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Is India's growth rate justified?
Mon, 17 Jun Pre-Open

The World Bank lowered India's growth outlook for the current fiscal to 5.7% from 6.1% estimated earlier and also lowered the growth projection for the world economy to 2.2% from 2.4% that it estimated in January this year.

The World Bank has also said that growth in India and several other emerging economies before the financial crisis was much higher than their potential. The potential GDP of a country is the ideal, or maximum possible GDP for that country if unemployment is at a minimum and all industries, offices, and services are operating at maximum possible output. The actual GDP of a country is the real, or actual, value of all goods and services produced. Actual GDP and potential GDP are often compared to produce one indicator of a country's relative economic health.

The output gap for India, or the difference between actual and potential output, was 2.5% in 2007, 2.2% in 2010 and 0.9% in 2012. A positive output gap means the economy is operating above its capacity to sustain the level of production, which is why it's called an inflationary gap. Operating above their potential growth rate has led to the overheating in Indian economy which led to high inflation and current account deficit.

The government's economic reforms through the second half of 2012, coupled with expected interest rate cuts, should lift India's growth pace through the second half of 2013. However, it will be some time before the economy starts expanding at its potential rate. But it is not yet clear that this will be enough to lift investment in 2013 and 2014. Global businesses are no longer willing to overlook the difficulties of doing business in India. In a more skeptical investment environment, the government's efforts, including lower interest rates, may have only a marginal impact on business sentiment and investment.

India's steep growth deceleration mostly closed a large positive output gap that had opened up in the post-financial crisis period. The 2012 output gap in India is either positive or close to zero (less than 1%), suggesting limited scope for growth to accelerate in the short run. In other words, the recovery is going to be slow and may take a long time.

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