India’s Potential Growth Rate and Economic Outlook 2025

India’s economy recorded a real GDP growth of 7.8% in the first quarter of 2025-26. This figure is below the average first quarter growth of 9.9% seen in the previous three post-pandemic years. The annual GDP growth rates from 2022-23 to 2024-25 were 7.6%, 9.2%, and 6.5%, respectively. Despite fluctuations, the potential growth rate remains estimated at 6.5%. The following sections explain the key factors influencing India’s growth prospects.

Recent GDP and GVA Growth Trends

The first quarter real GDP growth of 7.8% in 2025-26 is lower than recent averages but still robust. Real Gross Value Added (GVA) growth stood at 7.6%, below the 9.5% average of the last three years. Manufacturing showed strong growth at 7.7%, surpassing its previous first quarter average of 5.8%. Key services sectors such as trade, transport, financial, real estate, and public administration grew between 8.6% and 9.8%, but these are lower than prior averages.

Potential Growth Rate and Investment Dynamics

India’s potential growth rate is closely linked to the Gross Fixed Capital Formation Rate (GFCFR) and the Incremental Capital-Output Ratio (ICOR). The GFCFR has remained stable near 34.5% over recent years. The ICOR, which measures capital efficiency, is volatile due to its calculation method but averaged around 5.2. Using these metrics, the potential growth rate is estimated at about 6.5%. For growth to exceed this, either investment must rise substantially or capital efficiency must improve.

Role of Public and Private Investment

Public sector investment, especially in infrastructure, has increased its share in total fixed capital formation from 21.6% in 2021-22 to 25.1% in 2023-24. The central government led this surge but its capital expenditure growth slowed to 10.8% in 2024-25 from higher rates in earlier years. Meanwhile, the private corporate sector’s share in investment declined from 37% to 34.4%. Raising overall investment by about 2 percentage points and reviving private sector participation are crucial for accelerating growth.

Technological and External Factors Affecting Growth

Technological advances such as Artificial Intelligence and Generative AI offer growth opportunities. However, ageing capital stock and faster replacement needs due to new technologies may offset these gains. Globally, trade uncertainties and supply chain challenges pose risks. India’s net exports contribution turned negative in early 2025-26, a trend expected to continue. Diversifying trade and investment sources is vital for sustaining growth momentum.

Policy Implications for Sustained Growth

Achieving higher potential growth requires addressing constraints on private investment. Policymakers must identify sector-specific and aggregate barriers. Enhancing capital efficiency and boosting fixed capital formation are key priorities. Given the current global and domestic environment, a 6.5% potential growth rate is solid but raising it will be essential for greater employment and economic expansion.

Questions for UPSC:

1. Point out the factors influencing India’s potential growth rate and how Gross Fixed Capital Formation Rate impacts economic growth.
2. Critically analyse the role of public and private investment in India’s infrastructure development with suitable examples.
3. Underline the effects of technological advancements such as Artificial Intelligence on economic growth and labour markets.
4. Estimate the impact of global trade uncertainties on India’s export sector and suggest measures to diversify trade relations.

Answer Hints:

1. Point out the factors influencing India’s potential growth rate and how Gross Fixed Capital Formation Rate impacts economic growth.

1. Potential growth rate depends on Gross Fixed Capital Formation Rate (GFCFR) and Incremental Capital-Output Ratio (ICOR).
2. GFCFR indicates the proportion of GDP invested in fixed assets, directly influencing productive capacity.
3. Stable GFCFR (~34.5%) suggests steady investment but limits growth acceleration without increase.
4. ICOR reflects capital efficiency; a lower ICOR means higher output per unit of capital.
5. Volatility in ICOR due to pandemic-related disruptions affects growth estimates.
6. To raise potential growth above 6.5%, either GFCFR must rise or ICOR must improve (decline).

2. Critically analyse the role of public and private investment in India’s infrastructure development with suitable examples.

1. Public sector investment share in GFCF rose from 21.6% (2021-22) to 25.1% (2023-24), focusing on infrastructure.
2. Central government led surge in capital expenditure with high growth rates initially but slowed to 10.8% in 2024-25.
3. Infrastructure investments have high ICOR, implying slower efficiency but critical for long-term growth.
4. Private corporate sector’s share declined from 37% to 34.4%, indicating weakening private investment momentum.
5. Balanced growth requires reviving private investment alongside sustained public spending.
6. Examples – Government’s infrastructure projects like highways, railways, and urban development drive public investment.

3. Underline the effects of technological advancements such as Artificial Intelligence on economic growth and labour markets.

1. AI and Generative AI can boost productivity, innovation, and efficiency across sectors.
2. Technological adoption may lower ICOR by improving capital utilization.
3. AI can create new job categories but may disrupt traditional labor markets, causing skill mismatches.
4. Faster capital replacement needed due to new tech increases capital consumption, potentially offsetting growth gains.
5. Long-term balance expected between AI-driven growth opportunities and challenges of capital stock aging.
6. Policy focus needed on skill development and technology diffusion to maximize benefits.

4. Estimate the impact of global trade uncertainties on India’s export sector and suggest measures to diversify trade relations.

1. Global tariff barriers and supply chain disruptions challenge India’s export growth.
2. Net exports contribution turned negative (-1.4% points) in Q1 2025-26, likely to persist.
3. Trade diversification into new markets reduces dependence on traditional partners and mitigates risks.
4. Strengthening trade agreements with emerging economies and regional blocs can open new avenues.
5. Enhancing domestic manufacturing competitiveness supports export resilience.
6. Policy measures should promote export infrastructure, ease of doing business, and innovation-led exports.