India’s economy can overtake China’s if it can stay on track
But complacency toward reform and trade links could haunt New Delhi
Alicia Garcia-Herrero
April 12, 2024 17:00 JST
Alicia Garcia-Herrero is chief economist for Asia-Pacific at investment bank Natixis in Hong Kong and an adjunct professor in the economics department of the Hong Kong University of Science and Technology.
Will India’s gross domestic product ever surpass that of China?
Ten years ago, no one would have given this question much thought. But times are changing. The Chinese economy may now be more than five times larger than India’s, but India is growing much faster than China, and no one expects that to change anytime soon.
Already, since 2010, India’s economy has overtaken those of the U.K., France, Italy and Brazil in size. Japan, which last year slid behind Germany to become the world’s fourth-largest economy, is set to be the next to fall behind India, sometime in the next few years.
Unless there is a major shock then, the Indian economy is on track to converge in size with that of China over the coming decades. Whether Indian output will actually overtake that of China is hard to predict, since that will depend on how swiftly Chinese output decelerates and how long India continues to benefit from conditions favorable to its growth momentum, including an expanding, urbanizing population and Western investment interest in the country as a hedge against dependence on China.
China’s growth rate has been coming down from its previous double-digit pace since 2010, with the government this year aiming simply for a rate of “around 5%.” But for an economy with a per capita GDP above $10,000, 5% growth would already be exceptionally good. South Korea is the only country to have reached that income milestone and then sustained average GDP growth above 5% for another decade.
Chinese growth will likely have its ups and downs in the coming years, but its structural deceleration is a fact of life. Every factor behind China’s potential economic growth is slowing, including potential contributions from labor, labor productivity and investment. Returns on investment have been coming down for the past decade and are now similar to those of developed economies.
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Without major structural reforms, China’s growth rate will subside to about 2.4% by 2035. It will then continue to slow as China’s urbanization rate, currently at 60%, approaches the 75% of developed economies. As the country’s overall population declines , the pace of annual growth may hover around 1%, like that of Japan today.
India is at a very different point in its development. Over the last decade, its average growth rate has been about 7%, which should be sustainable given that even with recent urbanization, only about 35% of its population lives in cities.
India can also be expected to draw significantly more foreign direct investment into its manufacturing sector. Such flows provided a significant lift to China in past decades, but now foreign companies and government are looking for alternative production bases amid the great power competition between Washington and Beijing.
India’s central role in the Indo-Pacific region, anchored by the world’s largest population and the country’s rising economy, will lock in U.S. interest. The European Union, too, is keen for India’s momentum to continue as it battles over export markets with China.
One key uncertainty with this picture involves Chinese innovation. China has been increasing spending on research and development to levels similar to those of developed economies, though the amounts remain much lower than those of South Korea or the U.S. This investment has already been paying off, with China moving quickly up the ladder in many industrial sectors and making breakthroughs in a number of scientific fields.
However, this innovation drive does not seem to be generating any productivity gains in terms of China’s total factor productivity. This phenomenon, which bodes ill for reviving China’s growth momentum, appears related to the lack of substantial economic reform over the last two decades.
It can also be traced to the increasingly difficult environment facing the most vibrant part of China’s economy, the private sector. Adding in headwinds from Washington’s tightening technological containment measures, it is difficult to be optimistic about Chinese growth.
At the same time, it is worth asking whether India might fail to sustain its current momentum. It would not be the first time. Do not forget that India’s economy was not much smaller than China’s as of 1990. But excessive planning and government-led industrial policies, and a lack of agricultural reform, held India back as Chinese growth exploded.
Reflecting on China’s experience, India will need to work harder on its own “reform and opening up” agenda.
Reform moves by the government of Prime Minister Narendra Modi during his second term, which is about to come to an end, suggest that he had gotten the message. But it is an open question about what direction he will take should he win a third term, as expected, when Indians go to the polls later this month.
Modi’s “India First” agenda, which carries a clear tone of self-reliance, especially as far as the industrial sector is concerned, is worrying. His divisive social agenda also could bring headwinds.
