India’s Growth: Critical Turning Points and Geostrategic Implications

India’s economy is in the midst of a rapid transition and is expected to overtake the US in size by 2030. With its GDP projected to cross US$3tn this year and US$8tn within the next decade, this transformation is extraordinary in terms of both its scale and its speed, with India’s growth now accelerating faster than any other major economy’s. Last month’s Sign examined the key underlying drivers of India’s transformation – its favourable demographics resulting in mass-scale urbanisation, technology adoption, consumerism and financial inclusion – all underpinned by India’s representative democracy and the resulting peaceful development of its society. In absolute terms, India’s growth is comparable only to China’s, which underwent a similar transition from 2006-2014 as its GDP expanded from US$2.7tn to US$8.1tn. China’s growth transformed its industries, its capital markets, its society and its politics and also drove seismic geostrategic shifts that resulted in global political and economic realignments. India’s rise over the next decade is likely to drive similar domestic transformations, ending extreme poverty, creating a massive urban middle class, and scaling domestic companies into global leaders. However, even though India’s rise is widely expected to be peaceful, its emergence as a real economic superpower will also likely disrupt the global economic and political status quo, shaping and re-shaping regional and global power alliances over the next decade and beyond.

This month’s Sign takes a closer look at the potential impact of India’s growth, looking to China’s own transformation as a potential harbinger of the changes that will transform India and the world as it moves through a similar growth phase over the coming years.

Comparing India and China’s Development Curves

As highlighted in last month’s Sign, India’s combination of a scaled economy and accelerating growth has led to a compression in the time required for India to add each successive US$1tn of to its GDP and, at current growth rates of 7.5-8.0% , this will result in India’s economy crossing US$5tn by 2024 and US$8tn by 2028 (see Figure 1 below) .

On a comparative basis, in terms of scale and growth India’s economy today is where China’s was approximately ten years ago. In 2006, China’s GDP approached the US$3tn mark that India is due to cross this year. Moreover, China was coming off a near decade of rapid growth that had seen the size of its economy more than triple, much like India’s has done from 2007 through today. Further, China in 2006 was on the jumping off point of an economic boom that led to its GDP expanding to US$8tn under a decade, despite the macro-economic shocks of the global financial crisis. India’s economy is similarly poised today and is also due to scale to US$8tn within a decade, driven by the macroeconomic and structural factors discussed in last month’s Sign. While China’s journey to US$8tn has been a shorter one than India’s is expected to be, due to higher average GDP growth rates, the overall trajectory of the two countries promises to be very similar. The chart below compares the relative 20-year growth journeys of India and China from US$1tn to US$8tn economies.

While nearly all growth curves can be made to look similar if zoomed in or out to the appropriate timeframe thanks to the compounding effects of growth, the similarity of the two countries trajectories’ in this instance is indicative of more fundamental underlying similarities in fundamental economic factors, and China’s experiences are relevant to India.

The Three Phases of Growth in the Rise to Global Significance

The rise to global significance can be split into three distinct phases.China’s own growth path can be divided into these phases as follows:

• Phase I: Hardship and Poverty, which correspond roughly to the long and often flat journey of its GDP to $1bn, marked by hardship and poverty;
• Phase II: Economic Liberalisation and Participation, from the inflection point and rise that took it to c.$3bn, marked by economic liberalisation and participation, and;
• Phase III: Rise to Global Significance, which marks its rise to global significance alongside the continued growth that brought GDP to c.$8bn.

Each of these phases had very different growth drivers, development implications and wealth creation characteristics, resulting in significant differences in average GDP growth across the periods, with growth in the 25 years up to China becoming a trillion-dollar economy averaging 8%, against a blistering 14% in the nine years that took it US$3tn.

There are turning points that mark the transition between each phase, marked by step changes in GDP growth, which fall into a general pattern that China appears to have followed. In the first phase, it is a recognition of the inadequacy of the current model to deliver further sustained growth that forces a rethink of the economic model. For the remaining two phases, in one view, the momentum built in the previous phase (and an absence of major dislocations such as a war or a civil deadlock) is sufficient to inexorably carry GDP growth into the next phase, while in another view continuous enlightened leadership is required to foster stable long-term growth and remove any barriers thereto. Either way, the phases are significant and distinct in their characteristics.

