At a time when India’s economic growth rate (often measured in terms of GDP) is being hotly debated, the latest Economic Survey (led by Chief Economic Advisor V Anantha Nageswaran) has “reassessed” and upped India’s “potential” economic growth rate from 6.5% to 7%.

A country’s potential economic growth rate is different from the better-known annual growth rate. While the Gross Domestic Product growth rate is the rate at which an economy grows in a particular year, the “potential” GDP growth rate tells how fast that economy can grow without triggering unwanted levels of inflation.

Typically, if demand for goods and services expands too fast — what a GDP growth rate essentially is — it results in prices rising too fast for comfort. That’s because supply cannot keep up with demand. Think of potential growth rate as the growth rate that a country should be achieving under normal circumstances: A pace more than the potential growth rate comes with the risk of higher inflation, and a growth rate less than the potential rate implies that the country is not fully optimising its resources.

It follows that to raise a country’s GDP growth rate in a sustainable manner, the government must attempt to raise the potential growth rate. The potential growth rate, in turn, depends on three main factors (see TABLE).

One, the capital stock in the economy. This refers to all the physical assets in the country — roads, bridges and machinery etc. — that can generate growth.

Two, the labour input. This refers not just to the number of people but also their capacity, their skills.

Three, total factor productivity (TFP). This refers to the efficiency with which labour and capital are used in an economy.

Research from RBI has shown that India’s potential growth rate had been falling over the years. In the 2003-2008 phase, which was India’s highest growth period ever, the potential growth rate was 8%. Between 2009 and 2015, it fell to 7%. By 2023, even the CEA acknowledged that around the time the Covid-19 pandemic hit India, the potential growth rate had fallen to 6.5%.

In the latest survey, however, the CEA notes that “cumulative impact of policy reforms over recent years appears to have lifted the economy’s medium-term growth potential closer to 7 per cent”.

The survey specifically notes the reforms “over the past three years” that have enhanced India’s potential. These include manufacturing-oriented initiatives — such as the Production-Linked Incentive (PLI) schemes, FDI liberalisation, and logistics reforms — that have helped boost India’s ability to produce more (read supply).

On the labour front, the survey finds that “labour law consolidation, reduced regulatory compliance and State-level regulatory reforms have begun to lower frictions in the labour market. At the same time, sustained investments in education, skilling and the apprenticeship ecosystem are strengthening workforce quality and employability.”

The survey points out that international experience shows that such “step-ups in potential growth are most credible when reforms are persistent rather than episodic, and when macroeconomic stability is maintained.” While domestically, “India fulfils both these conditions” the survey does end with the caveat that geopolitical conflicts and their ill-effects have the ability to hold India back from achieving its potential.