Define potential GDP and explain its determinants. What are the factors that have been inhibiting India from realizing its potential GDP?
Potential gross domestic product (GDP) is defined in the OECD’s Economic Outlook publication as the level of output that an economy can produce at a constant inflation rate. Although an economy can temporarily produce more than its potential level of output, that comes at the cost of rising inflation. The highest market value of goods and services that can be produced in an economy over a period of time is known as potential GDP. Unlike normal GDP that estimates during current duration, potential GDP seeks to find the highest value that can be obtained.
Determinants of potential GDP
- Inflation
The inflation rate in the country in a year influences the GDP growth. Higher inflation can boost the potential GDP rate.
- Recession
Recession is the slowdown in growth rate for two consecutive quarters. Recession can significantly reduce the GDP.
- Factory output
The output of finished goods from factories increases its contribution to GDP. Continuous growth will be suitable for high GDP.
Factors inhibiting potential GDP of India
- Low productivity
High employment generation in economy will show that potential GDP to be high but it will not be achieved due to low productivity from employment generation.
- Currency depreciation
GDP is calculated using American dollars after converting it from Indian rupees. The depreciation of Indian rupees vis a vis American dollars will reduce GDP value.
- Decrease in foreign capital
The inflow of foreign capital may decrease over a period of time due to various factors. This will result in economy not being able to emulate the potential numbers.
- Lack of Infrastructure
The infrastructure growth in domestic economy may not be in predicted lines. This will hamper the final contribution to GDP output.
Hence, potential GDP is a theoretical prediction that may not always be equal to final output. Various external factors may also be responsible for altering the prediction.
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