Prof K Subramanian at Idea Exchange: ‘The economy can grow by eight per cent despite negative narratives’

Let me start with a couple of examples, just to anchor the idea. In 1970, the Japanese economy was $220 billion. By 1995, in a 25-year period, it had grown 25.6 times, to be precise, to become a $5.5 trillion economy. If you take China, its GDP grew 22 times between 1996 and 2021. So over a 25-year period, countries have actually grown so much. And that is because of the power of compounding.

The assessment that I’m making for the Indian economy is a multiplication of GDP (gross domestic product) about 15-odd times, which is certainly not as high as the 26 times that Japan grew, or the 22 times that China grew by.

A key macro-economic development happened in India in 2016, which was us implementing the inflation targeting regime. Before 2016, India’s inflation was about 7.5 per cent. Since then, despite Covid, the war in Ukraine, supply chain problems and at a time when advanced economies have faced 2.5 to four times the historical average inflation, India has had an inflation of five per cent. That’s the kind of difference which will translate into a lower rate of depreciation, one for one. This is the most important difference. The other estimates haven’t taken this important development into account.

Prof K Subramanian at Idea Exchange (Express Photo By Renuka Puri)

Now, five per cent inflation means that the Indian rupee’s purchasing power is eroding faster than that of the US at two per cent, which is what led to the significantly higher depreciation. With a seven per cent plus inflation, the Indian rupee was losing value much more. The currency had to depreciate more in order to keep the purchasing power intact. So conceptually, it should be now very clear that higher the rate of inflation, higher will be the rate of depreciation. Conversely, lower the rate of inflation, lower will be the rate of depreciation.

Without taking this very important macroeconomic development into account, they have extrapolated that whatever rate of depreciation has been in the past will prevail. I’ve tested this across various 25-year periods. Fundamentals, eventually, do show up over long runs.

As I have said in the book, with an eight per cent rate of growth, the rate of depreciation is likely to be about half a per cent. I will round it off to one per cent because depreciation will reduce the value in dollar terms compared to the rupee. So eight per cent in real growth, five per cent inflation, that’s 13 per cent in nominal terms. There is one per cent rate of depreciation, so 13 minus 1 is 12 per cent, right? Now, there is this ‘Rule of 72,’ which is used to know how many years it takes to double your money. If you divide 72 by the rate of interest (12 per cent), you actually get the number of years (six) it takes to double the money.

Professor K Subramanian at Idea Exchange (Express Photo By Renuka Puri)

From 2023 to 2047 is a 24-year period, 24 divided by six is four, so there will be four doublings, right? In 2023, India’s GDP was $3.28 trillion, I’m going to round it off to 3.25 so that we can do the math. The first doubling is 3.25 to 6.5, second doubling is 6.5 to 13, third 13 to 26, fourth 26 to 52 or close to $55 trillion. This is the power of compounding. I’ll end by saying that my main ask for the Indian economy is basically eight per cent growth in real terms. There’s no stretch goal involved because five per cent inflation is conservative.

Harish Damodaran: An eight per cent growth per year for 25 years is a huge ask. And along with it, your incomes will grow. We will need more food. Where will the land come from and who will grow India’s food?

This is the question upon which I reflected the most. First, when you look at growth at any level — individual, company or country — it is always a function of your investment rate and what you’re making out of that investment or your return on investment (RoI), which in macro-economic terms we call productivity. Second, it’s really important for us to understand the differences between the Indian economy vis-a-vis some of the advanced economies. This will help us understand why eight per cent growth is sustainable for 20-25 years and why we won’t encounter the law of diminishing returns for the next 20-25 years. Formalisation of the economy will drive productivity growth, our formal sector firms are catching up with their global peers and there is credit creation in the economy. Ours is a catch-up growth.

On SUSTAINABLE DEVELOPMENT:  The plumbing we’ve done in 10 years will make a big difference, an example of which is our digital infrastructure. Even in the US, I can’t just pay through Google Pay. The seller can show data and get credit from the bank

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If you take the extent of credit creation in the economy, the advanced economy average is that for every hundred units of GDP, the credit created is about 180 per cent. For India, the same number is 58 per cent. For every 100 units of GDP, we have only 58 units of credit being created. So there is a huge runway for credit to expand and credit actually leads to investment. It also leads to productivity improvements. I’ve seen this in Bandhan Bank, for instance. A glass bangle seller on a thela was given credit by us. Six months later, he had set up a shop that sold bangles as well as cosmetic items. Ten months later, his wares had saris and dress material. He expanded because we gave him credit. When credit is given for asset creation, it enhances investment, productivity and growth in the economy.

