The Tectonic Shift in India's Economic Policy

The Tectonic Shift in India's Economic Policy

The new economic thinking is based on three key principles: growth and efficient welfare; ethical wealth creation; and a virtuous cycle for economic development. Together, these would lead to a decade of inclusive growth

Illustration by Raj Verma Illustration by Raj Verma

The Indian economy witnessed a V-shaped recovery last year after the pandemic-induced decline in the first quarter as India was the only large country that experienced two consecutive quarters of positive growth; see this year’s Economic Survey and Monthly Economic Report (MER) May 2021 for evidence. After the Covid-19 second wave halted this recovery for a couple of months, the Indian economy is geared up for fast growth. This confidence stems from the fact that India is the only country to have launched path-breaking reforms and radically altered its economic thinking amidst the pandemic. As developed over the last three Economic Surveys of the Government of India, the new economic thinking for India relies on three key principles to achieve the objective of “Minimum Government, Maximum Governance.”

Krishnamurthy Subramanian, Chief Economic Adviser to the Government of India

While we all romantically reminisce about the 1991 reforms today, we must remember that the then government faced stringent opposition from all corners, including the ruling party itself. Many did not foresee the enormous impact that the reforms were to create. The full import of the change in economic thinking was realised over time. Similarly, the benefits of the radical change in India’s economic thinking post Covid will manifest in India’s growth path over the coming decades.

To draw a parallel, India winning the 1983 Cricket World Cup was epochal because it came against all expectations. Almost three decades later, India winning the 2011 World Cup was as seminal because it heralded India’s arrival as a cricket superpower when India fulfilled the high expectations. Similarly, the 1991 reforms happened when there was no expectation of such a seminal turn. The path-breaking reforms post Covid — again almost three decades later as with the 2011 World Cup win — will fulfil the high expectations of India becoming an economic superpower.


As shown in the figure below, the first principle lays out explicitly the policy objective while the other two principles specify the models for achieving the policy objectives at differing levers of granularity. First, complementing an exclusive focus on economic growth with efficient welfare so that growth generates the resources for welfare programmes and the efficiency of welfare programmes ensures that the resources are utilised optimally to not only reduce inequality but also to enhance aggregate demand in the economy. The explicit separation between economic growth with efficient welfare enables comparative advantage and thereby enhances efficiency. Specifically, rather than hobbling macro-economic policies with the objective of reducing inequality and thereby jeopardising growth prospects, the separation enables optimisation of macroeconomic policies for growth, on the one hand, and microeconomic policies for efficient delivery of welfare to the masses on the other hand.

Second, this government, in reflecting the shift in the thinking of new India, views wealth and wealth creation — created ethically — as a boon and not a bane. This is a significant break from the muddled narratives that view profit as a dirty word and returns India back to its DNA, where the common person writes shubh laabh, that is, generate profit by doing good, at the altar in his home. Thus, enabling and empowering of private sector becomes a key element of state policy with the resulting emphasis on privatisation and asset monetisation. This policy enables two fundamental drivers of economic policy — incentives and information — to work for the economy rather than against it.

Third, the macroeconomic model for growth relies on the virtuous cycle originating from private investment with public capital expenditure (capex) helping to “crowd in” private investment. Supply-side reforms that alleviate various frictions on the supply side of the economy help to accelerate private investment as well.


The Hon’ble Prime Minister’s speech in the Budget Session of Parliament on February 10, 2021, highlighted a seminal, durable turn in India’s economic history as he underlined the importance of wealth creation and role of the private sector. Acknowledging this pivotal moment, on February 11, 2021, The Hindu Business Line titled its lead editorial “Watershed Moment” and wrote:

“On the floor of the Lok Sabha, (the PM) made two major points: One, the country needs wealth creators or producers in the first place for that wealth to be distributed, and that they should not be unfairly attacked; and two, the idea of the government running public enterprises has outlived its time and that the bureaucracy in any case should not be running them. Scarcely ever has any senior politician, let alone a prime minister, spoken with such candour in Parliament… Economic Survey 2019-20 made a detailed case for promoting wealth creators, making a crucial distinction between being ‘probusiness’ and ‘pro-crony’.”

