First, consider labour. Youthful entrants to the labour force are expected to top 12 million per year over the next five years. Absorbing these workers alone would require a 10 per cent growth rate with employment elasticity of 0.25. In addition, segments of the 300 million or so Indians living below the poverty line will have to transfer to higher-productivity employment. By way of comparison, the unemployment impact of the global financial crisis in economically advanced countries only affected 22.5 million workers. Although it is difficult to obtain one precise number, The Economist recently estimated India’s unemployment rate to be 10.8 per cent in 2010, while the National Sample Survey round of 2009–10 shows it to be over 20 per cent for those with a degree or diploma.

Growth can facilitate equity if both jobs and wages rise — but this requires the creation of large numbers of higher-productivity jobs. Inclusive growth, which is the current policy objective, should be understood not as redistribution from a productive section to the rest, but as creating the right conditions for the masses to contribute to and participate in growth. Successes with conditional cash transfers in Brazil suggest that subsidising activities which improve human capital is a good way of providing incentives for the very poor and compensating for market failures that exclude them. Improving infrastructure and public-service delivery increases the rewards of hard work. Further developing technology — such as mobile phones — frequently used by the poor has great potential. With such initiatives, generic labour resources have high potential for growth.

Second, consider finances. Savings have risen structurally in India — a promising sign, since other rapidly growing Asian economies generally had high savings rates. This is consistent with research showing that lagged savings lead growth. India’s capital availability is roughly 40 per cent of GDP, derived from a savings-to-GDP ratio of between 36 per cent and 32 per cent and a ‘safe’ current account deficit of between 2 per cent and 4 per cent of GDP. Given India’s incremental capital output ratio (ICOR, a measure of how efficiently these investable funds are used in production) of four, we should expect a 10 per cent rate of growth, give or take.

Infrastructure spending is expected to rise from 6 per cent to 9–12 per cent of GDP, as US$1 trillion is expected to be spent over the next five years. The funds will come from a combination of domestic savings, government budgetary support and foreign investment. If the current account deficit is about 3 per cent, only one-quarter of this total amount, or around US$250 billion, can come from foreign savings. This is a large absolute amount, creating many earning opportunities for capital from abroad. But the bulk still has to come from domestic resources, so better financial intermediation of domestic savings is also required.

Indian entrepreneurs have demonstrated they can become competitive, given the opportunity. The potential availability of labour, finance and productivity implies that aggregate supply is able to expand in the longer run. Diversity in sources of growth, a demographic advantage, network effects, the crossing of a threshold of growth, cautious liberalisation and the strengthening of institutions all suggest that India has entered a robust catch-up growth phase.

Each of these elements can be used to derive an assessment of potential growth. Underestimating India’s potential could lead to excessive monetary–fiscal tightening, and the Reserve Bank of India, using non-inflationary past trend growth as a measure, has estimated long-run potential growth of about 8 per cent. Using filtered past trend growth could further lower expectations to 7 per cent, while the peak labour–financial resource-based measure would be about 9–10 per cent.

Inflation, persistently high since 2007, suggests India has reached its level of potential output. But upward shocks to costs could raise inflation even if India’s supply response is elastic. Oil shocks, rising wages in response to high food prices — since food holds a large share of the consumption basket — and poor systems and governance are all potential sources of such an upward inflationary creep. And since international food inflation now influences India’s domestic price level, the exchange rate also matters.

That India’s current bout of high inflation started with the jump in world food prices in 2007, and was sustained by the large depreciation in 2008, favours such an explanation. Where supply shocks dominate and prices are sticky downward, a first round of price increases should be allowed, but a second round, such as a generalised rise in wages, needs to be prevented.

The estimates show that supply shocks largely explain inflation but no sustained excess of output over potential since 2003–05, implying that inflation was due to multiple supply shocks, rather than sustained second-round effects.

Since India runs a current account deficit, higher growth creates world net demand. International reform of distortions creating cost pressures through excessive volatility in commodity prices would also help maintain Indian growth.

Ashima Goyal is Professor of Economics at the Indira Gandhi Institute of Development Research in Mumbai.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Ideas from India’.