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

‘In the light of a potential growth rate of 6.5%, the achievement of 6.4% in 2024-25 should not be considered as disappointing’
| Photo Credit: Getty Images/iStockphoto

The First Advance Estimates (FAE) of National Accounts for 2024-25 show a real GDP growth of 6.4% and a nominal GDP growth of 9.7%. These numbers have fallen short of the Reserve Bank of India’s revised growth estimate of 6.6% for real GDP, as in its December 2024 monetary policy statement and 10.5% for nominal GDP growth as in the 2024-25 Union Budget presented in July 2024.

The annual growth of 6.4% can be seen as consisting of 6% growth in the first half and 6.7% growth in the second half. There is, thus, a clear improvement expected over the Q2 growth of 5.4%. The sharp fall in 2024-25 annual GDP growth from that of the previous year at 8.2% is seen only in the case of GDP. With respect to Gross Value Added (GVA), this difference, between 7.2% and 6.4%, is much less. On the GVA side, it was the manufacturing sector which suffered a sharp fall in sectoral growth from 9.9% in 2023-24 to 5.3% in 2024-25.

Growth prospects for 2025-26

The Gross Fixed Capital Formation rate at constant prices has ranged between 33.3% and 33.5% during 2021-22 to 2024-25. Thus, it appears to have stabilised around 33.4%. It is expected to continue at this level in 2025-26. The average Incremental Capital Output Ratio (ICOR) has been marginally higher than 5 in recent years. Assuming ICOR to be 5.1 in 2025-26, we may consider a 6.5% real GDP growth to be realistic.

There may not be much change in the global economy even though Donald Trump’s assumption of office may create more uncertainty. India will have to largely depend on domestic demand.

In particular, the Government of India has to ensure that there is no relaxation in its investment expenditure. In fact, the slightly lower growth in 2024-25 is largely linked to the slowdown in the Government of India’s investment growth which has remained negative at (-)12.3% even after eight months into the fiscal year.

With a lower nominal GDP growth in 2024-25 of 9.7% as compared to the budgeted nominal GDP growth of 10.5%, the budgeted Gross Tax Revenue (GTR) of ₹38.4 lakh crore may not be realised if the budgeted buoyancy of 1.03 is maintained. As per Controller General of Accounts (CGA) data, GTR growth for the first eight months was 10.7%. If this growth is maintained for the remaining months also, the realised buoyancy would be about 1.1, which is higher than the budgeted buoyancy. In such a case, tax revenue shortfall will be minimal. In other words, any revenue constraint or likely pressure on fiscal deficit would not constrain the government’s ability to achieve its capital expenditure target of ₹11.1 lakh crore.

Reason for the dip

However, after the first eight months, the level of the Government of India’s capital expenditure has remained limited to ₹5.14 lakh crore, that is 46.2% of the Budget target. In the remaining four months, the Government of India’s capital expenditure may be accelerated. It may still fall well short of the target. This has been the main reason for the dip in overall real GDP growth in 2024-25.

Going forward in 2025-26, the Government of India will have to continue to rely on an accelerated capital expenditure growth which can be kept at least at 20% on the revised estimates for 2024-25. Sustained government capital expenditures can have a favourable effect on private investment. The size and the pattern of investment expenditure of the government should be designed to accelerate private investment as well.

Medium- to long-term growth prospects

Over a period of next five years, the best that India may hope for is a steady real GDP growth rate of 6.5%. This is in line with the International Monetary Fund’s real GDP growth projection for the Indian economy, as in its October 2024 release, which is at 6.5% over the period 2025-26 to 2029-30. This real GDP growth may be accompanied by an implicit price deflator (IPD)-based inflation of about 4% which can give a nominal GDP growth in the range of 10.5%-11%. In years in which global conditions improve and the contribution of net exports to GDP growth becomes significant, real GDP growth may touch even 7%. If a real growth of around 6.5% and a nominal growth in the range of 10.5%-11% are maintained over the long run with an average exchange rate depreciation of 2.5% per annum, India should be able to reach a per capita GDP level consistent with a developed country status in the next two and half decades. But the task is not going to be easy. It will be hard to grow at 6.5% as the base keeps on increasing. In fact, in the earlier years, the growth rate will have to be higher. But, at present, the potential rate of growth appears to be 6.5%. However, it can change.

In the light of a potential growth rate of 6.5%, the achievement of 6.4% in 2024-25 should not be considered as disappointing. In fact, the achievement of 8.2% in 2023-24 should be considered as a flash in the pan. The current year’s growth rate of 6.4% as in the first advance estimates should be seen in the context of India’s potential growth rate.

C. Rangarajan is former Chairman, Prime Minister’s Economic Advisory Council, 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