Dislocations impact the timing and can delay the transition to the next phase. Wars, civil conflict, policy and execution paralysis and natural catastrophes stand out as four key factors that can impact the duration of time in a phase. For China the dislocations that made the most difference included, major external factors such as the global financial crisis and internal ones such as Tiananmen Square. Dislocations in other parts of the world can also benefit a nation on this path, for example, America’s dislocation as it embarked on two wars following 9/11 distracted it while China continued to grow unencumbered by real competition for resources, global expansion into foreign market and participation in major global institutions.

The Three Phases of Growth in China

China’s recent ascension provides the route map for the three-phase journey and the human drama that accompanies it and how that translates into economic, social, political and investment changes that shape the nation and ready it for global significance. The rise of other great powers in history, whether they be America, the British Empire or further back to the Roman Empire, will most likely have followed the same pattern in the pattern of their rise.

Phase I: Hardship and Poverty. In China, this period lasted from 1949 to 1997, during which it underwent massive economic and social upheaval, including the communist revolution, the Great Leap Forward, the Cultural Revolution, the first wave of economic reforms and the subsequent Tiananmen Square Crackdown. This period saw multiple phases of massive but unsustainable growth, followed periods of regression and retrenchment so that average GDP growth for the phase overall was fairly flat, taking nearly 50 years to reach US$1tn, and averaging c.8% per year from 1960 onwards.

The turning point for China came in the late 1970s when Deng Xiaoping introduced a series of economic reforms that unleashed massive pent up demand and potential in China’s economy, driving a quadrupling of its GDP in during the 1980s. China’s progress to a US$1tn economy was however significantly delayed a decade later by the Tiananmen Square Crackdown and its aftermath, which saw leftist hardliners slow down further reform efforts and curb capitalist activity for a number of years.

While China’s first phase was driven by a poverty entrenching communist regime that damaged the living standards of the mass population, large scale industrialisation and increasing economic participation gradually came through to a limited number of urban centres, particularly on the eastern seaboard. Real value during this phase was captured largely by political insiders with connections to government officials in charge of economic initiatives.

Phase II: Economic Liberalisation and Participation. China entered this period from 1998 to c.2007, during which its GDP expanded from US$1tn to US$3tn, averaging 15% annually. As core communist economics was abandoned in this period, inspired by the view that a more open and capitalist economy somewhat like America’s was the way to prosperity, the country saw expanding economic inclusion and participation across wider parts of the country and the standard of living rose nearly across the board. This second phase also saw a massive influx of foreign investment in China, as multi-national corporations flocked to the country to participate in its growth.

China’s growth model focusing on industrial sectors, infrastructure investment and exports alongside policies favouring large and state-owned enterprises served it well in creating overall value. However, it led to an increasingly imbalanced economy with low consumption rates and an undersized services sector. This phase was also marked by the absence of established or consistently enforced rules and low transparency for market participants, particularly investors. Few investors made real returns, but a credible group of them emerged ready for the next phase.

The turning point was driven by the global financial crisis rather than an organic policy change per se, which saw Chinese GDP growth drop from 14.2% in 2007 to a low of nearly 6% in Q4 2008, triggering a massive US$586bn financial stimulus package which stabilised China’s economy, but was still unable to sustain the growth rates of the previous years.

Phase III: Rise to Global Significance. This phase started in 2008 and remains ongoing While China’s GDP continued to grow strongly and crossed US$8tn as early as 2013, China’s leaders had clearly lost confidence in a US-style open economy while struggling to determine an alternative model adopt. As a result, they failed to implement reforms during this period and the economy continued to develop largely under the impetus of the previous growth model, fuelled by economic stimulus and rising debt levels, but delivering lower growth due to overinvestment and the resulting overcapacity. China’s response to the global financial crisis also delayed the implementation of reforms, the move to more sustainable growth model, and more active engagement in international affairs. The early part of the period is a good example of how the effects of dislocations can delay the effective transition between phases.

