Potential output growth rate in India – measurement, impact and determinants

The present study revisits the estimation of potential output growth rate in India in the post global crisis period, using three univariate methods viz.,Hodrick-Prescott (HP) filter,BN decomposition and ICOR. It then assesses the leading indicator properties of the output gap (i.e. actual output minus potential output) for inflation – both headline and core. Finally, it empirically estimates the impact of the fixed investment rate, the fiscal deficit and inflation on the growth rate of potential output. The findings of the study support those of earlier studies regarding the substantial variation in the estimates of potential output growth rate generated by alternative methods. The potential output growth rate, as estimated by the HP filter in 2010–11 was found to be lower by around 0.5 percentage points than that in 2005–08. Granger Causality tests and a two-variable unrestricted Vector Autoregressive model (VAR) showed that output gap is a leading indicator of inflation in India with a lag of 3 quarters. The paper, also finds that while the fixed investment rate has a positive impact on the growth rate of potential output, the fiscal deficit and inflation have adverse effects.