RaboResearch - Economic Research

Country Report India

Country Report


Economic growth has been strong recently and is expected to strengthen somewhat in the near future. Although economic policy in India is moving into the right direction, the pace is slow, which eventually might hurt economic growth. The reduction of the current account deficit that has taken place recently decreases the country’s vulnerability to international financial market volatility.

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. 

Key developments

1.Pace of economic reforms remains sluggish as monsoon parliament session washed out

Although the Modi government intends to tackle structural issues that have stalled investment and limited economic growth in recent years, reforms are difficult to implement. First, the Bharatiya Janata Party (BJP) does not have a majority in the upper house (yet), while major reforms require passage there. Second, many areas in which reforms are needed fall under the responsibility of state governments, and thus require passage through local parliaments. The National Democratic Alliance (NDA) coalition including the BJP, however, controls only 12 out of 29 states, so progress in these areas will also remain slow. To increase the overall reform pace, the BJP needs to win state elections to increase its power in states, but also to secures more seats in the upper house. Crucial will be winning the Uttar Pradesh regional elections in the spring of 2017, as this is by far the largest state in India.

Since the NDA lacks a majority in the upper house, a goods and services tax (one value added tax which creates an internal market) and land acquisition bill (to ease the process to acquire land to start new projects) did not pass the Indian parliament during its monsoon (July-August) session. The session therefore ended without agreement on major reforms, but the government will likely try to bring the first bill to a vote in the upcoming winter parliament session. Further delays of the reform process might start to hurt investor’s confidence as well as economic growth.

2. Economic growth strengthens

Economic growth in FY2014-15 was 7.3%, an acceleration compared with 6.9% economic growth in FY2013-14. Compared with previously published growth figures for 2013 and 2014, this looks like a large increase. However, due to a change in India’s GDP calculation method  implemented in January 2015, economic growth figures for those and next years have been revised upwards. Although economic performance is improving, the picture is thus less positive than plain growth figures might suggest. Going forward, economic growth is expected to strengthen to 7½% in 2015 and 2016 (figure 1). Household consumption will be supported by low oil prices. Furthermore, economic growth will benefit from government plans to spend an additional 11 billion USD this year on infrastructure to improve conditions for private investment. As a result, however, the FY2015-2016 budget deficit target has been relaxed from 3.6% to 3.9% of GDP. The government remains committed to bring down the budget deficit though. Business investment will probably also benefit from Modi’s Make in India project and minor reforms passed in the Budget session in May 2015, like enabling private firms to mine coal. That said, it remains uncertain whether India’s highly indebted corporate sector will increase investment in manufacturing and infrastructure. Failure to implement major reforms poses another downward risk to economic growth.

Figure 1: Economic growth strengthens
Figure 1: Economic growth strengthensSource: EIU
Figure 2: Current account has improved
Figure 2: Current account has improvedSource: EIU

3. Monetary policy moves closer towards international standards

A positive sign is that Indian monetary policy is moving closer towards international standards, as the central bank started to target consumer price inflation (CPI), instead of whole sale inflation. Furthermore, new legislation to create a Monetary Policy Committee (MPC) is being drafted and will possibly be finalised by the end of 2015. Current policy targets inflation below 6% until January 2016. From FY2016-17 onwards, the MPC will likely target 4% plus or minus 2 percentage points. The MPC will improve transparency and predictability and bring India’s monetary policy framework closer to international norms, as currently the RBI governor can set policy rates on his own. The MPC will be made up of government and Reserve Bank of India (RBI) nominees. Although the implementation of an MPC might increase government influence in monetary policy making, as under the draft proposals the finance ministry would have the power to name four of the seven members of the committee, it is expected that the RBI governor Rajan will continue to dominate monetary policy for three reasons. First, Rajan has good relationships with Modi and several officials in the finance ministry. Second, as Modi and the officials are aware that investors highly respect Rajan, they are unlikely to take actions that could create the perception that the government is undermining Rajan. Third, former RBI governors have come under government pressure to lower rates in the past, but they remained independent and did not yield to these pressures. This trend is not expected to change, regardless of the MPC structure.

4. Stronger external position decreases vulnerability to international financial market volatility

India is better prepared to deal with possible capital outflows. Foreign reserves have steadily been built up to more than USD 355bn (in August 2015) since Rajan became RBI governor in September 2013. Moreover, the current account deficit has been reduced significantly, although it is still a weakness (figure 2). Besides, business sentiment seems to have improved since Modi took office, although continued failure to implement structural reforms may cause a downside risk to investor confidence. Rajan indicated that India will use its reserves to reduce exchange rate volatility if necessary. 

Factsheet of India
Factsheet of IndiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

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, 30,9% of the rural population and 26.4% 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 17% 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 2014 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.

Economic indicators of India
Economic indicators of IndiaSource: EIU, Rabobank
Carlijn Prins
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
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