Michael Debabrata Patra: The Indian economy - opportunities and
challenges
Keynote address by Dr Michael Debabrata Patra, Deputy Governor of the Reserve
Bank of India, at Nomura's 40th Central Bankers Seminar, Kyoto, 25 March 2024.
* * *
I am honoured to be invited to Nomura's 40th Central Bankers Seminar. The
discussions here assume topical relevance in the context of the tectonic shifts
underway in the global economy that present new challenges for the conduct of central
banking. Besides divergent growth pathways and the varying speeds and magnitudes
of disinflation, regime shifts impart their own layers of uncertainty.
In the parlance of the game of cricket, with which India is seen as synonymous and this
also true of the game of baseball, there is a spot in the middle of the blade of a bat from
which the ball rebounds with maximum acceleration and minimal vibration in the batter's
hands to usually race across the field or sail over it. It's called the sweet spot. The
Indian economy is at a sweet spot in its evolution. Real GDP is growing at the fastest
pace among major economies. Inflation is approaching its target albeit unevenly. The
external balance sheet is stronger than ever before, underpinned by ebullient capital
inflows, a modest current account deficit and large foreign exchange reserves. Fiscal
consolidation is into its third consecutive year after the pandemic. The corporate sector
has deleveraged and is poised to launch a new cycle of capital investment. The
financial sector is sounder and more resilient, as it prepares for intermediating the
resource requirements of a rising growth trajectory over the next few decades.
Reflecting these developments, financial markets are ignited with robust optimism even
as investors are already positioning themselves to buy into the unfolding India narrative.
Against this backdrop, I thought I would present to you a few facets of the state of the
Indian economy, some exciting opportunities and the main challenges to India's
aspirational goals. In the interest of time, I will be selective rather than enumerative. For
instance, I will not speak of the transformative social change that is taking place in lifting
415 million (the combined population of the US and Japan) of its people out of poverty
between 2005 and 2021, or the world leadership India has already attained in the
production of a wide range from various agricultural commodities to tractors to
smartphones to IT services, digital payments and satellite launching space technology.
The State of the Economy
India's growth trend is on the cusp of a post-pandemic upshift, with early signs of it
rising above 7 per cent recorded during the 2000s before COVID-19 struck. While
private consumption typically accounts for about 60 per cent of India's GDP, it is
investment and exports that provide the turning points. In the period 2021-24, the export
lever has been muted by global headwinds, but public expenditure on infrastructure is
taking over as the locomotive of the step-up in the growth trend. Recent surveys
indicate that private investment is getting crowded in.
India's recent growth performance has surprised many, triggering a flurry of upgrades.
For instance, the International Monetary Fund (IMF) has cumulatively revised its
forecast for 2023 upwards by 80 basis points between April 2023 and January 2024. In
its latest update, it expects India to contribute 16 per cent of global growth, the second
largest share in the world in terms of market exchange rates by which metric, India is
the fifth largest economy in the world and positioned to overtake Germany and Japan
within the ensuing decade. In purchasing power parity (PPP) terms the Indian economy
is already the third largest in the world. According to the OECD's December 2023
update, India will overtake the US by 2045 in PPP terms to become the world's second
largest economy. This underlying strength will also be reflected in the PPP value of the
Indian rupee (INR).
Opportunities
In this setting, let me cite a few tailwinds that will likely power India's take-off.
First, demographics favour the rising profile of growth. Currently, India has the world's
largest population and the youngest. The median age is around 28 years; not until the
mid-2050s will aging set in. Thus, India will enjoy a demographic dividend window of
more than three decades, driven by a rising working age population rates and labour
force participation rate. This is a striking contrast to a world widely confronted with the
challenge of aging.
Second, India's growth performance has been historically anchored by domestic
resources, with foreign savings playing a minor and supplementary role. In fact, India
bears out the puzzle of high correlation between domestic saving and investment rates
that was observed by Martin Feldstein and Charles Horioka way back in 1980. This is
also reflected in the current account deficit (CAD) which remains within a sustainable
threshold of about 2.5 per cent of GDP. Currently, the CAD averages about 1 per cent
and this is associated with various indicators of external sector resilience - illustratively,
external debt is below 20 per cent of GDP and net international investment liabilities are
below 12 per cent. Debt servicing absorbs less than 7 per cent of current receipts, with
principal repayments due over 12 months accounting for less than 48 per cent of
international reserves. Reflecting these innate strengths, the INR has been among the
least volatile currencies in 2023; it has, in fact, been appreciating in both nominal and
real terms during the early part of 2024.
