Pressing the Indian Growth Accelerator
Policy Imperatives1
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India’s real GDP growth slipped substantially after the North Atlantic financial crisis. Return to a sustained high growth trajectory is feasible but it will need much more focused attention to the revival of manufacturing and to the acceleration of investment in transport and infrastructure. The immediate priority is to achieve the kind of fiscal quality and low inflation levels exhibited during 2003-08, with focused attention to increasing efficiency and compliance in tax revenue collection. Higher tax revenues can facilitate increases in public investment, which then crowd in private investment. The task ahead will be more difficult in view of the protracted slowdown in global growth and trade.


India’s real GDP growth slipped substantially after the North Atlantic financial crisis. Return to a sustained high growth trajectory is feasible but it will need much more focused attention to the revival of manufacturing and to the acceleration of investment in transport and infrastructure. The immediate priority is to achieve the kind of fiscal quality and low inflation levels exhibited during 2003-08, with focused attention to increasing efficiency and compliance in tax revenue collection. Higher tax revenues can facilitate increases in public investment, which then crowd in private investment. The task ahead will be more difficult in view of the protracted slowdown in global growth and trade.

I. Introduction

India’s real GDP growth averaged almost 9 percent per annum during the 5-year period 2003-04 to 2007-08, but then growth slipped substantially, reflecting both domestic and global factors. Real GDP growth fell to 6.7 percent in 2008-09 under the impact of the North Atlantic financial crisis (NAFC), but quickly rebounded to an average of 7.7 percent during 2009-12 benefitting from the unprecedented large and coordinated fiscal and monetary stimulus. However, subsequently (2012-14), annual growth averaged under 5-6 percent2. Softer global demand, volatility in international financial markets on the back of the NAFC, higher domestic inflation, and governance issues have been among the main factors that led to the investment and growth deceleration.

Slowdown in growth in the post-NAFC period is not peculiar to India. Since 2012, emerging and developing economies (EDEs) have, as a whole, slowed down in a synchronized and protracted manner. Growth rates since 2012 are lower than the pre-NAFC average in more than 70 percent of the EDEs, which points to a broad-based slowdown (IMF, 2014b, c). However, the growth slowdown in India during 2012-14 has been more severe than the group of EDEs, which would suggest that domestic factors have compounded the global slowdown impact.

Going forward, given the adverse external environment, the strong growth momentum of the 2000s may not be repeated in the EDEs over the next 2-3 years even if the favorable factor accumulation and productivity growth of the 2000s were to prevail, (Cubeddu et al, 2014). Recovery in global trade is still very subdued, with growth rates less than half those recorded in the 1990s and 2000s up to the crisis. There is a risk that the world could get stuck for some time with a “mediocre” level of growth (Lagarde, 2014), but also a perception that the global economy might see an extended period of secular stagnation (Summers, 2013). Similarly, concerns have been expressed that, going forward, the Indian growth rate is likely to be lower (IMF, 2014a; Nagaraj, 2013). More generally, Pritchett and Summers (2014) argue that cross-country analysis indicates that abnormally rapid growth is rarely persistent; regression to the mean is empirically the most salient feature of economic growth. In developing countries, episodes of rapid growth are frequently punctuated by discontinuous drop-offs in growth and accordingly, these authors expect that growth in China and India will be much less rapid than is currently anticipated.

Recent economic developments augur well. Amongst the major EDEs, sentiments have turned in favor of India: the IMF in January 2015 revised downwards its growth prospects for major EDEs other than India, while keeping its growth outlook unchanged for India (IMF, 2015). The subsequent upward revision in India’s growth estimates by the Central Statistical Organization for 2012-14 and the 7 percent plus growth in advance estimates for 2014-15 also provide grounds for optimism for the scenario painted in this paper, but it will require sustained policy efforts on a continuing basis. The Union Budget 2015-16 (presented in February 2015) with its announced push towards infrastructure investment, amidst continued fiscal consolidation, adds to the realism of the scenario presented in this paper.

Against this backdrop, the key policy concern for India is: despite a relatively adverse global environment can growth be revived back to the high growth phase of 2003-08 in an environment of macroeconomic and financial stability – low and stable inflation, moderate current account deficit, moderate fiscal deficit and a strong financial sector? These are the issues addressed in this paper, which is concerned with painting a scenario whereby India can return to the golden growth trajectory in the medium to long term, exhibiting the kind of policy and animal spirit synergies that characterized the 2003-08 period. This scenario assumes that some degree of normalcy will return to the global economy, and that India also addresses its own growth impediments in the next couple of years. The objective is to demonstrate that return to a sustained high growth path is well within the realms of feasibility for India, but it will require sustained policy efforts on a continuing basis.

In order to do this, it is helpful to understand the long-term growth dynamics of the Indian economy since independence, the special features of the golden period of 2003-08, and the contributing domestic factors for the current slowdown (Section II). We then provide one possible growth scenario for the medium and long-term (Section III) and outline the key features of policy imperatives that are needed to stimulate such sustained growth (Section IV).

II. The Indian Economy: A Story of Consistent Growth

India’s growth since independence is often characterized as having been slow till the late 1970s, with a pick-up in the subsequent period. However, a closer look at the growth dynamics indicates a consistent acceleration in growth since the 1950s, except for an interregnum during 1965–81 (Mohan, 2011a). Industrial growth was not slow in the entire 30 years after Independence as has often been believed. Stagnation only set in during the mid-1960s (Table 1)3. There has been a continuing and consistent acceleration in growth of services over the decades that really accounts for the corresponding acceleration in overall GDP growth (except for the 1965–81 interregnum). There is nothing particularly special about service sector growth during the 1990s and 2000s, except that the acceleration over time has continued. The slowdown in growth during the 1965-81 period, ‘the darkest in the post independence economic history of India’, can be attributed to the various restrictive policy actions put in place during this period that effectively closed the Indian economy and slowed down Indian economic growth, just when various East Asian countries were opening up and accelerating their growth (Panagariya, 2008).

Table 1:

India’s Real GDP Growth


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Source: Central Statistics Organization, Government of India; Reserve Bank of India.Note: Figures in parenthesis are based on the new NAS series with 2011-12 base.

The slowdown in growth witnessed during 1965–81 was reversed during the 1980s, with the initiation of reform measures aimed at increasing domestic competitiveness. Beginning in the early 1990s, growth impulses gathered further momentum in the aftermath of comprehensive reforms encompassing the various sectors of the economy. These included: ex-ante real devaluation of the rupee in 1991, industrial deregulation, a significant opening of the economy to foreign direct investment (FDI) and foreign technology, gradual trade liberalization, substantial reduction in tax rates and rationalization of the taxation structure through the 1990s, deregulation of interest rates, reduction in statutory pre-emption, and improvement in the monetary–fiscal interface4. These reform measures were greeted with a great deal of enthusiasm by the private sector as demonstrated by tremendous increases in its investment intentions.

There was, however, some loss of the growth momentum in the latter half of the 1990s which coincided with the onset of the East Asian financial crisis, setbacks to the fiscal correction process, quality of fiscal adjustment, slowdown in agriculture growth affected by lower than normal monsoon years, some slackening in the pace of structural reforms, monetary tightening to contain inflation, and containment of the excessive enthusiasm and optimism with regard to investment plans in domestic industry that had followed the 1991 deregulation. Then, as in every episode of economic slowdown, it was the manufacturing sector that was notable in exhibiting sluggish growth. In each episode, it was the revival of manufacturing growth that then led to sustained overall economic growth. We seem to be seeing a similar phenomenon this time around, although there are some key differences as well.

The Golden Era of Growth: 2003-08

After 2003-04, there was a distinct strengthening of the growth momentum. Restructuring measures by domestic industry, overall reduction in domestic nominal and real interest rates, fiscal consolidation, improved corporate profitability, a benign investment climate, strong global demand, and easy global liquidity and monetary conditions all contributed to the high growth during 2003-08. Growth during this period was broad-based, with all the three key sectors – agriculture, industry and services – contributing to the momentum. There was a marked acceleration in both public and private investment in this period.

The progressive reduction in fiscal deficit freed up resources for investment by the private corporate sector. This improvement was underpinned by an improvement in gross tax/GDP ratio of the Central government and containment of subsidies. Thus, the significantly higher public sector and private corporate sector savings rates, in conjunction with a broadly stable household savings rate, led to a substantial increase in the overall savings rate of the economy, making more resources available for the significant increase in domestic investment that occurred.

