Source: The post “Estimating India’s potential growth rate” has been created, based on “Estimating India’s potential growth rate” published in “The Hindu” on 14 October 2025. Estimating India’s potential growth rate.
UPSC Syllabus: GS Paper 3 – Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.
Context: The potential growth rate represents the maximum rate of economic expansion that an economy can sustain without generating inflationary pressures. For India, it has traditionally been estimated around 6.5%, though recent data suggests it may currently be higher at 7–7.8%, based on the first quarter GDP performance for 2025–26.
Recent Growth Performance
- The first quarter real GDP growth of 2025–26 is estimated at 8%, compared to an average of 9.9% between 2022–23 and 2024–25 (post-COVID recovery years).
- Average real GDP growth for the last three years stood at 6%, 9.2%, and 6.5%, respectively.
- On the output side, real GVA growth for Q1 of 2025–26 was 6%, lower than the 9.5% average for the previous three years.
- Growth was driven largely by manufacturing and services (especially transport, trade, and finance).
Potential Growth and ICOR Relationship
- The Incremental Capital Output Ratio (ICOR) is crucial in determining potential growth.
- Real GFCF averaged 5% of GDP between 2022–23 and 2024–25.
- Assuming an ICOR of 5.2, potential growth stands at around 5%.
- Therefore, maintaining or raising potential growth requires higher GFCF or lower ICOR (more efficient investment).
Trends in Capital Formation and Investment
- The Gross Fixed Capital Formation Rate (GFCFR) in Q1 2025–26 was 6%, marginally above the recent three-year average.
- Public sector investment has risen, especially in infrastructure, but private investment remains tepid.
- The public sector’s share in total GFCF has risen from 6% in 2021–22 to 25.1% in 2023–24, while private investment slowed down.
- Sustained growth needs a revival of private capital formation, supported by conducive policies.
Policy Implications of a 6.5% Potential Growth Rate
- A 5% potential growth rate may seem modest, but it remains realistic under present global conditions.
- To lift potential growth above 6.5%, India must:
- Raise GFCFR by at least 2 percentage points.
- Increase corporate sector share in total investment from 37% to 34.4% (2021–24) levels.
- Ensure efficient use of capital (reducing ICOR).
Prospects and Influencing Factors
Positive Influences:
- Technological innovations such as Artificial Intelligence (AI) and Gen AI can raise productivity and reduce ICOR.
- Continued public investment in infrastructure enhances supply-side potential.
- Structural reforms in logistics, energy, and manufacturing may boost long-term capacity.
Negative Influences:
- Rising capital intensity and rapid technological changes may cause jobless growth.
- Tariffs and supply chain uncertainties could constrain exports.
- Global slowdown and geopolitical tensions may depress external demand.
Challenges
- Weak Private Investment Sentiment: Private firms remain cautious due to policy uncertainty, cost of capital, and global demand slowdown.
- High ICOR (Low Investment Efficiency): Inefficient use of capital leads to lower returns on investment, limiting productivity growth.
- Slowing Global Demand and Export Weakness: Net exports contributed only –0.4% to growth in Q1 2025–26. Global supply chain disruptions and tariff uncertainties persist.
- Overreliance on Public Investment: Excessive dependence on government capital spending risks crowding out private investment.
- Technological Displacement: AI and automation may reduce employment elasticity, making growth less inclusive.
- Structural Bottlenecks: Land acquisition hurdles, regulatory delays, and inadequate infrastructure impede investment cycles.
- Macroeconomic Risks: Persistent fiscal deficits, inflationary pressures, and geopolitical uncertainties constrain policy flexibility.
Way Forward
- Boost Private Investment: Strengthen investor confidence through regulatory stability, faster project clearances, and credit access.
- Enhance Capital Efficiency: Focus on productivity-enhancing investments in manufacturing, digital infrastructure, and R&D to lower ICOR.
- Balanced Public Investment: Maintain public spending on infrastructure while catalysing private sector participation through PPP models.
- Export Diversification: Reduce dependence on select markets; expand trade partnerships and improve global competitiveness.
- Macroeconomic Stability: Maintain inflation control and fiscal prudence to ensure sustainable capital formation.
Conclusion: India’s potential growth rate currently hovers around 6.5%, with possibilities of rising to 7% if investment efficiency improves. While the post-pandemic recovery has been robust, sustaining higher growth requires reviving private investment, improving productivity, and strengthening capital efficiency. Achieving this balance will ensure inclusive, non-inflationary, and sustainable long-term growth.
Question: What is India’s potential growth rate and what factors influence it? Discuss with reference to recent trends in GVA and investment.
