India's 2047 ambitions need large foreign capital inflows, deep reforms

India's 2047 aspirations require large foreign capital inflows and deep reforms to reverse the recent outflow

The political discourse in India is unified around the aspiration of becoming a developed nation, or Viksit Bharat, by 2047. We must examine the arithmetic of this ambition.

 

The World Bank defines a high-income country as one with a per capita gross national income of around $14,000. India currently stands at about $2,700. A mechanical calculation shows that reaching a per capita of $14,000 from $2,700 over 20 years would require an annual compound growth rate of 8.5 per cent.

 

Concurrently, the Indian population expands by roughly 1 per cent a year. When we adjust for this moving target and population expansion, the required growth rate in aggregate output is roughly 9 per cent a year. Sustaining a 9 per cent compound growth rate over two decades is a formidable task.

 

Economic growth requires a mechanical coming together of two variables: The volume of investment and the efficiency of that investment. The metric for efficiency is the incremental capital output ratio (ICOR). It measures the units of capital required to generate one additional unit of output. In a well-functioning developing economy, the ICOR is typically around 4. In India, recent data places the ICOR closer to 5. If the required growth rate is 9 per cent, and the ICOR is 5, the arithmetic dictates an investment-to-gross domestic product (GDP) ratio of roughly 45 per cent.

 

To begin with, our own savings can finance this investment. India’s current gross domestic savings (GDS) rate is approximately 30 per cent of GDP. There is a structural ceiling to this number. A developing country cannot compress current consumption indefinitely without causing human distress. A required investment rate of 45 per cent minus a domestic savings rate of 30 per cent yields a gap of 15 percentage points of GDP. For a $4 trillion economy today, this translates to a capital shortfall of $600 billion a year. As aggregate output expands, this absolute financing requirement scales up proportionally.

 

Two distinct problems come to mind when we see these numbers. The first is the current hesitation of the private sector to invest anywhere near the required numbers. Firms, both Indian and foreign, require specific conditions to commit capital at this scale.  They require predictability in the policy framework. They demand equal treatment for private firms, foreign firms, and public sector undertakings. They require a retreat from central planning, a modern tax administration, and deep internationalisation of the economy. Most of all, they base their calculations on the operation of the rule of law in the economy. Let us assume that the government completes the execution of the large reform projects required to achieve this environment over the next two years, thus removing this constraint.

 

The second problem is the availability of funds. There is a shortfall of 15 percentage points of GDP between the available resources (30 per cent of GDP) and the required number (45 per cent of GDP). The gap must come from abroad.

 

The global financial system holds infinite capital. This capital is constantly searching for yield and institutional safety. If India constructs a sound policy framework and offers viable investment projects, global capital will readily deploy in India at the required scale.

 

We must compare this requirement with Indian economic history. Over the past three decades, India integrated into the global economy and became an established investment destination. Yet, the current account deficit has not seen large values. In the latest decade, it has averaged just 1.07 per cent of GDP.

 

India’s growth aspiration requires 15 per cent. The historical peak is 5 per cent. If India is to decisively move towards developed status, we cannot rely on the conventional trickle of foreign capital. We require a flood. The change required cannot be achieved through minor adjustments in sectoral policy or marketing campaigns. It requires a foundational overhaul of institutional certainty.

 

What constitutes this institutional overhaul?

 

First, the removal of most capital controls. At present, foreign capital faces an obstacle course in entering India. We need to change gears from a system of capital controls to a system of capital encouragement. This will require a full transformation of overt capital controls, taxation of foreigners, financial regulation and AML/CFT (anti-money laundering and countering the financing of terrorism) frameworks. The Indian state has to stop being hostile to foreign capital if we want to grow the economy.

 

Second, regulatory and legal predictability. Long-term capital, such as sovereign wealth funds and pension funds, evaluates risk over decades. These allocators abhor the drama of the Indian policy environment, where bold new measures are announced frequently. Capital requires mundane predictability. What is required is the implementation of simple, economically sound policy frameworks, followed by decades of little change. The flow of non-strategic policy adventurism deters capital.

 

Third, the depth of debt markets. Equity capital alone cannot supply 15 per cent of GDP. A large fraction of these inflows must come in the form of debt to finance infrastructure and corporate expansion. In addition to removing capital controls, the domestic debt market has to work better.

 

Fourth, reducing the cost of capital. Foreign investors apply a risk premium to Indian assets. This premium stems from macroeconomic uncertainty. When the state executes discretionary currency policy, loose fiscal policy, and opaque debt management, risk premiums rise. Consistent fiscal consolidation, formal inflation targeting, and a mature view of exchange rate fluctuations are required. They are the essential mechanisms that lower the risk premium faced by Indian projects. A stable macroeconomy, managed by independent and technically competent government policy agencies, is the foundation for large-scale foreign investment.

 

The road to 2047 is paved with capital. The arithmetic suggests that our domestic engines, while strong, are insufficient to reach the required altitude. The gap between domestic savings and required investment is a structural reality. To become a

 

developed nation, the Indian state has to change its colours: From a suspicious system that seeks to block foreign capital to one that promotes capital flows. This demands a restructuring of domestic institutions to make India the most efficient, certain, and predictable home for capital in the emerging global order.

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The author is an honorary senior fellow at the Isaac Centre for Public Policy, and a former civil servant