It is also noteworthy that monetary management could succeed in containing inflation during this period, despite an unprecedented volume of inward capital flows. This was facilitated by the multiple instrument approach, including innovations such as the market stabilization scheme that was used to sterilize the impact of large and volatile capital flows (Mohan and Kapur, 2011). Notably, inflation during this high-growth period was broadly similar to that in the preceding period, even as global commodity inflation was substantially higher during this period. On the other hand, the increase in minimum support prices in respect of agricultural commodities during 2003-08 was lower than that in 1997-2003, which in turn was lower than in 1991-97. Thus, the government’s agricultural support price policy was favorable towards the objective of inflation control during 2003-08, although this policy might have also benefited from the generalized lowering of inflation beginning in the latter half of the 1990s. The financial sector also performed well, with continuous improvements in asset quality and efficiency indicators, thereby contributing significantly to increased investment in the private sector (Mohan, 2011b).

Infrastructure investment was also stepped up by about 1 per cent of GDP over the period, with the increase divided roughly equally between the public and private sectors, thereby increasing the share of private sector investment in infrastructure. A notable increase took place in investment in roads, whereas that in the railways kept stagnant as a share of GDP. Improvements in infrastructure then contributed to the high growth in manufacturing and trade.

Consistent Growth in Savings and Investment

The secular uptrend in domestic growth since independence is clearly associated with consistent trends of increasing domestic savings and investment over the decades. Gross domestic savings increased from an average of 11 per cent of GDP during 1950–65 to over 33 per cent of GDP in 2003–08; over the same period, correspondingly, the domestic investment rate also increased continuously from 12 per cent to 34 per cent5 (Table 2). A significant feature that emerges from these trends in savings and investment rates is that Indian economic growth has been financed predominantly by domestic savings.

Table 2:

Savings and Investment Rates

(Percent to GDP)

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Source: Central Statistical Organization, Government of India; Reserve Bank of India.

The recourse to foreign savings—equivalently, current account deficit (CAD) —has been rather modest in the Indian growth process. We may also note that the two decades of the 1960s and 1980s, when the current account deficit increased marginally towards 2 per cent of GDP, were followed by significant balance of payments and economic crises. The increase in the CAD in 2011-13 led to similar difficulties. The long-term upward trends in savings and investment have, however, been interspersed with phases of stagnation, influenced particularly by developments in government finances.

The Great Slowdown: 2012-14

The growth slowdown during 2012-14 has occurred after almost a decade of consistent high growth, including a sharp recovery from the 2008-09 crises. This reflects a number of factors (Kapur and Mohan, 2014). First, while the macroeconomic policy response to the NAFC – both monetary and fiscal policy – was admirably rapid, there was, at least with hindsight, overshooting of the stimulus, which sowed the seeds for inflation and current account pressures. Subsequent monetary tightening, though somewhat tepid, then had the expected dampening impact on economic activity and growth. The efficacy of monetary policy to deal with inflation in this period was blunted by the persistent inflation in food items, which required monetary policy to be in a relatively tighter mode for a longer period (Anand and Tulin, 2014).

Second, the quality of the fiscal stimulus, which focused on tax cuts and increased revenue expenditure (particularly in subsidies) while keeping capital outlays stagnant, added to demand pressures, which were then mirrored in high inflation. That the growth recovery in 2008-12 was on steroids is reflected in the very large unprecedented growth in the rate of government consumption (see Table 1). The withdrawal of the fiscal stimulus has also been hesitant and slow. There was an attempt to keep up public investment in roads and power through a step-up in public-private partnerships (PPPs) along with the fiscal stimulus in 2008-10, but then a steep decline took place after that, thereby contributing to the growth slowdown, particularly in manufacturing and in key infrastructure sectors.

Third, the delayed and incomplete withdrawal of the fiscal stimulus led to crowding out of the private sector, which might have also hampered private corporate investment. The extraordinary growth in gross fixed capital formation observed in 2003-08 almost halved in 2008-12. Simultaneously, the high nominal interest rate environment in an environment of subdued growth also impacted corporate profitability and investment. The availability of domestic resources for the private corporate sector was squeezed from all sides.

Fourth, the CAD widened well-beyond comfort levels by 2012-13. The global environment has imparted headwinds: growth in volume of global exports of goods as well as “goods and services” combined during 2012-14 was almost a third of that during the 2003-07 period, which then impacted Indian exports and overall growth. High domestic inflation and negative real interest rates on deposits encouraged gold imports; incomplete pass-through of international crude oil prices to domestic fuel prices led to greater demand for imported petroleum products; and appreciation pressure on the real exchange rate from large capital flows further added to CAD pressures. Furthermore, in contrast to previous episodes of large capital flows, there was little foreign exchange intervention: foreign exchange reserves were not increased and the real exchange rate appreciated while the CAD widened. In fact, capital inflows were encouraged through continued opening of the capital account, particularly to potentially destabilizing debt flows.

Fifth, a key feature of the great slowdown is the near collapse of manufacturing growth in 2012-14, which has been near zero during this period (according to data on index of industrial production) – an almost unprecedented event for the Indian economy since independence. This is difficult to understand since until 2012, manufacturing growth averaged in excess of 8 per cent. Given the macroeconomic factors outlined above – some monetary tightening, higher inflation, private sector crowding out, slowdown in global demand and real exchange rate appreciation, a slowdown would have been expected, but a collapse to zero growth is puzzling. One additional factor for weak manufacturing activity in this period is the emergence of policy bottlenecks, such as obtaining environmental permissions, fuel linkages, or carrying out land acquisition which led to stalling of a number of large projects. This may in turn have discouraged new investment (Government of India (GoI), 2013), particularly in infrastructure projects and manufacturing. Restoration of sustained high overall growth will be critically dependent on reinvigoration of the manufacturing sector.

Some caution is however needed in analyzing the recent industrial performance based on the index of industrial production (IIP), given that IIP data have indicated much lower growth than that indicated by the Annual Survey of Industries (ASI) in the past few years. For example, during 2008-12, the IIP indicated an annual average industrial growth of 4.7 percent, while the ASI data (net valued added adjusted for wholesale price index (manufactured products) inflation) indicated an annual growth of 9.1 percent. In 2012-13, on the other hand, the ASI data indicate an even lower growth than the IIP [(-) 2.5 percent versus 1.1 percent]. ASI data for 2013-14 are not yet available.

The assessment of manufacturing growth (and overall real GDP as well) has now been further complicated by the new series on National Accounts Statistics (NAS) released in January 2015, with 2011-12 as the base year. The revised NAS series indicates manufacturing growth of 6.2 percent and 5.3 percent in 2012-13 and 2013-14, respectively, vis-à-vis the estimates of 1.1 percent and (-) 0.7 percent in the earlier (2004-05 base) series (see Table 1). The difference is attributable to the change in the compilation methodology for manufacturing from the factory-level value addition approach (based on ASI data) to the headquarter-level value addition (based on the Ministry of Corporate Affairs database); the new methodology now captures in-house services like marketing and presents full value of what that company is delivering (Sen, 2015). As noted earlier (footnote 2), a more thorough assessment of these growth dynamics and the intensity of the slowdown would be possible once a consistent data series for the earlier years is also available in the new series.

All these macroeconomic and policy developments contributed to the Great Slowdown during 2012-14. Overall, the key policy messages from the 2012-14 slowdown reinforce the messages from the 2003-08 high growth phase: need for prudent fiscal policy, a low and stable inflation environment, appropriate capital account management, maintenance of a competitive real exchange rate, and a focus on infrastructure investment. The 2012-14 episode also flags the issue of containing the CAD within prudent limits, although the CAD is ultimately a reflection of other domestic macroeconomic and financial policies.

III. Getting Back to High Growth: A Simulation for 2017-32

India reached a per capita GDP of around US$1500 and overall GDP of about US$1.9 trillion in 2013-14. What should be our aspiration for growth over the next couple of decades? Given the progress made over the past two to three decades, it is not unreasonable to aim for doubling of per capita income in each of the next two decades. That implies a per capita annual growth rate of around 7 per cent on a sustained basis, and over 8 per cent per year for overall GDP. Even then, Indian per capita income would be around $6000 (2011-12 prices) by 2035, and GDP would be in the region of US$ 8.5 to 9 trillion. Even if this relatively ambitious growth path is achieved, India’s GDP in a couple of decades would be just over a half of US GDP today, and per capita income would be about 12 per cent of the current US level. Thus, the aspiration of such a growth objective should be seen as a reasonable but ambitious one. But is it feasible?

