India – The Next Global Growth Engine?

Global economic development of the last two decades was dominated by the rise of the Chinese economy. Now the transformation of China’s economy towards a consumer- and service oriented growth model is reducing growth rates. In this blog post we examine the question of whether India has the potential to replace China as the locomotive of global economic growth.

Comparing India’s and China’s growth

Between 1991 and 2014, China’s annual growth rate reached on an average about ten percent. The reason for this strong economic dynamic was in particular the combination of high exports and a high level of investment. At the moment we can observe a substantial changeover of the Chinese growth model. The high level of investment of the last years caused overcapacities. At the same time, low interest rates gave rise to a real estate boom with rising prices and wages. Hence the average annual wage of an employee doubled between 2007 and 2013 and wages did increase faster than productivity. Therefore China’s international competitiveness declined and the export-driven growth decreased.

India’s economic growth hasn’t been that dynamic during the last years. Between 2001 and 2015, Indian gross domestic product (GDP) grew on average by 7.25 percent per year. But for the upcoming years, the International Monetary Fund (IMF) believes that India’s GDP will grow faster than the Chinese GDP. For 2016 to 2020, according to the expectations of the IMF, annual growth rates of GDP should range between 7.5 and 7.7 percent. By comparison: during this period of time, China’s economic growth is expected to range between 6 and 6.3 percent per year. India’s growth rate is not only larger than China’s but also larger than the average of the emerging market and developing economies (see figure 1).

An important driver of Indian economic growth is the demographic development. According to the calculations of the World Population Datasheet 2015, India’s population was approximately 1.315 billion people in mid-2015. This means that India’s population was almost as large as China’s. By 2030, population of India is supposed to reach more than 1.5 billion people. At the same time, China is expected to reach a total population of 1.4 billion people. Depending on how one defines the Indian middle class, it is estimated to be between 24 and 300 million.

Public debt and government’s capacities to act

During the first years of the new millennium, India’s public debt reached a value of more than 80 percent of the Indian GDP. Since then debt-to-GDP ratio is declining. In 2020, according to the calculations of the IMF, public debt in India is expected to achieve less than 60 percent of GDP (see figure 2). In developed economies, debt-to-GDP ratios have been risen due to global financial and economic crisis 2008/2009. By now, public debt in advanced economies has attained more than 100 percent of GDP on an average. Until 2020, the IMF does not expect significant improvements in developed countries.

Due to the improved state of public finances for the next years, India will be able to finance investments in education, research and development. Industrial countries are supposed to have less financial capability to make these expenditures. Therefore India will be able to realize higher increases in productivity and thus higher rates of GDP growth.

No wonder India was termed one of the few ‚bright spots‘ by the IMF in 2015. Aided by cheap capital in the EU and the US, Foreign Direct Investments into India grew by 24.5 percent from $36 billion to almost $45 billion in 2015, mostly in infrastructure and the services sector.

Additional strengths of the Indian economy

One of the key reasons for the relatively healthy situation of the Indian economy is the drastic drop in global commodity prices. According „The Economic Times”, a leading Indian business daily, a $25 drop in crude oil price is like a notional $10 billion stimulus to the Indian economy. This has helped to bring down the current account deficit to below two percent of the GDP (as compared to five percent in 2012) and projected to be a surplus for the coming quarter ending March 2016. The Indian government has hiked the excise duty on petrol and diesel multiple times and garnered close to $29 billion in additional revenues which will definitely help it to meet the fiscal deficit target of 3.9 percent this year and the targeted 3.5 percent in 2016-17. Inflation, which was threatening the Indian growth story in 2012 and 2013, is largely under control with the Wholesale Price Index in negative territory 15 months in a row.

The 2015 mid-year economic review showed an economy growing largely on the basis of private consumption and government investment. The government investment has been largely the result of the sustained infrastructure focus (almost $40 billion allocated in the 2016 government budget presented on the 29th February this year. In addition to mega projects like 100 smart cities and a network of high speed trains, the government has set ambitious targets for renewable energy with 100 Giga Watts to come from solar power alone in the next seven years. This investment thrust with the ‘Make in India‘ initiative where the government fast tracks and facilitates greenfield projects in manufacturing has attracted some global behemoths in sectors like automotive and engineering to scale up their investment plans.

