Strengthening India’s Growth Multiple in the Global Slowdown

India, the world’s fastest growing major economy, has been one of the few bright spots in an increasingly volatile world that has seen global risk rising. A comprehensive reforms programme implemented by the Modi government helped economic growth accelerate to c.7% even as global growth has slowed, sharply increasingly India’s ‘Growth Multiple’ (defined as Indian GDP growth as a multiple of global GDP growth). With global political and economic uncertainty set to increase for the foreseeable future, India has a unique opportunity to further cement its position as pillar of growth and stability globally. India’s finance minister, in her maiden budget speech predicted India as a US$5tn economy by 2024, which will require an average GDP growth rate of 8% over the next five years to achieve. The Sign of the Times in February 2019 laid out the case for a US$5 trillion economy and its key drivers and in April further laid out the structure of India’s trajectory into a new phase of this growth. While India’s ability to sustainably grow at this rate is largely driven by a series of country specific macro-drivers independent of government policy, India of course is not immune to the global slowdown underway. The recent slowdown in growth over the last few quarters – GDP growth for Q2 2019 was c.5%, the slowest in six years – is at least partially attributable to on-going global macro-economic volatility. Against this backdrop, for India to defend or even increase its Growth Multiple over the rest of the world it will need to accelerate and deepen its current reform program (alongside tactical monetary and fiscal policy actions to manage global volatility and risk). If India can deliver on this, it has the potential to leapfrog most large western economies over the next decade, in a similar fashion as China did following the Global Financial Crisis. In addition, not to be underestimated, the government will need to avoid the traps that derail growth, such as wars and conflicts. The Modi government will need to steer a careful course through a looming global crisis and its own challenges, leveraging the positive drivers of its democracy, demographics and development.

The Next Phase: The US$5 trillion Economy

As highlighted in a series of previous Signs of the Times 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. India’s rapid growth is being propelled forward by a series of fundamental economic drivers which are independent of both global macro and Indian domestic policy, helping to potentially protect its growth from the broader global slowdown, including (i) its favourable demographics and large, educated workforce; (ii) large-scale urbanisation and the shift from agriculture to services and industry; (iii) mass-scale technological adoption enabled by the spread of telecommunications and low-cost smartphones; (iv) mass consumption as households move from low income to middle income status; and (v) large scale financial inclusion increasing participation in the formal economy. With many of these drivers having reached critical mass in the last several years, India has established a solid basis for further growth. Of course, India like every country in the interdependent world in which all nations operate remains susceptible to external events that can accelerate or hinder growth, as well as to internal political moves that can damage or derail growth, as the experience of the previous Congress government has demonstrated.

India’s growth since 1960, or even during the past decade, has not unfolded uniformly, but has taken place in the context of distinct growth phases. Following a pattern established earlier by China, India has to date passed through two of these growth phases and is currently in the process of transitioning to a third, namely

  • Phase I: Hardship and Poverty (1947-2006), which corresponds roughly to the long and often flat journey of its GDP to US$1bn, marked by hardship and poverty, and an average annual growth rate of c.4%.
  • Phase II: Economic Liberalisation and Participation (2007-2018), from the inflection point and rise that took it to c.US$3bn, marked by economic liberalisation and participation, with an average annual growth rate of 7.3%, and;
  • Phase III: Rise to Global Significance (2019- ), which marks India’s ongoing rise to global significance as GDP rises to US$5 trillion and beyond, with potential average annual growth rates of 8% and beyond.

The transition between each phase is marked by turning points that drive the step changes in GDP growth. The turning point for the transition between the first and second phase of India’s growth came in 1991, when it discarded its failed socialist style planned economic model and embraced the market economy, driving increased foreign investment and exports and helping the economy scale to US$1tn by 2006. During Phase II growth averaged 7.3% but was highly uneven due to various global and domestic factors. Following rapid initial growth boosted by the increased liquidity post the global financial crisis, a series of self-inflicted major dislocations quickly brought growth to a halt: Multiple large corruption scandals under the Congress-led government paralysed further policy reforms, and 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. The turning point came in 2014 when voters elected the BJP and its leader Narendra Modi with an unprecedented parliamentary majority. Mr. Modi’s government restarted India’s reforms program and attracted FDI back to the country, with GDP projected to cross US$3 trillion this year, positioning India on threshold of the transition from Phase II to the Phase III. This is an important ‘Turning Point” for India. To understand and plan for this phase, the government will need to consider three concurrent factors that impact the growth story of India, namely:

  • Independent Drivers. The momentum and impact of the above five domestic drivers which can take India to US$5 trillion economy.
  • Supporting Policy and Internal Dislocations. Internal decisions and events can damage or support growth. Importantly, India’s Independent Drivers have transcended the government’s ability to directly drive economic growth, so that the most effective support the government can give is in the form of removing obstacles to these drivers’ continued ability to deliver growth.
  • External Supporting Events and Dislocations. External events that can either damage or support growth.

The first of the three factors is largely independent of the others and is a major driver that, unhindered, can take India to a US$5 trillion economy, which has now become a formal target of the current Modi administration.

