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.