There is near unanimity that India’s GDP growth had been slowing down, even before the pandemic struck. Per capita growth averaged 5.3 per cent per annum during 2012-20, but slid to 3.8 per cent between 2018 and 2020. Opinion is, however, divided on whether this is a structural or a cyclical decline, and whether it has been caused by domestic or external drivers. As we come out of the two ‘lost years’ caused by COVID-19 (FY21 and FY22), accelerating growth assumes pivotal importance since it helps improve people’s lives by creating gainful employment, alleviating poverty, and so on. Clarity is needed, therefore, on what drives India’s economic growth. We analyse its growth performance over a period of 26 years (1994-2020) to answer these questions.

We break down growth in terms of three indicators – share of export in GDP, formalisation (share of large firms in national output), and ratio of corporate-investment to corporate-sales. While the first two indicators are driven by domestic competitiveness and global trade growth and hence are structural in nature, the third one is cyclical. Per capita growth accelerated by 3 per cent between 1994- 2004 and 2004-08: half of this was due to structural indicators and the rest due to an unprecedented business cycle upswing. Since the business cycle played a significant role, part of the acceleration had to be corrected sooner or later. Consequently, the decline in growth of 1.1 per cent between 2004-08 and 2008-12 was largely due to a business cycle downturn, with marginal improvement in structural indicators. Finally, the slowing down of growth by 0.6 per cent between 2008-12 and 2012-20 can be attributed equally to structural and cyclical indicators. In a nutshell, the structural indicators have worsened since 2012, and need to be addressed urgently and effectively to accelerate growth going forward.

The reforms of the 1990s ushered in a competitive economy, allowing large Indian firms to expand without requiring a license, enter industries hitherto reserved for MSMEs (micro, small and medium-sized enterprises), and opening Indian markets to competition from the external world. Since large firms are on average four to eight times more productive than smaller firms, this unshackling resulted in formalisation increasing from 35 per cent in 1995 to 45 per cent by 2012. Opening up the economy to external trade also led to India's exports in GDP to increase from around 7 per cent in 1991 to 25 per cent by 2012. Increase in competitiveness helped steadily increase India's share in global export from about 0.6 per cent in 1991 to about 2.1 per cent in 2012. The domestic reforms were coupled with unprecedented growth in global GDP of about 3.5 per cent per annum during the first decade of the new millennium, against the long-term trend of 3 per cent, giving further impetus to India’s growth.

India's growth story has lost steam since 2012. Formalisation has been declining, falling to 37 per cent by 2020, while India’s share in global export has remained flat at 2.1 per cent. The decline in formalisation has been caused by the unprecedented build-up of non-performing assets in the economy, precipitated by falling corporate profitability, among other reasons. Macro factors like the appreciating real effective exchange rate (REER) played a significant role in the stagnant share of our exports in global export. Lastly, the global economic environment itself has deteriorated sharply since the North Atlantic Financial Crisis. Annual world trade growth was 15 per cent during 2004-08, but fell to just 4 per cent during 2008-12 and a to a paltry 1.2 per cent during 2012-20.

It must be pointed out in no uncertain terms that large firms have already played a pivotal role in India's growth performance so far, since they are common to both the structural growth indicators: Formalisation and export to GDP ratio. Formalisation increases, by definition, because of expansion of share of large firms. Large firms account for about 55-60 per cent of India's exports and hence are important to drive growth through the export route as well. But large Indian firms are yet to become global champions: Only about 15 per cent of their revenue comes from exports, the rest from domestic sales.

Given the global headwinds and the fact that formalisation has a natural ceiling to it – the manufacturing sector is already 60 per cent formalised and the services sector is at around 25 per cent – we will have to work harder to even repeat our historical growth performance of 5.2 per cent per capita annual growth over the last 26 years (1994-2020). India may get some help from the changing geopolitics, where international companies are looking to diversify their footprints beyond China as part of a 'China+1' strategy and we could emerge as an alternative. However, it is important to realise that while geopolitical considerations play a role, final investment decisions are generally made keeping economics in mind. Thus, we cannot get complacent and not focus on reforming the economy.

India’s New Growth Recipe should focus on improving the competitiveness of our large firms by making them global champions so that they can tap into external markets far more than what they have managed to achieve so far. This will not only re-ignite the formalisation channel, but more importantly, help us compete in the vast global market.

We are at an inflection point in our economic journey. If India does not confront its challenges head on and improve its competitiveness, its annual per capita growth may slide-down further to around 4.5 per cent over the medium term. However, if it manages to strategically focus on its priorities, it can sprint-ahead and grow at 6.5-7.0 per cent per capita.