The long road ahead

With Prime Minister Narendra Modi setting a stiff target of turning India into a $5-trillion economy by FY25, the government has its work clearly cut out. It has to put in place favourable laws, institutions, and policies to create the right ecosystem for the economy to grow from $2.73 trillion in the next five years and convert its mission statement into reality. The first building block of this grand vision was laid out by chief economic adviser Krishnamurthy Subramanian through his “blue sky thinking” in the Economic Survey 2019. Finance minister Nirmala Sitharaman followed by backing the ambitious target with the 2019-20 Union Budget.

Can India attain this target? Some economists might be sceptical, but the government is confident. Drawing inspiration from the investment-led and export-driven economic model of Southeast Asian tiger economies, Subramanian has drawn up a sustained 8% GDP growth model. It is driven by a “virtuous cycle of savings, investments, exports and supported by favourable demographic phase” in which the working age population is higher than others. His model is based on the belief that these favourable demographics will continue for the next two decades, if not more, and thereby help achieve the prime minister’s vision.

Private sector investment is the key to the success of Subramanian’s model. So what will drive the “animal spirits”—a term used by British economist John Maynard Keynes to describe the psychology behind economic decisions—of the private sector? A domestic savings rate of 35% of GDP, a significant bump up from 30.5% today, is critical to boost investment by the private sector and public sector enterprises. Higher domestic savings mean less crowding out of the private sector, higher borrowings, and hopefully the start of a new investment cycle.

Moreover, investment by domestic players will also lead to greater global participation in India. Subramanian highlighted the need for economic reforms such as removing barriers to the growth of small and medium enterprises and speeding up legal enforcement of contracts to spur foreign investment. As the Economic Survey said: “Investment, especially private investment, is the attractor that drives demand, creates capacity, increases productivity, introduces new technologies, allows greater destruction and generates jobs.”

But hitting $5 trillion will be a challenge. Subramanian is focussing more on an exportled model instead of the current consumption-led growth story. Higher savings will automatically mean reduced spending and, therefore, lower consumption. Critics argue such a strategy might not work because the lure of India for most foreign players is its huge and growing domestic market. Economists also feel achieving 8% growth can be quite daunting. According to many studies, including those by the erstwhile Planning Commission, exports need to grow at 20% on a sustainable basis for the next five years to achieve this growth rate.

Sunil Sinha, principal economist at credit rating agency India Ratings and Research, says achieving double-digit export growth—required for 8% GDP growth—is a huge ask given the double whammy of slowing global growth, growing trade friction between the U.S. and China, and protectionist policies adopted by most nations in recent years. “The external environment has changed dramatically after the 2008 global financial crisis and is now turning into repeated trade frictions; accelerating exports growth would be challenging,” adds Sinha.

Sitharaman has not only taken the essence— the importance of private investment—of the Economic Survey forward, but also pushed the envelope by announcing a slew of measures to bring foreign capital for investments into the country. They include increasing foreign direct investment limits in insurance, aviation, and media; reducing domestic sourcing requirements for single-brand retail; and allowing foreign portfolio investments in real estate investment trusts.

The government plans to set up a sovereign wealth fund like China to tap into a broader international investor base; it also plans to borrow in the international market to take advantage of lower interest rates and ensure that both private and public sector enterprises are not starved of funds. But the economic skies are still cloudy.

India needs to invest heavily in world-class infrastructure like roads, ports, and highways if it wants the investment-led model to work. Even Sitharaman admitted that the country will require ₹100 lakh crore in the next five years to do so. While focussing on private public-partnership, she has not shied away from setting an ambitious target to meet her expenditure targets. Disinvestment proceeds will account for ₹1.05 lakh crore, although it is not clear whether it will be through strategic sales or one public sector unit buying another to finance the government’s fiscal deficit. The finance ministry expects a record dividend payout of ₹1,06,042 crore—a 42% jump over last year—from the Reserve Bank of India (RBI), nationalised banks, and other financial institutions. The RBI has also been roped into the growth story.

The Economic Survey says investment will not be hampered by low interest rates if the demographics remain favourable, a clear signal to the RBI to bring down interest rates further. This will not only act as a catalyst for greater private sector investment but also ensure that the government’s two critical financial arms work in tandem to ensure 8% growth. But the question is: Will all these efforts pay off? The road ahead will certainly be long and bumpy.

This story was originally published in the August, 2019 issue of the magazine.