1 March 2018

India's Economy Returns to the Top

Between 2014 and 2016, India was able to claim the title of the world’s fastest-growing large economy, overtaking China, which had held that title for most of the previous three decades.  Thanks to a rapidly-growing domestic market and rising levels of investment, India’s economy was expected to retain this title for the foreseeable future, particularly in light of the downwards trend for economic growth rates in China. 

However, India’s economy ran into a series difficulties over the past year, resulting in the country’s economy failing to meet its lofty expectations and forcing India to relinquish its title as the world’s fastest-growing large economy.  Among these difficulties were the Indian government’s decision to withdraw 86% of the country’s banknotes from circulation and its introduction of the new Goods and Services Tax (GST), both of which caused major disruptions for Indian businesses and consumers and created numerous disruptions for the Indian economy.  As a result, India’s economy failed to match the rate of growth achieved in China in 2017, the first time that it had failed to do so since 2013.  Nevertheless, despite India’s recent struggles, the country is well placed to record higher rates of growth in the coming years and to once again outpace the world’s other leading economies.

In the fourth quarter of last year, the Indian economy expanded by 7.2% on a year-on-year basis, a slightly better performance than had been expected.  In fact, while it was clear that the worst of India’s economic slump was over, there were still a number of headwinds buffeting the Indian economy in recent months.  Nevertheless, many sectors of the Indian economy contributed to an improved performance in the fourth quarter of 2017.  First, government spending rose significantly in the latter part of last year.  Second, consumer spending also improved following the disappointing levels of consumer spending recorded earlier in the year.  At the same time, many of India’s leading manufacturing sectors also recorded healthy rates of growth in recent months.  While growth improved last quarter, the impact of demonetization and the GST continued to be felt in many sectors of the Indian economy and prevented growth from rising even further during this period.  Nevertheless, the Indian government will be happy with the level of growth achieved in the final quarter of 2017 and will hope that it signals even higher rates of growth for the Indian economy in 2018.

While 2017 was, as a whole, a challenging year for the Indian economy, we expect 2018 to be a much better year for what is now the seventh-largest economy.  In fact, we are expecting economic growth in India to once again approach the 8% level later this year, returning it to the rates of growth that were expected of India before its recent struggles.  Over the near-term, the disruptions caused by the government’s demonetization program and its Goods and Services Tax will continue to hold down economic growth from reaching its full potential. 

However, as the year progresses, we expect India to experience a significant rise in investment, while Indian consumer and business spending levels are expected to rise in a big way in the months ahead.  Of course, the Indian economy still faces a number of risks that could hinder its ability to grow faster.  One of these risks is inflation, which has surged above 5% in recent months and could yet rise further over the course of this year.  Political risk levels in India also remain uncomfortably high and this could prevent Prime Minister Narendra Modi from implementing some of the economic reforms that he hopes will bolster Indian growth prospects in the coming years.

While India’s economy has suffered from many disruptions in recent years, we continue to believe that India’s longer-term economic growth potential remains high.  In fact, over the next five years, we are forecasting average annual GDP growth rates of 7.9% for India, a higher level of growth than that of any other large economy between 2018 and 2022.  In fact, barring any internal or external shocks, India’s economy has the capacity to grow by 8% per year for the foreseeable future.  This is due to a number of factors, including India’s rapidly-expanding population (in contrast to China), its increasing attractiveness for foreign investors, and its substantial presence in many high-growing industries and service sectors.  On the other hand, it is important to remember that China averaged 10%-per-year GDP growth rates for 30 years with a much slower growing population, thanks to the Chinese government’s ability to enact nationwide economic reforms and to become the world’s low-cost manufacturing center. 

For India, achieving such high rates of growth will be difficult as India’s lacks the degree of centralized economic policymaking that was found in China, and is struggling to develop into a major export-oriented manufacturing center.  Of course, some of India’s more dynamic states are achieving consistent double-digit growth rates.  However, too many Indian states have failed to enact the reforms needed to attract investment and develop vibrant manufacturing and service sectors, and these states comprise a large share of India’s vast population.  As a result, India will grow rapidly, and some parts of the country will grow very rapidly, in the years ahead.  It just won’t be able to match China’s economic miracle, an important consideration for businesses and investors looking at opportunities in India.