What should India do to achieve an 8% growth path?

In his statement after the latest monetary policy was announced, Reserve Bank of India Governor Sanjay Malhotra noted that economic growth continues to be below our aspirations.

This is not the first time that he has spoken about an aspirational growth rate, which is quite different from the potential growth rate that policymakers usually focus on. The latter tells us what is possible right now, given the growth in capital stock, labour force and productivity. The former is based on ambition for the longer term.

These two statements by the finance minister and the central bank governor come against the backdrop of an economy that has till now maintained its recent growth momentum, along with low inflation as well as a comfortable external situation, despite turbulence in the world economy.

However, there is always the risk of such relative outperformance leading to a form of hubris that could bury the stark facts about the faster growth rate required to reach the Viksit Bharat goal by its deadline. India’s two most important economic policymakers thus did well to look beyond the economy’s immediate achievements.

The tricky question is whether the Indian economy can accelerate even as the world economy is expected to lose momentum because of frictions such as rising protectionism. Sitharaman noted in her speech that the rules of international engagement are being rewritten, and there is little clarity about what the new equilibrium would look like. However, she was clear that what is happening right now is a structural transformation in the international economic system rather than a temporary disruption.

There are some lessons to be learnt from another decade when some countries maintained their economic performance in the midst of global turmoil. That was the decade of the 1970s. There were broadly three categories of countries that could ride out the storm in those ten years, even as some of them faced temporary shocks.

First, there were commodity exporters that saw prices soar of natural wealth below the ground, especially the price of petroleum after the two big oil shocks of the decade.

Second, export-oriented economies of East Asia and Southeast Asia managed to keep shipping goods to foreign markets despite the trouble all around.

Third, there were some countries in Latin America that were more dependent on domestic than international demand, and they tried to keep their economies on track through heavy borrowing from domestic savers as well as international investors.

Commodity exporters rode the wave of higher prices but very few of them managed to build diversified economies that did not depend on a few blessings of nature. Latin American countries imploded under the weight of excess debt, and have not regained their old dynamism even five decades later. That leaves the export powerhouses in Asia that continued to grow their economies, albeit with big crises along the way, such as the currency crisis they faced in 1997.

These broad lessons from the 1970s can be useful in thinking about India’s own economic aspirations in what appears to be a difficult international economic environment. India is neither a big commodity exporter nor an economy dependent on foreign demand. It is well known that the main driver of economic growth in India is domestic demand. There are two important issues that need attention in this context.

One, domestic demand would in effect mean that Indian households have growing incomes to spend. That in turn requires not just robust job creation, but also a higher share of labour income in the economy. The other big component of private sector demand is business investment in new machinery. That will happen only when companies see strong consumer demand on the ground.

Two, a government may be tempted to fill the gap created by any weakness in private sector demand by increasing its fiscal spending through borrowing. Such a strategy makes sense when the economic sluggishness is cyclical rather than structural. The Indian government has run a sensible fiscal policy over this decade.

In other words, moving towards the sort of aspirational growth rate that the finance minister and central bank governor alluded to will require strong domestic savings, policies that strengthen domestic demand while staying an open economy, policies that enhance productivity growth and the tactical use of fiscal or monetary policy.

The risk of trying to move faster without the underlying growth drivers has most recently been revealed in Indonesia. President Prabowo Subianto has been in power for a little more than a year, and he often spoke about the need to lift economic growth to 8% within the next five years. However, fiscal strains led to hasty cuts in key government programmes at a time when household income growth has not kept up with increases in the cost of living, eventually sparking off civil unrest.

The upshot: Economic stability helps economic growth in the long run.

The author is executive director at Artha India Research Advisors.