Placed in a historical and comparative perspective, it can be noted that, broadly speaking, East Asia’s GDP increased ten-fold over about 30 years (1975-2005). If India achieves the kind of growth outlined above for a similar period of three decades, it would also achieve a comparable expansion. There are only a handful of countries that have achieved sustained growth over such long periods and thereby succeeded in escaping the “middle income trap”. Thus, given the continuing high levels of poverty in India, it is essential that we persist in our efforts to do so, but recognize that such a sustained high growth cannot be taken for granted: it will need sustained efforts.

Going forward, for annualized GDP growth to return to around 8-9 per cent, it is apparent, and consistent with the messages from the overview in the previous section, that both domestic investment and saving levels will have to increase significantly from their current somewhat depressed levels. One such consistent scenario for growth and corresponding savings and investment levels has been put out by the National Transport Development Policy Committee (2014) in its recent India Transport Report: Moving India to 2032. The simulations reported here are essentially taken from this Report6. The simulations rely on the fundamental accounting identity of standard national income accounts, and include detailed information on key items such as investment and consumption/savings (disaggregated into public and private components) and net exports/imports. Projections of these components, in turn, are based on past relationships and trends, while also taking into account the government’s announced medium-term fiscal plans. They are also conditioned on the expected practice of sound macroeconomic and financial policies. The growth and investment relationship draws upon historical productivity estimates reflected in incremental capital output ratios, supported by estimates on total factor productivity that has been achieved in recent years. Implications of the investment and growth projections for balance of payments – both current and capital accounts – and the overall external sector sustainability are also factored in, while also imposing a cap on the recourse to sustainable foreign savings. The projections are the preferred point estimates, picked following consultations with a broad range of stakeholders in government and in the private sector (NTDPC, 2014).

The projections aim to provide a consistent macroeconomic framework and their implications for returning Indian annual GDP growth to around 7 per cent in the near future and then ascending to 8-9 per cent in the following quinquennial periods from 2017-2032. The results then provide some assessment of the feasibility of achieving such a growth objective, should the return to such a growth path be seen to be within the realms of reality? Another way of interpreting these projections is to see the results as implications of achieving such a high growth path: what they imply for the evolution of key macroeconomic variables.

This scenario entails the gross domestic capital formation (GDCF) rate to increase from about 35 per cent in 2012-13 to around 39 per cent during 2017-22 and further to 43 per cent by the 5-year period 2027-32. The corresponding rates of domestic savings would be about 36 per cent during 2017-22, rising to 41 per cent during 2027-32. These projections envisage an increase in all the three major components of savings – household, private corporate and public savings (Table 3).

Table 3:

Savings and Investment Rates: Projections

(Percent to GDP)

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Source: Reserve Bank of India; National Transport Development Policy Committee (2014).

While the projections may seem ambitious, they appear to be reasonable and achievable, given that the domestic savings rate and the investment rate had reached as high as 37 and 38 per cent, respectively, in 2007-08. The fact that Indian savings and investment rates have exhibited a secular uptrend since independence, although interspersed with some short periods of stagnation, also provides comfort in the likelihood of reaching the projected savings and investment rates. Of course, these projections are contingent on the pursuit of sound and stable macroeconomic and financial policies and continuing structural reforms, as elaborated in the rest of the paper. In this scenario, the absorption of external savings has been kept at around 2.5 per cent of GDP throughout the period, which is judged to be consistent with a sustainable CAD. We draw out the implications of this on the trajectory of balance of payments, capital flows, and desired foreign exchange reserves.

What do the projections imply for overall efficiency of the economy? One crude measure of productivity is the incremental capital output ratio (ICOR). International experience suggests that the best ICORs achieved for any sustained period fall in the region of about 3.5 to 3.6. Indian ICORs have ranged between about 3.5 and 4.5 for much of the past three decades (Chart 1 Chart 1). Our projections embedded in the desired growth paths of GDP and GDCF imply an ICOR of about 4.2 over the next couple of decades. We are therefore assuming a relatively high level of efficiency in resource use, but which is consistent with Indian historical achievements and also other recent evidence on productivity. For example, according to estimates in RBI (2014), the trend rate of growth in total factor productivity (TFP) of the overall economy increased from 1.1 percent per annum during the 1980s and 1990s to 2.3 percent during the 2000s (2000-01 to 2008-09), led by manufacturing and service sectors (Chart 2). Overall, the contribution of TFP growth to real GDP growth increased from 21 percent during the 1980s and 1990s to 30 percent during the 2000s. For the next two decades, we can expect the TFP growth to be at least of the same order as was recorded during the 2000s. If infrastructural shortages are addressed satisfactorily, then TFP growth can easily exceed the one estimated for the 2000s, which can provide an upside boost to growth prospects.

Chart 1:
Chart 1:

Incremental Capital Output Ratios

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Note: Incremental capital output ratio is computed as the ratio of average investment rate to average annual growth during the specific period.Source: World Economic Outlook Database (April 2014), International Monetary Fund.
Chart 2:
Chart 2:

Estimates of Total Factor Productivity Growth

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Source: RBI (2014).

Even with relatively optimistic agriculture growth scenarios of around 4 per cent per year, overall GDP growth rates in excess of 8 per cent are really not possible to achieve without a very major restoration of manufacturing growth in India to annual growth rates approaching a sustainable 10 per cent. Even with such an optimistic manufacturing growth scenario, the share of manufacturing in Indian GDP would not exceed 15 per cent, while agriculture can be expected to fall below 10 per cent, in 20 years. Whereas such a high rate of manufacturing growth was indeed achieved during 2005-08, it has since tapered off and collapsed to almost zero during 2012-14. The achievement of the kind of growth projected here is thus critically dependent on the revival of competitive Indian manufacturing in a sustained fashion over the next couple of decades.

Financing Growth

Domestic Savings

We first examine how the investments projected could be financed. We begin by assessing the way different constituents of savings can be expected to behave: household savings, private corporate sector savings and public sector savings. Household savings have been the bedrock of domestic savings in India, exhibiting a steady increase over the years. They reached about 21 per cent of GDP during 1997-2003 and ascended further to just under 24 per cent during 2008-12. We have therefore projected a slow increase to about 28 per cent by 2027-32. From the point of view of financing of investment by the public and private sectors, it is the household financial savings that are important. Net household financial savings increased from about 6-7 per cent of GDP during the 1980s to about 10 per cent in the 1990s, stabilizing at this level thereafter. It is only in the very recent years that they have again fallen to around 7 per cent, as savings appear to have been directed to gold. In the near future, we expect financial savings to be restored to the earlier 10 per cent level, as inflation subsides, monetary conditions stabilize and households begin to obtain positive real interest rates on their deposits and other financial savings. Financial savings are then projected to increase gradually to around 13 per cent by 2027-32. This would appear reasonable with increased financial depth and inclusion in the economy as income increases at the kind of pace projected. We would, in particular, expect increasing shares of savings going into contractual saving such as insurance, provident and pension funds. This tendency should get accentuated as urbanization gathers pace and people have to insure themselves for their retirement. The unfolding demographic structure is also conducive to savings.

A distinguishing feature of the golden era of growth (2003-08) was the dramatic increase in private corporate savings from 3.9 per cent of GDP during 1997-2003 to about 7.8 per cent during 2008-12. It was the buoyant profitability of that period and high corporate investment levels that induced the private corporate sector to keep such high levels of retained earnings – or we could reverse the causation: It was the high levels of profitability that allowed high retained earnings that helped greatly in financing high levels of corporate investment. Restoration of private corporate investment will critically need enhancement of profitability so that private corporate savings again reach their earlier level of 7.5 per cent of GDP within the next 3-4 years. We have then projected them to increase to 9.5 per cent by 2027-32.

