5 June 2017

India's Economy Slows

Over the past two years, India has become known as the world’s fastest-growing large economy and expectations were that India would hold this title for the foreseeable future.  However, a sharp decline in the rate of economic growth in the first quarter of 2017 means that China once again overtook India in terms of growth, a major blow to Indian pride.  Obviously, much of the blame for this slowdown has been placed on Prime Minister Narendra Modi’s demonetization program, a move that had been expected to reduce India’s economic growth over the near-term.  However, there were a number of other factors that contributed to this sharp slowdown in growth in early 2017, and some of these factors could prove to be a long-term drag on growth in India.  Overall, while India is well placed to record higher rates of growth in the coming months and years, the country must still overcome a number of challenges if it is to regain its title of the world’s fastest-growing large economy.

The Indian economy expanded by 6.1% on a year-on-year basis in the first quarter of this year.  While this would be a solid result for most emerging markets, it represented a sharp decline from the growth rates recorded in previous quarters and was the lowest rate of growth in India in more than two years.  Most of the blame for this slowdown was given to the Indian government’s demonetization program that resulted in 86% of the banknotes in use in India being taken out of circulation late last year.  Moreover, India’s construction sector contracted in the first three months of this year, while nearly all sectors of the country’s economy recorded lower-than-expected rates of growth.  Another factor that contributed to this lower rate of economic growth in early 2017 was the fact that the government changed the base year that it uses for the calculation of Indian GDP, although this had been expected to provide a boost, not a brake, for India’s official rate of economic growth.  Altogether, the first quarter of this year was one that was highly disappointing for an economy that many businesses and investors are increasingly counting on to generate growth.

It is easy enough to use the issue of the Indian government’s demonetization program to place the blame for India’s poor economic performance in early 2017.  However, there are a number of other factors that contributed to this slowdown and could have a greater impact on India’s economy in the future.  First and foremost, India has failed to attract the level of investment that had been expected once India overtook China to become the world’s fastest-growing large economy.  There are a number of reasons for this.  One is the simple fact that investors continue to view India as a place with much higher levels of risk than China or many other emerging markets in Asia.  Another reason for the disappointing investment levels in India is the fact that the country’s banking sector remains fraught with risk, something that has depressed bank lending levels in recent years.  Unless the government takes steps to reform India’s banking sector, and to pass new laws dealing with bankruptcy, banks will remain hesitant to lend in India, holding back investment at a time when it is sorely needed to boost economic growth in India.

Despite these recent troubles, the outlook for growth for the Indian economy remains generally positive.  For example, India’s domestic market continues to grow at a rate well above that of nearly all other large economies and this will prove to be attractive to businesses and investors considering activities in India.  Likewise, despite many hurdles, India continues to be a prime location for potential investment in low-cost manufacturing operations, something that will help to diversify the Indian economy in the years ahead, particularly as production costs elsewhere in Asia rise rapidly.  Furthermore, there are hopes that Prime Minister Modi and his government will be able to enact some of the much-needed economic reforms that they have promised in the coming years, making it easier for businesses and investors to expand their activities in India.  Thanks to these factors, India is likely to quickly regain its title as the world’s fastest-growing large economy later this year.  However, if India hopes one day to emulate the three decades of 10% GDP growth that China achieved, even more will have to be done to attract investment and diversify the Indian economy.