Viksit Bharat calls for 2.5 percentage points higher growth, says Montek Singh Ahluwalia

Q. India’s economic growth has been slowing in recent years. What key structural reforms are needed to bring growth back to the 8% trajectory on a sustained Basis?

A. The economy is currently growing at 6.4% in FY25, and this is expected to continue. This is not a bad growth rate, given what other countries are experiencing but it is not in line with achieving Viksit Bharat by 2047. For that, we need around 8.5% growth per year over the entire 22-year period from 2025 to 2047. And since we can expect a slowdown in later years as the economy climbs up the per capita GDP ladder, the “reference rate” we should aim at in the earlier years should be 9% plus.

In other words, Viksit Bharat calls for a growth rate that is 2.5 percentage points higher than at present. This will not be easy. The 1991 reforms raised the longer-term growth rate by about 2 percentage points above the pre-reforms rate. We now need an even larger acceleration.

That will require higher levels of investment and also deeper reforms, implemented more decisively so that we can benefit from higher total factor productivity growth. This will be especially challenging because the international environment is not supportive. The policies of developed countries are also highly uncertain. We will need all the creativity and flexibility we can muster to respond to them. We also face new long-term challenges related to climate change.

Q. The Union Budget 2025-26 focused on boosting consumption, but spending on the social sector and capital building remains flat. Will this be sufficient to drive sustained economic expansion?

A. I don’t think the tax cut can be viewed as a boost because it might increase consumption. The effect of the Budget on aggregate demand is reflected in the change in the fiscal deficit. Since the deficit is being reduced the net effect is actually contractionary. Once the fiscal deficit is fixed as a target, the effect of a tax reduction, via the additional consumption it generates, has to be compared with the effect of some other expenditure that could have been incurred if the concession had not been given.

It is expansionary only if the increase in aggregate demand because of the consumption increase is greater than the increase that would have come from other expenditure that might have been undertaken. For example, if the alternative is to increase the minimum wage in the Mahatma Gandhi National Rural Employment Guarantee Scheme, the extra expenditure from that would have generated more consumption demand in the system because that group’s marginal propensity to consume is much higher. One can of course justify the tax reduction if the idea is to benefit income tax payers, but that is not the same thing.

In any case, short term boosts in demand cannot be viewed as a boost to longer-term growth. That requires action on investment, ease of doing business, improved infrastructure, etc.

"The policies of developed countries are highly uncertain, and we will have to show considerable imagination and flexibility to respond to them" Q. The Economic Survey emphasised deregulation and the Budget has announced a high-level committee to review non-financial deregulation. What are the most critical areas where reducing regulatory burden can accelerate growth and investment?

A. I think this is a very welcome initiative. Our procedures are very complex and place a heavy compliance burden on entrepreneurs. They are much more complicated and time consuming than those in East Asia. They are a hindrance to doing business especially for small entrepreneurs. That is why one often hears that young entrepreneurs in the tech space often leave the country and set up their businesses abroad.

There are also too many regulations where violation attracts criminal prosecution. A study by Manish Sabharwal found over 15,000 such provisions. We would be much better off relying on economic penalties, which can be increased, if necessary, while avoiding criminal prosecution. Making entrepreneurs liable to arrest for non-compliance all too often becomes an excuse for corruption.

I should add that we need to deregulate in both the central and state governments spheres so I hope the terms of reference of the Committee that is being set up will invite it to look at state regulations also. The Centre cannot act in this area, but it can signal to state governments that such a cleaning up is important. Areas that need massive cleaning up at the state level are the regulations related to land and change of land use.

Finally, I hope the proposed Committee will not just be a committee of government officers. It must ideally be headed by an outsider and have adequate representation from business and also experts familiar with procedures in other countries. It should invite suggestions from business bodies in the country, especially from small and medium industries and start-ups.

Q. What fiscal and tax policy measures should the government adopt to balance macroeconomic stability with higher public investment in infrastructure, innovation and social development?

