When Will India Reach its Full Potential?

Abstract

India has always held great economic promise. Its recent economic performance has captured the imagination of policymakers, financial markets, analysts, as well as the general public, and led to bold predictions of even greater things to come. But it is often said that India is a place of contradictions-in effect, an admission that India can excite and disappoint at the same time. This time is no different. While making bold projections of future achievement, many are also pointing to some of the growth constraints that India faces.The purpose of this article is to explore India's growth possibilities, but to do so using a credible yardstick against which its growth can be measured. Comparison with other countries is somewhat useful, but ultimately performance needs to be measured against India's own intrinsic capabilities. These capabilities are neatly summed up in a measure of the country's long-term potential growth rate, that is, the pace of growth that the economy can sustain over an indefinite period of time based on its own internal structural capacity.This article proposes such a measure. It then assesses India's past, present, and near-term future performance against this measure. In addition, India's technical capacity to sustain growth in excess of this pace over a protracted period is examined. Finally, the article examines in some detail two fundamental constraints that have the potential to frustrate India's growth aspirations and identifies the steps that will be necessary to overcome those hurdles.RECENT PERFORMANCE AND CYCLICAL OUTLOOKIndia's economic growth over the past 25 years has been quite impressive, with real growth averaging just under six percent. In 2003, however, India seemed to move up onto a significantly higher growth plane, posting growth of 8.3 percent and maintaining above eight percent growth ever since.Unsurprisingly, this has people extrapolating such performance long into the future, and the technical feasibility of such forecasts is the main subject of this article. At the outset, it must be acknowledged that India's recent growth acceleration came in the context of a global boom. Following the sharp slowdown in 2001, the world economy spent two years rebuilding momentum. Recovery was cemented in 2004, when global growth hit a blistering 5.3 percent, the strongest pace experienced in over 20 years. Since then, the pace of global growth has remained remarkably strong, racking up 4.9 percent in 2005, and on track to tip the scales at 5.1 percent in 2006. It would be surprising were India not to grow above-trend in such circumstances, which is the same as saying that it is doubtful that all of India's growth has been self-generated.What lies in the immediate future? At the time of this publication, the global economy is beginning to moderate, as a slowdown in U S consumer spending spreads from country to country. Softer global demand is expected to dampen demand for India's exports to some extent. However, the slowdown is bound to increase competitive pressures in global markets, which means that India's relatively low cost base will still be eagerly sought by globalizing companies. Further, the rapid growth of recent years is expected to translate into stronger domestic consumer spending, while ample business opportunities and improvements to the investment climate will combine to maintain robust investment spending growth. On balance, then, we see a solid cyclical outlook for India, sufficiently so that, fearing an onset of inflation, the central bank has raised short-term interest rates to the highest level in six years. Export Development Canada (EDC) is expecting India's growth to ease to 7.5 percent by the end of 2007, less than seen in the past three years but still well ahead of the longer-term average.INDIA'S THEORETICAL LONG-TERM GROWTH TRACKComparing India's recent growth track to its longer-term trend-or to the performance of other countries-is of limited use. …