Several authors, including us, have argued that a growth rate of 6.5% appears to be the potential growth rate of India as of now. But the first quarter growth rate of 2025-26 is estimated at 7.8%. Does this alter our perception about the potential growth rate?
The first quarter real GDP growth in the post-COVID-19 years, from 2022-23 to 2024-25, has averaged 9.9% as compared to corresponding average levels of the second, third and fourth quarters of 7.0%, 6.9% and 7.5%. Thus, a 7.8% real GDP growth in the first quarter of 2025-26 is below the average for the first quarter of the previous three years. The annual real GDP growth rates for 2022-23 to 2024-25 were at 7.6%, 9.2% and 6.5%, respectively.
On the output side, real GVA growth in the first quarter of 2025-26 was 7.6%. This was also lower than the corresponding average GVA growth of 9.5% in the previous three years. The GVA growth in the first quarter of 2025-26 was largely based on improvements in the growth rates of manufacturing and the three important services sectors. It was mainly in manufacturing that the first quarter 2025-26 growth at 7.7% was higher than average first quarter growth for the previous three years at 5.8%.
Potential growth rate and ICOR
We may note that in the three important service sectors — namely trade, transport and others, financial, real estate and others, and public administration and others, growth rates in the first quarter of 2025-26 were quite high at 8.6%, 9.5% and 9.8%. But these were still lower than their corresponding averages in the previous three years at 12.9%, 11.3% and 13.1%, respectively. An increase in potential growth rate would require a sustained increase in growth in all these sectors. It is also important to note that the real gross fixed capital formation rate (GFCFR) in the first quarter was nearly the same in 2023-24, 2024-25 and 2025-26 at 34.5%, 34.6% and 34.6%, respectively. Thus, there is no structural break.
The estimation of 6.5% as potential growth rate in our article, “Potential growth stays at 6.5%” (The Hindu-BusinessLine, July 4, 2025) is based on the behaviour of GFCFR and Incremental Capital-Output Ratio (ICOR). While the GFCFR does not fluctuate too much, the ICOR is very volatile. The probable reason is that it is not estimated independently. It is derived from dividing the real GFCFR by real GDP growth rate. Thus, the fluctuations in growth get reflected in the ICOR. It is notable that the real GFCFR has been stable at 33.6%, 33.5%, and 33.7% of GDP during 2022-23, 2023-24 and 2024-25, respectively. Using an average ICOR on the GFCFR, the potential growth rate may be derived. With the GFCFR remaining at an average of 33.6% and an ICOR of 5.2, the potential growth rate remains at around 6.5%. For potential growth to rise above this level, it is important that the GFCFR improves tangibly above this average level for the previous three years or the ICOR falls below 5.2.
It may be noted that growth rates and the ICOR have been volatile in recent years because of the COVID-19 pandemic and subsequent adjustments. In estimating India’s potential growth rate, one has to look at its performance over a much longer period. India’s real GDP growth rate during 2011-12 to 2023-24 averaged 6.1%. In assessing a country’s growth potential one may have to give greater weight to recent performance.
On public sector investment
The ICOR is a reflection of how efficiently capital is used. Technology and management ultimately determine the ICOR. One can be confident of sustained higher growth only if fixed capital formation rate goes up. A recent phenomenon in gross fixed capital formation is the bigger role played by government expenditure. In recent years, the share of the public sector in total real GFCF has increased from 21.6% in 2021-22 to 25.1% in 2023-24. Public sector investment is largely focused on infrastructure which has a high sectoral ICOR.
The surge in public sector investment was largely led by the central government. However, that momentum appears to be slowing down. Growth in the Centre’s capital expenditure was at 39.4%, 24.4%, and 28.9% in 2021-22, 2022-23 and 2023-24, respectively. However, this growth fell to 10.8% in 2024-25.
In order to increase the potential growth rate above 6.5%, we will need to increase the GFCFR by about 2% points from the recent average GFCFR which is around 34%. This will call for an increase in the share of real investment of the private corporate sector in total GFCF which has fallen from 37% to 34.4%, during 2021-22 to 2023-24. This may be supplemented by a reduction in the ICOR.
Prospects of growth
Some of the influences that may affect the long-term potential growth on the positive side would include the impact of changing technology such as Artificial Intelligence (AI) and Gen AI. On the negative side, there would be the impact of a growing share of capital consumption as capital stock becomes older and new technologies call for a replacement of old capital at a faster rate. These forces may balance themselves out, leaving India’s long term potential growth close to 6.5%.
The global trade environment also remains challenging for India. Given the tariff and supply chain uncertainties, much depends on the pace at which India is able to diversify its trade destinations and investment sources globally. After remaining positive for the previous four consecutive quarters, the contribution of net exports turned negative at (-)1.4% points in the first quarter of 2025-26. This trend is likely to continue. We may recognise that a potential growth rate of 6.5% is, in the present world environment, a reasonably high level, although for creating a higher growth of employment, we do need to push our potential growth further. For this, we need to get the private investment rate to move up. Policymakers need to address this issue at the aggregate and sectoral levels. They must understand what is holding back private investment and suggest appropriate remedies.
C. Rangarajan is Chairman, Madras School of Economics and Former Governor, Reserve Bank of India. D.K. Srivastava is Honorary Professor, Madras School of Economics and Member, Advisory Council to the Sixteenth Finance Commission. The views expressed are personal
Published – October 14, 2025 12:16 am IST