Yet, all in all, India seems set to have an economy as large as that of China by around the middle of the century, as well as a much larger population. Crucially, whether India manages this feat will be in its own hands. Complacency about reform and openness will be just as problematic for New Delhi as it is now for Beijing.
This time, India’s rapid economic growth has legs
Factors that previously sapped momentum have finally been addressed
Richard Yetsenga
February 16, 2024 17:00 JST
Richard Yetsenga is chief economist and head of research at ANZ Banking Group in Sydney.
The high quality of the Indian economy’s recent performance is inarguable. The country was the fastest growing major economy in 2022 and 2023 and is forecast to be so once again in 2024.
There are three tailwinds that suggest this torrid growth phase could last quite some time yet.
The first is the base. India became a low-middle income economy only in 2018 and it was not until after the COVID pandemic that per-capita gross domestic product sustainably eclipsed $2,000. The gains from reform will inevitably be greater when the starting point is lower.
But economic tinder still needs the spark of reform, the second factor. Here too, recent progress is palpable, however.
The introduction of a national goods and services tax in 2017 simplified a complex web of central and state taxes and helped streamline 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 over the last decade.
Both the World Bank and the International Monetary Fund have hailed India’s world-class digital public infrastructure, which has enabled the government to better target welfare programs and improve tax compliance.
Human development indicators show similar trends in improvement. Access to flushing toilets and cooking gas, infant mortality and household electrification have all shown extraordinary improvement over the past decade. A decade ago, 40% of households were without electricity; today the share has shrunk to less than 3%. Development is improving the lives of more than just the few at the top in India.
The third tailwind is China, which has provided the spark. The reversion of China’s growth rate to the economic mean has prompted both capital and attention to shift farther afield.
Over the last four years, net foreign direct investment 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 foreign direct investment.
Also over the last four years — a hostile period for capital flows into emerging markets — net portfolio flows into India have been positive, while China has experienced its largest outflows in modern times.
The evidence seems clear, yet doubters continue to question whether India can keep outperforming. Perhaps some expect India to disappoint in the future because they have been disappointed in the past. There is, indeed, a legacy of disappointed expectations.
But clarifying the disappointment is important. India’s historical challenge has been not so much about growing quickly as about sustaining growth. Between 2004 and 2010, for example, India’s GDP growth averaged 7.2%.
One issue is that India has a reputation for chronic underinvestment, but that is yesterday’s story. Capital investment is now above 30% of GDP, higher than that of Taiwan and on par with South Korea.
India is the only Asian economy with an investment-to-GDP ratio that is higher than it was before the pandemic. Its import dependence has also declined, due to stronger remittances and the rise of global capability centers, which build upon India’s previous success in business process outsourcing. Remittance volumes have also grown strongly since 2022.
Rather than the closed-economy reality that previously characterized India, the economy is now more open than China’s was at a similar stage of development. Trade, as a share of India’s GDP, has averaged around 50% over the past decade compared with less than 15% in 1990.
It is true that the average import tariff rate on agricultural goods remains high, but tariffs on manufactured goods were down to around 10% as of 2008 from above 80% two decades before. After a 10-year hiatus, India has recently begun signing trade agreements once again, with pacts finalized with Australia and Mauritius and talks underway with Oman, the U.K. and four other European nations.
Household consumption in India is likely to outperform the rest of the region over the next year or two, with household expectations regarding income, employment and spending firing on all cylinders.
India’s most pressing macroeconomic policy challenge is to ensure that recent steps to reduce the near-20% rate of growth in credit are effective and that 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 sectorwide lending growth needs to slow further to bring it into better alignment with deposit growth.
The government’s conservative budget plan for the new fiscal year beginning in April will help. A sharp slowdown in overall spending and a lower-than-expected budget deficit target of 5.1% of GDP will take some steam out of the economy, even as infrastructure spending continues to rise.
Still, to fulfill India’s economic potential, more reforms will be needed. India remains prone to imposing restrictions on trade to address cost-of-living challenges, the agriculture sector is still highly protected and production often subscale, and women’s labor force participation is unenviably low.
But there is still time. India’s past legacies should not distract from opportunities in the present.