The turning point into Phase III proper was Xi Jinping’s ascent to China’s supreme leader in 2012, who quickly announced an ambitious program of “comprehensively deepening reforms” as China reached middle-income country status. This program has been accompanied by the consolidation of domestic power, related anti-corruption purges, and increasing surveillance and censorship of society. While growth has slowed to currently c.6% p.a., these developments have also reduced volatility, increased stability and curbed some of the uncertainty and risk that accompanied China’s earlier high growth phases. While China since Xi Jinping has certainly become less liberal, the increased regulation (at least when consistently applied) provides both stability and a more transparent playing field for market participants. Although, this is clearly not the shape of things to come in this phase if China is to unlock the potential of its vast economy, a measure of certainty and control seems to be the prize that the leadership and investors will align on. In parallel, President Xi has also overtly increased China’s geopolitical reach, with initiatives such as the AIIB, the OBOR, the BRICs Bank, its naval build-up and others evidence of an economically and politically expansionist China. Phase III proper has been marked by China’s transition from significance based merely on its share of the global economy to being a superpower in its own right, with the agency to take on other powers on strategic issues, become a participant in conflicts and assume leadership positions in multi-lateral institutions such as the UN or WTO.

The Contours of China’s Journey in the Early Years of Phase III

The period from 2008 to c.2015 encapsulated the benefits of impetus from the previous phase and the transition to a reform effort. This resulted in a fundamental shift in China’s economy and society and planted important seeds for China’s growing role in the world. Several key elements of this shift are highly relevant for India as it reaches a similar phase in its trajectory of growth and development. Given that India is the only country globally that can match China in terms of scale, and therefore potential global impact, these developments are clearly critical, and include:

1. Growth Diversified Geographically. During the period of high growth in Phase III, China’s economic activity diversified geographically from its coastal industrial centres, which had driven rapid growth over the prior decade, to the inner provinces in Central and Western China. This was driven by both push and pull factors, including large-scale fixed asset investment by the government and China’s large banks as well as by rising wages in the coastal provinces pushing labour intensive manufacturing to the hinterland. As a result, between 2005 and 2015, the inner provinces narrowed their gap vs. the eastern provinces in terms of per capita income by c.5%.
2. Mass Poverty was Addressed. Driven by the rapid growth in per capita income and the rebalancing of growth between the regions, 235m people were lifted out of poverty between 2005 and 2015 and China was successfully able to reduce the proportion of people living under US$2 per day (the ‘international poverty line’) to under 1% of its population, and the proportion of people living under the lower middle income poverty line (US$3.2 per day) to 7%. China’s development focus was accordingly able to shift to improving the income of the 27% of China’s population which lives below the upper middle-income poverty line (US$5.5 per day).
3. A Massive Urban Consumer Class Emerged. With increasing economic value-add driving wages in China’s urbanised coastal provinces, these regions transitioned to hubs for high value industries including financial and business services, technology, and high-value manufacturing driven by large-scale investments in R&D and education. The accompanying emergence of educated, middle income populations gave rise to mass-scale consumption as total retail sales across China grew at a 21% CAGR from US$1.0tn in 2006 to US$4.4tn in 2014.
4. Chinese Companies Achieved Global Scale. In 2006, Chinese companies made up only 4% of the Fortune-500. By 2014, Chinese companies made up c.20% of the top-500. This period saw the emergence of private sector companies across manufacturing and services, with the market capitalisation of listed domestic companies increasing 6x from US$1.1tn in 2006 to US$6.0tn in 2014, driving massive wealth creation. Importantly, the relative scaling of China’s corporate giants has slowed since then, due to both the country’s domestic slowdown and the more competitive environments they have faced abroad.
5. China Became a Leader in World Trade. By 2006, China’s export-driven model was well-established, and it had already overtaken France and Japan and become the world’s third largest exporter. Between 2006 and 2014, China continued its rapid industrial expansion and became the largest exporter globally by a significant margin, embedding itself deeply into global supply chains and deepening its trade with its immediate neighbours in Asia, shifting the nexus of global trade routes and reorganising supply chains across industries.
6. Chinese Demand Drove Global Commodity Markets. China’s rapid domestic growth, particularly its industrial and infrastructure buildout, created a massive impact on global commodity markets, with prices growing rapidly at a 6% CAGR across categories between 2006-2014. Over the last decade, China’s consumption of more than half of global demand for cement, aluminium, nickel, coal and copper (despite accounting for only 15% of global GDP), has had geopolitical implications, reshuffling major trading and strategic relationships between producers and consumers of critical commodities across the world.
7. China Seeded as a Major Global Power Player. As a result of all of the factors laid out above, China was able to leverage its enhanced economic power and integration into a position of increasing geopolitical influence. Initially focusing on proactively using existing international frameworks such as the WTO to its own advantage (e.g. bringing 15 cases against the US against 23 brought against it), China from 2013 onward under Xi Jinping also began establishing multi-lateral institutions of its own across investment, trade, finance and security to increasingly become a global rule maker, rather than just a participant.