It is necessary to restore confidence in future Indian growth for corporate investment to increase again in the next couple of years. This brings us to the desired trajectory of public sector savings, which consist of two broad categories: public authorities and non-departmental commercial enterprises. Public authorities include government administration and “departmental enterprises”, which are essentially commercial government enterprises that are not corporatized (e.g. railways), and “non-departmental enterprises” are the corporatized public sector enterprises. As a consequence of the fiscal stimulus of 2008-09, savings turned distinctly negative after having become mildly positive at 0.5 per cent of GDP in 2007-08, which was a remarkable turnaround from (-)5 per cent in 2000-01. This broadly corresponds to the revenue deficit of the Centre and States combined. Interestingly, both departmental and non-departmental public enterprises have maintained consistent positive saving rates of between 3.5 and 4.5 per cent of GDP over the past decade and a half. With the slow unwinding of the fiscal and revenue deficits, government savings have remained in negative territory, though some improvement has taken place in the last couple of years. With such a correction, not only will public sector savings improve but the crowding out of the private sector would also be reversed. It is essential that the envisaged fiscal correction does take place over the next 2-3 years: as the revenue deficits of both central and state governments approach zero, government savings could again attain positive levels as in 2007-08. Only then will it be become feasible for private sector investment to increase to the magnitudes projected. Accordingly, we have projected overall public sector savings to increase from the current level of just over 1 per cent of GDP to 3 per cent in 2017-22, rising to 3.4 per cent by 2027-32. It is possible that even greater improvement can take place, particularly if the overall tax/GDP ratio can be improved over the years.

The plausible projections of savings enhancement made above in each of the three main segments, the household sector, the private corporate sector, and the public sector, yield a good possibility of gross domestic savings increasing from the current 31-32 per cent level to about 36 per cent in 2017-22 and 41 per cent in 2027-32.

External Savings

In recent years, there has been a great deal of stress laid on mobilizing external savings to finance Indian investment for growth, particularly in infrastructure. In estimating the maximum feasible level of external savings that can be mobilized to finance overall investment in India, it is important that such external capital flows should be sustainable from the point of view of servicing such inflows over time. This was done in the NTDPC modeling framework by utilizing a debt sub model which projects the implications of debt flows servicing needs over time. For a country with an increasing size of its economy as projected, even relatively small proportions of its GDP start assuming large absolute magnitudes from the point of view of international capital markets.

Net capital flows that are absorbed by the economy as a whole are identically equal to the CAD. Considerations for sustainability indicate that the CAD should not exceed around 2.5 percent of GDP on a continuous basis. As the CAD increased to levels exceeding 4 per cent of GDP in 2012-13, we have already seen the kind of instability that can be caused by adverse developments in international financial markets.

Indian exports have grown at a healthy pace since 2002, significantly faster than world exports. In fact, the total exports of goods and services almost doubled as a share of GDP between 1998-2002 and 2008-12, reaching a level of about 22 per cent of GDP. Except for 2008-09 and 2009-10, which were crisis years for global trade, Indian exports of goods and services have been growing at 20-25 per cent per year since 2002. In view of the protracted current slowdown in global trade, and the low probability of a revival of the high growth rates achieved earlier, we are projecting a relatively slower pace of growth at 11-12 per cent between 2017 and 2032. Even at this pace, exports of goods and services would increase from the current level of about 25 per cent of GDP to about 30 per cent of GDP in 2017-22 and 38 per cent in 2027-32. By way of comparison, the current level of exports of goods and services of China amounts to about 31-32 per cent of its GDP. Imports of goods and services are projected to grow correspondingly while keeping a sustainable level of CAD at about 2.5 per cent of GDP. Such projections of exports and imports will not be feasible without the corresponding growth in all aspects of investment in transport, logistics, ports and airports.

As India’s external account expands in the manner projected, and as India’s economy and its financial markets become more open, it will be necessary to build foreign exchange reserves in a prudent manner, so that financial stability can be maintained even in the face of the inevitable capital flow volatility. Foreign exchange reserves have been posited to be maintained at a level of about 6 months of imports of goods and services on a consistent basis. The projections suggest that this would imply an increase in foreign exchange reserves from the current 16 per cent of GDP to about 19-20 per cent in 2017-22 and rising to 22 per cent in 2027-32. (At present, Chinese forex reserves amount to about 18 months of imports and 41 per cent of GDP). Such an expansion of reserves would also be consistent with the required expansion of base money, the Reserve Bank of India’s balance sheet, which is necessary to fuel the monetary expansion consistent with GDP growth. Thus, the consistent need for accretion to forex reserves implies that net capital flows will need to be in the region of about 4.5 per cent of GDP during 2017-32, if the CAD is kept at a level of about 2.5 per cent of GDP. This would allow annual reserve accretion amounting to about 2 per cent of GDP over the period. In absolute terms, the implications of such a scenario are that net annual capital flows will need to be about $135 billion in 2017-22, rising to about $330 billion in 2027-32 (at 2012-13 prices). From an external sustainability point of view, and given the more volatile nature of debt flows, the projections assume that the equity component will dominate, at 60-65 per cent of net capital flows, with debt flows (35-40 per cent) being the residual. These proportions are also broadly consistent with the prevailing debt equity ratios in the Indian corporate sector.

The key lesson from this exercise is that even if the CAD is kept at a modest range of around 2.5 per cent of GDP, total net capital flows that will be needed amount to large and growing magnitudes over the medium term. There will, therefore, be a need to ensure high external confidence in the Indian economy so that such external capital flows are forthcoming.

Infrastructure Investment

Achieving a high sustained rate of economic growth requires corresponding investments in infrastructure, including all aspects of transportation. If industrial growth is to be ratcheted up to growth rates of around 10 per cent, and if there is to be the kind of trade growth projected, the demands for the provision of power, transportation and logistics will also grow commensurately. The continued expansion of trade requires corresponding investments in ports, airports, and in all forms of domestic transport linkages.

With this perspective in view, infrastructure investment will need to pick-up significantly in the coming years for stable and sustainable growth. NTDPC (2014) projects that overall infrastructure investment will need to increase substantially from around 5.4 percent of GDP in 2011-12 to around 8 percent during the 2020s and beyond – levels consistent with the economic growth and transformation experiences of South East and East Asian countries (tables 4 and 5)7. It had indeed reached 6.2-6.3 per cent in 2008-10. So, aiming for 7 per cent in the medium term and ascending to 8 per cent later is realistic. While an increasing proportion of infrastructure investment could be undertaken by the private sector, the public sector will have to continue to play the predominant role. The share of public sector in infrastructure investment is projected to be around 57 percent of the total infrastructure spending in 2017-22, somewhat lower than the current estimate of 60 percent. In view of the difficulties that have now emerged with regard to the implementation of PPP projects, and their financing, it is possible that the role of public investment in infrastructure may need to be higher than what is projected here8. Even if that happens, it is important that such investments are made remunerative with high economic returns (Lall, 2015).

Table 4:

Infrastructure Spending: 2006-12

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Source: National Transport Development Policy Committee (2014).
Table 5:

Infrastructure Investment: Projections

Percent to GDP

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Source: National Transport Development Policy Committee (2014).

Sector-wise, the public sector is expected to continue to be the leading investor in sectors such as electricity, railways, and roads and bridges, while the private sector would be the driving force in the “communications” sector, and in ports and airports. For the public sector to carry out the enhanced role, fiscal consolidation, as indicated earlier, assumes importance.

Significant success has been achieved in ramping up investment in roads over the past two decades, and particularly since the year 2000. The joint initiation of the National Highways Development Project (NHDP) and the Prime Minister’s Gram Sadak Yojana9 (PMGSY) has since 2000 improved road connectivity between major cities on the one hand, and within rural areas, on the other, thereby contributing to the productivity enhancements that have benefitted the economy as a whole. Overall investments in roads tripled from 0.4 per cent of GDP in the late 1990s to around 1.2 per cent by the late 2000s.

There is now a clear need for raising the share of Indian Railways in total infrastructure investment in a similar manner from the current level of about 0.4 per cent of GDP to 1 per cent and above by 2017-22 and continuing at similar levels for at least the next decade and a half. This is essential for improving productivity of the manufacturing sector overall and for linking inland nodes to ports to aid in the sustained growth required in trade, both exports and imports. A specific requirement for the expansion of railways capacity is to enable the transportation of bulk freight like coal and iron ore and steel in the volumes that will be necessary to fuel overall economic growth. With power demand elasticity with respect to GDP being about unity, the generation of power will need to increase four fold, along with the projected GDP over the next couple of decades. Given the composition of India’s energy sources, and even allowing for significant substitution away from coal, such growth in power generation will imply an increase in the corresponding demand for coal by at least a factor of three. With railways freight capacity being almost fully utilized already, it is clear that major enhancements are needed in the carrying capacity of Indian railways. Thus, just like the NHDP has transformed the Indian road system, the program for Dedicated Freight Corridors (DFCs) needs a similar focused investment program. Corresponding investments will also be needed to expand port infrastructure significantly for the enhanced import of energy commodities, both oil and coal, along with containerized freight.

