Country Report India
India is experiencing an upward momentum. Growth is accelerating and the government is incrementally implementing needed reforms, inflation is easing and the current account deficit has narrowed.
Strengths (+) and weaknesses (-)
(+) Positive demographic characteristics
India will enjoy the benefits of a growing working age population. This should boost economic growth in the years ahead.
(+) Large and diversified economy
India has a large, diversified economy, which limits its vulnerability to external shocks. While the agricultural sector is the main employer, the services sector accounts for about two-thirds of GDP.
(-) Infrastructural bottlenecks and difficult business environment
Infrastructural bottlenecks are estimated to reduce GDP growth by one to two percentage points per year. Businesses also face hurdles in the form of red tape, corruption and state intervention.
(-) Political environment hampers reform process
The federal structure of India complicates decision making and policy implementation while the political environment remains fragmented, even after the BJP securing a majority in the Lok Sabha.
1. GDP growth is strengthening
GDP growth has accelerated in 2014 and is expected to continue to strengthen in the years ahead. Compared to 5% real GDP growth in 2013, growth accelerated to 6% in 2014. Most pronounced has been an increase of government consumption growth, more than doubled in 2014 compared to 2013. This was partly due to the fact that 2014 was an election year, but also, more importantly, the new government –elected mid-2014 - has streamlined expenditure approval procedures. Investment growth also increased markedly, from -0.1% in 2013 to 2% last year due to on the one hand a renewed emphasis on public investment in infrastructure and, on the other hand, streamlined bureaucratic procedures combined with increased confidence within the private sector. In 2015 and 2016, investment growth is expected to accelerate strongly on the back of business friendly reforms, which will also stimulate foreign investment, a gradual easing of monetary policies and continued public investment in infrastructure.
Furthermore, private consumption growth, the main growth driver in India, will be supported by modest inflation and the mentioned easing of monetary policies and will consequently continue to strengthen. The government is however expected to slow government consumption growth. Together, these factors are expected to push real GDP growth to around 6.5% in 2015 and 2016.
2. Modi starts up reform process
The new government is pushing ahead with its reform agenda. However, as the Bharatiya Janata Party (BJP) lacks a majority in the upper house while many necessary reforms fall under the jurisdiction of local governments, it will be an incremental process. The BJP, led by Narendra Modi, convincingly won the 2014 general elections and as a result secured a majority (282 out of 543 seats) in the Lok Sabha, India’s lower house of parliament, on its own. It was the first time in 3 decades that one party managed to achieve this. The new government, led by prime minister Modi, quickly started to implement a reform agenda. Bureaucratic processes were streamlined to improve India’s notoriously slow and complicated bureaucracy. Furthermore, fuel subsidies were removed in line with the government’s aim to curb fiscal spending growth, and land acquisition laws were amended slightly. FDI limits in the construction and insurance sectors were also raised. In addition, the government has laid out disinvestment plans, including plans to sell stakes in key state-owned enterprises and plans to introduce a goods and services tax. These (planned) reforms show that policies are moving in the right direction. However, many reforms require approval by India’s upper house of parliament, in which the BJP and its National Democratic Alliance (NDA) coalition do not have a majority, and the BJP can thus expect an obstructionist upper house. In addition, many areas in which reforms are needed fall under the responsibility of provincial governments, such a labour reforms. Such reforms can therefore only be carried out in the 12 of the 29 provinces that are under NDA control. This implies that the reform process will be incremental and India will thus not change overnight. As a result, there is a risk that the currently high expectations are not met, which might lead to a loss of confidence. For the Modi government it is therefore vital to keep the reform process continuously moving in the right direction.
3. Pro-active monetary policies
The Reserve Bank of India (RBI, the central bank) has been implementing a vigilant and pro-active monetary policy regime. Sincethe respected economist Raghuram Rajan became governor of the Reserve Bank of India (RBI, the central bank) in September 2013, the central bank has implemented pro-active monetary policies aimed at containing inflation. This has restored domestic and external confidence, which was at an all-time low in the second half of 2013. Inflation has eased since, from 10% in 2013 to around 7% last year and will likely continue to ease on the back of low oil prices. In response, the central implemented a small 25 bps interest rate cut. So far, the RBI has not implemented further rate cuts. However, as inflation is estimated at around 6% this year, below the RBI’s 2015 target of 8%, further rate cuts are not unlikely.
4. Current account deficit narrows
India’s current account deficit has narrowed significantly since 2013, which reduces the country’s vulnerability to financial market volatility. With India’s current account deficit at a whopping 8.5% of GDP in 2012, the country was seen as vulnerable to a reduced of capital flows to emerging markets in 2013. However, since then the country has been able to reduce its current account deficit to around 2% of GDP last year, mainly as it restricted gold imports, which led to a narrowing of India trade deficit from 11% of GDP in 2012 to 4.8% of GDP in 2014. Although the gold import restrictions are being eased, the resulting upward pressure on import growth will be countered by a lower oil import bill as a result of the currently low oil prices. As a result, the trade and current account deficits are expected to remain stable, which should support confidence in India.
India is a large and extremely diverse country with huge regional differences, a huge gap between rich and poor, and very diverse economic sectors. Per capita income was about USD 1,600 in 2014 (roughly USD 5,800 in PPP terms). India’s Planning Commission reported that in 2011-2012, 25.7% of the rural population and 13.7% of the urban population lived below the national poverty lines (which are lower than the World Bank’s standard of USD 1.25 per day). Although India is still home to more undernourished and poor people than all of sub–Saharan Africa, progress on poverty reduction has been impressive when India’s rapid population growth is taken into account. India will benefit from a growing working-age population in the coming decades. This could be a catalyst for growth but also a source of social unrest. The agricultural sector is very important to the rural community. Although it only produces 18% of GDP, about two-thirds of the population depends on this sector for its livelihood. At the other end of the spectrum there is the world-class IT sector that is a major driver of the services sector. India has a federal structure and many subjects have been delegated to state governments. At the central level, the Bharatiya Janata Party (BJP) secured a majority in the lower house of parliament in the recent election. It was the first time in three decades that one party managed to do this. This should bode well for progress on reforms, as India’s fragmented political scene has been an important impediment to reforms in the past. However, as the BJP lacks a majority in the upper house of parliament and many areas that need to be reformed fall under the jurisdiction of regional governments, obstacles to reform remain. There is frequent social unrest and occasional communal violence in some parts of India, often in areas that have a strong tribal presence or experience religious and ethnic tensions.