China has of course continued to develop under Xi Jinping and make progress across all of the above metrics, albeit a slower pace than in the early years of Phase III. While the country appears to have settled into a sustainable growth rate supported by stable institutions, the risk of further dislocations to China’s development of course remains: the US-China trade war escalating at the expense of China’s growth, a widening of the multi-front power confrontation to contain China, or internal instability resulting from a popular backlash rejecting increasing authoritarian and central control are all plausible risks that could derail many of its recent gains and set the country back by several years.

India’s Transition: The First Two Phases - Implications for India and the World

India’s first two phases mirror China’s own experience and therefore point to important implications from China’s third phase for India as it looks to plot its course over the next decade. Importantly, India has mostly completed the first two phases of the journey by following an economic development model of its own making which has not served it quite as well as China’s, but given its openness holds the promise of greater benefits going forward.

Phase I: Hardship and Poverty (1947-2006). It took India six decades after its independence from British rule for its economy to scale to US$1tn (or c.US$1,000 per capita income). During much of this phase, India followed a Soviet-style command-and-control driven economic model with a heavily regulated private sector, production and prices set by the government, investment “The energies of investors were directed towards winning licenses, rather than capturing markets or producing superior goods, and profits tended to be guaranteed irrespective of quality or efficiency.” channelled into state-owned firms, high tariffs, a lack of currency convertibility and restrictions BBC, India: The Economy, 3-Dec-1998 on foreign investment. Access limited government licenses to steel, power and communications and so allowed a few well-connected business houses to build diversified empires while the overall private sector remained shallow and walled off from global competition. As in China, value was captured by political insiders. This period was marked by high inflation (averaging c.7% p.a.) and slow growth (averaging 4.1% p.a.) Development was uneven and growth was extremely volatile and vulnerable to external and domestic shocks including wars with neighbours Pakistan and China, global drought and famine and political instability.

The turning point came in 1991, when India discarded its failed socialist style planned economic model and embraced the market economy. Facing a severe balance of payments crisis, India’s government radically removed licensing requirements and opened up to foreign trade and investment. The subsequent years saw continuous but gradual reforms by successive governments which helped drive increased foreign investment and exports and saw growth accelerate to 6.3% between 1991 and 2007, helping the economy scale to US$1tn.

Phase II: Economic Liberalisation and Participation (2007-2018). India’s transition to Phase II coincided with an unprecedented global liquidity boom and increased inflows to emerging markets globally, (which were at least partially unleashed by China’s rise through Phase II.) This influx of capital combined with the opening of key sectors to foreign investment and competition helped industries such as financial services, information technology, pharmaceuticals, telecommunications, consumer goods and retail achieve global scale. More widespread growth in turn drove mass inclusion in terms of access to financial services, connectivity, education and healthcare.

Growth averaged 7.3% during this 12-year period but was highly uneven due to various global and domestic factors. The initial years (2007-2010) saw India capitalise on increased liquidity post the global financial crisis, and growth averaged 8.5%, creating the expectation that India could move through its Phase II at a similar pace to China, and quickly hit US$3tn of GDP.

However, the Indian government seemed to fall into a self-inflicted major dislocation that stopped its progress. Multiple large corruption scandals under the ruling Congress-led coalition government paralysed further policy reforms, a battle with a foreign investor, Vodafone, led to a massive outflow of capital and precipitated the collapse of the rupee, depreciating by c.50% between 2007 and 2013, further eroding returns. These and other factors including external changes (such as quantitative easing in the US) led to growth falling to 5.5%.

