If you look at the fiscal deficit and inflation amidst a scenario where there have been twin crises – Covid followed by the Ukraine war – I think the macro fundamentals have looked very good when put against the previous global financial crisis. Firstly, it was only a demand-side shock and not a supply-side shock as Covid was and not immediately followed by another shock like the Ukraine war. India entered the global financial crisis in very good economic health but emerged as part of the fragile five due to a very high fiscal deficit. It led to significant capital flight when the Fed started tapering. In contrast, India has done very well with inflation at 90% of the historical average when advanced economies are anywhere between 2.5 to 4 times their historical average.From the interim budget to now, the government has brought down the fiscal deficit even more. Is this aimed at a sovereign rating upgrade?
I do not think that even during Covid when things were far worse… India’s government policies are not or should not be aimed at such a flawed measure like sovereign credit ratings. The government is following fiscal discipline because it is the right thing to do. Given how poorly the sovereign credit ratings are seen…they do not reflect our fundamentals. I think basing our policy on such a noisy measure is not something that I think the government is doing.
The government is talking of taking the deficit number to below 4.5% next year. How feasible is that?
I had said that in the full budget, the actual fiscal deficit number will be lower than the budgeted number because growth will be higher and that is exactly how it transpired. The nominal growth assumed in the budget estimates is 10.5%. I think it will be higher than that. As a result, the fiscal deficit number will be lower than the budgeted number. The budget number is 4.9% of GDP. I think it’ll be 4.8% or 4.7%. Since the 2020 budget, this has been a characteristic of under-promising and over-delivering by the government. Bond markets already have looked at that credibility.
Then comes the growth. You seem more optimistic than the consultants with a $55 trillion forecast when India turns 100. It is kind of a fairy-tale reading.
When I make a prediction, I do not make the prediction out of thin air. There is a rule of 72. It essentially is a close approximation for the number of years it takes for money to double. If your money is growing at 7%, then your money will double in ten years. If it is growing at 10%, your money will double in seven years. Now, when we look at currency movements, a key determinant of the nominal value of a currency is the difference in inflation between two countries.So your main deviation from the rest is on the currency outlook?
If you look at the data since 1991, India’s inflation has been 7.2% on average, up until 2016 when we implemented the inflation-targeting regime. During a period when India’s inflation was more than 7%, US inflation on average was 2%. In other words, the difference in inflation was more than 5%. The rupee depreciated between 3% and 3.5% on average – which means that the currency in real terms was appreciating at about 1.5%. But that real appreciation of 1.5% was being drowned by the inflation differential of more than 5%.
Did the inflation-targeting regime change that?
What has happened since 2016 is that India has implemented the inflation targeting regime, which requires the central bank to deliver inflation at 4% ± 2%. In other words, inflation has to be between 2% and 6%. From 2016 onwards, the average inflation, despite Covid, despite the Ukraine war, has been 5%. That’s the average from 2016 till March 2024. A reasonable expectation for inflation in the next two-and-a-half decades is 4% and 5% if you want to be conservative. The decline in inflation by at least 2% will one-for-one translate into a lower depreciation of the currency.
How does it take us to $55 trillion?
Now, in 2023, India’s GDP was $3.28 trillion. Let me approximate it to $3.25 trillion so that I can work with round numbers. The first doubling is from $3.25 trillion to $6.5 trillion. The second doubling is from $6.5 trillion to $13 trillion. The third doubling is from $13 trillion to $26 trillion. This is an explanation of the numbers using the Ernst and Young prediction. They are assuming the rate of depreciation of the rupee vis-a-vis the dollar to be what has been historically the case. Eventually, over a 20-25-year period, fundamentals have to show up in the currency.
Are these two alone sufficient to get to that number?
Not only has the rate of inflation fallen, even the rate of productivity growth from 2014 onwards till the latest data – I have used the Penn World Tables data – the rate of productivity growth in India has actually more than doubled from 2014 compared to the previous period. So, the rate of productivity growth from 2002 to 2013 is 1.3%. From 2014 onwards, it is 2.7%.
Yet another premise is 8% growth for 20 years as happened in China. Isn’t everything – from the political scene to global trade – completely different from what it was when China began its journey?
Firstly, from 1991 onwards, despite us being a democracy, we have grown at 7%-plus on average. This is despite 10 years of not-that-great policies and some of the policy paralysis etc. Second, China’s growth before 2007 was even higher. The reason I’ve chosen it from 2007 onwards in my book is that in 2007, China’s per capita GDP at that time was almost identical to what our per capita GDP is today. Most of what we have learned in economics is based on growth drivers that we have seen in formalised advanced economies with saturated credit penetration. In contrast, in India, anywhere between two-thirds and three-quarters of our economy is still informal. Just the formalisation – a growth driver that has been absent for advanced economies – will definitely be there for India.
What would be the two or three most important policy decisions that need to be taken to get to your forecast?
First, I would say credit creation. Ubiquitous credit creation. In 1960, India’s private credit to GDP ratio was 8%, and South Korea’s was 6%. In six decades, South Korea’s private credit to GDP ratio has increased to 168%, while India’s has been at 58%. Second is formalisation. And third, innovation and entrepreneurship.