India’s “Growth Multiple”: Insulated from but not Immune to Global Macro Risk

In the five-year periods before and after the Global Financial Crisis of 2008, global economic growth was strong, averaging 4.7% and 4.1%, respectively. While India’s Growth Multiple during each of these five-year periods remained fairly steady at 1.7-1.8x on average, actual growth in India was highly volatile during both periods. Particularly in the period 2009-2014, corresponding roughly to the first half of Phase II of India’s growth, allegations of corruption and a complicated regulatory and taxation framework meant that growth ranged from 10% in 2010 to 5.5% in 2012 and India was widely perceived to have squandered its opportunity to emerge as a major global economy at that time. Over the last five years however, roughly corresponding to the second half India’s Phase II growth, this perception appears to have changed, thanks in large part to the supporting policies undertaken by the NDA government (see inset), which have unlocked the India’s ‘Independent Drivers’ ability to deliver growth through mass inclusion and increasing economic participation. In the face of external dislocations created by the ongoing global slowdown, India’s GDP growth has continued to materially outpace global growth, emerging as one of the few bright spots in a global economy that is seeing increased volatility and risk. While there has been a temporary lapse in the country’s growth over the last few quarters arising from internal (losses in India’s financial services sector) and external (US-China trade dispute) dislocations, India remains well positioned to grow and maintain a healthy growth Multiple of 2.1x against the global economy, with the potential to build this out further given the implementation of additional supporting policies.

Among the key ’Supporting Policies’ introduced by the NDA government during the past five years, those that have focused on the removing obstacles to growth have been among the most effective. Among these, the initiatives that have increased ease of doing business have been critical to unlocking growth. With India ranked a lowly 142nd on the Global Ease of Doing Business Ranking in 2014, the government’s focus was the removal of regulatory and legislative roadblocks that reduced India’s competitiveness and attractiveness as a market, including reforms like project clearances, labour law compliance, land acquisition, new business formation and bankruptcy resolution (see inset). These in turn resulted in India achieving an unprecedented jump in its Global Ease of Doing Business Ranking, 77th in 2018. Of course, many of the government’s other major initiatives, particularly around inclusion e.g. driving banking/financial inclusion, cashless payments, and transparency in governance , also increased India’s long-term growth potential by also increasing economic participation and made Indian businesses more competitive.

An importance consequence of India’s reforms has been an increased resilience of the Indian economy against global volatility. Whereas the earlier phase of 7-8% growth in India (2004-2014) was underpinned in part by external supporting events in the form of a strong global economy and liquidity, in the current phase, the slowdown over the last three quarters notwithstanding, India’s growth has been driven by virtue of its intrinsic growth drivers and the government’s supporting policies, resulting in a significantly higher Growth Multiple.

This Growth Multiple notwithstanding, the Indian economy’s linkages with the rest of the world, and therefore its sensitivity to external dislocations’, continue to increase, primarily through trade and investment. Since India liberalised its economy in the early 1990s, its dependence on trade has more than doubled (from c.20% in 1994 to c.43% in 2018) . As such, the impact of potential external events remains significant, and its relative decline in GDP growth over the last few quarters (see below) is at least partially attributable to the recent slowdown in global growth (in addition to domestic structural and cyclical factors).

However, Indian GDP growth is expected to recover to c.7.5% levels in the near-to-medium term , and India is expected to maintain its Growth Multiple of c.2x over the rest of the world. However, given the ongoing headwinds caused by the macro-economic slowdown, generating growth above this level (with 8% representing the base case growth needed for India to provide adequate opportunities for its burgeoning workforce) will likely require the government implementing further supporting policies. The potential prize for India is an attractive one: in times of volatility, global capital and assets tend to flow towards economies that demonstrate stability, and at a time where the global economy is re-setting to a lower growth trajectory, India has a unique opportunity to emerge as a premier global investment destination, and in the process, secure and strengthen its linkages to and its position in the world.

Delivering a Stable and Sustainable 8%+ Growth Trajectory: Strategic Financial Policy Initiatives

Ms. Nirmala Sitharaman, India’s new Finance Minister, in her maiden budget speech last month outlined the vision to make India a US$5 trillion economy by 2024 and emphasised the need for further structural reforms to achieve this. Achieving this target will require sustainable and stable levels of growth in excess of 8% over the coming years, above the levels India’s five growth drivers are likely to support in the current global macro-economic environment. To fully leverage India’s potential this stage, in particular its population and demographics and its highly entrepreneurial business environment, two policy areas stand out as potential focal points for ’Supporting Policies’: those that support mass inclusion as a key factors underlying India’s growth drivers, and those that reduce the cost of doing business as a key blockage to further growth and economic activity.

This month’s Sign of the Times is focuses on the latter, the policy initiatives that can drive the ease of doing business, and more importantly, make a structural change to India’s cost structure. Successfully doing so can drive private sector investment and job creation by making Indian businesses more profitable and competitive globally, thereby unlocking further GDP growth based on India’s own five macro-drivers. To make a lasting impact to the ease of doing business, India will need to focus on reducing the cost of doing business. India’s businesses already have the unique advantage of the largest and lowest working population in the world. However, this comparative advantage is currently mitigated by various other costs of doing business which are higher in India than elsewhere in the world. If India can effectively change its cost structure it can create a level playing field for all Indian firms, in particular small and mid-sized ones, to compete with their larger peers in India and abroad and thereby drive investment, job creation and economic growth.

A systematic focus on making private companies more competitive can dramatically improve their ability to grow globally and compete in international markets, and therefore also improve India’s overall terms of trade with the world, driving both exports and growth. There are a number of critical obstacles faced by companies in India today that are contributing to both the difficulty and cost of doing business, and the government’s focus will need to be on addressing these: (i) a high cost of capital, (ii) high levels of taxation, (iii) working capital constraints, (iv) high logistics costs and (v) high transportation costs. In this regard, there are five supporting policy initiatives focused on structural cost reductions that should form a multi-pronged, coordinated policy response by the government across fiscal and monetary policies, and structural reforms: