Optimistic possibilities for Indian growth
Business Standard, 8 June 2025.
The overall context of macroeconomic policy comprises two main issues. The first is the sustained problem of weak private investment over a long period. The second is the remarkable developments in the global economy and a glimmer of possibility for a better position for India. The recent moves by the monetary policy committee, of cutting rates, are in the right direction, and should be seen in the larger macro policy context.
The most important element of India's growth is the emergence of large, high productivity, private firms which control greater resources of labour and capital. Watching the growth of these firms is hence of essence in understanding the Indian journey. In the annual reports of large private non-financial firms, a good measure of investment is the year-on-year growth of the net fixed assets. This has averaged 6.6% from 2016-17 to 2023-24 (a period of 8 years). If we think of the inflation target as 4%, this is a real growth of 2.6% a year, which is not consistent with Indian success.
Why did private Indian firms reduce the intensity of their investment? Largely speaking, this has to do with the problems of central planning and rule of law. Building a business requires immense commitments of emotional energy, time, effort, capital, and children. When the external environment imposes unreasonable levels of policy risk and expropriation risk, private persons feel inclined to pull back. This is the essence of how the socialist pattern of society -- of government control of products and processes inside private firms, coupled with arbitrary power in picking winners -- induces stagnation [EiE Ep89 Industrial policy].
Holding these things constant, a better financing environment will help matters. Holding these risks constant, if more capital were available at a lower cost of capital, this would give higher investment. One perennial lever for this lies in the capital controls regime. Removing capital controls in India is always a good idea, as this reduces the cost of capital within India. There has been some progress of this nature in the recent period, and we hope that much more can happen in the coming year.
And then, there is monetary policy. The fundamental foundation of RBI has to be the inflation target of 4% [EiE Ep68 Inflation targeting]. The biggest contribution that RBI can make to Indian prosperity is to make inflation predictable and stable. When we look at the core CPI, RBI got a big deflation done, getting inflation down from about 6% in the August 2020 to December 2022 period, to about 4% today. This makes cutting rates today sensible.
The international environment has changed in ways that open up new possibilities for India. Recent events have estranged China even more from the core of the world economy. Global firms are trying even harder to reduce their dependence on China as compared with the way things worked earlier. Difficulties in the US also encourage global firms to do more in GCCs and other contracting mechanisms in India.
For a long time, I have been skeptical about the China+1 claims that were made about India: I have kept my eyes glued on the FDI and goods exports data, and noticed that these didn't really budge so far. But it's possible to see early signs of gains now. A ratio to watch is China's exports into the US divided by India's exports to the US. In March 2025, this got down to a historically low value of 2.63. It has trended down from values like 8 in 2019, and slowly gotten better in India's favour.
A good measure of Indian exports is goods+services exports, excluding petroleum products and excluding gold. This was stagnant at about $55 billion for 2022-2024. It has shown some growth in recent months going upto a peak value near $70 billion. The FDI data remains very weak. It is hard to imagine a path to sustained Indian success without much better performance in FDI in India, as foreign firms hold the keys to globalisation and to the knowledge of how high productivity firms work.
An important problem holding India back on exporting is the barriers to globalisation. Tariff and non-tariff barriers make raw materials expensive for Indian producers. Capital controls make capital expensive for Indian producers, and capital is the biggest raw material in many industries. For the first time in many years, we are starting to see gains on these, i.e. with trade liberalisation and capital account liberalisation. This bodes well for Indian exports growth.
The Indo-UK FTA made gains on Indian trade liberalisation, the likes of which had eluded Indian policy makers in preceding years. We may hope that similar big removals of trade barriers would feature in future Indo-US and Indo-EU agreements. And then, once a few important countries have low barriers, the case for trade barriers against anyone else melts away. The wise path for Indian trade policy lies in focusing on China's macroeconomic crisis, and dumping by China Inc., with liberalisation for everyone else.
Every trade liberalisation exerts forces upon the macroeconomy. Lower tariff stimulate import demand, leading to a deterioration of the trade balance. This trade deficit induces INR depreciation to restore equilibrium. Cutting the domestic interest rate also reduces capital inflows, which pushes in the same direction.
If India succeeds as a venue for globalised production, through reduced tariffs, through the desire of global firms for China+US+1 production, and through Indian capital account decontrol, then there can be gains in capital flows into India that can countervail the forces of depreciation.
Levers of policy are often used to try to fight INR depreciation. This is a critical time in India's history, where the stars are aligning in favour of Indian success. The best stance of macro policy is a combination of trade liberalisation, soft monetary policy, improvements on the foundations of policy (the problems of central planning and rule of law), capital account decontrol, and a weaker INR.
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