How to maintain 7% growth for India

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One country stands out from the overall somber tone of the International Monetary Fund’s (IMF) recent World Economic Outlook update. Against the backdrop of sluggish global growth of 3.2% in 2022, the IMF expects India’s gross domestic product (GDP) to grow by 7.4%. It is the fastest growing of all major economies except Saudi Arabia, which is the incidental beneficiary of the upward pressure on global oil prices resulting from the Russian president’s war. Vladimir Putin against Ukraine. India may be buying Russian crude oil at a discount, but as the world’s third-largest oil importer, it is still burdened by high oil prices.

One could quibble that India has had an exceptionally difficult pandemic, so its economy now has exceptional leeway to bounce back. But other countries hard hit by covid, such as Mexico, are not faring as well. It can also be noted that with India’s still rapid population growth rate, per capita income is growing more slowly than its overall GDP figures. But a population growth rate of 1% does not fundamentally change the situation.

India’s annual GDP growth above 7% is actually a continuation of a steady acceleration, from around 5.7% in the 1990s to 6.2% between the turn of the century and the financial crisis in 2008, then at 6.9% since the crisis on the eve of the covid pandemic. The country has benefited from a vibrant technology sector, surprisingly robust agricultural productivity gains and decent manufacturing growth. With the worst of the pandemic now behind him, the country’s economy is running at full speed.

The question is whether it can last. Unfortunately, there are good reasons to believe that, given the current set of economic policies, the answer is “no”.

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To maintain its growth momentum, India needs to export a lot more. The country has never been an exporting power, to put it mildly. Service exports are helpful, but the outsourcing of back-office and customer-facing services is now about to slow down as companies take more ownership of their operations. The commitment of the current Indian government to invest in logistics looks promising, but only time will tell how the investment projects will unfold. The depreciation of the rupee can make the export of goods more competitive and limit the consumption of imports. But the Reserve Bank of India (RBI), treating exchange rate stability as an important totem, was reluctant to drop the rupee.

Going forward, Indian exporters will face a less favorable external environment. The Chinese economy has slowed down. The United States may not be able to avoid recession, and Europe is already one. It is therefore unclear where the demand for Indian exports will come from. Every Asian economy that has managed to grow its manufacturing sector has grown by exporting, but that path may no longer be available to India.

The country can, of course, borrow abroad to finance its current account deficit and its domestic investments. But India continues to underperform as a destination for foreign direct investment, which is deterred by bureaucratic obstacles to doing business. Having rejected suggestions to issue bonds in dollars, the government is now seeking to encourage foreign investors to buy bonds in local currency. But this revised strategy is no less risky. Foreign investors in local currency bonds tend to cut and run at the first sign of trouble, as they would otherwise be hit by the double whammy of falling bond prices and falling exchange rates.

The Indian government also lacks the ability to borrow from residents to fund additional spending on infrastructure, healthcare and education needed to sustain long-term economic growth. General government debt is already around 90% of GDP. The primary budget deficit, which excludes interest payments, is 3% of GDP. The government pays an average of 8% interest on its debt.

But Indian authorities are only able to keep interest rates there and maintain a veneer of debt sustainability by requiring banks and other institutional investors to hold government bonds. This in turn limits the ability of Indian banks to provide critical investment finance to the private sector. Meanwhile, much of what the government collects in revenue goes toward duty and interest payments. Additional investment spending will therefore have to come from the private sector. And private savings are low by international standards.

More fundamentally, the government seems to have struggled to implement structural reforms. After being pushed back by interest groups, it essentially sidelined important labor and product market reforms.

Given its favorable demographics, democratic regime and large and diversified economy, India could in principle grow at 7% or more in the coming years. But the only path that remains open to such growth is through structural reforms that all of a sudden ease all the aforementioned constraints. ©2022/ProjectSyndicate

Barry Eichengreen and Poonam Gupta are Professor of Economics at the University of California at Berkeley and a member of the Economic Advisory Council to the Prime Minister of India, respectively.

In Opinion, Diva Jain separates the hype from the reality of ESG investing. Dharmakirti Joshi and Adhish Verma explain what can power India already high food inflation. Barry Eichengreen and Poonam Gupta explain how to maintain GDP growth above 7%. Can India become a high-income countries? Long Story plots three scenarios.

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