Third, the response to the COVID-19 pandemic through a large fiscal stimulus took the
general government fiscal deficit to 13.1 per cent of GDP and public debt to 89.3 per
cent of GDP in 2020. A gradualistic path of fiscal consolidation was adopted beginning
2021-22 that has brought the general government deficit to 8.6 per cent of GDP and
public debt to 81.6 per cent of GDP by March 2024. Employing a dynamic stochastic
general equilibrium (DSGE) model, it is estimated that reprioritising fiscal spending by
targeting productive employment-generating sectors, embracing energy-efficient
transition and investing in digitalisation could lead to a decline in general government
debt to 73.4 per cent of GDP by 2030-31. In contrast, the debt-GDP ratio is projected by
the IMF to rise to 116.3 per cent in 2028 for advanced economies and to 75.4 per cent
for emerging and middle-income countries.
Fourth, India's financial sector is predominantly bank-based. In 2015-2016, the
overhang of asset impairment in the wake of the global financial crisis and the ensuing
years was addressed through a deep surgery in the form of asset quality review (AQR).
A massive recapitalisation was undertaken during 2017-2022. The beneficial effects
started to show up from 2018 - gross and net non-performing assets ratios declined to
3.9 per cent and 1 per cent, respectively, by March 2023, with large capital buffers and
liquidity coverage ratios well above 100 per cent. An Insolvency and Bankruptcy Code
(IBC) has created the institutional environment for addressing stress in banks' balance
sheets. On-site supervision is complemented with off-site surveillance, which harnesses
SupTech, big data analytics and cyber security drills. More recently, a virtuous credit
upswing has taken root alongside a strong improvement in bank profitability. Stress
tests for credit risk and interest rate risk reveal that banks would remain above
minimum capital requirements even under severe stress scenarios. Macroeconomic
and financial stability are providing the foundation for medium-term growth prospects.
Fifth, India is undergoing a transformative change leveraged on technology. The trinity
of JAM - Jan Dhan (basic no-frills accounts); Aadhaar (universal unique identification);
and Mobile phone connections - is expanding the ambit of formal finance, boosting tech
start-ups and enabling the targeting of direct benefit transfers. India's Unified Payments'
Interface (UPI), an open-ended system that powers multiple bank accounts into a single
mobile application of any participating bank, is propelling inter-bank, peer-to-peer, and
person-to-merchant transactions seamlessly. Payment systems in India operate on a 24
by 7 by 365 basis. Functionalities like offline payments, feature phone payments and
conversational payments have been incorporated. The internationalisation of the UPI is
progressing rapidly.
Sixth, inflation in India is moderating after surging on multiple and overlapping supply
shocks from the pandemic, weather-induced food price spikes, supply chain disruptions
and global commodity price pressures following the Russia-Ukraine conflict. Notably,
however, inflation in India peaked early in response to coordinated monetary-fiscal
policies to anchor inflation expectations and dissipate idiosyncratic food price
pressures. As a result, inflation has fallen back into the tolerance band since September
2023, with core inflation steadily ebbing to even below the target. The coordinated
approach allowed the RBI to look through the first-round effects of food price shocks so
that supply management balanced supply with demand. This minimised the financial
stability and growth risks of monetary policy tightening.
Challenges
India has emerged from the pandemic scarred but resilient and poised to make a tryst
with its developmental ambitions by riding the thermals that these opportunities are
generating. Take-off will have to contend with the headwinds posed by several
challenges. Again, I propose to be selective in the interest of time.
Reaping the demographic dividend hinges around expanding the contribution of the
workforce to GDP growth. Currently, the contribution of labour to value added in India
compares poorly in a cross-country perspective - in terms of appropriate skills for a
specific job, only 51 per cent is employable, highlighting the criticality of the upskilling
missions that are underway such as Skill India that aims to bridge the skill gap and
enhance employability. Startup and entrepreneurship support initiatives foster
innovation and job creation. Digital transformation through the Digital India campaign
opens up new avenues for employment. Rural employment programmes and women
empowerment schemes also promote the contribution of labour to value added. More
than 80 per cent of the workforce is employed in the informal sector, which I shall
address shortly. Furthermore, India ranks low in women's participation in the workforce1
. Increasing female labour participation is a key challenge, needing social norms in
favour of working women; incentivising diversity in educational institutions and work
places; flexible working hours and women friendly policies and facilities at work places;
2
and promoting work-life balance - metaverse may offer exciting opportunities.
A qualified labour force contributes best when supported by high quality infrastructure.
India's per capita investment in infrastructure at US $ 90.6 in constant 2015 dollars
terms in 2020 needs to be scaled up by lifting infrastructure investment growth from
around 3.5 per cent to at least 6 per cent to achieve world class standards. This will
require transparent regulations, faster clearances, smooth land acquisition and climate
clearance policies, and adequate finance. The sustained infrastructure spending and
logistics push across successive union budgets is creating the environment for
financing India's infrastructure goal. Infrastructure creation has been a key focus of
public policy, with flagship schemes like the National Infrastructure Pipeline (NIP) and
PM Gati-Shakti Mission, complemented by a jump in the share of public investment in
total investment 2015-16 onwards. Sub-national governments and the private sector
have also been empowered through interest free loans for capex and through the
Production Linked Incentive (PLI) Scheme to step up their capital expenditure. The
infrastructure push encompasses roads, railways, ports, electricity, digital infrastructure,
and rooftop solarisation.
