Sustainable recovery: The policy challenge is to increase trend growth

The gross domestic product (GDP) estimate for the third quarter this financial year, released last week, will ease some near-term policy pressure. The data from the Ministry of Statistics and Programme Implementation showed the Indian economy expanded by 6.2 per cent in the October-December (2024) quarter, reversing the growth-rate decline over the past couple of quarters. Along with the quarterly national accounts data, the government released the second advance estimates (SAE) for this financial year, the first revised estimates for 2023-24, and the final estimates for 2022-23. The SAE projected a GDP growth rate of 6.5 for this financial year, marginally higher than the 6.4 per cent projected in the first advance estimates.  However, with an average growth rate of 6.1 per cent in the first three quarters of the year, the asking growth rate in the fourth quarter will be 7.6 per cent, which may be difficult to achieve. 

Notably, the upward revision in the current year’s estimates was accompanied by a significant upward revision in the previous two years as well. The growth rate for 2023-24 has been revised to 9.2 per cent, a full one percentage point higher than the previous estimate. The growth rate for 2022-23 has been revised to 7.6 per cent compared to the previous estimate of 7 per cent. There are various ways of looking at these numbers. The obvious conclusion is that growth this financial year will be significantly lower than in the previous two years. Some economists are calling it “normalisation”. The average growth rate in eight years ended 2019-20 was about 6.6 per cent. The challenge for Indian policy managers is accelerating the trend growth rate. However, this won’t be easy.

  From the medium-term perspective, as things stand, some of the basic desirable conditions in India are favourable. For instance, India has a stable government, which ensures policy stability to a large extent. Besides, balance sheets of both banks and companies are healthy. Nevertheless, private corporate investment remains subdued, affecting prospects. The corporate sector may be unwilling to make large investments because of several reasons, including global uncertainties. Overall gross fixed capital formation in real terms this financial year is expected to grow 6.1 per cent, which will be lower than the projected GDP growth rate.  In recent years, government capital expenditure has been a key driver of growth and is likely to continue playing this role in the foreseeable future.

  Although the Union government has done well in terms of fiscal consolidation by containing the fiscal deficit in the post-Covid period, it would, from 2026-27, target keeping the debt stock as a percentage of GDP on a declining path to give itself more flexibility. The government has told the International Monetary Fund that reducing the fiscal deficit to about 3 per cent of GDP will be difficult. This suggests the government intends to keep its capital expenditure high to support growth. While higher capital expenditure will help growth, the government would be well advised to carefully consider the implications of higher government borrowing requirements in terms of availability of savings and the cost of capital for the private sector. Sustained higher government demand for savings could affect private consumption and investment demand.