Why in news?

The latest Economic Survey, led by V Anantha Nageswaran, has reassessed India’s long-term economic prospects and raised the country’s potential growth rate from 6.5% to 7%.

This reassessment comes amid an active debate on India’s current GDP growth trajectory and reflects the Survey’s view of improved structural and medium-term growth capacity of the economy.

What’s in Today’s Article?

• What Is Potential Economic Growth and Why It Matters?
• What Determines a Country’s Potential Growth Rate?
• India’s Declining Potential Growth: The Trend
• Why the Economic Survey Sees Higher Potential Growth?

What Is Potential Economic Growth and Why It Matters?

• A country’s potential growth rate differs from its annual GDP growth.
• While GDP growth measures how fast the economy expands in a given year, potential growth shows the pace at which it can grow without causing high inflation.
• If growth exceeds this level, demand outstrips supply and prices rise; if it falls below, resources remain underused.
• Therefore, to achieve sustainably higher growth, governments must focus on raising the economy’s potential growth rate, not just boosting short-term demand.

What Determines a Country’s Potential Growth Rate

• Capital Stock - Potential growth depends on the size and quality of physical assets—such as roads, bridges, ports, factories, and machinery—that support production and expansion in the economy.
• Labour Input - This includes not just the number of workers, but also their skills, productivity, and capacity, which directly influence how much an economy can produce.
• Total Factor Productivity (TFP) - TFP reflects how efficiently labour and capital are used together. Higher efficiency allows faster growth without inflationary pressure.

India’s Declining Potential Growth: The Trend

• Research by the Reserve Bank of India shows that India’s potential growth rate has declined over time:
  • 2003–2008: around 8%, India’s highest growth phase
  • 2009–2015: fell to 7%
  • Around the Covid-19 period: declined further to 6.5%, as acknowledged by the Chief Economic Adviser.
• This decline underscores the need for sustained reforms to rebuild long-term growth capacity.

Why the Economic Survey Sees Higher Potential Growth?

• Reforms Lifting Medium-Term Growth - The Chief Economic Adviser notes that the cumulative impact of recent policy reforms has raised India’s medium-term potential growth to around 7%, reversing earlier declines.
• Manufacturing and Supply-Side Push - Key reforms over the past three years—PLI schemes, FDI liberalisation, and logistics improvements—have strengthened manufacturing capacity and boosted the economy’s ability to expand supply.
• Labour Market Improvements - Measures such as labour law consolidation, lower regulatory compliance, and state-level reforms, along with investments in education, skilling, and apprenticeships, have reduced labour market frictions and improved employability.
• Conditions for Sustained Gains - The Survey stresses that credible increases in potential growth require persistent reforms and macroeconomic stability—conditions it says India currently meets.
• The Caveat: External Risks - Despite domestic strengths, the Survey cautions that geopolitical conflicts and global disruptions could still constrain India’s ability to fully realise its growth potential.