The turning point came in 2014 when voters grew tired of the incumbent government and elected Mr. Modi on the back of his reformist credentials with an unprecedented parliamentary majority. Following his election, Mr. Modi’s government restarted India’s reforms program and attracted FDI back to the country and growth has rebounded back to a c.7.5%-8.0% trajectory . After adding only c.US$80bn of nominal GDP p.a. between 2010 and 2014, in the last five years, India has added c.US$200bn p.a. and scaled from US$2tn to US$3tn. With its GDP expected to cross US$3tn this year, India is now on the threshold of making the transition from Phase II to the Phase III.

While Phase II in India was certainly more inclusive than the previous phase in terms of value creation, fortunes were both made and lost due to the instability of growth, high volatility and dislocations caused by bad policy. And while India’s growth attracted significant international capital, only a small portion of investors were able to generate returns, or even preserve value throughout the cycle. Those that survived emerged tougher, smarter and more ready to launch into the next phase.

Phase III - India’s Critical Next Decade (2019-2028): Rise to Global Significance

As India stands on the cusp of Phase III, what should it and the world at large expect as it makes this transition? China’s rise provides an indication of the transformation that India seems likely to undergo in the next decade. The drivers of this transformation– urbanization, financial participation, consumerism, to name a few – put into perspective the priorities of India’s government over the next decade. One of the important lessons is that the government is in fact not required to be an architect of growth, but is accountable for removing obstacles to that growth. Failure to do so will lead to losses at the ballot box (a risk that China’s leadership never faced.) Unlike China, however, India today is not encumbered by the dislocation of a global financial crisis, which leaves it in a stronger position to scale from US$3bn to $8bn in a sustainable fashion. Further, with elections this year providing a fresh five-year mandate, India’s next government can build real momentum for the country’s rise in global significance, leading to an India that by the end of the next decade can carry much more weight globally than China did as a US$8tn economy.

The key elements of India’s coming transformation include the following:

1. Balanced Growth, Mass Inclusion and the End of (Extreme) Poverty. India’s next decade will likely see significant regional rebalancing with growth accelerating in its poorest states, a trend that has already been visible over the last four to five years. Indians will also benefit from the deepening inclusion – financial, digital, healthcare, educational and quality employment - which will ensure increasingly broad access to the country’s economic opportunity for internal and external participants and ensure that India effectively eradicates extreme poverty in the next decade.
2. India’s Cities Will Develop into Upper Middle-Income Metros. Like China, India will face rapid urbanisation over the next decade, with India’s urban adding c.300m people by 2030. . While India’s track record of creating urban infrastructure to date has been poor , the wealth created by increasing urbanisation can potentially open up technological and financial resources that can fund the next wave of infrastructure – something which is already visible in the large new metro rail and road projects launched in a number of Indian cities –triggering in turn a virtuous cycle of increased consumerism that eventually leads to the creation of world-class cities.
3. India Will Create the Next Wave of Global Corporations. With a large low-cost labour pool, a robust entrepreneurial ecosystem across multiple sectors, and more limited state involvement in the economy , India has already created global market leaders in knowledge intensive sectors such as IT and generic pharmaceuticals with little government backing. In the next decade two new waves of Indian companies will likely rise to global dominance, firstly in knowledge-intensive sectors, where Indian entrepreneurs will set out to contribute to solving India’s (and the world’s) biggest challenges using data analytics, fintech, health-tech and ed-tech, and secondly in selected manufacturing segments, where Indian companies will scale into low cost leaders.
4. India Will Deepen Its Trade and Investment Linkages with the World. India’s global corporations will of course be major exporters as well, just as India will attract global companies to set up a scaled presence in India. Moreover, India’s demand driven by 1.4bn consumers will reorder existing global trade flows as countries adjust their trade priorities to absorb India’s excess output and meet its domestic demand, impacting global commodity prices and capital flows.
   India Will Assume the Role of an Emerging Superpower. India’s economic expansion will ripple through the global political and security landscape. India has largely been welcomed by Western powers as an attractive partner fuelling the growth of their own economies. However, much like China who was welcomed as an economic partner two decades ago but went from being a junior partner to being a rival. India’s relationships too may eventually suffer an international backlash, unless India learns from China’s missteps. India has an opportunity to proactively position itself as a counterweight to China, and as a more sustainable partner based on shared values with liberal democracies.
5. India’s Growth Will Put Further Strain on Regional Relationships. Conversely, India’s strengthening will exacerbate existing regional power imbalances between it and its smaller neighbours. Despite Prime Minister Modi actively courting India’s South Asian neighbours to improve ties and the country’s standing in the region, many of India’s neighbours today remain actively hostile (e.g. Pakistan), ambivalent (e.g. Bangladesh) or largely indifferent (e.g. Sri Lanka) to the country they perceive as an aspiring regional hegemon. Unless India is able to form an inclusive vision for its development that improves overall regional growth and security, these attitudes will only harden over time as India’s bilateral leverage increases.

