India could be an upper middle income country within a decade

India is currently what the World Bank describes as a lower middle income country. The average income of an Indian was $1,935 in 2020. The International Monetary Fund (IMF) now estimates that number will go up to $3,769 in 2027, the latest year for which the multilateral lender publishes its forecasts, which were recently redone after the Indian government pointed out some inconsistencies in its calculations. This means that per capita income in India is expected to cross $4,000 towards the end of the decade. India will thus be on the cusp of becoming an upper middle income country, according to the current definition used by the World Bank.

How long have other countries taken to double their per capita income from $2,000 to $4,000? The accompanying table provides data from some comparable Asian countries that have made the journey after 1980 and some that are on the verge of doing so. China, Taiwan and South Korea clearly maintained a scorching pace of economic transformation when they were broadly at our current level of development. Thailand, the Philippines, Indonesia and Malaysia took more than a decade. India seems on track to double its income at a rate that Sri Lanka and Vietnam maintained.

For any country, average income in US dollars depends on a combination of nominal economic growth in its domestic currency and the exchange rate of that currency against the dollar. How both move then matters. China let its currency appreciate in the four short years that its average income doubled to reach $4,000. Thailand saw its currency collapse in the second half of 1997. Such sharp movements in exchange rates undoubtedly affect the conversion of nominal average incomes calculated in terms of national currencies into a common measure like the US dollar.

However, no country will see its standard of living shoot up or reduce sharply over long periods of time just based on the international value of its currency or movements in domestic prices. That is because exchange rates eventually reflect inflation differentials between various countries, so a country with high inflation will see its exchange rate come down over a reasonably long period of time, and vice versa. A lot more depends on the rate at which economic output is growing in real terms, or after stripping out the effects of inflation.

Two of the original Asian Tigers—Taiwan and South Korea—as well as China are good examples. They could successfully double their average incomes in terms of US dollars in six, five and four years respectively. Others took far more time. Why these three countries could race ahead, while comparable countries with similar structural features and economic policies could not, is one of the great debates in development economics. The median time taken in this small sample is 10 years, which is close to what India will need, by current estimates, to reach a per capita income of $4,000.

There is another factor to consider: the state of the world economy, especially since export growth was such a big part of the economic strategy of successful Asian economies when they were in the early stages of their economic transformation. But global economic growth is not a dominant influence. A quick—and perhaps simplistic—look at the data shows that there is a negative correlation between the number of years taken by a country to double its income in US dollars and the pace at which the world economy expanded in the relevant time periods for each country.

In other words, a country is more likely to quickly double its average incomes when the world economy is also doing well. However, this negative correlation is weak, and not the dominant explanation (the R-squared is 0.1203). That continues to be rapid domestic growth sustained over long periods of time.

In its new Report on Currency and Finance released a few weeks ago, the Reserve Bank of India has estimated that India can maintain an economic growth rate of between 6.5% and 8.5% over the medium term. Rapid growth is needed not just to boost our position in international rankings, but also provide economic opportunities to a young population, especially given our failure to create quality jobs in productive enterprises. There are also shocks to consider. Indian output is still below where it would have been if the pandemic had not struck, and is expected to remain below trend for perhaps another decade. (Note: this is about the level of output rather than its growth rate.) A climate shock is on the horizon.

This decade may see India narrow its income gap with countries such as the Philippines and Sri Lanka, especially the latter because of its ongoing economic tragedy. India will need more time to reduce the income gap with most of the other countries considered here. A lot will depend on whether we move ahead near the lower or higher end of the potential growth estimate made by our central bank.

This article was originally published in Mint on May 25, 2022.

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