Where will India's economic growth settle in the next 2-3 years?
a reasonable bet for India's growth would be about 7% or higher in the next few years. The baseline growth draws upon the average growth rate of about 6.75% in five pre-Covid years. In the near term, monetary and fiscal policies are unlikely to be able to contribute to this growth estimate any more than they have in the past five years.
Economic growth is arguably the best antidote to poverty. Not only does it ensure the material well-being of those who directly participate in economic activity, but it also generates fiscal revenues that allow public policy to benefit those left behind in income and wealth creation. Hence, our policymakers' fixation with the pace of India's growth is well justified. So, where will growth settle in the next 2-3 years?
Forecasts are known to suffer from large errors, not because they tend to have an inherent systemic bias, but due to the inability of forecasters to foresee shocks. These shocks are more commonly seen, and are larger, in developing economies than in advanced economies.
Look Back to Look Forward
Two, a realistic assessment of the direction and pace of key policy decisions, including monetary, fiscal, regulatory and structural policies. This assessment should be done knowing that regulatory and structural policies impact growth with a 2-3 years' lag. The goods and services tax (GST), which was introduced in 2017, took about three years for its design and tax collections to stabilise. Thus, the growth forecast for the next few years should take into account the impact of both recent reforms and those likely to be introduced soon.
Third, domestic and external shocks. Domestic shocks emanate from factors associated with macroeconomic or financial sector stability. External factors are the outcome of sharp revisions in global growth, investment or trade outlook, tightening of global liquidity - as evidenced by Wednesday's announcement by the US Federal Reserve of doubling the pace on tapering - and elevated risk aversion.
Accounting for all these considerations, a reasonable bet for India's growth would be about 7% or higher in the next few years. The baseline growth draws upon the average growth rate of about 6.75% in five pre-Covid years. In the near term, monetary and fiscal policies are unlikely to be able to contribute to this growth estimate any more than they have in the past five years.
Having been exceptionally accommodative in the past two years, monetary and fiscal policies are unlikely to exhibit any additional room for supporting growth in the next couple of years. As normalisation gathers pace, they may impart a slight negative impulse to growth. In contrast, reforms undertaken in the past few years should yield a growth dividend. Additional contribution to growth may result if policy efforts continue to focus further on easing the regulatory burden, and as wider structural reforms are implemented.
There are unlikely to be any unforeseen domestic risks. The risk of macroeconomic instability - a combination of high inflation, high current account deficit (CAD) and high fiscal deficit - is low. Inflation remains range-bound under an inflation targeting framework and an independent central bank. CAD, too, is unlikely to bloat because of a runaway real exchange rate appreciation or a large terms-of-trade shock.
Fiscal deficit has breached past records during Covid, and will hopefully regain sounder footing by the restoration of high nominal GDP growth and a medium-term fiscal framework. The financial sector is also likely to remain healthy. When Covid struck India, this sector had already achieved a measure of stability through policy efforts over the last five years, even as they have not yet succeeded in yielding a growth-supportive rate for bank credit.
Caution, Tapered Road Ahead
The global tightening of liquidity is likely to have implications. But India has adequate policy room and a full toolkit - judicious use of foreign reserves, the exchange rate, monetary policy, communication, swap lines and the reforms narrative - to respond to these repercussions. Storms such as tapering have not lasted for more than 1-2 quarters in the past, and can be handled so that they pass without inflicting any significant real damage on the economy.
A large increase in oil prices has traditionally mattered for India. But the impact of this shock has declined over time because of three factors: a shift of the economy towards the less oil-intensive services sector, a shift toward renewables and greater energy-efficiency of economic activities.
The global growth and trade outlook, too, matters. Any decline in global demand has direct implications for India's exports and growth. Yet, with global trade having overcome challenges, the world trade outlook seems robust, especially if India can maintain a competitive exchange rate.
What, then, would be the preconditions to attain growth rates much higher than 7%? Whenever India has recorded rates higher than the trend growth rate, it has been due to the two engines of private investment and exports reviving faster than they did in the past. The investment cycle seems to have started to revive due to ample liquidity in the system and improved availability of financing, as well as the near completion of the decade-long deleveraging cycle.
As the global trade outlook improves, it would pay to leverage the situation by enhancing India's share in the global market for exports of both goods and services. Success in exports depends on competitiveness and the ability to penetrate new markets. Market access is determined by joint efforts of the private sector and the government.
