India: Rapid Recovery and Stronger Growth after the Crisis
9 percent per year, and potentially even faster. Indeed, the government has set a target of such a rate of growth. This is predicated on a stronger supply response in agriculture, as well as higher investment rates and modestly higher factor productivity. If sustained, these would allow India to attain growth rates of 10 percent and higher toward the end of this decade. The potential output gap that opened up during the crisis also allows scope for this upside potential, although the gap is not very large. On the downside, three main factors may lead to slower growth: rising real interest rates, an appreciation of the rupee, and continued slow growth in the rest of the world. Rising real domestic interest rates would most likely result if fiscal adjustment is slower than envisaged and increased borrowing forces rates higher. External shocks could also complicate the picture, especially if global growth is much slower than assumed. Other global shocks could include higher commodity price inflation, especially for petroleum and food, and sudden reversals of capital flows because of shocks in global financial markets. India’s external remittances are large, now nearly 4 percent of GDP, and are relatively steady and diversified (with overseas workers going to the Persian Gulf and a wide array of advanced countries). And even in this crisis, remittances have exhibited little volatility; indeed, receipts have risen in much of the period under review. Domestic shocks that could undermine fast growth include the possibility of rising core inflation (and, hence, tighter monetary policies and higher interest rates), which would force demandside moderation as well as agricultural supply shocks. On the supply side, other risks include rising skill shortages and growing infrastructure deficits (e.g., power, water, transport). Inflation is an immediate concern; core inflation has risen to about 7–8 percent, up from the precrisis levels of 4–6 percent. Much of it appears to be related to the rising food inflation, which should abate as better weather returns and expected supply responses materialize. Fiscal vulnerability is also high because of the consolidated general government’s heavy debt (debt-to-GDP ratio of about 80 percent) and large deficits after this crisis. If both are unexpectedly persistent and rising, medium-term growth could fall by about 1.0–1.5 percentage points below the forecast level, down to 7.0–7.5 percent annually. Externally, if commodity prices were to worsen sharply, the effects would be of similar magnitude.
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