India

India’s GDP cannot grow beyond 3 to 5% per annum in the foreseeable future

A 10% GDP growth is needed to avoid a catastrophe. But barely 5% appears possible. The Government is draining household savings and yet must borrow or sell its assets, explains Sonali Ranade

(Photo by Sonu Mehta/Hindustan Times via Getty Images)
(Photo by Sonu Mehta/Hindustan Times via Getty Images)
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Sonali Ranade

  1. Narendra Modi has never invested in the public sector. Instead he has drained their surpluses through forced dividends and share buy-backs to fund the Govt's PSBR. He has been providing some funding for infrastructure from the budget. But these have so far yielded nothing by way of surplus. Hence the public sector will make no significant contribution to growth over the next five years.
  2. That leaves the private sector, which has two sources of funding for growth. Its internal surpluses or savings which are roughly 10% of GDP. Given an ICOR of around 3, the private sector can generate an internally funded growth in output of about 3.3% pa. For the rest, it must either borrow from households, or it must borrow from the Government, which is broke or it must borrow abroad.
  1. The households save about 16% of the GDP, and are the real milch cattle of the economy. Of this about 5% goes to savings in physical assets like land, gold or housing that generate insignificant returns for the economy, though very handsome returns for households. The balance 11% finds its way into financial markets via deposits in banks, investment in bonds, including Govt bonds, and corporate debt and equity issued by firms.
  2. Note, both the Govt. and the private sector are in contention for this 11% pool of savings to fund themselves. The Govt demand for funds is determined by its revenue deficit + whatever outlays on infrastructure it envisages. Under Modi these have shifted from investing in industry to investing in roads, railways and central vistas. None of these yield very much by way of a surplus for the Govt. This PSBR now totals about 12% of GDP, if you add all the borrowings of Central Govt + state Govts. In short, even if Govt takes every penny saved by households in financial assets, Govt would still have to borrow 1% of GDP abroad or sell assets from its stock for a like amount.
  3. So the private sector gets no money from domestic households since a bulk of the savings by households are risk averse, seek capital preservation, and they flow to the Govt via many disguised channels. The private sector thus has to borrow abroad whether it is directly via bonds or indirectly by selling larger slices of its equity to FIIs, and the like.
  4. In all, the private sector gets about 1% of GDP as FDI and FII investments p.a. But one way or the other, these have to again go to the Govt to fund its PSBR gap. Push all the numbers to the ultimate, and you have a picture of the Govt soaking up 12% of the GDP as its borrowings. Note here that almost 50% of all Govt expenditure now comes via borrowings. Tax revenues at 12 to 13% of GDP cover only half of what Govt spends. How broke can you get beyond that?
  5. But let's add up all the possible GDP growth given known sources of investment in the economy. What do we have? Agriculture, that requires but receives no investment at all can at best grow at 3% every year which contributes at best 1% to GDP growth. Then we have the private sector, which gets 10% of GDP as investment and can generate about 3.3% of GDP growth with that investment. And then you have the Govt. which contributes nothing but only drains whatever FDI and FPI bring in. What do we have in all? Agriculture 1% plus 3.3% from private sector going a grand total of 4.3% pa.
  6. Could we grow after that 4.3%? Very unlikely unless we boost productivity of capital across the economy. That is possible. My back of the envelope math says we can generate about 2.5 times the GDP we currently extract from all our assets. But that requires single minded focus on structural productivity like urbanisation, public transport in small towns, connectivity, scrapping rent laws etc.
  7. I am very skeptical that we can exceed 4.3% - or let's say 5% - GDP growth on sustainable basis. We need at least twice that level to avoid a catastrophe. Productivity & not FDI is the key to getting there.

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