9 minute read 28 Oct 2021

India will lead global growth but may face a 3-year delay in its US$5 trillion target.

India to emerge as global growth leader in FY22

India is likely to achieve the US$5 trillion GDP target by FY28

By D. K. Srivastava

EY India Chief Policy Advisor

A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.

9 minute read 28 Oct 2021
Related topics Tax

India will lead global growth but may face a 3-year delay in its US$5 trillion target.

In brief

  • The Indian economy is poised to lead global growth in FY22 and retain this position for the next five years.
  • COVID’s deleterious impact has postponed the US$5 trillion target for India by at least three years.
  • Improved fiscal performance of the center in FY22 may permit accelerated infrastructure investment, further strengthening growth momentum.
  • Uplifting India’s saving and investment rates may prove to be critical for increasing potential growth to 7% or above in the medium term.

The central bank, major multilateral institutions and rating agencies released their latest FY22 real GDP growth forecasts for India. As per these forecasts, GDP growth ranges from 8.3% (World Bank) to 10% (ADB). These exceptionally high levels of growth do partly reflect a base effect since India’s GDP had contracted by (-)7.3% in FY21. The FY23 growth forecasts, therefore, indicate a more normal level of growth in the narrower range of 7.5% to 7.9%.

Taking a longer-term view, as per the October 2021 issue of IMF’s World Economic Outlook, the Indian economy is poised to become the global growth leader FY22 onwards. Not only does it overtake China amongst major economies in FY22, it is projected to retain this position for the next five years (Table 1).

Forecasts of real GDP growth percentage

Further, India will be one of the few countries to surpass its pre-pandemic real GDP magnitude by the end of 2021 (end FY22 for India) after the COVID shock forced most economies to contract in 2020 (FY21 for India). Countries like France, Germany, UK and Japan are likely to remain in the negative in terms of the magnitude of real GDP as per the IMF (See In-Focus section of October 2021 issue of EY Economy Watch).

India may reach the US$5 trillion target in FY28

Given these growth prospects, we may reassess the likely year by which the Indian economy would reach or just cross the US$5 trillion mark in three alternative scenarios. In our benchmark solution, we utilize the IMF projections for real and nominal GDP growth up to FY27. The exchange rate projections are also based on data from the IMF. In this benchmark case, the Indian economy crosses the US$5 trillion mark by FY29. In the pessimistic scenario, the real GDP growth is reduced by 1% point starting FY23 as compared to the benchmark solution. Other parameters namely IPD based inflation and exchange rate depreciation are kept at the same levels as in the benchmark solution. In this case, the crossover point shifts one year forward to FY30. In the optimistic scenario, real GDP growth is increased by 1% point beginning FY23 as compared to the benchmark solution. In this case, India reaches the US$5 trillion mark by FY28. The original target date for reaching the US$5 trillion threshold was FY25[1]. As such, it is primarily due to the adverse impact of COVID-19 that achieving this landmark for the Indian economy now stands postponed by at least three years.

India’s US$5 trillion target

Fiscal performance in FY22 may permit accelerated infrastructure investment

Data from the CGA on monthly central finances showed that the center’s gross tax revenues (GTR) grew by 70.5% during April-August FY22 over the corresponding period of FY21, and by 30.1% over the corresponding period of FY20. Non-tax revenues of the center also showed a high growth of 72.6% during April-August FY22. As a proportion of the budgeted magnitude, non-tax revenues during the first five months stood at 61.2% as compared to just 22.4% last year. Further, the sale of Air India by the central government has reinvigorated the government’s disinvestment agenda. This sale is at an enterprise value of INR18,000 crore, out of which INR15,300 crore is the debt to be retained by Tata Sons. The balance of INR2,700 crore would accrue to the government. As per available information[2], the government plans to privatize a number of PSUs this year including BEML, Shipping Corp, NINL, Pawan Hans, CEL and BPCL and is hopeful to meet its ambitious disinvestment target of INR1.75 lakh crore.

The center’s fiscal deficit in the first five months of FY22 amounted to only 31.1% of the budgeted target as compared to the corresponding average level of 94.7% over the last four years. In fact, fiscal deficit relative to GDP during April-August FY22 was at its lowest level since FY01.

