7 minute read 25 Aug 2023
India — towards becoming the third largest economy in the world

India — towards becoming the third largest economy in the world

D. K. Srivastava
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.

7 minute read 25 Aug 2023
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India is climbing the ladder of large economies at an accelerated pace.

In brief

  • India is predicted to become the third-largest economy by FY28, overtaking both Japan and Germany.
  • In that year, India’s GDP is estimated to be US$5.2 trillion, crossing the US$5 trillion benchmark.
  • Strategies to absorb oil price shocks and contain government borrowing at prudent levels would help India sustain high growth in the medium term. 

India’s medium-term growth prospects

While most advanced economies (AEs) are facing an economic slowdown, chronic shortages, high inflation, and aging populations, the Indian economy is acknowledged to be the fastest-growing large economy by major multilateral organizations, including the IMF.

Size of the Indian economy in market exchange rate and purchasing power parity (PPP) terms

In comparing the relative size of the economy, using GDP as a summary measure, two perspectives can be drawn. One relates to the conversion of the domestic currency using the market exchange rates and the other, using the PPP conversion rate. Table 1 shows that in market exchange rate terms, India’s GDP overtook that of the UK in 2021 (FY2022 for India), making it the fifth-largest economy. Further, the Indian economy is projected to overtake both Japan and Germany in 2027 (FY28 for India) to become the 3rd largest economy. At this point, the US economy would still be nearly six times as large as the Indian economy 1.

In PPP terms, which focuses on the purchasing power of the domestic currency within the economy, India is already the third-largest economy, well above Japan and Germany. Further, at the end of 2027 (FY28 for India), the US economy would be only about 1.7 times that of India in PPP terms. In the next few decades, if India can maintain a real growth of about 6% to 7%, it would be possible to catch up with the US economy2.

There are, however, various critical economic parameters other than GDP that are relevant in such inter-country comparisons of economic growth prospects and potential. We consider some of these below.

Trends in the growth of population and workforce

In the current century, unlike other major economies, the Indian economy has a significant advantage linked to the economic potential of its large size and age structure of its population. Recent population trends3  indicate that India has already overtaken China in terms of total population. With this, India is estimated to have the largest share of the global population at 17.8%, equivalent to more than one-sixth of the global population. In terms of the share of working-age population, India is expected to overtake China in 2030. This share is projected to remain not only higher than that of China in the remaining decades of this century, but the gap is also estimated to increase. Further, India would maintain the lowest old-age dependency ratio throughout the remaining decades of the century relative to the peer countries4 , enabling higher saving and investment rates.

A key challenge for the Indian economy is to find productive employment for the large and growing working age population. Creation of suitable employment opportunities is therefore India’s key current policy challenge. This situation may become even more challenging due to the emerging labor-saving technological developments relating to AI and Generative AI. It is notable that India’s total labor force participation rate estimated at 49.6% in 2024 is the lowest among peer countries. India’s female labor force participation rate at 24.1% would also be the lowest amongst these countries.

Trends in indebtedness

Another critical economic dimension is to assess a country’s liabilities relative to its respective GDP, as this indicates the burden of debt servicing for future generations which is to be provided from future income. India is most favorably placed in comparison to its peers with a total debt-GDP ratio5 of 172.7% at the end of December 2022. In comparison, China’s total debt-GDP ratio is nearly 300% and that of Japan is more than 400%. These high liabilities would have to be serviced by these countries, especially in a period when the share of their working-age population would be shrinking. Considering the liabilities of the government alone, India’s general government debt-GDP ratio is the second lowest after Germany.

Strategies for promoting and stabilizing India’s growth

Technological innovations pertaining to AI/Gen AI result in growth-promoting but employment-reducing impacts. India must ensure, by suitable policy support, that the employment reducing effect of these technological developments is overcome by the growth-expansion effects in a manner such that net employment growth remains suitably positive while overall GDP growth is considerably enhanced. Table 2 provides a summary of some of the recent available estimates of the economic impact of AI/Gen AI on the global as well as the Indian economies. 

It is also important to look at economic strategies that would ensure sustaining a high level of growth over the medium term and beyond. Strategies to absorb oil price shocks and contain government borrowing at prudent levels would increase India’s capacity to minimize the adverse economic impacts of externally rooted shocks. In this context, there is a need to redetermine the FRBM norms. In particular, there is a need to provide suitable flexibility for increasing fiscal deficit relative to GDP on the combined account of central and state governments in the face of significant global economic slowdowns or recessions.

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  • Show article references#Hide article references

    1. For the year-wise profile of the size of the Indian economy as measured by its GDP in market exchange rate terms up to FY2048, see, EY (2023). India@100: Realizing the potential of a US$26 trillion economy.
    2. EY Economy Watch (August 2022). In focus section ‘India’s growth potential: the next 25 years and beyond’
    3. India’s total population in 2023 is estimated at 1428.6 million while that of China is estimated at 1425.7 million (https://www.unfpa.org/data/world-population-dashboard)
    4. Includes US, China, Japan, Germany in the context of this discussion
    5. Total debt covers liabilities of households, private non-financial corporations, and the government

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Summary

In the forthcoming decades, India would benefit by capitalizing on its AI/Gen AI potential to take advantage of its unfolding demographic trends. Alongside, government’s debt stabilization efforts would increase India’s capacity to minimize the adverse economic impacts of global economic upheavals. From a policy perspective, India must prioritize investment in productivity-enhancing technologies pertaining to AI/Gen AI and education and skilling facilities for its large and growing working age population.  

About this article

D. K. Srivastava
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 COVID-19
Upvote