What led to this pivotal change in India’s political economy? Understanding this aspect is critical to predict whether the change is ephemeral or durable. After all, it is not as if the case for enabling the private sector has not been made in India before. The unparalleled acceptance stems from the unique approach of the 2020 Economic Survey, which combined modern economics with ancient Indian wisdom. Mint aptly described this Survey as “old wisdom and modern economics”. Hitherto, the appeal to free markets and the private sector in India had been motivated by drawing on the ideas of Adam Smith and his descendants, thereby encountering resistance from the average Indian worried about imposition of western ideas. Naturally, the polity reflected this worry of the average Indian. As a result, reforms post 1991 were done mostly in stealth, thereby putting a big question mark over the durability of reforms.

In contrast, the change towards embracing wealth creation is a durable one because the polity now recognises that ethical wealth creation has been part of India’s DNA for millennia. The idea of ethical wealth creation as a noble human pursuit is rooted in India’s old and rich tradition ranging from Kautilya’s Arthashastra in the North to Thiruvalluvar’s Thirukural down South. Given the demonstrated economic benefits that India reaped—both historically and post the 1991 economic reforms — the political conviction towards embracing wealth creation has been laid solidly.

The reforms announced post Covid articulate this pivotal change in India’s economic thinking. These include inter alia: (i) The government of India’s enterprise policy focussed on enabling the private sector, under which the government will remain in a select few sectors and that too with only a handful of public sector enterprises; (ii) privatisation this year of Air India and BPCL in the non-financial sector and two public sector banks and one insurance company in the financial sector; (iii) opening up of several sectors to competition including defence production, mining, power distribution and cryptography.


The virtuous cycle originating from private investment is crucial for sustained economic growth in India. By examining the sample of countries that grew at least at 5 per cent per annum in real terms over at least a decade, The Economic Survey 2018-19 demonstrated that sustained economic development originates from private investment. Investment leads to productivity gains and creation of jobs, both of which increase disposable income in the economy and thereby foster consumption. Thus, in the first-round effects embedded in the virtuous cycle, private investment is the most crucial for enhancing consumption. In the second-round effects embedded in the virtuous cycle, anticipated increases in consumption spur further investment by the private sector. The virtuous cycle delivers explosive growth as consumption and investment feed each other symbiotically.

This virtuous cycle model for economic development is an adaptation of the “Accelerator–Super Multiplier” model developed by Nobel laureates Paul Samuelson and John Hicks. India’s model with its emphasis on public capex during economic downturns differs significantly from the Keynesian prescription of government spending via revenue expenditure (revex) or doles during economic downturns. This emphasis on public capex is necessary in India today. For example, Bose and Bhanumurthy (2013) show that an increase in revex by 100 only adds 98-99 to the economy while increase in capex by 100 adds 245 to the economy in the same year and 480 over the next several years.

The virtuous cycle originating from private investment relies on three key aspects: (i) countercyclical fiscal policy; (ii) public capex, especially in infrastructure; and (iii) reforms to alleviate supply-side frictions.


Do you know that the Imambara in Lucknow was built to provide work to people during a period of famine? This is an example of countercyclical fiscal policy that was implemented historically in India. Fiscal policy has to be countercyclical in order to accelerate the virtuous cycle because private investment needs an environment of low macroeconomic uncertainty to prosper. When fiscal policy is pro-cyclical, because tax revenues required for fiscal spend are lower in recessions/slowdowns and higher when the economy is booming, such policy exacerbates the intensity of business cycles and thereby increases macroeconomic uncertainty. The increased macroeconomic uncertainty created by pro-cyclical fiscal policy deters private investment while lower macroeconomic uncertainty engendered by the smoothening of business cycles spurs private investment; see Economic Survey 2020-21 for the details. Second, higher growth generated during downturns by countercyclical fiscal policy enhances debt sustainability by increasing the wedge between the nominal interest rate and the nominal growth rate. Third, public investment during economic downturns is self-financing over the medium-term because the fiscal multipliers from public investment are significantly higher during economic downturns and recessions. The Union Budget this year powerfully implemented this change, thereby signalling a dramatic change in the government’s investment policy.