A. That is a very broad range of objectives for fiscal policy to pursue. As far as macroeconomic stability is concerned the important thing is that the fiscal deficit should not be too large since a large deficit effectively crowds out private investment. The finance minister has successfully reduced the central fiscal deficit to 4.4% of the GDP in 2025-26. She has also outlined a trajectory for bringing the debt-to-GDP ratio down to 50% by 2030-31. She has not indicated what this means for the fiscal deficit, but analysts have worked out that it implies a continuing reduction in the fiscal deficit to about 3.5 % by 2030-31.

That is good, but what matters is the combined deficit of the Centre and the states. If the fiscal deficit for the states stays at say 3%, the total of the Centre and states’ fiscal deficit will be 6.5% of GDP. This is lower than it is at present, but it will still be much higher than for most other developing countries.

Looking ahead, we also have to consider the other pressures there will be for additional expenditure, especially in the areas you mention, and how these can be fitted into the lower fiscal deficit.

India’s infrastructure is improving, but there is a long way to go, and we have to continue to invest in this area. Since budgetary resources are scare, we should rely much more on public-private partnerships (PPPs). We have had good experience of this in the roads sector and in airports over the past twenty years. Railway station development, for example, in many cities can be left to PPPs. Similarly, there is no reason why some of the trains, especially those aiming at the section of the public that wants a higher quality of service and is willing to pay, should not be privatised.

You mentioned innovation and that is certainly important. There is a strong case for additional public expenditure on R&D in agriculture, especially because climate change will require more resources to develop climate appropriate new seeds. We also need to increase R&D in the private corporate sector. The best instrument for this may not be public expenditure, but rather more generous tax deductions. We used to allow 200% tax deduction against research expenditure. This should be reintroduced.

Turning to social development, there is general agreement that we need to spend at least 1% of GDP more on education and the same amount on health. Defence is another area where we need to spend more. Our defence expenditure has fallen to below 2% of GDP and this is not consistent with the growing geopolitical tensions in our neighbourhood. It needs to be raised to at least 3% within a five-year period. This is not nationalistic drum beating. It is simply a realistic assessment of the need to upgrade our capacity to the minimum needed.

Fitting all these additional expenditures into the Budget over the next five years or so while still reducing the fiscal deficit will be a challenge. We need to take steps that will improve the yield from taxes, without raising rates. An obvious area for action on the tax front is the goods and services tax (GST). Experts agree that we should simplify the GST rate structure with no more than two rates, with a possible sumptuary third rate for luxuries. The simplification would improve the ease of doing business and lead to higher revenues.

It is true that this can only be done by the GST Council, but since the move has been endorsed by all political parties, we should act speedily on it. The finance minister could take a note to the GST Council making specific proposals in this regard and also make the note public. It could even be discussed in the Parliamentary Consultative Committee before submission to the GST Council. I think it would help mobilise political support for the changes.

On the expenditure side, we should start thinking of phasing out some expenditure. There is a case for a phased reduction in subsidy on nitrogenous fertiliser, which is leading to an imbalance in fertiliser application and wasteful use of nitrogenous fertiliser that actually damages the soil. It could be replaced by a suitable cash subsidy to farmers which would even save money. There is also a case for phasing out the 5 kg of free food given at present to almost 67 % of the population. Since the NITI Aayog has estimated that only about 5% of the population is below the poverty line, the coverage of the free food scheme could be drastically reduced to say 15 or at most 20 % of the population.

Q. The government should consider implementing the privatisation programme it had announced earlier. The idea was that public sector organisations except those in strategic sectors would be fully privatised. This seems to have been put in cold storage.

With our cities bursting at the seams, don’t you think urbanisation is a challenge?

This is indeed a major challenge. If Viksit Bharat comes about, we must plan to provide for a large increase in the urban population, but our existing cities are full to the brim. We need more new cities that can absorb the additions to the urban population.

Expansion of urban spaces runs into problems of land availability and meets political opposition. Perhaps the best way to overcome this problem is to encourage some of our larger states to split into smaller states, and let the new states choose a city to expand to a new capital. The creation of a capital city for a new state would create a political environment in which the usual opposition to land acquisition may be muted. The Centre should consider offering central assistance to any state wishing to split into two, or even three, for the largest states, with the objective of expanding an existing city in that area into a new capital or building an entirely new capital.