There is a symbiotic relationship between efficient transport provision and industrial growth. Thus, the kind of growth projected will not be possible without enhanced infrastructure spending, and the enhanced infrastructure spending will be infructuous if manufacturing growth does not accelerate significantly. Total investment in transport, both public and private, would need to increase from about 2.6 per cent during the 11th Five Year Plan to about 3.3 per cent of GDP during the 2030s, with public sector component being 2.1-2.2 per of GDP and the private sector investment component at around 1.5-1.6 per cent of GDP. The much enhanced level of investment in roads over the past decade or so relative to previous periods demonstrates that it is possible to achieve such an accelerated growth in a short period of time.

IV. Policy Imperatives for Getting Back to the High Growth Path

The objective of taking growth back to around 9 percent and the required increase in savings and investment rates will need very significant policy reform in a range of different activities. That such reform has been carried out on a relatively continuous basis since the early 1980s, intensifying in the 1990s and accentuated in the infrastructure sector since the mid-1990s, gives confidence in the potential ability of the country’s policy making system to rise to the challenges of the future. In principle, Indian institutional capacity for governance and reform has exhibited considerable resilience, although the institutional development and reform needed to get to the next steps in the ladder towards achieving middle income status will be of a much higher order than that achieved in the past.

We focus on five key areas of policy action. First, Indian public finances have to be brought back to an even keel so that resources start becoming available for increased public investment in infrastructure. Most attention in this area is typically devoted to containment of the fiscal deficit through expenditure containment. We argue that, while current expenditures, particularly those on subsidies, do need to be contained, it is now time to give as much attention to increase revenues through enhancement of the tax-GDP ratio. Second, private savings, both household and corporate, need to be brought back to their earlier levels. A sustained reduction in inflation that leads to the maintenance of low nominal interest rates, but positive real interest rates, will help in restoring corporate profitability, while encouraging household savings towards financial instruments.

Third, the external account has to be managed on a continuous basis so that external savings can be attracted in adequate magnitudes, while ensuring external stability, and maintaining a competitive real exchange rate. Fourth, recognizing that there has been a significant slowdown in manufacturing growth, specific measures need to be taken to revive manufacturing and then accelerate competitive manufacturing activity. There has to be a much greater focus on labor using manufacturing to take advantage of the expected shift of such manufacturing away from China in the coming years. Finally, it must be recognized that the achievement of high sustained economic growth, particularly in manufacturing, is not feasible without a step up in infrastructure investment, particularly in transport with an emphasis on the railways. We now turn to elaboration of each of these areas.

Public Savings and Fiscal Policy

Fiscal consolidation is necessary for sustained growth in an environment of macroeconomic and financial stability. A key factor that has led to a decline in the domestic savings rate since the NAFC has been the increased revenue deficit of the central government (Table 6).

Table 6:

Fiscal Position of the Central Government

(Percent to GDP)

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Source: Reserve Bank of India and Union Budget documents.Note: Data for 2014-15 and 2015-16 are revised estimates and budget estimates, respectively. Ratios with respect to GDP for 2007-08 to 2009-10 are based on the 2004-05 base GDP series, while those for 2012-13 to 2015-16 are based on the new GDP series (2011-12 base).

The government reaffirmed its commitment, in the Union Budget 2015-16, to pursue fiscal consolidation, by reducing the fiscal deficit to 3.0 percent of GDP by 2017-18. The aim must be to eliminate the revenue deficit completely and then move towards a small surplus. It would then be possible to limit government borrowing exclusively for public investment purposes in both social and physical infrastructure. This would be critical to enable domestic savings to finance growth of 9 percent and above in a sustainable manner.

The increase in subsidies, from 1.4 per cent of GDP in 2007-08 to 2.5 percent in 2012-13 has been a key component of the increased revenue deficit (Table 6). Enhanced fuel subsidies to kerosene, diesel and LPG constituted the main component of this increase. The policy objective must be to bring back overall subsidies to be in the region of about one per cent as has been achieved earlier. Such a move would free up around 1 to 1.5 per cent of GDP for public investment in infrastructure.

The government completed the process of eliminating diesel subsidies in an incremental manner and announced deregulation of diesel prices in October 2014; a similar process could be followed for reducing or eliminating LPG subsidies. The sharp drop in the international crude oil prices in late 2014, if sustained, should facilitate an accelerated adjustment in this direction. The phased elimination of such subsidies would also allow for a more efficient use of petroleum products. The challenge will be the maintenace of deregulated prices when oil prices rise again. The demand for petroleum products is generally adjudged to be relatively price inelastic. In the Indian context, the problem has been compounded by the relatively sticky administered prices. However, the empirical evidence in Kapur and Mohan (2014) shows that demand for oil in India does respond to prices in a significant manner: the estimated price elasticity of demand for petrol is (-) 0.66, for diesel is (-) 0.36 and for kerosene oil is (-) 0.54. Thus, the elimination of fuel subsidies will be beneficial for growth in a number of different ways:

  • Reduction in revenue deficit, leading to increase in government savings, and reduction in the crowding out of the private sector;

  • Sustained reduction in the CAD as a result of reduced demand for fuel;

  • Higher overall efficiency in the use of energy, and hence in overall economic activity; and;

  • Provide more resources for growth-enhancing public investment in infrastructure. In this context, the decision of the government in January 2015 to increase the basic excise duty by Rs. 2 per liter on both petrol and diesel to fund infrastructure projects, especially roads, is also a welcome step.

The second issue with respect to fiscal policy is that the recent fiscal consolidation efforts have been focused excessively on reduction in expenditure, and particularly in capital expenditure. Consequently, revenue expenditure has increased. This needs to be reversed.

Improving Tax/GDP Ratio

On the revenue side, the gross tax/GDP ratio of the Centre has recorded a significant fall from its peak of 2007-08 of 12 percent, to 10 per cent in 2013-14 reflecting the stimulus measures and weakening of economic activity. The revenue receipts (net)/GDP ratio of the Central government is now below the levels prevailing in the late 1980s – reflecting the lower tax revenues as also perhaps more devolution to States (Chart 3).

Chart 3:
Chart 3:

Central Government Revenues

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Cross-country analysis indicates that the general government revenue/GDP ratio in India is quite low, even taking into account its per capita income (Chart 4). The revenue/GDP ratio in India has declined since the NAFC, even as this ratio has increased in other major EME regions.

Chart 4:
Chart 4:

Government Revenues and Income Levels

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Note: Data pertain to 2013 and includes 179 countries.

A comparison of India with the OECD countries indicates that the corporate tax revenues in India are higher than in the OECD (3.6 percent to GDP versus 3.0 percent in 2011) (Chart 5); in contrast, the personal income tax revenues in India are found to be significantly lower than the OECD (1.8 percent to GDP versus 8.5 percent in 2011) (Chart 6). This pattern is also evident in other emerging and developing economies (Abramovsky, Klemm and Phillips (2014).

Chart 5:
Chart 5:

Corporate Tax Revenues

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Source: Revenue Statistics 2013, OECD; Government of India.
Chart 6:
Chart 6:

Personal Income Tax Revenues

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Source: Revenue Statistics 2013, OECD; Government of India

Low income levels in India can partly explain the relatively low personal income tax collections in India, but it appears that the income tax rates are also notably lower in the Indian context. This is true for both the peak income tax rate as well as the income thresholds at which the various tax rates kick in (Chart 7). For example, the peak income tax rate in India was 30 percent in 2013, whereas it averaged 36 percent in the OECD countries10; in as many as 15 OECD countries, the peak personal income tax rate was 40 percent and above11. Also, the minimum income tax rate averages 10 percent in the OECD countries vis-à-vis zero on India, although this specific comparison is complicated by differences in basic exemptions and credits across countries. Turning to an analysis of the income thresholds levels, the peak income tax rate in India is applicable to annual incomes of Rs. 1 million and above, i.e., almost 11 times the per capita income in 2013. The corresponding OECD average was 4 times the per capita income (Chart 8).

Chart 7:
Chart 7:

Personal Income Tax Rates

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Source: OECD Tax Database (
Chart 8:
Chart 8:

Personal Income Tax Thresholds

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Source: OECD Tax Database (

As regards corporate taxes, the Indian tax rate is somewhat higher than that in the OECD countries (Chart 9). However, the effective tax rate12 is notably lower than the statutory rate, although the gap has narrowed somewhat in the last few years (Chart 10). The Union Budget 2015-16 proposes to address this issue through reduction in the corporate tax rate to 25 percent over the next four years, accompanied with rationalization and removal of various exemptions and incentives.

