Updated: February 18, 2020 10:22:22 am
The Indian government has set itself a big target, namely, that the Indian economy will have an aggregate income or gross domestic product (GDP) of $5 trillion by 2024-25. One sees this target number everywhere — touted in various government documents, including the Economic Survey, referred to in the Budget speech and, in newspaper editorials.
What is unfortunate is that there is little effort to take it beyond a slogan. It is not unusual to have politicians trying to galvanise people around slogans and banners. However, when it comes to targets and aims pertaining to the economy, it is important to have the officials and advisers go beyond the headline, to lay out the details and the road-map for the target. For international observers and particularly investors, not to see these creates doubts about professionalism.
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Minimally, one needs to flesh out what the $5-trillion target means in terms of more granular indicators, such as annual growth, inflation and so on, so that we can then begin to craft policy. The translation to more basic indicators is easy to do. All one needs is pen, paper, calculator and a little patience. It is the kind of exercise which school children can do faster than adults.
Let us begin. In 2018-19, India’s GDP was $2.75 trillion. India’s latest official growth rate happens to be 4.5 per cent. We all hope that this disappointing performance will be short-lived but for the sake of basic arithmetic, let us ask how long it will take to get to the $5-trillion mark if India continues to grow at this rate. Clearly, in 2019-20, the GDP will rise to $2.87 trillion, which is $2.75 trillion plus 4.5 per cent of 2.75. Continue in the same fashion to compute the size of the GDP and it becomes clear that the target of $5 trillion will be reached not in 2024-25, but in 2032-33.
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As pointed out above, this is no surprise. A target is not something that happens by business-as-usual. It is aspirational. We have to get the nation growing faster than the abysmal performance seen in recent times. So what we need to do is the reverse arithmetic. Set the target as $5 trillion dollars for 2024-25 and compute the implicit growth rate that will get us there. This turns out to be 10.48 per cent or, approximately, 10.5 per cent.
This is a hugely ambitious target. As far as I know, the only example of any nation growing for six consecutive years at an average annual rate of over 10.5 per cent was China from 2003 to 2009. China had another comparable sprint from 1991 to 1997 but there were some fluctuations then.
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Can India get this rate? Right now, with India’s economy spiraling downwards, it seems not possible but let us look back at our own history. From 1947 till now, India’s economy grew at over 10 per cent only twice — in 1988-89 and 2007-8. Of these, the first may be dismissed because the previous year the economy had grown very slowly, by 3.5 per cent. So a large part of the growth in 1988-89 was a catch-up. Further, the late 1980s were a period of fiscal profligacy for which India paid a big price in 1991. Thus, from our own history, the only example from which we can learn is the remarkable growth in 2007-8, made all the more remarkable by the fact that India had been growing well for several years, starting from 2003. And from 2005, India was actually growing over 9 per cent. This was a period of professional fiscal policy and steady effort at building infrastructure. India’s economy was making big news in the international media and investment poured in. India’s investment-to-GDP rate climbed to an all-time record of 39 per cent.
There are lessons to be learned from this history, but even with that, to grow at 10.5 per cent for six consecutive years at this time is nearly impossible. For one, our investment-to-GDP ratio has crashed to 30 per cent and this takes time to re-build. If we can get back to a growth rate of 7 per cent we will be lucky.
There is one aspect of the aggregate economy that I have not talked about as yet — inflation. Virtually all serious commentators agree with me that in purely real terms, the $5-trillion target is unreachable, but maybe we can make it by a combination of real growth and inflation.
A popular argument goes like this. One way India can get to the target is if, alongside say 7 per cent growth, India has an inflation of say 3.5 per cent. Then India’s nominal GDP growth rate will be 10.5 per cent. That was the target growth. These commentators would admit that by this combination of real growth and inflation, a part of it would be the chimera of prices, but we would still get to the target figure. I have heard this argument repeatedly and by serious commentators, both among defenders and critics of government policy. But the argument is wrong.
The five trillion target is in dollar terms. Typically, if India has higher inflation than the US, the rupee would depreciate vis-à-vis the dollar to account for that. For the sake of pure arithmetic, assume US inflation is zero, India’s inflation is 10 per cent, and India’s real growth rate is 0. In that case, in rupee terms, India’s economy will grow by 10 per cent. But how much will India’s economy grow in dollar terms? The answer is zero. This is because the rupee will typically depreciate by 10 per cent to match the inflation differential, and so the larger GDP of India in rupee terms, when converted to dollars will show no growth.
It follows that we cannot get to the $5-trillion mark by supplementing the growth that falls short of 10.5 per cent with inflation, as many have argued. But this should immediately make it clear that there is another way of getting to the target. This can happen if the US dollar loses value. We can then get to the target of $5 trillion because that will mean less in real terms.
In other words, let us say we get real GDP growth up to 7 per cent per annum. Let us also assume India maintains its target inflation of 4 per cent. The only route then is to persuade Trump to get US inflation up to 7.5 per cent. This will weaken the dollar vis-à-vis the rupee by 3.5 per cent each year. In short, there are two routes: A huge policy initiative to boost real growth or the luck of a dollar depreciation.
This article first appeared in the print edition on February 18, 2020 under the title “Economic Graffiti: The $5 trillion arithmetic.”
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