Moving away from very large states to more manageable states will also improve development effectiveness. If states were willing to devolve funds and functionaries to lower levels, there may be less need to split states, but they are not. If states are going to be run in a centralised way, I have no doubt that smaller states would be much more effective.

Q. Employment generation remains one of India’s biggest challenges. What labour market and skilling reforms are required to create more high-quality jobs, particularly in manufacturing and services?

A. Employment is indeed a weak spot in performance. However, the problem is not due solely to inadequacy of skills. We are not creating enough jobs, and I don’t think enough jobs can be created if the growth rate remains 6.4%. We need to jack up the growth rate to 8% at least.

The recent announcement of an apprenticeship scheme is an important initiative. This is an area where other countries have done much better than we have, and we should look at the reasons for this more carefully. The scheme that has been announced should be carefully evaluated to see whether it is having the effect intended and if not, how it can be improved.

Q. Despite various policy initiatives, manufacturing’s share in GDP remains low and is even declining. What reforms and incentives can drive a substantial and sustained revival?

A. This is indeed a long-standing weakness in our performance. When I was in the Planning Commission more than a decade ago, we had set a target that the share of manufacturing value added in GDP should be raised to 25%. We were not able to achieve it. The same target was repeated by the NDA government, but the results have not been better. In fact, the share has continued to fall and is now down to 13%.

One reason for the poor performance is our failure to create an environment that would encourage the sector to get into exports and thus access the huge demand that exists in the world economy for simple manufactures. One reason for our failure to capture export markets is poor infrastructure, though this is improving. Another reason is that we have high import duties on basic inputs into such manufactures, which makes Indian products high cost. Lowering import duties on basic inputs—steel, metals, aluminium, polyester fibre, etc—would help. But there are strong vested interests that oppose this.

Q. With increasing global economic uncertainty and a new US administration, what kind of trade and tariff policy should India pursue to safeguard its interests while strengthening its integration into the global value chain?

A. Trade policy in the years ahead does pose a major challenge because the US and other developed countries are turning increasingly protectionist. The protectionism is also of a new type. President Trump, for example, has pronounced that India is a tariff king and he would like reciprocity in tariffs. This suggests that the US will levy tariffs on countries which are equal to the tariffs that the partner country levies on imports of the commodity from the US. This means the US may have different tariffs for different countries for the same commodity.

We have to wait and see how the situation evolves but let me enunciate some broad considerations which should guide our trade negotiators. To start with, we should recognise that our tariffs are much higher than those levied by other developing countries and it can be argued that we would actually benefit from lowering them. If done gradually, accompanied by a corresponding depreciation of the exchange rate, it will not affect the competitiveness of Indian products.

Traditionally, we have favoured trade liberalisation through multilateral negotiations in the WTO. However, developed countries have more or less given up on the WTO route and they prefer to enter into FTAs. If this is the only way to get market access to developed markets, we should also try to negotiate FTAs with our most important markets.

We have succeeded in negotiating some small FTAs, but negotiations with the UK and EU have been impossibly slow. Our negotiators will have to approach these negotiations with a give-and-take approach so that we can come to an agreement. It is a pity that we opted out of the Regional Comprehensive Economic Partnership (RCEP) which would have integrated us with the East Asian market. Reportedly our industry was not confident about its ability to compete with China. If the presence of China was the main problem, we should perhaps join the Comprehensive Progressive Trans-Pacific Partnership where China is not a member.

As far as the US is concerned, it is our largest export market, an important source of technology and FDI and also a major player in global value chains. We do not quite know what position the US will take. It is not interested in an FTA but there is talk of a trade pact. It is in our interest to have an understanding with the US that does not disturb our markets too much. I am not sure what the trade pact will cover but it looks as if they will pressure us to lower tariffs. The finance minister took some important steps to reduce customs duties in the Budget after several years of raising them. This was a good step and there is room to do more. I hope our trade negotiators can adopt a practical approach and come up with a mutually acceptable package.

@surabhi_prasad