Chart 9:
Chart 9:

Corporate Income Tax Rates

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Source: OECD Tax Database.
Chart 10:
Chart 10:

Corporate Tax in India: Effective Rate

Citation: IMF Working Papers 2015, 053; 10.5089/9781498301114.001.A001

Source: Receipts Budget (various issues), Government of India.

Available information indicates that there were only 3.6 million people in 2011-12 – just 0.3 percent of the country’s population - who reported taxable incomes above Rs.500,000 (Table 7). By way of comparison, we may note that the number of passenger vehicles sold in the country in 2011-12 was 2.6 million. Here, it is also relevant to note that the category of taxpayers with incomes above Rs. 1 million normally gets substantial dividend income, which is currently tax-free in the hands of the investor as the company distributing dividend pays dividend distribution tax at the rate of 15 per cent. Hence, such high income individuals are taxed at a lower overall effective marginal rate than those having little or no dividend income. The need to focus on expanding this category of taxpayer base, therefore, is crucial at this point (GoI, 2014a). As noted earlier, the peak income tax rate in India of 30 percent is well-below that in the OECD countries and moreover, the peak rate in India kicks-in at much higher (relative) income levels. The Union Budget 2015-16 addresses this issue to an extent through the proposed surcharge of 2 percent for assesses with taxable income above Rs.10 million

Table 7:

Income Tax Collections in India: 2011-12

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Source: Standing Committee on Finance (2012), Direct Taxes Code Bill, 2010, 49th Report, Lok Sabha Secretariat, New Delhi; and SIAM.

Cross-country evidence indicates that broadening the tax base (including through withholding taxes etc) is the key to increasing tax revenues in many low-income countries (Besley and Persson, 2014). This is true for advanced economies as well. For example, the Scandinavian tax systems have very wide coverage of third-party information reporting and well-developed information trails ensure a low level of tax evasion. Moreover, broad tax bases in these countries further encourage low levels of tax avoidance and contribute to modest elasticities of taxable income with respect to the marginal tax rate13. The subsidization or public provision of goods and services complementary to working -including child care, elderly care, transportation, and education - encourages a high level of labor supply. Such public provision of labor complements implies that the effective labor supply distortions are less severe than implied by the tax-transfer distortion claims (Kleven, 2014). Tax compliance is as high as 90 percent in advanced economies, if third party information practice exists; the compliance rate increases to 99 percent if both withholding and third party information practices exist.

Overall, there appears to be considerable room for increasing the tax/GDP ratio. The net result of a sustained thrust on tax compliance in all areas – both direct and indirect taxes – should result in greater buoyancy in the tax/GDP ratio than has been experienced in the past. This can be achieved without any major increase in tax rates, through widening of the tax base and rationalization of exemptions, The number of income taxpayers can be increased from the present 35 million to at least 60 million; a wider legal tax base increases equity as well as compliance (GoI, 2014a).

Taking into account the fiscal correction that is being programmed as also the fiscal consolidation record of 2002-08, and greater efforts at compliance, public sector savings should recover in the manner projected: gross domestic savings rate could then increase by around 2-3 percent of GDP, or even higher. A similar event occurred about 10 years ago when public sector savings had become negative (Mohan, 2011b). The envisaged fiscal correction will make more resources available to the private sector and contribute to the recovery of private sector investment and profitability and hence private sector savings.

It is well recognized by all that infrastructure investment is critical to loosening supply side constraints and promoting manufacturing. Fiscal consolidation is also important here. Despite increasing private investment in infrastructure, it is necessary to enhance public investment in infrastructure on a sustained basis. The case for higher public investment now is also on account of limitations of the public private partnership (PPP) projects seen in the country in the recent past (GoI, 2014b). Here, it is also relevant to note that cross-country evidence indicates that increased public infrastructure investment raises output in both the short and long term, particularly during periods of economic slack and when investment efficiency is high. Debt-financed projects could have large output effects without increasing the debt-to-GDP ratio, if clearly identified infrastructure needs are met through efficient investment (IMF, 2014d). However, if the efficiency of the public investment process is relatively low, due to poor project selection and execution, increased public investment leads to more limited long-term output gains. Thus, along with better project selection and execution, the culture of economic user charges must be reinforced so that infrastructure investment is remunerative; second, with increasing incomes, expenditures on non-merit subsidies must be curtailed and directed toward infrastructure investments. And, as argued earlier in this section, there is a significant scope to improve the Indian tax revenue/GDP ratio through better tax administration and a wider tax base for direct taxes. As regards indirect taxes, the introduction of the Goods and Services Tax (GST) Bill in the Lok Sabha in December 2014 is encouraging and its early enactment is expected to provide higher revenues as well as efficiency gains. Strong fiscal consolidation on these lines, along with quality of its adjustment, would provide a conducive environment for higher domestic savings, lower domestic interest rates and, more flexibility to monetary policy in its operations.

Household Savings and Management of Inflation

Although overall household savings in 2012-13 were only marginally lower than the peak attained in 2007-08, there has been a significant change in the composition of these savings, with a pronounced shift away from financial savings towards physical savings. This shift affects adversely the availability of resources for the rest of the economy, especially the private corporate sector. Hence, ensuring positive real returns on bank as well as postal deposits in an environment of low and stable inflation is necessary to reverse the downward trend in household financial savings, along with focused thrust on contractual savings schemes. This endeavor can be expected to be facilitated by the agreement (February 2015) on monetary policy framework between the Government and the Reserve Bank.

With increasing urbanization and longevity, one might have expected a greater shift in financial savings towards contractual savings such as provident and pension funds and life insurance products as the financial sector got diversified. Given that the vast majority of Indian household savers continue to be in the middle income categories, they exhibit a marked preference for safe savings avenues such as postal savings and public sector bank deposits. Since there is really no social security worth the name in the country, and pensions are available to only the privileged few, there would be significant unmet demand for safe assets that provide a mildly positive real rate of return. Thus, there is a pressing need for the provision of savings vehicles that meet such demand in the form of simple, easy to understand, pension and life insurance products which combine some elements of defined benefits while remaining predominantly defined contribution schemes. Not only will such schemes provide much needed elements of social security, they would also be ideal for financing infrastructure projects that typically need long term finance.

As persistently high food inflation has been a key driver of headline inflation, monetary policy will have its limitations. Accordingly, policies aimed at improving productivity and output in agriculture through reorientation of government spending way from current spending (fertilizer, power and irrigation subsidies) towards capital outlays will be extremely helpful. Appropriate policies with regard to minimum support prices are also critical (Bhalla, 2013).

There also needs to be better recognition of the changing diet of Indian consumers towards non-cereals including fruits, vegetables, poultry, meat and dairy products. With increasing incomes and accelerating urbanization, demand for these products will continue to grow much more than that for cereals. Without the existence of appropriate rural infrastructure and an efficient supply chain, including refrigeration facilities in both warehouses and trucks, the markets for these products remain segmented to limited geographic areas within the vicinity of cities. Burgeoning non-cereal food demand will therefore contribute to inflation on a consistent basis giving rise to wage pressures and more generalized inflation, and loss of competitiveness. Inflation containment will therefore also depend on a more focused roll out of rural infrastructure in terms of both transport and energy, mainly a public sector function. Specific policies are also needed to promote private sector activity in investing in the overall agriculture supply chain as the basic infrastructure is enabled.

Private Corporate Sector and Manufacturing

The private corporate savings rate has declined by more than 2 percentage points between 2007-08 and 2012-13. This reflects reduction in profitability on the back of the slowdown in aggregate demand and the impact of higher interest rates necessitated by the persistence of inflation. Success with fiscal consolidation and inflation management will allow lowering of nominal interest rates, which will allow higher corporate profitability and higher corporate savings. Persistently high inflation during 2009-13 has also added to some exchange rate overvaluation during this period, and this is clearly visible from CPI-based real effective exchange rate indices. Success with inflation management will also provide a conducive environment for stability in the real exchange rate, which will encourage exports, manufacturing activity and corporate health, while also contributing to the as well as contribute to sustainability of the current account deficit (Kapur and Mohan, 2014).

