Context

• The debate around India’s potential growth rate, its sustainable level of economic expansion without triggering inflationary pressures, remains central to macroeconomic discourse.
• Although India’s recent GDP growth has shown fluctuations, many economists, including the authors of the cited text, maintain that the country’s potential growth rate currently stands at 6.5%.
• It is, therefore, important to critically analyse the arguments, examining empirical evidence on recent growth patterns, the role of capital formation and the Incremental Capital-Output Ratio (ICOR), and the impact of public and private investment trends.

A Contextual Overview of Recent Growth Performance

• The first quarter of 2025–26 recorded a 7.8% real GDP growth rate, a figure that appears robust at first glance.
• However, this number is below the average first-quarter growth rate (9.9%) of the previous three years (2022–23 to 2024–25).
• Similarly, real GVA growth for the same quarter was 7.6%, lower than the 9.5% average of earlier years.
• Thus, while India’s short-term growth remains strong, it does not represent a structural acceleration sufficient to alter the long-term potential growth trajectory.
• Sector wise, manufacturing was the key outperformer with a 7.7% growth rate, higher than its three-year average of 5.8%.
• By contrast, major service sectors, trade, transport, financial services, and public administration, registered lower growth compared to their historical averages.

Potential Growth and the Role of Capital Efficiency

• A central analytical framework employed in the text is the relationship between Gross Fixed Capital Formation Rate (GFCFR) and the Incremental Capital-Output Ratio (ICOR).
• Potential growth is determined by how much new investment (capital formation) translates into productive output.
• In recent years, India’s GFCFR has remained stable, hovering around 33–34% of GDP, with the ICOR averaging 5.2.
• Using these parameters, the authors reaffirm their estimate of a 6.5% potential growth rate (calculated as GFCFR ÷ ICOR).
• Since neither variable shows a structural shift, GFCFR has plateaued and ICOR remains volatile, there is no empirical basis for revising the potential growth estimate upward.
• To exceed 6.5%, India must either raise the investment rate by 2 percentage points or reduce the ICOR through enhanced capital efficiency.

Public Sector Investment: Catalyst or Constraint?

• Public investment has recently become a more prominent driver of fixed capital formation.
• The public sector’s share in total GFCF rose from 21.6% in 2021–22 to 25.1% in 2023–24, largely due to infrastructure spending by the central government.
• While such investments enhance long-term productive capacity, they also exhibit high sectoral ICORs, meaning they yield returns over a longer horizon.
• Moreover, the growth rate of central government capital expenditure, which surged above 30% during 2021–23, fell sharply to 10.8% in 2024–25, signalling a moderation in public investment momentum.
• To achieve a higher potential growth rate, the burden must shift toward private corporate investment, which has declined from 37% to 34.4% of total GFCF during 2021–24.
• A revival of private sector participation is therefore crucial for sustaining capital deepening and efficiency improvements.

Technological, Structural, and Global Influences

• Emerging technologies, particularly Artificial Intelligence (AI) and Generative AI (GenAI), hold potential to boost productivity and lower ICORs through automation, process optimisation, and innovation.
• However, these gains may be partially offset by rising capital replacement needs, as older technologies and equipment become obsolete faster.
• These opposing forces may balance out, keeping long-term potential growth near the 6.5% mark.
• Externally, India faces a challenging global trade environment, marked by tariff uncertainty and supply chain realignments.
• The negative contribution of net exports (–1.4 percentage points) to growth in Q1 2025–26 underscores these headwinds.
• Hence, sustaining high growth will depend on diversifying export markets and broadening global investment linkages, both of which require agile trade and industrial policies.

Policy Imperatives and the Path Ahead

• A 6.5% potential growth rate remains realistic and relatively strong by global standards.
• However, for higher employment generation and inclusive growth, India must push beyond this ceiling.
• Policy priorities should therefore focus on:
• Reviving private investment through regulatory reforms, tax incentives, and financial deepening.
  • Improving capital efficiency by investing in technology, logistics, and skill development to reduce ICOR.
  • Sustaining public infrastructure investment, especially in transport, energy, and digital connectivity.
  • Enhancing export competitiveness amid shifting global supply chains.
• These measures, if pursued cohesively, could help raise India’s potential growth closer to 7% or more over the medium term.

Conclusion

• India’s growth performance in recent years reflects resilience but not a structural transformation.
• Despite cyclical upticks in quarterly GDP data, the economy’s underlying productive capacity remains aligned with a 6.5% potential growth rate.
• Stable investment levels, declining private sector participation, and moderate capital efficiency constrain a higher trajectory.
• Moving forward, India’s challenge lies not merely in achieving short-term growth spurts, but in sustaining and broadening the investment base, both public and private, to unlock a new phase of potential-led expansion.