India defying expectations

Why can’t we acknowledge elements of both and still conclude the economy’s trajectory has improved?

"Rather than the ‘closed economy’ reality that formerly characterised India, the economy is now more open than China was at a similar stage of development.”

The high quality of the Indian economy’s recent past is unarguable – it was the fastest growing major economy in 2022 and 2023 and is forecast to be so again in 2024. And there are three tailwinds suggesting this growth phase could last quite some time yet.

Recent growth

The first is the base. India didn’t become a low-middle income economy until 2018 and it wasn’t until after the pandemic that the country’s per-capita gross domestic product (GDP) sustainably eclipsed US$2000. The prospect of convergence is stronger when the distance to best practice is greater.

But economic tinder still needs the spark of reform, the second factor. Recent progress is palpable.

Reform agenda

The introduction of a goods and services tax in 2017 simplified a more complex web of central and state taxes as well as streamlining the movement of goods across India’s 36 states and territories.

The rate of highway construction has tripled since 2015. Capital expenditure on railways, as a share of GDP, has more than doubled in the last decade. Both the World Bank and International Monetary Fund have called out India’s world-class digital public infrastructure, which is enabling the government to better target welfare programs and improve tax compliance.

Human development indicators show similar trends in improvement. Access to flushing toilets, cooking gas penetration, infant mortality and household electrification have all shown extraordinary improvement over the past decade.

A decade ago, 40 per cent of households were without electricity. Today it has shrunk to less than 3 per cent. India’s development is improving the lives of more than the few.

The China impact

The third tailwind is China, which has provided the spark. China’s reversion to the economic mean has prompted both capital and attention to look farther afield. In the last four years net foreign direct investment (FDI) as a share of GDP has been three times higher in India than in China.

Fifteen years ago, flows into China were sometimes four times larger than into India. Expats and international expertise typically follow FDI. Over the same period – a hostile one for capital flows into emerging markets – net portfolio flows into India have been positive while China has experienced its largest outflows in the modern period.

The evidence seems clear, yet the Icarians still have plenty of voice. Perhaps some expect India to disappoint in the future because they have been disappointed in the past? There is a legacy of disappointed expectations.

Sustaining growth

But clarifying the disappointment is important. India’s historical challenge has been not so much about growing quickly as about sustaining growth. In the three years either side of the global financial crisis, India’s GDP averaged 8.5 per cent. In my view, sustainability has become much more likely.

India has a reputation for chronic underinvestment, but that's yesterday’s story. Capital investment is now above 30 per cent of GDP, higher than Taiwan and on par with Korea. India is the only Asian economy with an investment-to-GDP ratio above pre-pandemic levels.

Its import dependency has also declined, due to stronger remittances and the rise of global capability centres. The trend in remittances has improved sharply since 2022.

Rather than the ‘closed economy’ reality that formerly characterised India, the economy is now more open than China was at a similar stage of development. Trade, as a share of GDP, has averaged around 50 per cent over the past decade compared with less than 15 per cent in 1990.

It is true the average tariff rate on agricultural goods remains high, but tariffs on manufactured goods fell to about 10 per cent in 2008 from more than 80 per cent two decades before.

After a 10-year hiatus, India has recently reached trade agreements with Australia and Mauritius and is negotiating with the UK, Oman and four European nations.

We expect household consumption in India to outperform the region over the next year or two, with household expectations on income, employment and spending firing on all cylinders.

Macro challenges

India’s most pressing macro policy challenge is to ensure recent steps to reduce the near-20 per cent rate of growth in credit are effective and the benefits of financial sector reform are not eroded by another boom-bust credit cycle.

Tighter regulations around personal loans and credit cards are likely to help, but sector-wide lending growth needs to slow further to better mirror deposit growth.

India’s conservative 2025 budget will help. A sharp slowdown in revenue spending, but still with a further rise in expenditure on infrastructure, and a lower-than-expected fiscal target of 5.1 per cent of GDP will take some steam out of the economy.

Even with India’s recent track record, reform and refocussing dividends can’t last for ever. Further reforms will need to come.

India is still quick to turn to restrictions on trade to address cost of living challenges, the agriculture sector remains protected, and its operations can be sub-scale and women’s labour force participation is unenviably low.

To fulfil its economic potential, these issues ultimately need to be addressed. But there is still time. Don’t let India’s past legacies distract from opportunities in the present.

Richard Yetsenga is ANZ Group Chief Economist

A version of this article was published by Nikkei Asia on 16 February 2024.