There are limits of the lessons from China, centring on the differences in their political systems and the overall geopolitical environment in which they operate. In terms of their political systems, India and China of course differ in terms of the degree of central control they enjoy over their respective economies. However, while China has certainly enjoyed far more authoritarian control, it is about to lose some of that as its economy grows in complexity and particularly as the private sector grows, and India under Modi has pushed through reforms that seem drastic even by China’s standards: demonetisation, unification of state taxes, bankruptcy law, a nationwide critical healthcare scheme, mass financial inclusion.

In terms of the geopolitical environment, the global context in which India will make the journey to US$8tn will likely be very different from China’s journey, occurred at a time when the Western liberal order, including liberal democracy, free markets, action through multi-lateral institutions reigned supreme. India’s rise on the other hand is occurring at a time in which this same order is clearly under attack. The rise of populism and protectionism in the West and the accompanying threats to globalisation in general, the redrawing of 20th century strategic alliances are all disrupting national economic, political and security strategies across the world. Importantly however, India’s rise into the bi-polar world that China’s emergence has created provides an important opportunity for all the players to adopt a new model, given sufficient visionary thinking on this by the leading powers. Depending on how India chooses to play this game, dislocations to China’s growth could be opportunities for India to position and reposition in the economic and geopolitical landscape.

Conclusion: Choices in The Asian Century for the West, in Precis

Stepping back, the relentless path through three phases of two nations with c.1.3 billion people poses one of the most important shifts in the power structures of the world. While mass media in the West seems obsessed with populist drama around energy-draining domestic issues which create regional and global angst – Brexit, the wall with Mexico, the Mueller report and so much more – the visitor to the East sees both less drama playing out and is left feeling the positive energy of a continent rising inexorably, driven by two giant nations. Regardless of how these issues play out and their global implications, the facts regarding Asia’s rise stand as certainties (see above). The combined effect of China’s rise, the re-weighting to Asia, and India’s increasing economic weight will not just transform India but also add to the complexity of our increasingly multi-polar world. Current powers will need to fundamentally rethink their engagement with Asia. The path ahead seems to offer three geostrategic alternatives:

1. Acceptance of India and China’s Rise to Geostrategic Significance. Accepting the rise of Asia as one of the most significant development of the 21st century, existing power and economic blocs will need to determine their relationship with India and China. Many democracies might well see India as a strategic partner for the region, while treading a tricky middle path that seeks accommodation with both India and China. Looked through this lens, the rise of India could offer the best opportunity to avoid a conflict between existing powers, establishing a new multipolar world order inhabited by multiple powers and led by (at least) three.
2. Neglect of India and China from Attention Deficit. The West is clearly in the midst of an all-consuming wave of populist pressure to focus on domestic issues. This may lead them to neglect being strategic in building the relationships they need with both countries. A more transactional approach may begin well, but as the last decade shows, it ultimately leads to a loss of position for the West and the risk that it wakes up one morning feeling it has lost to rising giants such as China.
3. Containment, Division and Conflict. The rise of two giants in Asia seems unavoidable and this is ultimately threatening, especially if there is a view that they are a threat to the “way of life” for existing powers. Existing powers can choose to between them and indeed, India seems a natural choice for democracies or they can choose to contain or confront both. The middle path of attempting to turn India against China seems like a likely ploy too. This strategy clearly creates risks of conflict for the world at large. The rise and fall of previous powers in history suggests that there is a pattern to how this will play out.

These decisions will likely lead to a longer-term reordering of geopolitical power groupings and thereby impact the shape of any future world order. India’s rise to global significance provides the US and the West with the opportunity to define the world as the relationship between three parties with checks and balances rather than as a two-party conflict between the US and China.

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