NEW DELHI: A gradual economic recovery is under way in India, and the economy can easily hit the $3.5 trillion mark in next five years, provided the government keeps the reform momentum going, Nomura India Executive Director and India Economist Sonal Varma said in a webinar organised by ETMarkets.com on Thursday.For India to become a $3.5 trillion economy, GDP has to grow at 7.5-8 per cent on a sustainable basis, which is not that tough, given the reforms roadmap that the government has. Lower crude oil prices will help contain inflationary pressures and fiscal deficit , which will in turn draw higher foreign direct investment, she said. FDI or foreign direct investment is a more stable form of capital flow, which can strengthen the fundamentals of any economy. Data suggests the current account deficit was financed by FDI flows this time around, which has put lesser weight on the government’s balance sheet, which is a big positive.“We are already a $2 trillion economy, growing at a nominal rate of around 11.5 per cent (7.5 per cent real + 4 per cent inflation ),” Varma said. “It is not a tough ask. What we need to do is ensure that policies are enacted that can sustain our growth at 7.5-8 per cent without generating inflationary pressures,” she added.The green shoots visible right now are FDI flows and private capex, which are showing a pickup. Varma said various stalled projects have been revived, which is a positive trigger for both the economy and the markets.There were less number of stalled projects in June 2015 compared with the year ago period. Private capital expenditure this year is much better than past two years. Apart from that, the government has been on a reform overdrive and has announced various new projects in chemical products, metals, electricals, transport services, construction and real estate segments.However, business confidence is still mixed. Although it had improved post elections in mid-2014, but that tempo seems to have been lost, the Nomura economist said.According to Varma, weak global demand, especially the slowdown in China, is also weighing on the market sentiment. A good budget, clearer signs of domestic growth recovery and faster reforms can be positive triggers for the market.The forthcoming budget will be important for markets and economy. However, Varma does not see any populist measure from the government even though the outcome of the Bihar elections were not in line with what most market participants were hoping for.What can strain on India’s balance sheet is impact of the Seventh Pay Commission, which could be as high as 0.7 per cent of GDP. The government has to figure out ways to finance this expenditure. Even most global credit rating agencies have voiced their concerns over the same.The total impact of the pay commission award is estimated to be Rs 1,02,000 crore, which would be 0.7 per cent of GDP. Of this, the central government will have to budget for around 0.5 per cent of GDP and the rest has to be paid by railways, Varma said.Asked about various avenues from which the government can raise money, she said it may have to hike the service tax rate (14.5 to 16 per cent) or/and excise/custom duties or go for higher asset sales (not only disinvestment, but also telecom spectrum).She said government’s capital expenditure (as a percentage of GDP) may take a hit as a result of the pay panel award.Global rating firm S&P has already expressed concerns over the slowdown in the pace of reforms. India’s rating can come under stress if the government fails to pursue its reforms agenda and overshoots the fiscal deficit target, it said.“We are not expecting any populist measure in the budget. But credit rating agencies would want to see the impact of the Seventh Pay Commission on fiscal prudent (both centre and states), reforms outlook (especially GST ) and growth outlook,” Varma added.“We are not expecting a downgrade, but no upgrade either. The outlook is stable for now,” she said.Commenting on concerns over the impending rate hike by the US Federal Reserve, Varma said there might be some nervousness ahead of the hike, but it would also clear the uncertainty.Nomura’s view is that the Fed will hike rate in December, but the future pace would be gradual: only two 25bp hikes throughout 2016. So, the hikes should not be too disruptive, she said.