The five-trillion math

India’s gross domestic product (GDP) in 2018-19 is estimated at $2.75 trillion (the International Monetary Fund’s figure is $2.71 trillion) at market exchange rates. Prime Minister Narendra Modi has set an ambitious target of a $5 trillion economy by 2024-25. This is meant to be a challenging aspirational target rather than a projection. 

But is it a feasible and virtuous target? 

According to the Economic Survey 2018-19, assuming an inflation rate of 4 per cent, a rupee depreciation rate of 1.4 per cent ($1 = Rs 75 by 2024-25) India needs to grow at a real annual rate of 8 per cent (12 per cent nominal) to get there. 

The rupee, however, depreciated at twice this rate (2.8 per cent) over the last five years. If one were to work with an annual depreciation rate of 2.8 per cent, the $5 trillion target would be reached in 2025-26. 

A similar simulation using India’s GDP denominated in dollars for the year 2018-19 indicates the target can be reached by projecting a nominal annual growth rate of 12 per cent. This, however, makes no provision for the depreciation of the rupee. This depreciation is reflected in the real growth rate of 8 per cent. If the real growth rate of 8 per cent is used instead of the nominal 12 per cent, the $5 trillion target will be reached only by 2026-27.  

The basis on which the Economic Survey 2018-19 used a nominal growth rate of 12 per cent (and a real growth rate of 8 per cent) for its projections is unclear. Average annual nominal growth over the last five years was 11.1 per cent. Sustaining a nominal GDP growth of 12 per cent, and a real growth of 8 per cent, over the next five years, was unlikely even at the time the target was announced. This has become even more improbable following the recent sharp downturn in growth.

A robust growth rate going forward would enable India to catch up with Germany and Japan in terms of GDP
It is consequently both interesting and useful to look at different spreadsheet-based scenarios estimating the likely size of the Indian economy going forward, working with the averages of the last five years — a nominal GDP growth of 11.1 per cent, annual depreciation rate of 2.8 per cent, and inflation rate of 3.6 per cent (GDP deflator). 

Two separate methods have been used in the simulations. In the first, working with the 2018-19 GDP in dollars, the annual depreciation rate is kept constant at 2.8 per cent, with real growth varying between 8 per cent, 7 per cent, 6 per cent and 5 per cent. In the second, working with the GDP in rupees growing nominally at 11.1 per cent per annum, the rate of depreciation is used as the variable, instead of the growth rate.

The received wisdom is that while exchange rates are volatile over the short run, over the medium- to long-run with which we are concerned in this exercise, they reflect the inflation differential between the concerned countries. Over the last five years there has indeed been a close fit between the average depreciation rate of 2.8 per cent and the difference between US and Indian (new series) consumer price inflation (3 per cent). 

The summary of the simulations according to both methods can be seen in the Table. The results are almost identical in both methods. They indicate that the 2024-25 target can be reached only with a real growth rate of 10-10.8 per cent per annum, as against 8 per cent projected in the Economic Survey of 2018-19. A real growth rate of 8 per cent would result in achievement of the target only by March 2027, while 7 per cent will deliver by March 2028, 6 per cent by March 2029-30, and 5 per cent by March 2031-32. 

The likelihood therefore is that it will take at least 10 years to become a $5 trillion economy. India is already the world’s third largest economy at purchasing power parity (after the US and China), and the fifth largest (after the US, China, Japan and Germany). A robust growth rate going forward, such as the $5 trillion aspirational target implies, would enable India to overtake, or at least catch up with, Germany and Japan in terms of aggregate GDP at market exchange rates.

 While aggregate GDP gives a country’s government access to large tax revenues to project hard power, arguably the single best measure for the well-being of citizens — soft power — is per capita GDP or income. Sustained rapid growth during the first decade of the current century enabled India to vastly reduce absolute poverty and transit from a low-income country (below $996 income per capita according to World Bank criteria) to low-middle-income status. 

India, however, remains the only G20 country in the low middle income (below $3,896 per capita) category, with a per capita income of $1,878 in 2018-19. Its global ranking in per capita GDP is 144, about half that of Indonesia, Sri Lanka, South Africa, Iran and Iraq, and less than a quarter that of Brazil, Mexico, China, Turkey and Malaysia. 

Working with the UN Population projections 2019, in all the above scenarios India would remain a low middle income currently with a GDP per capita just above $3,000, compared to $1,878 in 2018-19. It would need to grow at a real rate of 8 per cent to become an upper middle-income country by March 2031, at 7 per cent by March 2033, and at 6 per cent by March 2036.

A more virtuous target befitting a democracy would be to transit to the upper middle-income category by, say, 2030, around the level Sri Lanka and Indonesia are today. The $5-trillion economy would be an automatic milestone on the way. India would however still remain very far from escaping the middle-income trap of $12,055 per capita to significantly enhance its soft power by joining the elite high-income club currently comprising about 65 countries.    
The writer is RBI Chair professor in macroeconomics, ICRIER

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