Abstract
The recent decline in gross domestic product (GDP) growth in India raised a debate about whether it is a trend or a business cycle slowdown. We observe a cyclical downturn post-global financial crisis due to external and domestic conditions. With global recovery strengthening an appropriate demand management policies, the business cycle downturn can be reversed. At the same time, the economy witnessed negative shocks to trend growth caused by policy uncertainty. In this paper, we argue that these shocks are temporary. A stable policy environment can give positive shocks to growth. Policy action eliminating frictions that hamper efficient allocation of resources in factor markets can be seen as a positive shock that will pull up trend growth of output. Given that the supply of factors, namely labor, human capital, infrastructure, and non-infrastructure capital appears robust and productivity growth potentially strong, timely reforms that eliminate structural bottlenecks will enable trend growth to pick up.
Highlights
After growing at an average rate of 6.3% in the past three decades (1981–2011), India's gross domestic product (GDP) growth fell from 8.9% in 2011 to 6.7% in 2012 and further to 4.5% in 20131
We look at the supply-side factors that generated output growth in the past 3 decades, and assess whether their growth patterns can throw light on this question—is the economy currently operating below trend in a business cycle slowdown, or has trend growth of output itself declined?
Since the liberalization reforms in 1991, the Indian economy is subject to business cycle fluctuations with high output volatility, a characteristic feature seen in emerging economies (Ghate, Pandey, and Patnaik 2013)
Summary
After growing at an average rate of 6.3% in the past three decades (1981–2011), India's gross domestic product (GDP) growth fell from 8.9% in 2011 to 6.7% in 2012 and further to 4.5% in 20131. Following liberalization reforms in 1991, Ghate, Pandey, and Patnaik (2013) find that India started having business cycle fluctuations closer to market-based advanced economies, though characterized by stylized features of emerging economy cycles such as higher relative consumption volatility and countercyclical trade balance This raises a question about whether the recent GDP growth decline is in the trend or the cycle. Part of the slowdown can be attributed to negative shocks to trend arising from the policy and decision making framework This increased uncertainty in the economy led many projects to be stalled, which caused investment, in particular, to drag down output growth. We see a decline in infrastructure investment post-global crisis, and evidence suggests that besides cyclical factors, policy and structural reasons contributed to the fall.
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