What is holding back India's growth story?

Feels good to be writing again after 18 months. In this blog I would like to identify the key factor which is holding back the Indian growth story. Let's start by looking at the basic blocks of GDP. GDP can be captured in the following basic formula,

GDP= C+G+I +NX

C: Consumption

G:Government Expenditure

I:Investment/capital formation

NX: Net exports

India is a consumption economy and this evident in the following graph,

The above graph clearly shows, that private consumption is the main driver of Indian GDP. And private consumption as a % of the GDP has not changed a lot over the last 10 years. Government expenditure also has been constant at ~10% of the GDP. The main variant of GDP has been the capital formation.And it is this variation that holds the key to problem of static growth that the Indian economy is facing over the last 2-3 years.

Lets look at the % growth (net exports growth being shown on the secondary axis on the right) of each of these elements during the periods of 2004-2007, 2009-2012 and then from 2012-2015.

In each of the three periods, private consumption has been in the range of 5%-9%, hitting a peak of 9% in 2007 and the bottom of 5% in 2012. Government consumption also has been in a narrow range of 5%-8%. The exceptions being the 2008-09 and 2009-10, wherein GFC led to a huge stimulus being implemented by the Government to keep growth intact.

On the other hand, NX and capital formation growth rates have varied a lot. (Note: Considering that India was a net importer during the last 10 years, a smaller positive or negative growth is beneficial to GDP quantitatively). The falling growth rates of capital formation are a key reason for the static growth over the last 3 years. The strong contribution  and stable growth of both government and private expenditure is the reason why Indian economy has a floor when it comes to growth. However, these two key pillars of the Indian economy will not be the main drivers of any growth. A deficit expenditure by the government or a spurt in personal consumption on the back of a credit boom can lead to a strong growth of the Indian economy. However even though this will be positive in the short term, it will be negative in the medium term and can lead to bigger problems. Hence the focus has to be on pushing investments or making the country an export oriented one.

Becoming an export oriented economy is not a good theme in current global environment. The following statement in the WTO's press release on 30th September 2015 only makes it evident that purely focusing on export driven model will not work for India.

"If current projections are realised, 2015 will mark the fourth consecutive year in which annual trade growth has fallen below 3 per cent and the fourth year where trade has grown at roughly the same rate as world GDP, rather than twice as fast, as was the case in the 1990s and early 2000s"

Hence, a combination of investment which focuses on replacement of imports through domestic manufacturing and infrastructure development is required for GDP growth to pick up again. The Government initiatives of focussing on "Make in India" and attracting investments is a step in the right direction. "Make in India" has to be utilised as a platform for replacement of imports and the Government has to continuously focus on increasing investments and making the required changes so that investment can pick up. This is the only way the Indian economy can grow at a faster pace in the current global enviroment.

Data source: Reserve Bank of India