Public capex, especially in infrastructure, is critical to crowd in private investment. Capex “crowds in” private investment while revex “crowds out” private investment as the government borrows more but the pool of savings does not increase with revex. As shown in Chapter 2 of this year’s Economic Survey, savings pro-cyclically follow economic growth. As capex creates growth, the pool of loanable funds increases, thereby enabling both the public and private sector to draw from the same to fund their investment. This is particularly crucial during downturns in the economic cycle because risk-aversion in the private sector increases during downturns and thereby reduces private investment.

The capex announced by the government focusses on railways, roads, urban transport, power, telecom, textiles and affordable housing and draws on the plans laid in the National Infrastructure Pipeline. The central government has also incentivised state governments to focus on capex through a dedicated scheme for 50-year interestfree loans for the purpose of capex.

The key investments in infrastructure include the highest ever outlay of Rs 1.18 lakh crore for the Ministry of Road Transport and Highways, National Rail Plan for a future-ready Railways by 2030, development of the Western Dedicated Freight Corridor and the Eastern Dedicated Freight Corridor, and seven major port projects worth Rs 2,000 crore in PPP mode. Production-linked incentive (PLI) schemes have been implemented in 10 champion sectors to make Indian manufacturers globally competitive, attract investment in these sectors, enhance core competencies via transfer of cutting-edge technologies, create economies of scale, enhance exports and make India an integral part of the global supply chain. Similarly, technological infrastructure such as the India Stack, UPI and the JAM trinity are helping in fostering a better use of the economy’s resources.

As shown in the MER May 2021, evidence of the positive effects of public capex are already being witnessed. The ratio of Gross Fixed Capital Formation (GFCF) to GDP reached 34.3 per cent in Q4, FY21, among the highest in over 26 quarters. This created positive effects on construction, which grew at 14.5 per cent, private consumption that grew at 2.7 per cent after falling for three consecutive quarters and contact-intensive sectors that contracted by only 2.3 per cent after large declines in previous quarters. CEIC’s seasonally adjusted indicator for investment reached a 20-year high in January 2021 while the Purchasing Managers’ Index for Manufacturing had continually been in expansionary zone from September 2020 to May 2021. All these point to the start of the virtuous cycle with private investment leading the way.


The government post Covid has also implemented policies to alleviate several supply-side frictions that inhibit the acceleration of the virtuous cycle. These include financial sector reforms to enhance access to capital, labour market reforms to reduce the frictions due to stringent and complex labour laws, farm bills to enhance access to markets and investment in the agriculture sector and expanding the definition of small and medium enterprises to avoid dwarfism stemming from the nature of taxpayer incentives provided to small firms.

As the public sector banks represent the bellwether of the socialist era, the announcement of privatisation of two public sector banks is consistent with the new enterprise policy of the government of India. The process, when taken to its logical conclusion, will enable better access to capital and, thereby, help private investment; see Economic Survey 2020 chapter on Golden Jubilee of Bank Nationalisation for details. The creation of development financial institutions (DFIs) to fund infrastructure will significantly complement the infrastructure-driven growth push. The creation of a bad bank for clean-up of the banking sector heralds an important step in eliminating the overhang created by disastrous crony lending in the banking sector.

At the same time, these reforms are all focussed on bolstering the manufacturing sector, which is critical to create organised sector jobs and thereby increase aggregate demand in the economy. Logistics and power costs matter the most for manufacturing firms if they have to compete in the global markets. The infrastructure push in roads and railways is intended to reduce logistics costs. Similarly, infrastructure investment and reforms in the power sector are critical to reduce power costs for manufacturing firms. This focus on aggregate demand through job creation in the organised sector will help accelerate the virtuous cycle as the second-round effects embedded in the virtuous cycle require increase in consumption to spur further private investment.


The transformative change in India’s economic thinking will provide an impetus to inclusive economic growth via job creation in the organised sectors. As economic growth stems from the combination of rate of investment in the economy (as measured by the ratio of GFCF to GDP) and productivity (as measured by the incremental capital output ratio), the three-pronged approach will enhance both investment and productivity in the economy. The twin effects would lead to real growth of 6.5-7 per cent in FY23 and acceleration towards 8 per cent in the years ahead as the lagged effects on investment and productivity manifest fully. As the growth push is done by increasing both aggregate demand and aggregate supply in the economy, this growth should be accompanied by the reduction of supply-side frictions and thereby not accompanied by high inflation. In sum, this decade will be India’s decade of inclusive growth.

(The author is Chief Economic Adviser to Government of India)