By Sanjeev Sanyal

The prime minister has set out a clear vision for a $5 trillion economy by 2024-25, a nominal GDP of Rs 375 lakh crore. In turn, this requires sustaining a real GDP growth rate of 8% a year. What are the ingredients of a model that can generate such growth?

The overwhelming evidence, especially from East Asia, is that such high growth rates have only been sustained by an economic model driven by a virtuous cycle of savings, investment and exports supported by a favourable demographic phase. As discussed in the latest Economic Survey, India has already entered a period with a high share of workingage population, and will remain in this ‘demographic dividend’ phase for over two decades. However, favourable demographics is not sufficient.

Broth for Growth

Cross-country data shows that sustained high growth has always been driven by investment. Indeed, a GDP growth rate of 8% will typically require an investment effort in excess of 35% of GDP. Investment, especially private investment, is the ‘attractor’ that drives demand, creates capacity, increases productivity, introduces new technology, allows creative destruction and generates jobs.

East Asia is the most recent example of this investment-driven model. But western Europe did the same during post-World War 2 reconstruction, as did Britain in the 19th century. (London still relies heavily on Victorian infrastructure.)

Note that this is a departure from conventional economic thinking that tries to solve individual problems in silos. Instead, the Economic Survey argues for a virtuous cycle driven by asingle key driver.

Importantly, international experience is that a high investment effort must be backed by domestic savings. Foreign investment can provide additional funds, technology and international value chain linkages. But bulk capital always comes from domestic savings. Foreign direct investment (FDI) seems to be complementary to domestic savings rather than a substitute. (This is an extension of the well-known Feldstein-Horioka puzzle.)

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International data shows that savings are insensitive to real interest rates, except in extreme conditions. Instead, savings are driven by demographics and income growth.

This means that when demographics is conducive, it is possible to trigger a virtuous cycle of savings-investment growth. Notice how the relative insensitivity of savings to interest rates provides a key degree of freedom that can be exploited to structurally lower cost of capital.

Investment-led growth has its own constraints. First, consumption cannot be the primary driver of demand, since it requires high domestic savings. So, who provides the final demand for the large capacities created by high investment? Exports. This is why an aggressive export strategy must be a part of any investment-driven growth model.

While it is true that world trade is currently facing some disruptions, India’s share in global exports is so low that it should focus on market share. One could even argue that the current disruptions provide an opportunity for India to insert itself into global supply chains. The High Level Advisory Group, chaired by Surjit Bhalla, will shortly submit its report on how India can sharply increase exports.

Running the Cycle

Second, the investment-led growth model implies an expansion in the financial system by an order of magnitude — both banks and capital markets. In turn, this runs the risk that such a rapid expansion could be disrupted by a major financial crisis that derails the savings-investment dynamic. This is no idle concern as illustrated by the Asian Crisis of 1997-98.

Some Southeast Asian countries appeared to be recreating the East Asian miracle in the 1990s, but were unable to sustain the virtuous cycle because of large-scale misallocation of capital. India’s recent effort to clean up the banks and establish a bankruptcy process should be seen as valuable investment in this context.

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If India had attempted to press the accelerator five years ago, it would have almost certainly have been hit by a major financial crisis in a few years. Painful as it may have seemed, the banking sector clean-up and the introduction of the new bankruptcy framework are important foundations that will now prove valuable.

Economic Survey 2019 highlights many key reforms needed to trigger investment-driven growth, ranging from unshackling small and medium enterprises from the mindset of ‘dwarfism’, to the use of real-time data for feedback loops. Nonetheless, speeding up the legal system must be top priority, as contract enforcement is now arguably the single biggest issue constraining private investment.

It is commonly assumed that case pendency is a large, insolvable problem.

But the Survey shows that 2,279 additional judges in lower courts and 93 in high courts would be enough to reach 100% care clearance rate (zero accumulation) at even current productivity levels.

Moreover, the efficiency gains needed to clear the backlog within five years are large, but not unachievable. Improving the legal system is, perhaps, the best investment India can make.

The writer is principal economic adviser, GoI



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