The world's fastest growing economy? That we are and might continue to be. But then at our stage of development, the economy is only expected to grow faster than economies that have higher income, with older population and have built the required social and economic infrastructure ahead of us. For example, Brazil, Mexico, and Indonesia, with per capita GDP (Contant USD) at 10,077, 8,831 and 4,074, respectively are classified as upper middle-income countries by the World Bank and will grow at rates slower than India.
What we should instead really focus on is the fact that we are a lower middle-income with much lower per capita GDP (USD 2090 in 2022) and our median age is less than 30 years. Our youth (15-29 years) workforce participation level has just been about 40% during the most recent years.
A comparison with Brazil, Indonesia and Mexico suggests that our youth (15-24 years) labour force participation (LFPR) is 14.5% lower than that of Mexico. Mexico has the lowest LFPR among these countries.
Brazil's LFPR at 54.5% is 80% higher than that of India. Consequently, it has a lower potential to grow, as it has already realised some of its demographic dividend. This is where the opportunity and also the challenge lies for us. And this is what governments -- current and incoming -- must focus on.
Table 1: Labour Force Participation Ratio (LFPR) and Youth Population
Angst of the Amitabh Bachchans and other issues to address
India's youth population in the 15-24 age group is more than two hundred million, which is more than 2x that of the combined youth population of Brazil, Indonesia, and Mexico. If we can provide meaningful work to an additional 15% of our youth population, which will bridge the gap with Mexico and Indonesia, we will add an equivalent of the entire working age population of Brazil to our economy. It will also leave us with fewer Amitabh Bachchans -- angry young men, in plainer speak.
At the same time, we are yet to build the social and economic infrastructure required for meeting even the basic needs of our society. Not forgetting that we still have not solved the problem of hunger and malnutrition that hundreds of millions of our people experience all the time.
In short, if we can work together to fix even our basic problems, we can grow faster than everyone else in the world. Growing faster than Brazil, Mexico or Indonesia is no cause for celebration, as our potential for growth is much higher than these and other higher income countries.
We, therefore, must discuss the following questions:
1. Do we have the capability to grow at rates higher than that are currently projected?
2. What should be our economic strategy for accelerating growth and realising our potential?
What has been our growth performance?
During the last twenty-five years, we have done well to speed up growth to reach an average of 6.2%, but there have been years when the growth rate has been exceptionally low -- pulling down the average rate. In all, we have experienced an average growth of just 3% during eight out of twenty-five years -- nearly one-third of the time and in three different periods that are linked to global crises.
If we exclude the low-growth periods, our average growth rate turns out to be 7.8%. That is, we have demonstrated the ability to grow at close to or higher than 8% (Chart below).
Chart 1: India’s Growth Performance: 2000-2024
Why does India not do well during Global Crises?
Even though we are not a major participant in the global value chain, we do get impacted by global events through commodity price inflation as our exports are low value-adding and we are dependent on rest of the world for our most critical needs, i.e., energy (oil and gas), edible oil and high-tech products.
India's share of global trade in goods and services is about 2%, and that of imports 2.6%. On the other hand, China’s share of exports is about 11%. During the recent years, our dependence on China for import of even the low value-adding manufactured goods has increased. Consequently, we are a net importer nation and that has been the case since opening of the Indian economy in early nineties.
In addition, our financial markets, equity as well as debt, have become addicted to short-term and speculative capital flows from richer countries, causing increased volatility during global crisis situations. The solution, therefore, is in investing in low- as well as high-tech manufacturing and improving our net domestic household savings rates, which have fallen from 23.6% in 2011-12 to 19.9% in 2022.
What have been the drivers of lower growth?
During the high-growth years of the last twenty-five years, we grew @ 7.8%, which was driven by growth in gross capital formation@ 12.3% and in exports at 11.3%. Private and government consumption grew @ 6.7% and 6.6%, respectively. That is, our growth was driven by all four pillars of growth -- private and government consumption, gross capital formation and exports (Table below).
Table 2: India's Growth Performance
Our biggest growth setbacks have been caused by a drop in capital formation, government, and private consumption, in that order.
Have we been able to manage variability (risk) of our growth?
Our risk of growth was lower during the high-growth years. For example, the risk of growth (measured in terms of coefficient of variation) was much higher at 120.1% during the low-growth years, compared to just 10.8% during the high-growth years (Table below).
Table 3: Variability of India’s Growth Performance
The biggest contributors to variability are gross capital formation (680.6%), the government consumption at 129.3% and private consumption at 105.7% (Last row of Table 3 above).
It is not a surprising result. We do expect gross capital formation to be volatile, as most capital investments are lumpy by their very nature and are driven by expectationsof and sentiments around future growth. On the other hand, the private and government consumption rates are expected to have low volatility, and they are less volatile in our case too.
In summary, we have proven that we can grow at a higher pace with lower risk of growth.
Did India navigate Global Financial Crisis better than the COVID crisis?
During the decade starting 2004, (when the Manmohan Singh-led UPA was in power), we grew by 6.8%, with variability being 25.5% -- a period during which gross capital formation (10.2%) as well as exports (13.9%) grew consistently (Table 2 and 3, above). However, the imports, driven by high global commodity price inflation, grew @ 14.1%, faster than exports -- putting pressure on the current account balance and causing fear among domestic as well as global investors who were struggling to recover from fall in demand.
