India at a crossroads

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Investors reassess India’s potential as era of cheap money draws to an end 

India has enjoyed rapid economic expansion over much of the last decade. Supported partly by strong capital inflows, its GDP grew by over 8% a year between 2005 and 2012. Foreign investment inflows grew from around US$20b in 2005 to over US$50b by 2012. This was accompanied by an increase in Mumbai’s Sensex stock exchange index of almost 150%. Other emerging markets experienced similar surges. 

India is vulnerable to external shocks 

Although the current account deficit improved to 4% of GDP in H1 2013, from 5% of GDP in 2012, GDP growth almost halved to around 4.8% in Q3 2013 as compared with the period before the global financial crisis. 

We expect growth in 2014 to pick up to 5% in our baseline. Nevertheless, with growth still subdued, the economy remains vulnerable to capital outflows triggered by further rises in US bond yields or a flight from risk. 

Short-term reforms have improved resilience 

There is scope to minimize the negative impact of a confidence shock in the near future. Raghu Rajan, the new central bank governor, has already taken some encouraging steps in this regard. He aims to curb inflation as well as bringing the monetary policy stance back to “normal”, after the extraordinary measures taken in July. 

Bold reforms over the medium term would lift growth  

With a fast-growing population, which we expect to exceed China’s within 20 years, India has the opportunity to change direction by improving the pace of innovation and the skills of its workforce. Some crucial reforms, which could lift growth in India, relate to several sectors, such as: 

  • Banking: improved access to liquidity, particularly for small- and medium-sized companies as well as for poorer households.
  • Mining: more liberalization of minerals policies would open up the sector.
  • Manufacturing: improved infrastructure for the production and distribution of coal and electricity would boost the sector’s share in overall GDP.
  • Education: increased employment and productivity from improved literacy would contribute to GDP growth. 

If India were able to implement some of these reforms, the improved skills of the workforce, higher investment and a faster pace of innovation could lift annual growth to well over 8% in 2016–20, relative to the 6%-7% that we currently expect.

While the obstacles to implementing some of these reforms are significant, the returns to India’s population are clear.