation, manage supply and demand side inflation, reduce red tape, and simplify processes. (PTI)

So far, the government seems content to achieve a growth of close to 6.5%. This is understandable, as the government’s focus appears to be managing macro-stability indicators, including inflation as it enters the pre-election cycle. However, once the elections are behind us, we think the policy priority may shift towards increasing the pace of growth. If growth reaches closer to the historically aspirational level of 8% over the next five years — a rate achieved on average during 2005-10 — India would likely become the biggest contributor to global growth in the next five years, as well as narrow the economic gap with China.

There do exist a number of “medium-term growth magnets” for India, which should keep it on track to register faster growth through this decade. The sowing of critical reforms across tax and industrial policies, improving the quality of public spending, deepening digital infrastructure networks, and an activist foreign policy should enable India to generate a higher GDP growth.

Against this backdrop of dividend-yielding reforms and strong macroeconomic fundamentals, the best way to aim for higher growth is to strengthen the basic building blocks of the economy so that growth potential can be realised without risking the external financing position or fiscal deficit. The policy push after the general election should play on the inherent advantages of India’s economy, namely productive capital use financed by a large domestic savings base, clean corporate and financial balance sheets, rising export share, and favourable demographics.

We estimate that leveraging these advantages can enable specific economic preconditions that should trigger a higher growth of 7.5-8.0%. None of these basic economic factors individually can push India’s growth rate higher, but moderate progress in each in tandem can make a decisive difference. For instance, there is currently some consternation that India’s investment growth has stalled, and is only rising because of public capex. While this might be partially true, India is at a point in its economic growth cycle where additional investment should continue to generate far higher returns, and potentially at a more productive pace, as project returns gain momentum. The government’s capex targets are already high, but the recent balance-sheet advantage may also enable private capex to pick up. A healthy external debt ratio also means there is ample room for the private sector to deploy additional resources to build up productive capacity.

One area where investment has the potential to increase is manufacturing, with India benefitting from the China-plus-one strategy-driven diversification in supply chains. The government’s incentives to push exports, coupled with investment in specific areas, should also bolster India’s export footprint. Such investment in productive capacity needs to be financed by savings — more on the domestic front so as to keep the current account position stable.

India’s domestic savings at 30.5% of GDP are already at robust levels and even a slight increase to 32.5-33.0% could finance investments high enough to push growth to 8% at current productivity rates. In turn, higher investment should increase the utilisation of India’s large labour force and help reap the country’s much touted demographic dividend in a largely ageing global economy. An increase in labour force growth to about 3.5% p.a from the current 1%, including higher female participation, in quality jobs should also lead to higher productivity.

Higher productivity enables more investment-led growth, thereby creating a virtuous cycle. That increasing savings leading to higher investment will generate more employment and create higher growth is not necessarily a deep insight as far as macro stability is concerned. However, we think the few specific pre-conditions described above are not especially far from where India’s current macro variables stand. This means a growth rate of 7.5%-8% should be achievable, if the policy focus remains on strengthening the basic building blocks of the economy.

There is no need to change India’s economic model to step up growth, aggressively deploying the existing advantages of the economy should do the job. Still, despite the positive dynamics, some of which are structural and some temporal, higher economic growth is not guaranteed. The government needs to persist with fiscal consolidation, manage supply and demand side inflation, reduce red tape, and simplify processes. While higher macro momentum is visible, with decent economic growth being generated, the risks of policy inertia also need to be watched out for, lest we remain content with 6% growth and a stable macro environment.

Rahul Bajoria is managing director and head of EM Asia (ex-China) Economics at Barclays. The views expressed are personal