The plumbing that we’ve done over the last 10 years will make a big difference, an example of which is our digital public infrastructure. Even in the US, I can’t just pull out my phone and pay somebody wherever and whenever through Google Pay. The seller can show data and get credit from the bank. World Bank data from 2014 to 2024 shows that the rate of new firm creation has been more than 200 per cent annually compared to 3.2 per cent a decade ago. As a result, we are the third largest entrepreneurial ecosystem in the world now, with more than 120 unicorns. They generate productivity, push the incumbent firms to become more productive and drive innovation. On the Global Innovation Index, we are ranked 39 from 85 in 2015.

On EIGHT PER CENT GROWTH: Formalisation of the economy will drive productivity, our formal sector firms are catching up with their global peers and there is credit creation in the economy. Ours is a catch-up growth

For credit creation, we cannot look at collateral only as the way to give credit, we need cash-flow based lending. None of this growth involves more food, so land is not a concern. Therefore, the premise that this growth will necessarily challenge our resources is not true.

Aanchal Magazine: Given that the net financial savings of households have nearly halved in FY23, do you see that impacting investment growth rate?

It’s important to understand the direction of causality when we talk about savings, deposits, loans, investment loans and deposits. What’s the counterpart of savings at the micro level? It is deposits. It could even be mutual funds. What is the counterpart of investment at the micro level? It is loans that you pay. According to the current theory of financial intermediation, banks are considered financial intermediaries, passing the money parcel. So in the theory of financial intermediation, there is no difference between a bank and a non-banking financial institution (NBFC).

On INDUSTRY-READINESS: These pillars are key — macro-economic growth, social and economic inclusion, agricultural renaissance, ethical wealth creation and a virtuous cycle driven by private investment

But in reality, a bank creates money. If I go to an ICICI bank branch for a Rs 10 lakh loan, it is not going to look at deposits as a necessary precondition for giving me a loan. It will check my credit worthiness and lend. I get a loan, then it gets credited as a deposit in my bank account. So the loan leads to the deposit, it’s not the deposit that leads to the loan. That’s how the loan becomes the asset. The loan creates deposits. This causality has not been understood very well in academic literature but people in the industry understand this very well. The accumulation of all deposits is the savings rate in the economy. The accumulation of all loans is the investment rate in the economy. From here, savings are not a precondition for investment. In fact, research shows that savings respond to growth. During the global financial crisis period and even later, the investment rate fell even though there was no change in the savings rate of the economy.

In 2018, when I joined as the Chief Economic Advisor, the investment rate had gone down though the savings rate was absolutely fine. The investment rate just responds to the anticipated demand and is not a function of savings.

Anil Sasi: You’ve referred to the middle-income trap in the book. The average income in Argentina is about $12,000, we’re under $3,000. We’ve got a long way to reach where Argentina is. Their problem is that they were not able to pull out the next five million up the class divide. The rich grew richer, so the per capita income has gone up, but the average income is not spread all through. Do you think that we might be headed that way?

Let me draw a parallel. If I have a mouse trap that is the size of this cup, the likelihood of a mouse getting trapped in it is not very high. But if I have a trap that is the size of this room, then not just one mouse, there will actually be 100 mice in it. The probability of a mouse getting trapped would be actually very high. If you look at the definition of middle-income itself, it is so expansive. Even if you grow a GDP per capita up to six times — let’s say from about $3,000, we go up to $18,000 or $19,000 — we will still be middle-income.

South Africa and Latin American countries are examples of countries that have been caught in the middle-income trap. Why? They did not refine their growth models as they grew. There is an important lesson in there for India as well on the extent of hand-holding and exposure to competition. If the domestic industry is not strong enough to compete, you will give some protection. But that can’t be forever. Take the Production-Linked Incentive (PLI) for instance. If it continues to be for the next 30 years, then the industry will never ever become capable on its own.

So, it is important to always think about economic policy in a dynamic sense. What is good in 2020 will not be good in 2030 or 2035, because by that time, the industries that need protection will have changed. Argentina or any Latin American country did not do this. Policy supporting industry today does not mean support ad infinitum.

Liz Mathew: After the Lok Sabha election results, the ruling party relies on allies, which will definitely affect the reform process and legislation. Regional parties are forcing the ruling party to go into welfare economics. How will this affect our growth?

