Avoiding the growth mirage: Reforms must go beyond capital infusion

The release of the World Economic Outlook in April by the International Monetary Fund (IMF) has brought in much rejoicing and enthusiasm among those concerned with India’s development. The chief executive officer of NITI Aayog might have jumped the gun when he declared that India has become the fourth-largest economy surpassing Japan, which has also been echoed by the Prime Minister.

 

The IMF report shows India’s gross domestic product (GDP) in 2024 at $3.91 trillion, against Japan’s $4.03 trillion, but it is projected to surpass the Japanese GDP by a slender margin in 2025 ($4.197 trillion vs 4.196 trillion). Of course, this is no mean achievement. An average annual growth in the range of 6-7 per cent over the past two decades has helped to make this possible. Despite some setbacks and global uncertainty, the economy has shown remarkable resilience and is poised to surpass Germany before the end of the decade to become the third-largest. 

 

In terms of per capita income, however, India ranks near the bottom in global rankings. It has a long way to go before achieving developed country status by 2047 — an ambitious target set by the Prime Minister. At $2,878.4 in nominal per capita GDP, India ranks 141st out of 197 countries; in per capita terms adjusted for purchasing power parity (PPP), it ranks 119th. 

 

The growth rate required to achieve this target ranges from a real rate of 7 to 10 per cent, depending on assumptions about inflation, exchange rate depreciation, and changes in the norm for determining the “developed country” category itself. What is clear, however, is that a “business-as-usual” approach will only confine India to the middle-income trap.

 

Therefore, serious structural and governance reforms need to be implemented expeditiously to reach this goal. Besides, it is not just about reaching the milestone of the targeted income levels, but also about creating gainful employment opportunities for the millions joining the workforce. With India’s population projected to stabilise only around 2045, transferring surplus labour from agriculture to more productive sectors such as manufacturing and services poses a significant challenge.   

 

Critical to accelerating growth in GDP is an appreciable increase in investments. Even if we assume that productivity will improve with the induction of new technology and better practices to improve the incremental capital output ratio (ICOR) from 5 to 4 —achieving a nominal GDP growth rate of 10 per cent would still require raising gross domestic capital formation to 40 per cent of GDP from the current 30–31 per cent. A massive increase in the rate of investment is needed from both the government and the private sector. While the past three years have witnessed a substantial rise in public investment, private investment remains sluggish.

 

It is also important to create the ecosystem for foreign direct investment (FDI), as with such investments, the country can gain from more advanced technology. Recent reports state that Indian industries rather than reinvesting their earnings in the country are repatriating their profits abroad. The net FDI in India in 2024-25 was just $0.35 billion, even though gross FDI was $81 billion. This was because $51.3 billion was repatriated and $29.20 billion was the outward FDI. Some introspection into the reasons for this trend and undertaking the required corrective action is called for.

 

Increasing the investment-to-GDP ratio in the country requires concerted efforts to reduce the cost of capital and minimise transaction costs through governance and institutional reforms. The inflation-targeting framework has helped tame inflation  — and hopefully, a benign rate will continue in the medium term to keep interest rates low.

 

The sharp reduction in the policy rate by 50 basis points on June 6 will reduce the cost of borrowing substantially, while the 100 basis point cut in the cash reserve ratio will inject liquidity into the financial system to help faster transmission of the lower rate.

 

On the fiscal policy front, however, we need a clear action plan to curtail the fiscal dominance of macroeconomic policies and expand the borrowing space for businesses. The time is opportune to rethink deficit and debt targets and implement an action plan.  Similarly, we need to move towards greater openness in trade and investments, irrespective of the threats posed by the Trump-era tariffs. This will require reforms to impart greater competitiveness to the Indian economy.

 

Much has been discussed about the reforms needed to free the factor markets, particularly land acquisition and labour market reforms. What has not been highlighted as much are the governance and institutional reforms required to fulfil the primary function of the government — namely, providing public services such as ensuring the safety and security of the people, protecting their property rights, and expeditiously enforcing contracts. These are the basic public goods that create the necessary conditions for businesses to thrive.

 

In a democracy, we cannot afford to have the “roving” and “stationary” bandits that Mancur Olson referred to in his seminal article (“Dictatorship, Democracy and Development”, The American Political Science Review, Vol. 87, No. 3 (Sep., 1993), pp. 567-576), because credible commitments to protect property rights and enforce contracts are necessary for broad-based growth.

 

A neglected aspect of reform urgently needed is governance, including the judicial system.  Fixing the administrative, regulatory and the judicial system has not received the attention it deserves.  In this context, a recent report in The Economist (How to fix India’s sclerotic justice system, May 24, 2025) underlining the ineffectiveness of India’s judiciary is instructive.

 

Of course, we believe in the philosophy that justice will be done in the next life if not in this, but businesses do not believe in that, nor would they wait that long. The backlog of cases in the Supreme Court at the end of 2024 stood at 82,496 and the pending cases in the High Courts in early February 2025 was 62,35,000 and in district and subordinate judiciary, a staggering 45.7 million.

 

According to the World Justice Report, India ranks 131st among 142 countries in justice delivery, below even Pakistan and Sudan. According to the Indian Justice Report, the backlog in courts is expected to increase by 15 per cent by 2030.  The World Bank estimates that enforcing a contract in India takes, on average, 1,500 days — compared to fewer than 500 days in developed countries and in China. As the Indian courts fail to resolve disputes in time, the judicial system becomes dysfunctional, and those who can afford— and have the means — resort to informal systems of justice.  Unless we fix this problem, accelerating investment and achieving sustained economic growth will remain a mirage.

 

 

The author is chairman, Karnataka Regional Imbalances Redressal Committee, Government of Karnataka. The views are personal