With an improved tax revenue growth performance, government may have the option to reduce the magnitude of the budgeted fiscal deficit, though there will be some pressure due to the impact of enhanced global crude prices on fertilizer and food subsidies. There may also be some slippage in non-tax and non-debt capital receipts as compared to the budget estimates. However, it may still be advisable to prioritize growth with a view to consolidate the ongoing growth momentum rather than looking at any possible reduction in the fiscal deficit as compared to the budgeted magnitude. Thus, the government could stimulate public sector demand while retaining the budgeted fiscal deficit level of 6.8% of GDP for FY22 while raising capital expenditure above budgeted levels in the remaining part of the current fiscal year.

Given that the National Infrastructure Pipeline (NIP) targets could not be met fully due to the adverse impact of COVID, the government should take advantage of the improved tax buoyancy and the recently launched National Monetisation Pipeline (NMP) to make up for some of the shortfalls relative to the original NIP targets.

With respect to COVID vaccination, India crossed the milestone of 100 crore doses on 21 October 2021. As on 25 October 2021, 102.3 crore vaccination doses have been administered of which 71.8 crore persons have received one dose and 15.3 crore persons have received both the doses. This implies that nearly 93% of the estimated eligible population[3], that is, population aged 18 years and above, has been administered with at least one dose. Efforts should be made now to complete the coverage of vaccination by the required two doses for the eligible population before considering expanding the program to cover population aged above 12 years, booster shots to vulnerable population segments, and vaccine exports. Investment in health infrastructure should continue to be the focus area.

Growth can be further accelerated by uplifting investment and saving rates

India’s medium-term growth prospects, as per the IMF forecasts up to FY23, indicate a convergence of real GDP growth towards 6%. This is still lower than the previous peak of trend growth rate of around 7.0% during the four years from FY08 to FY11. In fact, if we include the forecasted growth of 9.5% for FY22 and 8.5% for FY23, the trend growth rate is uplifted to only 4.9% by FY23. These trends indicate that more policy initiatives are needed to uplift the trend growth rate to 7% or above in the medium-term. In particular, the public sector, as a whole, led by the central government may do well to substantially increase its investment from the recent level of 7.2% of GDP in FY20, in nominal terms. Increased public sector investment is expected to induce an increase in private sector investment also. It is the falling trend in the overall investment rate from a peak of 39.8% of GDP in FY11 to an estimated 29.3% in FY21 that requires to be reversed (Chart 2). This would require increase in government capital expenditure which can be financed by augmenting the tax and non-tax revenues relative to GDP and containing the revenue account deficit to progressively lower levels.

India’s saving and investment rates

Fiscal consolidation may be resumed FY23 onwards

COVID-19 had forced the central government to respond with strong stimulus measures leading to a temporary but large departure from the FRBM target of fiscal deficit in FY21 and FY22 with a view to minimizing the economic shock and prioritizing recovery. The path of fiscal consolidation may be restored FY23 onwards. The COVID interlude has also given an opportunity to assess and re-define the debt and fiscal deficit targets. In the light of the contemporary empirical realities, the Fifteenth Finance Commission had recommended in its final report, the setting up of a High-Powered Intergovernmental Group to re-examine India’s FRBM. We have recently suggested that the combined debt-GDP target can be raised to 70% divided as 40% for the center and 30% for the aggregate of states[4]. This would translate to a sustainable combination of annual fiscal deficit to GDP targets of 4% and 3% for the center and the states respectively. Such a change, while retaining the interest payment to revenue receipts ratio broadly at 4.2% in view of the falling effective interest rate on government debt, would permit the central and state governments to increase their respective capital expenditure to GDP ratios enabling the fulfilment of the NIP targets which would also be helped by the recently launched NMP.

Summary

With a growth of 9.5%, India will be one of the few countries to surpass its pre-pandemic real GDP magnitude by end of FY22. Strengthening growth calls for utilizing available fiscal space to uplift capital expenditure, while retaining budgeted fiscal deficit level.

About this article

By D. K. Srivastava

EY India Chief Policy Advisor

A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.

Related topics Tax