Five important facts about the Indian economy

By Chetan Ghate

India’s remarkable economic growth in the last three decades has made it one of the fastest growing economies in the world. While India’s economic growth has been impressive, rapid growth has been accompanied by a slow decline in poverty, persistently high inflation, jobless growth, widening regional disparities, continuing socio-political instability, and vulnerability to balance of payment crises.

(1) India’s growth is unbalanced.

India’s growth has been unbalanced — both across states and between urban and rural areas. The fruits of growth have also not reached the bottom 20 % (roughly 250 million). Regionally, the variance of incomes within and between states have both been increasing. As of 2008, there was a 9.8 fold difference between the richest state Goa and the poorest state Bihar. This is larger than the real income gap between the GDP per capita of the USA and Angola, and only slightly smaller than the real income gap between the USA and India. At the district level, however, the gap is much larger. The fact that differences within India are comparable to cross-country differences is remarkable given that there are no political barriers to migration, approximately free trade, and a common set of federal institutions, policies, and governance. The growing regional disparities have dampened political resolve for further economic reforms that might further amplify regional inequalities.

(2) The service sector is the largest sector in a country at a low level of development.

During the course of development, most economies undergo substantial changes with large shifts in resources across the agricultural, manufacturing, and service sectors. In the context of the developing process, India stands out because India’s service sector currently is close to 60% of the economy. In spite of a large increase in services (and trade) and a rapid growth in the service sector, there has not been a corresponding rise in the share of services in total employment. The large size of the service sector is comparable to the size of the service sector in developed economies where services provide around 60% of output and an even larger share of employment. Further, the entire decline in the share of agriculture in GDP has been picked up by the service sector, with manufacturing sector’s share over the last 25 years staying roughly the same. In general, such a trend is experienced by high income countries and not developing countries. The service sector is also yet to significantly contribute to tax revenues. The agriculture sector in India continues to employ half the population (roughly 600 million) in low productivity jobs.

(3) India’s pro-poor growth strategy presents long-term macroeconomic challenges.

The first challenge is inflation. Rising rural per-capita incomes need to be matched with increases in rural productivity in order for redistributive schemes to be non-inflationary. In other words, high wages in agriculture with low productivity can be inflationary. The second challenge is the fiscal deficit, which is an additional source of inflation and has spilled over into the current account leading to a lot of exchange rate volatility. India’s exchange rate volatility may constrain the realisation of our growth objectives. The third challenge is raising productivity. A bulk of India’s labor force is engaged in low-productivity cottage type industries with little physical human or physical capital. This hinders productivity. The formal sector has also not expanded at the expense of the informal sector to absorb a greater part of the labor force. Finally, there is a raging debate on minerals versus forests, even though a bulk of minerals lie underneath agricultural land.

(4) Corruption is associated with lower economic growth.

Corruption is associated with lower growth and lower tax revenues. For instance, some estimates suggest that only 10% of the public distribution system (PDS) money in India reach the targeted population with the rest being all leakages. Not only do such leakages drastically reduce the effectiveness of anti-poverty schemes, the lack of tax revenues is compounded by huge transfer payments on social welfare programs leading to a large fiscal deficit.

(5) The Indian economy has grown greatly since the 1991 reforms.

Notwithstanding these challenges, the Indian economy has almost quadrupled in size since 1991, growing at close to an average of 7%. Savings and investment rates are higher at around 32% of GDP. Nominal per capita incomes in 2013 are in the 1500 USD range. The demographics of a young population offer a distinct growth advantage. Service sector productivity — the biggest sector in the economy — has also increased since the reforms. In terms of factor accumulation, sustaining growth is feasible. The current rupee crisis and global downturn notwithstanding, trade will continue to serve as an engine of growth in the years to come. Our share of the world’s merchandise exports has risen from 0.5% in 1993 to 1.5% in 2010.

Chetan Ghate is Associate Professor in the Planning Unit at the Indian Statistical Institute, Delhi. He is the editor of The Oxford Handbook of the Indian Economy. Oxford Handbooks in economics are available online as part of Oxford Handbooks Online.

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