Clipped from: https://www.thehindubusinessline.com/opinion/potential-growth-stays-at-65/article69769523.ece
One has to focus on long-term drivers of growth, including the saving-investment rates and the ICOR
Indian economy: Growth drivers | Photo Credit: Andrii Yalanskyi
India’s real GDP grew at 7.6 per cent in 2022-23, 9.2 per cent in 2023-24 and 6.5 per cent in 2024-25. This provides an average annual growth of 7.8 per cent which is also the compound annual growth rate (CAGR) over this period.
In fact, this average is without taking into account, the real GDP growth of 9.7 per cent in 2021-22 which was due to high base effects after the Covid year of 2020-21.
The 9.2 per cent growth rate recorded in 2023-24 also appears to be an outlier. The exceptionally promising post-Covid growth performance raises the question whether India’s potential growth rate has become 7 per cent plus.
In quantifying potential growth, one has to focus on long-term drivers of growth including the saving-investment rates and the incremental capital output ratio (ICOR).
On the output side, real GVA growth is largely driven by service sector growth. The three major service sectors namely trade, hotels, transport et. al., financial, real estate and professional services, public administration and defence et. al. services accounted for 18.6 per cent, 23.6 per cent and 12.5 per cent respectively of overall GVA, considering the three-year average over 2022-23 to 2024-25.
Their average annual growth during this period was 8.6 per cent, 9.4 per cent and 8.1 per cent respectively. Thus together, these three service sectors accounted for 54.6 per cent and showed an average growth of 8.8 per cent over this three-year period of 2022-23 to 2024-25.
Manufacturing, on the other hand, has accounted for a share of 17.2 per cent with an average growth of 5 per cent during this period.
Agriculture has done well in this period with an average growth of 4.5 per cent which compares well with its long-period average growth of 3.9 per cent covering the period 2011-12 to 2024-25.
Thus, manufacturing growth which has lagged behind the overall GVA growth, has to pick up to make India’s overall growth story more robust and balanced.
On the expenditure side, growth in private final consumption expenditure (PFCE) has averaged 6.7 per cent during the period 2022-23 to 2024-25. However, investment measured by gross fixed capital formation, had shown a higher average growth of 8.1 per cent during this period.
Within the overall profile of investment, the government’s thrust on capital expenditures has played a pivotal role with an average growth of 21.4 per cent during this period. Net exports contributed, on average, to the overall real GDP growth during this three-year period only (-)0.1 per cent point, highlighting the importance of domestic factors in India’s growth profile.
Saving and investment ratios
In order to consider issues pertaining to India’s potential growth rate, it is useful to look at the trends in real investment rate and its financing by domestic savings and net inflow of foreign capital. Chart 1 shows real and nominal investment rates as depicted by gross capital formation (GCF), gross fixed capital formation (GFCF) and savings relative to GDP, all in nominal terms.
Savings, together with net inflow of capital finance gross capital formation. The GCF/GDP ratio peaked at 37.5 per cent in 2007-08 and 2008-09 and after that it gradually declined on trend basis to reach a near stabilised level of 32 per cent in recent years. From this if we deduct, investment in valuables, change in stocks and discrepancies which follow a near similar pattern, we arrive at GFCF/GDP ratio which is presently stabilised at about 30 per cent. This is in nominal terms. In order to translate this to real terms, which is relevant for the growth analysis, we need to utilise the relevant deflators relating to GDP and GFCF.
Table 1 shows that the real investment rate measured by GFCF/GDP ratio is higher than the nominal GFCF/GDP ratio. Thus, the process of conversion of nominal saving rate to real investment rate can be considered in three steps.
First, the nominal saving to GDP ratio is considered which has fallen on a trend basis from a peak of 34.0 per cent in 2011-12 to 29.4 per cent in 2023-24. To this net inflow of foreign capital is added. This had declined on trend basis from 2.1 per cent in 2011-12 to 1.3 per cent in 2017-18, and has since recovered to a level of 2.5 per cent in 2023-24. This rise in net inflow of foreign capital has partly made up for the fall in nominal savings rate in recent years. Together, saving and net inflow of foreign capital finance gross capital formation from which, at the second step, valuables, change in stocks, and discrepancies are deducted in order to arrive at nominal gross fixed capital formation rate. Their level, relative to GDP has also come down over time from a peak of 4.4 per cent in 2011-12 to 2.0 per cent in 2024-25.
Thus, on trend basis, the fall in the nominal saving rate has been partly compensated by increases in net inflow of foreign capital and partly by fall in valuables, change in stocks etc.
At the third step, where the nominal GFCF is converted to real GFCF, there is another beneficial effect that arises due to differential price deflators associated with GFCF and GDP.
It may be noted that the Centre has relied heavily on government capital expenditure to support growth in recent years. Growth in the Centre’s capital expenditure averaged nearly 31.0 per cent during 2021-22 to 2023-24. It fell to 10.8 per cent in 2024-25.
However, there are signs of its revival as year-to-year growth in the months of March and April 2025 was 67.2 per cent and 61.0 per cent respectively. State government capital expenditure has also shown a rising trend. This reliance on government capital expenditure will have to be continued until private investment picks up. (To be continued.)
Rangarajan is Chairman, Madras School of Economics, former Chairman, Prime Minister’s Economic Advisory Council and Former Governor, Reserve Bank of India; Srivastava is Honorary Professor, MSE and Member, Advisory Council to the Sixteenth Finance Commission
Published on July 4, 2025
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