Was the 1991 liberalisation done by a majority government? No, it was done by a minority government. The major reforms in telecom, privatisation were done by a minority Atal Bihari Vajpayee government. First, there is ample evidence that politics is not necessarily a binding constraint for reforms. Second, we seem to put the onus of reforms only on the Central government when our Constitution has designed India to be a federal structure with Central, State and Concurrent lists. Let’s say a manufacturer needs land to build a factory, labour, capital to buy the equipment, power to run the factory and logistics to transport its merchandise, both within the country and outside. Of these major inputs, capital is the only one that is the domain of the Central government. Everything else is a domain of state governments, particularly land. Whenever I talk to entrepreneurs about their projects, they talk about land as the most important requirement, which is the state government’s responsibility.

Because you asked me about politics, I want to say that in the last 30 years, irrespective of the political dispensation, the Central government has been far more reformist. It is actually time that we start focussing on states for reforms.

Amitabh Sinha: How resilient is any growth projection to shocks from climate change?

Japan grew 26 times between 1970 and 1995. There were actually big shocks to the world economy — Vietnam war and the oil crisis that resulted in unprecedented double-digit inflation. Even during Covid they didn’t face that kind of inflation. Yet the economy grew. Similarly, when China grew its GDP 22 times from 1996 to 2021, there were Black Swan events like the global financial crisis and Covid. In a 25-year period, there will inevitably be headwinds, but equally there will be tailwinds as well.

Climate change, de-globalisation, the focus on industrial policy that many advanced economies are working on are all potential headwinds. But the potential of using AI can be a really good tailwind for India. One needs to look at not just challenges but also opportunities.

Sukalp Sharma: You introduced the concept of ‘thalinomics’ in the Economic Survey. There’s a suggestion to dissociate food inflation from inflation targeting. Is this a valid idea?

Food inflation is far more supply-side driven. The two items that actually contribute the most to food inflation are pulses and oil seeds. Even among vegetables, in a year when the produce is low, onion prices go up. Then in a year when production is high, onion prices go down. The Central bank can’t work on the supply side of the economy, the government has to.

So when one talks about policy, the Central bank should be tasked with those policy items that it can directly influence. Conceptually, core inflation does not include food or oil price inflation.

Ravi Dutta Mishra: India is trying to boost domestic manufacturing. But there is protectionism abroad in new sectors like clean energy and electric vehicles. We are facing a globalised market, unlike China, which had a free market at the time of its expansion. How will we tackle this challenge?

Emerging economies like India get tutored on tariff barriers. What was right for them cannot be wrong for us. GDP is basically consumption, investment, government spending and net exports. If you take the relative shares, you’ll see consumption accounts for about 60 per cent of GDP. That is completely domestic. Investment accounts for about 30 per cent of our GDP, of which FDI (foreign direct investment) would be 1.5 per cent. Even if it increases, say three per cent, it is only one-tenth of the domestic part. Government spending is another 10 per cent. Cumulatively, that accounts for 100 per cent.

When you start to think quantitatively, the argument that the global economy will have a significant impact on the Indian economy does not hold up. A country as large as India has the advantage of having a very large home market. We need to realise that strength and not blow up the impact of the global economy.

P Vaidyanathan Iyer: In this massive growth that we hope to achieve by 2047, how do you factor in skill development and jobs?

Employment and jobs are where the negative narratives have run far ahead of the actual evidence. A lot of the negative narratives have used the CMIE (Centre for Monitoring Indian Economy) data. But better quality data, for instance, KLEMS (Capital, Labour, Energy, Materials and Services) has found that apart from the 3.5 crore jobs that have been created in agriculture, nine crore jobs have been created over the last 10 years, which means everywhere, 90 lakh jobs have been created. This is consistent with the data on poverty reduction. If you look at the Gini index, consumption inequality has reduced in both rural and urban areas.

You can ask if the employment situation is so good, why has the government, in its recent budget, focussed on unemployment? The real world is not about binary narratives. We need to focus on employment because we have a young population and we need to skill people. The focus on skilling through internship opportunities is a good beginning. We need to focus on ITIs (Industrial Training Institutes) as well because they are adapting their curriculum to the demands of the industry. That is why these key pillars are important — macro-economic growth, social and economic inclusion (of which jobs are a critical determinant), agricultural renaissance, ethical wealth creation and a virtuous cycle driven by private investment.