During the latest decade, when the current government has been steering us, our growth has been slower at 5.9%, which was driven by lower growth in gross capital formation (6.5%) and a decline in growth in exports (5.2%).
Our consumption growth too declined during this period -- government consumption growth falling from 6.5% per annum to 5.5% and that for private consumption declining from 6.1% to 5.7%.
A big learning
Growth in Fixed Capital Formation is positively correlated with Growth in Private Consumption, and is, therefore, an important driver of aggregate growth
In the Chart 2 below, we see that the growth in fixed capital formation and private consumption is positively correlated at 0.59, implying that the growth in long-term investment helps drive private consumption or vice versa. Valuables and stocks, the other two components of gross capital formation, do not impact private consumption as much.
Chart 2: Gross Fixed Capital Formation and Private Consumption
In other words, it is possible to create a self-reinforcing virtuous cycle between fixed capital formation and consumption. That is, an investment (government as well as private) in labour intensive production for domestic consumption can help grow youth employment and, thereby, our household income, consumption, and savings.
And yet...
Even when we know that the Government Consumption helps navigate crisis better, the government has chosen not to spend
In Table 2 above, we saw that the government consumption tends to fall sharply during the low-growth years, i.e., the years during which the GDP growth was below the average growth of 6.3% -- a reduction caused by decline in growth in capital formation and exports. While we do not have control over exports in the short run, the government can follow a counter-cyclical policy and support growth through its consumption and investment decisions.
We do have people who argue that the government spending crowds out private spending or investment, but that is an irrelevant argument. The problem of crowing out private investment or consumption arises only in situations where households and private businesses are willing to invest and/or consume by borrowing. In a crisis, we neither expect households and private businesses to take the risk of borrowing nor do we expect the bankers to ease lending standards.
Therefore, the most productive solution lies in the government raising its spending level during years when the other engines of growth are not delivering, as the government is a risk-free borrower and can raise the required capital without worrying about rating agencies breathing down its neck.
We, however, observe (Chart 3 below) that government has chosen not to raise its consumption spending during the low-growth or crisis years. The growth in government spending, during the low-growth years, at 3.2% is less than half of 6.6% during high-growth years.
Chart 3: Growth in Expenditure by Growth Period
In short, the government consumption through increased employment can help raise the level of private consumption and thereby private capital formation.
Not only the growth in Government Consumption, but also the growth in Government Capital Formation is positively correlated with growth in Private Consumption
We observe a strong positive correlation between the government capital formation and private consumption in Chart 4, which is not surprising as a large share of government capital projects are executed through private businesses, providing indirect employment to low- as well as high-skilled workers.
Chart 4: Government Capital Formation and Private Consumption
Government a reluctant investor
If we now specifically look at growth in government capital formation, the government has been reluctant investor – the behaviour that is no different from what we saw with respect to government consumption (Chart 3 above).
During the crisis years (or low-growth years, as we call them), there has been a dramatic fall in government capital formation, and it takes time to recover (Chart 5).
For example, the government fixed capital formation declined during first global crisis (the bursting of internet bubble between 2001 and 2003) and it took a year and another government to raise the level of spending. Similarly, the situation was no different during the global financial crisis period, though we do know that the global financial crisis was far more severe than the bursting of internet bubble.
Post the COVID crisis, we do see a swift increase in government fixed capital formation during 2022, but that was after limited growth during 2017 and 2018 (4.5% and 1.1%, respectively).
Chart 5: Government Fixed Capital Formation
We still do not have data for the last two years to say that there is whole-hearted effort to support growth. The government speak has often been focused on managing fiscal deficit and prudence.
We need the government to commit itself to a policy of investment and consumption across cycles and not just be happy about being the fastest growing major economy
If the government follows a counter-cyclical policy, India's potential growth can easily exceed 8%, particularly given the fact that the government capital formation is positively correlated with private consumption, as seen in Chart 4 above.
The most productive approach is to raise consumption and capital expenditure for the state as well as the union government.
The government consumption expenditure, through filling of existing vacancies, enhances the capacity to serve our people and improves the quality of public services. It is the safest short-term solution for driving growth.
Similarly, the government capital expenditure that builds social and economic infrastructure for an average Indian, not large vanity projects, is the next most important step for encouraging private capital formation as well as household consumption expenditure.
We must avoid the trap of short-sighted view on fiscal deficit
While we were fortunate to experience a swift post-COVID recovery, we must avoid getting trapped by the financial market's short-sighted view about fiscal deficit. Lower fiscal deficit implies lower growth in a situation where private consumption as well as capital formation are yet to revive. We must remember that we still have not recovered the COVID-caused output losses.
We must look beyond being the fastest growing major economy
The private and government consumption growth at 3%, export growth of 1.5%, fixed capital formation growth of 10.2% for FY 2023-24 does not give us any reason for celebration, even if these rates put us into the group of the fastest growing major economies.
We must remember that the so-called major economies do not have 200 million youth (age Group 15-29) either waiting for employment after completing their studies or studying to build capability that can help them find a meanigful employment. Our challenges are far more intractable than those of Brazil, Mexico and Indonesia and our economic policies must address these challenges that arise from lack of growth in earnings, which, in turn, is caused by lack of growth in employment and its poor quality and the lack of risk capital with private business.
