Economic Indicators and Various Reports On It- GDP, FD, EODB, WIR etc

The $5 trillion arithmetic

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much.

Mains level : Paper 3- The ambitious target of $5 trillion economy.

Context

The Indian government has set itself a big target, namely, that the Indian economy will have an aggregate income or gross domestic product (GDP) of $5 trillion by 2024-25.

Lack of clarity

  • There is little effort to take it beyond a slogan.
  • When it comes to targets and aims pertaining to the economy, it is important to have-
    • The officials and advisers go beyond the headline.
    • To lay out the details and the road-map for the target.
  • Matter for investors: For international observers and particularly investors, not to see these details creates doubts about professionalism.

What growth rate is required to reach that target?

  • How long will it take to achieve the target at the present growth rate?
    • In 2018-19, India’s GDP was $2.75 trillion.
    • India’s latest official growth rate happens to be 5 per cent.
    • Target will be reached in 2032-33: Continue in the same fashion to compute the size of the GDP and it becomes clear that the target of $5 trillion will be reached not in 2024-25, but in 2032-33.
  • What is the required rate? Set the target as $5 trillion dollars for 2024-25 the required rate turns out to be 10.48 per cent or, approximately, 10.5 per cent.

Why 10.5 rate is an ambitious target?

  • The only example of any nation growing for six consecutive years at an average annual rate of over 10.5 per cent was China from 2003 to 2009.
  • Can India achieve this rate?
    • From 1947 till now, India’s economy grew at over 10 per cent only twice — in 1988-89 and 2007-8.
    • Of these, the first may be dismissed because the previous year the economy had grown very slowly, by 3.5 per cent.
  • What we can learn from the past growth rate?
    • The only example to learn from: The only example from which we can learn is the remarkable growth in 2007-8, made all the more remarkable by the fact that India had been growing well for several years, starting from 2003.
    • And from 2005, India was actually growing over 9 per cent.
    • What factors played the role in high growth?
    • This was a period of professional fiscal policy and steady effort at building infrastructure.
    • India’s economy was making big news in the international media and investment poured in.
    • India’s investment-to-GDP rate climbed to an all-time record of 39 per cent.
  • Current investment-to-GDP ratio: Our investment-to-GDP ratio has crashed to 30 per cent and this takes time to re-build.
    • If we can get back to a growth rate of 7 per cent we will be lucky.

Can inflation make the target achievable?

  • Combination of real growth and inflation can make it possible: Virtually all serious commentators agree that in purely real terms, the $5-trillion target is unreachable.
    • But maybe we can make it by a combination of real growth and inflation.
    • How the combination will work? One way India can get to the target is if alongside say 7 per cent growth, India has inflation of say 3.5 per cent.
    • Then India’s nominal GDP growth rate will be 10.5 per cent.
  • Why the inflation argument is flawed?
    • The five trillion target is in dollar terms.
    • Inflation will lead to depreciation: Typically, if India has higher inflation than the US, the rupee would depreciate vis-à-vis the dollar to account for that.
    • For the sake of pure arithmetic, assume US inflation is zero, India’s inflation is 10 per cent, and India’s real growth rate is 0.
    • In that case, in rupee terms, India’s economy will grow by 10 per cent. But how much will India’s economy grow in dollar terms?
    • The answer is zero.
    • Why is it so? This is because the rupee will typically depreciate by 10 per cent to match the inflation differential, and so the larger GDP of India in rupee terms, when converted to dollars will show no growth.
  • The other possibility of achieving the target?
    • What if the dollar loses value? But this should immediately make it clear that there is another way of getting to the target.
    • This can happen if the US dollar loses value.
    • We can then get to the target of $5 trillion because that will mean less in real terms.

Conclusion

There are two routes to achieve the target of $5 trillion: A huge policy initiative to boost real growth or the luck of dollar depreciation. The luck of dollar would mean nothing for us in the real term so the best course of action for the government is to seek the first option and try to achieve it.

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