Making the $5-trillion target possible

After a decisive mandate, India’s new government has settled down to work quickly to address several intricate problems being faced by the economy. As a precursor to the Budget, the Prime Minister has set a medium-term target of making India a five-trillion dollar economy in the next five years, starting a debate on whether it is feasible. According to the pessimists, the target looks ambitious.

However, the optimists feel that the target is achievable, provided suitable measures are taken well in time. Let us understand the challenges before the policymakers to reach the target in five years.

India’s nominal GDP at current market prices was ₹190.1 trillion in 2018-19. This works out to about $2.7 trillion at the exchange rate of ₹69.17 per US dollar prevailing on March 29, 2019.

To become five-trillion dollar economy in five years, India’s nominal GDP must grow at least at 12.7 per cent compounded annually, with an underlying assumption of the rupee-dollar rate remaining stable around the same level (See chart). The expected growth numbers for the current and the next two years are taken from the Budget documents. For 2022-23 and 2023-24, the numbers are assumed optimistically. And so, India’s GDP in 2023-24 is tantalisingly close to five-trillion dollar at the current exchange rate.

The exchange rate may spoil the arithmetic if the rupee depreciates against the dollar. The average annual depreciation of the rupee against the dollar in the last five years was 2.9 per cent, despite large depreciation observed in 2018-19. The rupee exchange rate is influenced by several factors, such as the fundamentals of the domestic economy, global geopolitical risks, crude oil prices, capital flows to emerging market economies (EMEs), anti-globalisation policies of developed countries, etc. One may therefore assume that the rupee may depreciate at least by 10 per cent in next five years in which case India may reach $ 4.4 trillion by 2023-24.

Structural reforms

According to the Central Statistics Office (CSO), although India’s average real GDP growth during the last five years has been 7.5 per cent, it has slowed down to 6.8 per cent in 2018-19.

Given the external headwinds and the twin balance-sheet problem, is it possible to push the real GDP growth to 7.5 per cent and above? One may argue that government has undertaken several structural reforms in last five years. Several big-ticket projects that are in the pipeline would be completed in the next two-three years. This may improve productivity and thereby contribute to a high GDP growth going forward.

EMEs are typically investment-driven economies. Productivity growth is generally slow and may not accelerate in a big way to reach the five-trillion dollar level unless structural reforms are sustained.

Monetary policy

While external headwinds are beyond the control of the Indian policymakers, they can at least keep their house in order so that the fundamentals of the economy — such as inflation, fiscal deficit, external current account deficit (CAD) etc — do not deteriorate. As India’s inflation is well below the target, the monetary policy can afford to support growth until inflation expectations remain benign. However, the fiscal consolidation should not be relaxed going forward.

Past experience shows that fiscal imprudence in India has adversely affected the domestic prices, CAD and exchange rate. Hence, public policy should endeavour to achieve a combination of 4-4.5 per cent inflation and 7.5-8.5 per cent real GDP growth in the next five years.

The maiden Budget of the new Finance Minister, presented on July 5, contains vision for making India a five-trillion dollar economy by 2023-24. Notable among the points are infrastructure development, push to the digital economy, private investment, fiscal discipline/other structural reforms, provisions for credit growth/financing by capital market, besides commitment to clear mess in the financial system, which can commence the virtual investment cycle.

The balance-sheet problem

There is a need to reflect as to why the Indian economy has slowed down recently. Is it a temporary blip, or is India heading toward further slowdown like the global economy? One of the major reasons for the recent slowdown is the persistence of the twin balance-sheet problem of the banks and the corporate sector.

While commercial banks’ balance sheets have shown early signs of improvement, the cleaning of NBFC balance sheets needs urgent attention.

The corporate sector is still languished with poor balance sheets due to imprudent borrowing, diversifying to multiple sectors without domain knowledge, and unethical governance practices flouting regulations in letter and spirit.

The gross fixed capital formation (GFCF) as proportion to the GDP at current prices was 29.3 per cent in 2018-19, which is not sufficient to accelerate the GDP growth to 8 per cent and above. There is limited scope for the CAD to supplement domestic savings, as it has already surpassed 2.1 per cent of the GDP in 2018-19. In the next two-three years, the GFCF should increase to at least 32 per cent of the GDP, financed predominantly by domestic savings.

Private investment has to increase, as its balance-sheet problem is resolved. If big industrial houses fail to accelerate their investment, MSMEs in rural areas — particularly in non-farm activities — may stimulate growth, given the incentive structure announced in the Budget. The manufacturing sector has to revive quickly to accelerate growth, increase export, and provide employment.

Structural reforms should continue outside the Budget. India can reach the five-trillion-dollar mark if the export sector contributes significantly, the GFCF increases to at least 32 per cent of the GDP, and productivity improves considerably to achieve growth above 7.5 per cent on a sustained basis.

The writer is a Visiting Fellow at the IGIDR and former Principal Adviser of the Monetary Policy Department at the RBI