The essence of expanding the role of the workforce in India's future lies in the
formalisation of jobs, which bring the role of the manufacturing sector to centre-stage.
India largely bypassed manufacturing in its developmental journey - services account
for two-thirds of India's economy today. India's manufacturing sector as a proportion to
GDP (in constant 2015 US dollar terms) remains much below the world average. Since
3
the 1990s, the average growth of manufacturing has been 7 per cent . With 8.5 per
cent growth, manufacturing's share would rise to 20 per cent of GVA by 2030-31, and to
25 per cent if the growth rate can be pushed up to 12.5 per cent - making India a global
manufacturing hub with forward and backward linkages for other sectors of the
economy. To achieve this, India must adapt to the fourth industrial revolution
(automation; data exchange; cyber-physical systems, the Internet of things; cloud
computing; cognitive computing and creating the smart factory, advanced robotics). A
skilled labour force will hold the key.
India's manufacturing and services must find expression in global markets - make in
India for the world. Intensified efforts need to be made to raise India's exports of goods
and services from US $ 768 billion or 2.4 per cent of the world total to US $ 1 trillion
each for merchandise and service exports or 5 per cent of the global total by 2030. The
potential exists in the form of sectors such as IT and digital services, value-added
agricultural products; high-value tourism; financial services; retail and e-commerce.
Global Capability Centers (GCCs) are already exploiting this potential by offering
unique opportunities to multinational enterprises (MNEs) to lead product innovation,
drive technological advancements, create next-gen intellectual property (IP) and
spearhead digitalisation initiatives on a global scale. India is preparing for this export
thrust through initiatives such as its production-linked incentive scheme, districts as
export hubs; and by supporting the export potential of micro, small and medium
enterprises (MSMEs).
As India emerges as an export powerhouse backed by a strong manufacturing base, a
natural corollary will be the full internationalisation of the Indian rupee. Several factors
are already in place. The Indian diaspora is the biggest in the world and India is the top
recipient of remittances. The Indian rupee trades three times more offshore than
onshore. India has local currency settlement arrangements with several countries in
Asia and the middle east and interlinking of payment systems is underway. Deep and
liquid financial markets are developing. The international financial centre in GIFT city,
Gujarat is emerging as global financial and technology hub with a thriving financial
ecosystem. The imminent inclusion of Indian sovereign bonds in global bond indices is
also likely to spur demand for exposure to India. The policy emphasis on
macroeconomic and financial stability is also a positive for the INR. If the INR's turnover
equals the share of non-US non-Euro currencies in global forex turnover (4 per cent),
the INR will have arrived as an international currency.
The last challenge I will dwell upon is the greening of the Indian economy for
sustainable development. At the Conference of the Parties 26 (COP26), India's
commitment towards the environment by 2030 included: (i) 500 GW non-fossil energy
capacity; (ii) energy mix comprising 50 percent renewable energy; (iii) reducing total
projected carbon emissions by one billion tonnes; (iv) reducing the carbon intensity of
its economy by 45 per cent; and (v) achieving net zero by 2070. It is estimated that a
cumulative investment of US$ 10.1 trillion is needed along with adequate access to
technology to meet the net zero target.
Conclusion
According to the distinguished British economist, Angus Maddison, who specialised in
the measurement and analysis of economic growth and development, India was the
largest economy of the world with the highest share in world GDP during 1 to 1000 AD.
Over the next 600 years, India intermittently fell to the second position, but reclaimed
the position of the world's largest economy by 1700 AD with a share of 24.4 per cent of
world GDP. After that came the colonial rule and a long retrogression.
Given the innate strengths I described and the energies and transformation that are
driving the nation to overcome its challenges and achieve its aspirational goals, it is
possible to imagine India striking out into the next decade with a growth rate of 10 per
cent. If this is achieved, India will become the second largest economy in the world not
by 2045 as shown earlier, but by 2032 and the largest economy by 2050.
Thank you.
Valuable comments received from Harendra Behera, Binod B Bhoi, Asish Thomas
George, and editorial help from Vineet Kumar Srivastava are gratefully acknowledged.
According to the World Bank (World Development Indicators), India ranked 170
among 186 countries in terms of the Female Labour Force Participation rate in 2022.
2
The metaverse refers to virtual worlds in which users represented by avatars interact
usually in 3D, facilitated by the use of virtual reality (VR), augmented reality (AR)
headsets and blockchain technology.
3
Current share of manufacturing is 17 per cent.