There are lessons to be learnt from countries like Vietnam, Cambodia and Bangladesh, which did not just maintain but actually grew their export shares even in the middle of a slowing global market. Hence, the key for India would be to actively scout for new export markets, and continuously build the export potential of both goods and services.
Forecasts are known to suffer from large errors, not because they tend to have an inherent systemic bias, but due to the inability of forecasters to foresee shocks. These shocks are more commonly seen, and are larger, in developing economies than in advanced economies.
Look Back to Look Forward
A credible forecast exercise is underpinned by three factors. One, the growth rate recorded in the past few years. Since economic structures, policy environment and initial conditions evolve rather slowly, the average growth rate in, say, the past five pre-Covid years should serve as a useful guide.
Two, a realistic assessment of the direction and pace of key policy decisions, including monetary, fiscal, regulatory and structural policies. This assessment should be done knowing that regulatory and structural policies impact growth with a 2-3 years' lag. The goods and services tax (GST), which was introduced in 2017, took about three years for its design and tax collections to stabilise. Thus, the growth forecast for the next few years should take into account the impact of both recent reforms and those likely to be introduced soon.
Third, domestic and external shocks. Domestic shocks emanate from factors associated with macroeconomic or financial sector stability. External factors are the outcome of sharp revisions in global growth, investment or trade outlook, tightening of global liquidity - as evidenced by Wednesday's announcement by the US Federal Reserve of doubling the pace on tapering - and elevated risk aversion.
Accounting for all these considerations, a reasonable bet for India's growth would be about 7% or higher in the next few years. The baseline growth draws upon the average growth rate of about 6.75% in five pre-Covid years. In the near term, monetary and fiscal policies are unlikely to be able to contribute to this growth estimate any more than they have in the past five years.
Having been exceptionally accommodative in the past two years, monetary and fiscal policies are unlikely to exhibit any additional room for supporting growth in the next couple of years. As normalisation gathers pace, they may impart a slight negative impulse to growth. In contrast, reforms undertaken in the past few years should yield a growth dividend. Additional contribution to growth may result if policy efforts continue to focus further on easing the regulatory burden, and as wider structural reforms are implemented.
There are unlikely to be any unforeseen domestic risks. The risk of macroeconomic instability - a combination of high inflation, high current account deficit (CAD) and high fiscal deficit - is low. Inflation remains range-bound under an inflation targeting framework and an independent central bank. CAD, too, is unlikely to bloat because of a runaway real exchange rate appreciation or a large terms-of-trade shock.
Fiscal deficit has breached past records during Covid, and will hopefully regain sounder footing by the restoration of high nominal GDP growth and a medium-term fiscal framework. The financial sector is also likely to remain healthy. When Covid struck India, this sector had already achieved a measure of stability through policy efforts over the last five years, even as they have not yet succeeded in yielding a growth-supportive rate for bank credit.
Caution, Tapered Road Ahead
The global tightening of liquidity is likely to have implications. But India has adequate policy room and a full toolkit - judicious use of foreign reserves, the exchange rate, monetary policy, communication, swap lines and the reforms narrative - to respond to these repercussions. Storms such as tapering have not lasted for more than 1-2 quarters in the past, and can be handled so that they pass without inflicting any significant real damage on the economy.
A large increase in oil prices has traditionally mattered for India. But the impact of this shock has declined over time because of three factors: a shift of the economy towards the less oil-intensive services sector, a shift toward renewables and greater energy-efficiency of economic activities.
The global growth and trade outlook, too, matters. Any decline in global demand has direct implications for India's exports and growth. Yet, with global trade having overcome challenges, the world trade outlook seems robust, especially if India can maintain a competitive exchange rate.
What, then, would be the preconditions to attain growth rates much higher than 7%? Whenever India has recorded rates higher than the trend growth rate, it has been due to the two engines of private investment and exports reviving faster than they did in the past. The investment cycle seems to have started to revive due to ample liquidity in the system and improved availability of financing, as well as the near completion of the decade-long deleveraging cycle.
As the global trade outlook improves, it would pay to leverage the situation by enhancing India's share in the global market for exports of both goods and services. Success in exports depends on competitiveness and the ability to penetrate new markets. Market access is determined by joint efforts of the private sector and the government.
There are lessons to be learnt from countries like Vietnam, Cambodia and Bangladesh, which did not just maintain but actually grew their export shares even in the middle of a slowing global market. Hence, the key for India would be to actively scout for new export markets, and continuously build the export potential of both goods and services.
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