Tuesday, December 16, 2008

What is India's trendline GDP growth rate?

I am amazed by the number of Indian economists who keep proclaiming in the newspapers, RBI and Finance Ministry that what we are seeing is driven by fear and not reality. So once things turn to normal, India will revert to its trend GDP growth of 8%. 

First, sentiment is reality. Remember the animal spirits of Keynes. Greenspan also said that if he could figure out when greed turns to fear, he wouldn't need any other model. 

Second, the 8% growth rate of 2003-08 for India was during the years of the global credit bubble. I would not be wrong to simply lop off 2%-3% off that to come to a trend GDP growth of 5%-6%. 

And since in FY10 we will go below trendline growth, I would bet on a GDP growth rate of 3%-4%. Even agriculture growth can be negative depending on where agri commodities prices move. So far, I have seen only a few brokerages such as GS or Macquarie talk of 5.5%-6% growth in FY10. This to me is the top end of the trendline growth of 5%-6%, not the bottom end of trendline growth of 8%.  


Econlogic said...

I agree with you about India's growth prospects over the next couple of years, but not with your observations about trend growth.

Potential output of a labor constrained economy is determined by growth of labor force and growth of labor productivity. If the economy tries to accumulate capital at a faster rate, diminishing returns to factor set in as labor acts like the fixed factor.

That is certainly not the case for India. Save skilled labor, given the huge under-employment and disguised unemployment, supply of labor is almost infinite on the margin. The economy can grow as fast as it can accumulate capital. Constant returns to scale production is possible for a long time.

Capital is the constraining factor. Trend growth therefore is determined by the savings rate and sustainable current account deficit. If you look at India's growth experience, each capex boom enhances the economy's trend growth by raising the savings rate.


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