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Determining India’s Potential Growth

India is making its comeback from a period of relatively subdued growth at a faster pace than the world economy, no matter how it is put across

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Much debate has ensued recently, about the appropriateness of RBI Governor, Raghuram Rajan’s recent remark: “in the land of the blind, the one eyed man is king” in reference to the Indian economy. No one seems to disagree with the content of the remark, though.While India shines like a bright spot in the current indifferent global economy, it can indeed perform better by its own past standards.

A recent research paper released by the RBI on its website endorses this argument. The paper makes an attempt to estimate the potential output for India, which provides a good reference for ascertaining where India’s output is compared to where it should be. In determining so, paper says that “output gap…has been negative since the Q3 of 2012, though the gap is closing slowly”.

Output gap is defined as the difference between actual output and potential output. A negative gap implies less than optimal economic performance and a positive gap implies better than optimal performance, which in turn can result in ‘overheating’ of the economy. The existence of a negative gap indicates that India’s actual output is lesser than is potential one, which suggests that India can perform better. However, a closing of the output gap implies that India is moving closer to its potential output, but is still has some way to go.

In terms of growth rates, RBI’s research puts India’s potential growth rate at 6.8 per cent, with a range of 50 basis points on either side. Since India has seen over 7 per cent growth in the past 3 quarters, it has either performed above potential or at least at close to potential, considering the upper end of the range. The catch here is, that the potential output is determined in terms of levels, and growth rate would presumably be derived from there. And different output levels imply different growth rates. Therefore, this number should be interpreted with some caution.

Nevertheless, other approaches to determine India’s trend growth rate also yield similar results. The determination of the number is made challenging by the lack of historical data for the new series which has 2011-12 as the base. With only 4 years of data available for the series, a medium to long term trend is impossible to determine. Another approach is to compare the average difference between growth as per the new series and old series, as had been discussed in this article a few months ago. While this provides a rule of thumb, however, a more accurate picture is awaited in the form of data from the CSO.

At any rate, it goes without saying that India is making its comeback from a period of relatively subdued growth at a faster pace than the world economy, no matter how it is put across.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Tags assigned to this article:
economic growth raghuram rajan inflation infrastructure

Manika Premsingh

Economist and Founder, Orbis Economics

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