India has a very young population with 50 percent of its population below the age of 25. This means that 50 percent of the Indians were born after the country started on its economic liberalisation path. Growing up in a market economy, they bring in an entrepreneurial and a can-do mind-set to the workplace compared to the more conservative generation before them. The influence of this can be seen in the number of start-ups registered in India – almost four technology start-ups every day which is only behind the United States and the United Kingdom and ahead of Israel and China. India is an integral part of the global research and development network with more than 1050 multinational corporations having their research centres based out of India. This has created jobs at the high end of the value chain as well as clusters of technology innovation hotspots in cities like Bangalore, Hyderabad etc. resulting in cascading growth of the knowledge economy.

Weaknesses of the Indian economy

The biggest threat at the moment to the Indian economy -is the Non-Performing Assets of its banks. Credit Suisse estimates that as much as 17 percent of the outstanding credit of the Indian banks can be categorised as stressed – much higher than the official figure of 12 percent. The top 10 indebted firms have an outstanding credit of $113 billion which is 12 percent more than 2013.  This has a twofold effect of paralysing the banking system as well as hindering the firms from pursuing their growth strategy. This is also the reason behind the current low levels of private investment. The 2016 budget has allocated $3.5 billion for recapitalisation of banks, a fraction of the $ 25 billion deemed necessary by the 2015-16 mid-year economic survey.

The demographic dividend which India boasts of is also a ticking time bomb if the 12 million entering the workforce annually are not integrated into the economy. Though IT and high technology is hyped as crucial in the knowledge economy, its impact on the overall job market is modest – the entire IT industry employs about 10 million, which is fewer those joining the workforce annually. Only 4.7 percent of the Indian workforce has formal training, as compared to 52 percent in the US, 75 percent in Germany and 95 percent in – South Korea according to the Indian National Skill Development Mission. The government has set a target of training 150 million skilled people by 2022, a daunting task especially considering the rapid technology changes brought about through digitalisation and industry 4.0. On the demand side, businesses have a shortage of the required skilled labour as almost 75 percent of the graduates which India’s university system produces are found to be not employable. This has the potential to result in a youth backlash as can be seen in recent protests in the states of Gujarat and Haryana.

The Modi government came to power promising radical reforms for a healthy economy. The flagship reform idea was that of the Goods and Service Tax (GST) bill which will unify India as a single market and remove the cumbersome bureaucratic maze which firms have to go through to have a Pan-Indian presence. The bill has not yet overcome the parliamentary hurdles, due to a blocking opposition, as well as, a government incapable of dialogue. Settling disputes is still a nightmare in India. According to the World Bank, it takes 1420 days to enforce a contract in India as compared to 538 in high-income OECD countries. Despite climbing up four places, India still ranks 130 in ease of doing business ranking by the World Bank in 2016.

Conclusion

The Indian government has positioned itself as a pro-business one by stressing -stability and predictability on one hand and reforms on the other. Reducing the corporate tax, online auctioning of natural resources, deregulation of the fuel sector, fiscal consolidation etc. point to a move in this direction. Nouriel Roubini estimated the potential growth of the Indian economy as up to 9 percent if the planned economic reforms are implemented. The unnecessary and dangerous focus on Hindu nationalism by the government is a distraction from undertaking the badly needed reforms and has the potential to scare away international capital as well as vilify the atmosphere of hope and change which the government promised on its way to power.

In order to become a growth engine for the global economy, it will be necessary that India imports goods and services from abroad in large volume. Until now, this has not been the case. In 2014, India imported products at a value of about $405 billion (see figure 3). Although this makes India the twelfth largest importer of the world, India’s imports are just 22 percent of Chinese imports. India has not followed the export model followed by the East Asian and the Chinese economies. The domestic market remains the focus of the majority of Indian corporations and neither is India tightly integrated into global supply chains like China or East Asia. Through committed investments in infrastructure and disciplined economic reforms, India can become the locomotive of the world economy in the medium to long term. Until then China and the US remain the only heavyweights in the arena.