India: can the fastest-growing large economy sustain its pace?

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India’s GDP growth accelerated in the first quarter of 2016 to a scorching 7.9% year-on-year (YoY), from 7.2% YoY in the previous quarter. Over the full financial year ending in March 2016 (FY2016), the economy clocked a pace of 7.6% – making India the fastest-growing large economy in the world.


Driven by private consumption

The major driver of this growth was private consumption, which accounts for 56% of India’s GDP. Private consumption growth remained resilient despite a weak rural economy brought about by two consecutive years of sub-par monsoons. Given the government’s commitment to fiscal consolidation – the fiscal deficit target of 3.9% of GDP for FY2016 was successfully achieved – government expenditure growth remained low, as expected, at 2.2% YoY. A slowdown in private capital expenditure resulted in gross fixed capital formation growing at a lacklustre 3.9% YoY.

While a 7.9% growth print is certainly laudable, it is reasonable to question whether such a growth pace is likely to be sustained?

Short-term drivers: consumption stimulus and monsoons

In the short term, growth is likely to be driven by two major factors. The implementation of the recommendations from the Pay Commission (read our note here) will lead to an increase in public sector wages, representing a stimulus of around INR 1 trillion (USD 15 billion). This will boost urban consumption. For ‘rural India’, initial forecasts point to an above-average monsoon season this year, which would help reduce the stress upon the rural economy.

Long-term drivers: India’s favourable demographics mean growth is a necessity

India enjoys favourable demographics. Besides 52% of its population being under the age of 25, India benefits from a falling dependency ratio, which provides strong support for long-term growth.

That said, the demographic boon could become a burden unless adequate employment opportunities are created. Every year India sees almost 12 million young people enter the labour market. With this in mind, the government has launched the ‘Skill India’ mission designed to provide ‘outcome-based skills training’ to help young people become employable and earn a decent livelihood.

Enhanced macroeconomic stability

One of the early achievements of the government and the Reserve Bank of India, led by its governor Dr. Rajan, has been to restore India’s macroeconomic stability. While less than three years ago India was considered as one of the ‘Fragile Five’, its macroeconomic stability has greatly improved, with inflation lower, at 5.4%, a reduced current account deficit at 1.3%, a well-contained fiscal deficit at 3.9% and record high foreign exchange reserves of more than USD 350 billion, which equates to more than 10 months of imports cover.

Exhibit 1: Macroeconomic stability to enhance the attractiveness of India within emerging markets

macroeconomic variables

Source: Axis Capital, BNPP IP, as of 17 May 2016. CAD: Current Account Deficit; IIP: Index of Industrial Production.

Note: design in red= Peak/ lowest for the period Apr-12 to Mar-14; dots in green = current values

India’s ease of doing business is improving

The government is focusing on improving the ease of doing business in India by cutting red tape and using technology to increase transparency. The government’s ambitious target is to improve India’s rank in the World Bank’s Ease of Doing Business index from 142 to 50 within the next few years. The government is even introducing a ranking of Indian states based on their ease of doing business, fostering healthy competition to attract investments and create jobs. This is what the government calls ‘competitive federalism’. As the central government may be unable to implement certain economic reforms because of its minority position in the Upper House of the Parliament, it is also encouraging progressive states to implement locally certain key economic reforms such as labour, land and power reforms.

While the positive effects of these initiatives are likely to show over time, some green shoots are already appearing. In a report released by EY in October 2015, India has been ranked as the “most attractive investment destination in the world for the next three years”. India was ranked the most attractive market by 32% of investors, scoring a 10 percentage point improvement for its ease of doing business rating.

Infrastructure development: focusing on roads and railways

A robust infrastructure network is critical to drive and sustain growth. In this regard, the government is focusing on two major areas: roads and railways. In the FY2017 budget, the allocation for roads rose by 25% YoY to USD 8 billion, while that for capital expenditure in Indian railways was increased by 30% YoY to USD 6.6 billion. A well-developed transportation network should both bring down the cost of logistics as well as having a multiplier effect by way of real estate development and creating new avenues of employment.

To tackle the growing challenge of India’s rapid urbanisation, the government has also initiated the ‘Smart City’ scheme. Its objective is to “promote cities that provide core infrastructure and give a decent quality of life to its citizens” (see our article on pages 6-7 of the Q2 Mumbai Monitor).

Promoting efficiency and inclusive growth

While good quality infrastructure is critical in realising India’s growth potential, one needs to ensure that the fruits of development are not cornered by the ‘haves’, leaving the ‘have nots’ high and dry. Tackling corruption has been at the top of the government’s agenda. An important reform initiative is the Direct Benefit Transfer (DBT) scheme to reduce leakages and direct subsidies (food, fertiliser and cooking fuel) to those that need them. This has been made possible by the implementation of the ‘Aadhaar’ card scheme, which provides a unique identification (UID) number to all citizens. Currently, more than one billion Indians already have an ‘Aaadhar’ card. The implementation of the DBT scheme is backed by the government’s ‘Jan Dhan Yojana’ scheme, which promotes financial inclusion by aiming to provide every household in the country with access to basic banking services and facilities.

India becoming too big to ignore

These initiatives, combined with a number of reforms to improve the ease of doing business in India, should create an enabling environment for job creation and sustained high growth, to the extent of likely propelling the Indian economy from its current 7th rank to a top 5 world economy in the next five years and to the top 3 in the next 20 years. [divider] [/divider]

Radiokafka /

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The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, portfolio transaction, liquidation and custody services for funds invested in emerging markets may carry greater risk.

Anand Shah

Head of Investments and Deputy CEO, India

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