Towards A $5 Trillion Economy
"Professional pessimists", as Prime Minister Narendra Modi termed them, scoff at the government's ambition to make India a $5 trillion economy by 2024-25. So is the PM being over-optimistic or are his critics missing the big picture? To answer that question, we need to examine the math.
India's estimated nominal GDP in 2019-20, the base year for our five-year computation, is $3.1 trillion. The nominal GDP growth is real GDP growth plus inflation at current exchange rates and is calculated in precisely this manner by the International Monetary Fund (IMF) and the World Bank for over 190 countries.
In his 2019-20 Economic Survey, Chief Economic Advisor (CEA) Krishnamurthy Subramanian has assumed average annual GDP growth of eight per cent from 2019-20 to 2024-25, an inflation rate of four per cent and an exchange rate of Rs 75 to the dollar by 2024-25. How credible are these assumptions?
Take the estimate of eight per cent GDP growth. This is higher than the average annual economic growth of 7.2 per cent in the Modi government's first five-year term. But keep in mind that GDP growth was impacted in the last two years of the government's term by two one-off events: demonetisation and the introduction of the Goods and Services Tax (GST). Both disrupted growth. In the final two years of the Modi government's first term, viz., 2017-19, GDP growth fell to below seven per cent, dragging the overall five-year growth average down from a putative eight per cent to 7.2 per cent.
With the shock treatment to the economy administered by demonetisation (to digitise the financial ecosystem) and GST (to coalesce multiple state-level taxes) more or less over, GDP growth can be expected to return to its 2014-17 trendline of 7.5-8 per cent. Thus the new CEA's extrapolation of future annual GDP growth averaging eight per cent is reasonable in the absence of a global recession.
What about inflation? The CEA has assumed an average rate of four per cent. With food inflation low, consumption subdued and interest rates high, long-term inflation is likely to remain moderate at 3.5-4.0 per cent.
The third assumption in CEA's projection relates to the exchange rate. Krishnamurthy Subramanian has pegged the rupee in 2024-25 at Rs 75 to the dollar. Over the past year, the rupee-dollar rate has been stable, with the rupee pulling back from over 71 to below 69. Significantly, the United States Federal Reserve has indicated that it could cut interest rates later this year. Though US economic growth is strong and unemployment has fallen to record lows of 3.6 per cent, an interest rate cut of 25 basis points (0.25 per cent) by the Fed will boost dollar flows to emerging economies like India.
With large foreign exchange funds of over $6 billion expected from Arcelor Mittal's acquisition of Essar Steel under the bankruptcy code (once the Supreme Court rules on the matter) and startups continuing to receive copious foreign investment, the rupee should remain stable over the long term, declining on average by the inflation differential between India and dollar-denominated economies at around two per cent a year.
The 2019-20 Union Budget's proposal to issue an overseas sovereign bond in September will draw additional foreign exchange at interest rates comparable to "top economies", according to Finance Secretary Subhash Chandra Garg. All of this could render the CEA's projection of an exchange rate of Rs 75 to a dollar in 2024-25 if anything, relatively conservative.
Now to the granular math. India's nominal GDP in the base year of 2019-20 is estimated at $3.1 trillion at current exchange rates. That makes India's economy already the fifth largest in the world, ahead of Britain and France and behind the US, China, Japan and Germany. An average annual GDP growth rate of eight per cent plus four per cent inflation (12 per cent overall) from 2019-20 to 2024-25 would take India's GDP to $5.44 trillion in 2024-25.
Here's how: A GDP of $3.1 trillion (in 2019-20) plus 12 per cent in each of five successive years will increase to $3.48 trillion (in 2020-21), $3.88 trillion (2021-22), $4.36 trillion (2022-23), $4.86 trillion (2023-24) and $5.44 trillion (2024-25). Now adjust for an increase in the exchange rate of the dollar from Rs 69 (2019-20) to Rs 75 (2024-25). Thus GDP of $5.44 trillion will at 2024-25 exchange rates amount to $5 trillion five years from now.
The key to achieving this is obviously boosting the average economic growth rate to eight per cent, keeping inflation at four per cent and working towards foreign exchange stability. If the math and sensible economic policies by the Modi government converge, India with a GDP of $5 trillion will in 2024-25 be the world's fourth-largest economy, pulling ahead of Germany and nipping at the heels of Japan.
By purchasing power parity (PPP) norms, India with a GDP of $11.4 trillion in 2019, as per IMF, is already the world's third-largest economy. Besides, if India's informal, shadow economy - which comprises, even after demonetisation and GST, around 30 per cent of all economic activity - is taken into account, India's GDP would be far larger than official figures indicate.
"Professional pessimists" shudder at the thought of good economic news. They will point to the 5.8 per cent GDP growth rate in the January-March 2019 quarter to argue against the possibility of future eight per cent growth, ignoring the fact that the average growth over the last five years was more than seven per cent despite the slowdown caused by demonetisation and the introduction of GST.
CEA Krishnamurthy Subramanian may share his predecessor Arvind Subramanian's name but not much else. His 2019-20 Economic Survey has this nugget on behaviourial economics: "India @75 is envisaged as a 'New India' where every individual realises his or her full potential and looks for opportunities to contribute rather than claim entitlements. Behavioural economists have long touted the power of the social norm . most people want to behave or be seen to behave incongruity with these norms."
Nevertheless, it is important for a diverse country to have its share of professional pessimists. They keep eternal optimists at bay and allow rational realists to win the argument.