Decoupling From Global Pessimism

By Frank-Jürgen Richter

Businessworld, January 4, 2019

The Indian economy has the potential to remain decoupled from the global economic pessimism, but for that to happen, bold and sustained policy moves are required. It will be interesting to see if this government can buck the trend

In the recent past, India’s economy has seen a strong recovery that has largely been propelled by domestic growth impulses. Since the fourth quarter of 2015-16, GDP growth fell q-o-q from a high of 9.0 percent – declining further to 5.6 percent in the first quarter of 2017-18. This was primarily on account of its government’s decision to demonetise 86 percent of its currency in circulation and the early problems emanating from the GST rollout. These effects have, however, subsided since as growth recovered to 7.7 percent in the fourth quarter of 2017-18, registering a gross fixed capital formation high of 14.4 percent in the same period.

This recovery can be attributed to growth in public administration, defence, construction and agriculture. Although the recovery in construction has been significant following a period of slowdown, public administration and defence growth at 13.3 percent in the fourth quarter (2017-18) was remarkable. This figure was almost twice that of the third quarter growth rate. The agriculture sector’s performance surpassed expectations too, and its contribution towards the overall growth rate was therefore significant.


Positive Outlook for Indian Growth

The International Monetary Fund (IMF) recently highlighted that India was on track to achieve 7.3 percent growth in the 2018 fiscal year, and that the Indian economy has the potential to grow even quicker – at 7.75 percent over the medium term on account of recent economic reforms. According to the IMF, “there remains considerable scope for potential output to increase even further” at more than 8 percent, but this will also be contingent on additional land and labour reforms as that could result in an uptick in investment. Additionally, there is potential to boost growth through simplifying and streamlining the GST further, a process that is underway already. However, the Fund also pointed out that progress in these areas has been limited, and that weak credit growth has been a dampener for growth.

All evidence suggests that the Indian authorities are cognisant of these challenges – and indeed, requirements – and are taking steps to address them. To what extent India can reap the benefits of its favourable demographics and domestic growth drivers will be dependent on India’s progress on this front.

Another salient feature of India’s consistent economic growth over the past two decades is that of consistency in government objectives, aspirations and policies. While it is true that different governments in India have focused on different aspects of economic governance and initiatives, the broader thrust has remained consistent – that of pushing for infrastructure development including roadways and traditional and renewable power; opening up India’s economy for greater private and foreign participation across different sectors; and a renewed focus on manufacturing.

It is not appreciated nearly as enough, but broad continuity in economic direction is an important factor in keeping investors interested in the Indian economy, irrespective of the political dispensation in place.


Global Trade Protectionism and India

The US-China trade war has sent alarm bells ringing globally. The repercussions will be felt worldwide and amid concerns over a broader global trade war, key indices in the Indian share market have also plunged due to increased caution among investors. The Bombay Stock Exchange (BSE) Sensex has witnessed regular downturns and the National Stock Exchange of India (NSE) Nifty’s performance too, has been similar.

Despite growing concern around the US-China trade war, there is a chance for India to actually benefit from it, even if only in the short- to medium-term. This is because the higher tariffs imposed by the two countries on each other’s products is likely to result in trade diversion, which could benefit countries such as India and those in the ASEAN region. The doom-and-gloom surrounding recent trade-related developments is creating and opportunity for India to boost its exports to both these economies, especially given that the range of goods the two countries have imposed tariffs on continues to grow. This, in turn, can also act as a shot in the arm for Narendra Modi’s Make in India initiative.


The Crude Challenge

For the first time since 2014, global crude prices touched US$80 a barrel owing to supply side challenges such as US sanctions on Iran and the crisis in Venezuela. The current high oil prices could negatively affect India, which is a large importer, in several ways. The IMF forecasted consumer inflation at 5.2 percent for this fiscal year and 4.8 percent for the following fiscal year – exceeding the RBI’s mid-point inflation target zone. As such, monetary tightening will be an obvious consequence.

It is also resulting in a persistently widening current account deficit, expected to witness an increase of 2.6 percent of GDP this fiscal, which is going hand in hand with the plummeting value of the Indian rupee. And compounding issues even further for India is the general pull-back by global investors from emerging economies, which has resulted in substantial portfolio outflows from countries such as India.

These external challenges present a stern test for Narendra Modi’s government.


The Need for Strong Policies

Although, India’s economic growth has been steady and is not expected to taper anytime soon, it must continue to enact reforms if it is to mitigate the external risks confronting its economy. And the potential for some trade diversion notwithstanding, the long-term implications of a prolonged trade war can be substantial, especially in the form of negative spillovers into the capital markets. Similarly, land and labour reforms have been a bugbear for a long time now, and the pace of reform needs to pick up.

To consistently achieve growth of over 8 percent, deep reform in these areas is imperative to reduce or remove bottlenecks. Another critical task for the Indian government is to create jobs and to increase productivity and investment. The former is of utmost importance given that an estimated 10 million Indians are entering the workforce each year, while the number of jobs available is substantially lower.

The next few months could be somewhat tricky for India as it heads into an election year – this is a period when governments in India have generally been averse to “rocking the boat” by implementing major reform. The Indian economy has the potential to remain decoupled from the global economic pessimism, but for that to happen, bold and sustained policy moves are required. It will be interesting to see if this government can buck the trend.


Frank-Jürgen Richter is Founder and Chairman of Horasis, the global visions community which hosts the annual Horasis India Meeting.