Globally, rapid industrialization and manufactured exports have been the most reliable levers for rapid and sustained growth. Virtually all countries that have sustained high growth rates for decades have done so on the back of manufacturing, with growth miracles of Japan, Korea and China being conspicuous illustrations of this phenomenon (Rodrik, 2013, 2014; Timmer et al, 2014). Thus, policies that promote manufacturing activity in India will have a key role, although the cross-country evidence indicates that the structural change in favor of manufacturing has softened in many countries and some countries are exhibiting premature deindustrialization. The newly initiated “Make in India” campaign is a clear recognition of this issue.

Although the Indian factor endowment is abundant in labor, Indian manufacturing has not been generally competitive in labor using sectors: there needs to be focused effort at correcting this, much as China and other East Asian countries have done over the past 30-40 years. This involves the tackling of legacy issues connected with regulatory impediments that constrain the use of both land and labor in Indian manufacturing. There has been a traditional prejudice against the location of industries in Indian cities, which is where skilled labor is likely to be available. Urban land ceiling regulations and other zoning requirements have traditionally limited the availability of urban land for industrial development. Thus, whereas in other successful manufacturing oriented cities it is not unusual to find multi-storied structures housing labor using industries such as clothing and other light industries, such manufacturing is almost totally absent in Indian cities.

There is a new window of opportunity that is emerging over the next 5 -10 years as labor-using manufacturing moves out of China as wages rise in that country. The current trend is for these activities to move to South East Asian countries such as Vietnam, Philippines, Cambodia and Bangladesh. A focused effort to address constraints emanating from labor and land laws will be critical for promotion of manufacturing in the country. There has been longstanding discussion of labor legislation hindering investment in labor using industries, along with small scale industry reservations. The latter impediment has now largely been removed, but labor legislation problems remain. The measures needed are well known, but it has so far not been felt to be feasible politically. The way forward has to include quick labor reforms accompanied by programs that promote social security for labor such as unemployment insurance and practical training and retraining programs. Recent initiatives in this direction are noteworthy. For example, Rajasthan has introduced some major reforms in three labor legislations - the Industrial Disputes Act, the Factories Act and the Contract Labor Act – to provide more flexibility to create more jobs and enhance ‘ease of doing business’ (GoI, 2014b). The threshold limit required for prior government permission before effecting layoff, retrenchment or closure has been increased from 100 workmen to 300 workmen under the Industrial Disputes Act, along with an improvement in compensation and financial security for the retrenched employees. The thresholds of 10 and 20 workers were increased to 20 and 40, respectively, under the Factories Act to reduce the ‘Inspector Raj’ related hassles. The grant of a Presidential Assent has allowed the reforms to take hold and supersede any constraints that may be imposed by overlapping central laws.

It is this combined and focused approach to urban land and labor reforms, along with the maintenance of a competitive real exchange rate, that can accelerate manufacturing investment in labor using industries. India has also exhibited competitiveness in heavy industries also such as steel, aluminum, automotives, and others. Such industries are more affected by governance issues related to environmental and other approval processes that have suffered in recent years, and from inadequate infrastructure. Some of the approval process issues are already being addressed and perhaps need further focus. In addition, it goes without saying that the efficient provision of power, transport, and logistics is also necessary for promoting such growth.

Foreign Savings and Capital Account Management

The Indian experience as well as of that of other economies indicates that high reliance on foreign savings increases vulnerability to financial crises. Opening the financial account appears to raise the frequency and severity of economic crises. Benefits of financial openness are most likely to be realized when implemented in a phased manner, when external balances and reserve positions are strong, and when complementing a range of domestic policies and reforms to enhance stability and growth (CGFS, 2009; Obstfeld, 2009). Debt capital flows increase vulnerability to future crises, and this was clearly seen in the NAFC. EDE regions such as Central and Eastern Europe which saw a large increase in debt flows and also had large current account deficits did face crises in the aftermath of the NAFC, while other EDEs did not. Given the structural growth, inflation and interest differentials in favor of EDEs, a fully open capital account would inevitably lead to large flows in search of arbitrage – creating booms when they come in and a bust once they leave. Thus, management of debt flows assumes importance. Indeed, one factor that reduces India’s external vulnerability, despite large twin deficits, is the fact the public debt is largely internally held.

It would be prudent to continue with this approach and further opening up of the government securities market to non-resident investment needs to be carefully watched and calibrated. Debt investments by non-residents in domestic securities are more volatile than in equity and can add to foreign exchange market pressures. More often, these flows react to monetary policy developments in advanced economies, as was the case in mid-2013 This issue is especially relevant at the current juncture, given the continued near zero policy rates in the US and other major advanced economies, and the likelihood of an extended continuation of very low interest rates. There is a view that the traditional fears about foreign-currency borrowing by residents are not applicable to investments by non-residents in local-currency denominated bonds and hence the limits on the latter category of investments should be removed (Patnaik et al, 2013). Such a notion was clearly disproved during the June-August 2013 turmoil.

Overall, it is evident that volatility in monetary policy in the major advanced economies is a source of volatility in capital flows and exchange rates in the emerging and developing economies. Swings in capital flows, if not managed properly, are often associated with macroeconomic and financial imbalances and potential financial crises in these economies. The international monetary architecture is characterized by asymmetry (Mohan, Patra and Kapur, 2013). Notwithstanding significant spillovers from the advanced economy monetary policy to the emerging and developing economies, international monetary coordination is skewed and restricted among the major advanced economy central banks only. The lack of international monetary coordination and its adverse consequences were evident during the 2013 taper episode (Mohan and Kapur, 2014; Rajan, 2014). Before the NAFC, it was the EDEs which typically complained of the adverse impact of volatile capital flows. After the onset of the NAFC and with extended UMPs in the major advanced economies – earlier, the US and now, in early-2015, the European Central Bank – other advanced economies have also started feeling adverse consequences of the UMPs in the major reserve currency economies. For example, Switzerland and Denmark have been forced to move to a regime of increasingly negative policy rates – “competitive monetary easing” – to discourage capital flows from the reserve currency economies. In the face of large speculative capital inflows, Denmark was forced to suspend issuance of domestic and foreign bonds in January 201514. These developments, the prevailing international economic arrangements and the weak empirical evidence on the benefits of open capital accounts all highlight the need for continued prudence in reliance on foreign savings and continued capital account management.

Transport Infrastructure

We have outlined the magnitude of growth needed in infrastructure investment overall and in transport investment in particular. We have also noted that even for the kind of growth needed in power generation, for example, it will not be feasible without corresponding expansion in transport capacity. The same is true for the expansion of basic industries like iron and steel and other heavy industries. We therefore argue that transport planning and programming for transport, and adequate investment in transport needs a new approach.

Much of the thinking on transport in India has been project centric and done within single-mode silos. The focus has been on stepping up investments to address specific problems usually well after serious logistic and transport dislocations have become more than apparent. Even the Five Year Plans were essentially collections of standalone projects, which were not necessarily connected. To achieve significant improvement in overall productivity and efficiency, it is imperative that future development of the network should be aimed at a better integration of the various modes so as to facilitate the development of multimodal transport, within the country for the expansion of exports and imports. So a key requirement for thinking on transport strategy is that it must be system based: it must cut across modes of transport, administrative geographies and integrate capital investment (both public and private) with regulatory and policy development. Thus, the country must develop planning capacity in transport that, on the one hand develops coherent medium and long term transport strategies, but on the other, is able to respond on an on-going basis to changes that occur over time in both technologies and relative prices. The NTDPC has proposed the setting up of “Offices of Transport Strategy” at both the national and state levels, so that transport investment can be planned and programmed adequately. If this is done, investments in roads, railways, ports and airports can be coordinated so that network efficiencies can be achieved.

Within such a systems approach, the key transformation needed is in railways. Much of investment in Indian railways since independence has been incremental: route expansion has been marginal and technological upgradation has been limited. For the kind of overall economic growth envisaged to become feasible, a transformational approach needs to be taken for modernizing and expanding Indian railways.

A key innovation which is already underway is that of setting up a network “Dedicated Freight Corridors (DFCs)”, similar to the NHDP in roads. Once this is done in the major trunk freight corridors, freight transportation by rail will become much more efficient. It could then begin to regain its lost share over the decades, particularly as investments are done in the modernization of rolling stock enabling multimodal transport. Simultaneously, as the freight traffic goes to DFCs, passenger trains can be speeded up and capacity can be expanded significantly.

For all this to be achieved, major reform has to take place in the Indian Railways so that its capacity expansion and technical upgradation can be enabled. The Indian Railways Report (2001) and the NTDPC Report (2014) have provided detailed blue prints on how this can be done. For our current purposes, we confine ourselves to saying that a business-as-usual approach to railways investment will not do and urgent action has to be taken now to initiate the kind of investment projections.

V. Conclusions

India’s growth record since independence suggests that it is capable of recording sustained growth over a long period, even if it is punctuated by some periods of lower growth because of business cycles or other reasons. Its institutional system has also demonstrated that significant policy changes are made in response to changing circumstances. Sometimes this is done relatively quickly, whereas at other times there may be significant delays before the needed policy change is done.

Much of the Indian growth record has been possible due to sustained growth in domestic savings and associated investments. The use of external savings has been relatively limited as a proportion of total investment. Whenever growth has stalled, it has been associated with stagnation in savings and investment, usually in the presence of a deteriorating fiscal situation and higher inflation.

The immediate priority for returning the country to a sustained higher growth path is to achieve the kind of fiscal quality and low inflation level that was exhibited during 2003-2008. However, focused attention now needs to be given to increasing efficiency and compliance in tax revenue collection so that the Indian overall tax/GDP ratio rises to levels that are consistent with comparable international experience. The focus in fiscal correction has generally been on reduction in expenditure and particularly capital expenditures. Whereas it is necessary to curb current expenditure such as that on ill-targeted subsidies, the restoration of growth involves increases in public investment for the delivery of public goods and services, which then crowd in private investment rather than crowding them out.

If such macro-economic stabilization, in terms of both fiscal deficit and inflation, can indeed be achieved over the next couple of years, the macro-economic projections presented in this paper suggest that it is within the realms of feasibility that the Indian economy can return to a 8-9 percent growth path for a sustained period of a couple of decades in the future. This would then begin to replicate the kind of growth experience exhibited by East and South East Asian countries, including China, in the immediate past and Japan in earlier periods. However, we do need to note that the task ahead will be more difficult now in view of the protracted slow-down in global economic growth and in global trade. The silver lining in future expectations of global slowdown is that the weight of the global economy is shifting to emerging market and developing economies in Asia, Latin America and Africa. Thus, even if the North Atlantic economies of North America and Europe do suffer secular stagnation in growth, as some are predicting, it is possible that the impact of global growth may be mitigated by counter balancing growth in EMDEs.

For the Indian growth story to exhibit that kind of dynamism, it is crucial for Indian economic policy to focus particularly on the revival of manufacturing and overall industrial growth, as was envisaged in the Industrial Policy Reforms of 1991 and beyond. It is not feasible to achieve a sustained overall GDP growth of 8-9 percent unless industrial growth in India is in double digits. The achievement of such industrial growth needs the maintenance of appropriate interest rates, a realistic and competitive real exchange rate, and focused attention on removing impediments in factor markets, particularly labor and land. In addition, competitiveness in Indian industry will depend on making Indian cities more efficient and hospitable to location of manufacturing entities within or in the vicinity of cities.

The achievement of overall high growth is also dependent on a step-up in overall infrastructure investment in both energy and transport. Given that the elasticity of power demand with respect to GDP is around unity, there will be need for sustained and continued investment in power generation, transmission and distribution. Associated investment will be required for making feasible the timely supply of energy resources such as coal and petroleum in adequate quantity from both domestic production and imports. Coordinated investments will be essential in transport facilities, particularly in Railways and Ports. In view of the deteriorating share of railways in both freight and passenger traffic over the last 60 years, there is need for a significant step-up in railways investment, which would be difficult to achieve without a major reorganization of the railways system.

Returning India to a high growth path is, therefore, quite feasible but it will need much more focused attention to the revival of manufacturing and to accelerating investment in transport and infrastructure, particularly in railways.


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The views expressed in the paper are those of the authors and not necessarily those of the institutions to which they belong. This paper is a revised and expanded version of an earlier draft “Getting India Back to the Growth Turnpike: What Will It Take?”. Comments from Nirvikar Singh and Paul Cashin on earlier drafts are gratefully acknowledged; the usual disclaimer applies.


The real GDP growth rates and related data in this paper are based on the National Accounts Statistics (NAS) series with 2004-05 base. A new NAS data series with base year 2011-12 was released in January 2015 by the Central Statistical Organization (SCO), but the new series currently provides data for 2011-12 onwards only. According to the new series, real GDP growth (factor cost) averaged 5.8 percent during 2012-14, notably higher than 4.6 percent in the 2004-05 series; however, the levels of the GDP in the new series are very close to that of the existing series, with the GDP in the new series being 1-2 percent lower than that in the existing (2004-05 base) series. Availability of back-data in the new series would permit a better assessment of the growth dynamics and the intensity of the slowdown (GoI, 2015). Real GDP growth is estimated to have accelerated from 6.9 percent in 2013-14 to 7.4 percent in 2014-15, according to CSO’s advance estimates. GDP growth rates and the various macroeconomic ratios with respect to GDP in this paper are generally based on the NAS series with 2004-05 base, unless indicated otherwise. Given that the levels of the GDP are broadly similar in the two series, there would be only a very marginal impact on the key macroeconomic ratios used in this paper.


The periodization in this paper follows and extends Mohan (2011a) and is based on significant policy changes (early 1950s, early 1980s, and early 1990s), or significant differences in growth rates (1997–2003, 2003-08, 2008-12 (the NAFC and domestic stimulus impact) and the period since then.


Improvement in the monetary-fiscal interface refers to various policy initiatives in the 1990s and the early 2000s to provide greater flexibility to monetary policy in its conduct and formulation. These initiatives included raising market borrowings at market-related yields, the phasing out of the automatic monetization through ad hocs, continuous development of the government securities market, enactment of fiscal responsibility legislation and restrictions on the central bank’s subscription to primary market issuances (RBI, 2004).


Assets held by the households in the form of gold, although a form of their savings, are shown under the head “valuables” on the investment side in the existing (2004-05 series) NAS statistics (see Table 2). Such investments picked up during 2008-13 (as noted later, reflecting higher domestic inflation, negative real deposit rates and higher gold prices). In the new NAS series (2011-12 base), assets held by the households in the form of gold are also being included in their physical savings.


The NTDPC was chaired by one of us, Rakesh Mohan, and the simulation projections were carried out under his supervision.


These infrastructure numbers are based on estimates for gross domestic capital formation (GDCF) according to National Accounts Statistics (NAS) and are typically lower than those usually made for infrastructure by the. Planning Commission. For example, expenditures made for buying land in the process of making infrastructure investments are not included in GDCF as these are regarded as transfer payments in the GDP context. This and other factors could lead to an underestimation of infrastructure estimates in NAS classification and hence this paper by 1-1.5 percent of GDP (NTDPC, 2014).


PPP projects have been hit by a variety of factors such as the growth slowdown, the policy framework with regard to land acquisition and environmental issues, slow regulatory approvals, and inadequate coal availability. Aggressive price bidding and a disproportionate burden of financing falling on the banking sector have also contributed to the current weaknesses with the PPP model (Lall, 2015).


Prime Minister’s Rural Roads Program.


All OECD averages in this paper for tax rates and collections are unweighted averages.


Personal income tax rates for the OECD countries refer to the federal tax rates, whereas the corporate tax rates include both federal and state tax rates.


Effective tax rate is the ratio of total taxes paid (including surcharge and education cess but excluding Dividend Distribution Tax and Fringe Benefit Tax) to the total profits before taxes (PBT).


Similarly, for the US, evidence indicates an inverse relationship between evasion and information reporting: the tax evasion rate is found to be 56 percent for incomes with little or no information reporting, 8 percent for incomes with substantial information reporting and 1 percent where there is both substantial reporting and withholding (Kleven, 2014).


To quote the press release of Danmarks Nationalbank of January 30, 2015: “Danmarks Nationalbank has purchased foreign exchange in the market and reduced the monetary-policy interest rates. This has resulted in a widening of the negative spread between money market rates in Denmark and the euro area. The interest rate spreads for government bonds, however, have remained positive in the longer maturity segments”.

“Danmarks Nationalbank expects that stopping the issuance of government bonds will contribute to reducing the interest-rate spreads in the longer maturity segments and thereby limit the inflow of foreign exchange”.

Pressing the Indian Growth Accelerator: Policy Imperatives
Author: Rakesh Mohan and Muneesh Kapur