India: The rise of a major economic and geopolitical player amid challenging structural risks

Slowing short-term economic momentum, strong long-term growth prospects

Since the end of the Covid-19 pandemic, India has returned to a fast growth trajectory, fluctuating around an average of just above 7% – the highest rate among the world’s largest economies. Recently, future prospects have been revised slightly downwards, with the IMF forecasting +6.5% real GDP growth in the coming years; since last year, the economy has been noticeably decelerating as a result of weakening consumer demand and domestic investments. To offset economic headwinds, the new head of the Reserve Bank of India (RBI, India’s central bank) is considering interest rate cuts and letting the Indian rupee float without intervention to stimulate exports, but those policy changes could bring the overvalued rupee further from its historic low against a strong US dollar and fuel extra inflationary pressures. Inflation in India remains a persistent issue, especially for food. As India imports a third of its energy needs, inflation (at 5.2% last December) could again get closer to the inflation target’s upper band (6%), and thereby raise the cost of living, complicating monetary policy. Depreciating pressures on the rupee and higher inflation could also impact the business environment risk (currently in category C/G).
 

Besides those short-term concerns, the outlook remains promising for the Indian economy. The huge domestic market, the government’s boost to the manufacturing sector (with a focus on self-sufficiency and bold export goals), the dynamic IT services industry and a business-friendly government are strong factors behind India’s upbeat economic prospects. 

Moreover, the banking sector, a major weakness for the country not so long ago, has been cleaned up and put on a firmer footing after the bad loans crisis was tackled.

Sound external accounts and moderate external debt

India’s balance of payments is good, with a small current account deficit (1.1% of GDP expected in FY24) supported by diversified exports, and – at around 15% of its current account receipts – resilient workers’ remittances (India being by far the world’s largest recipient country). This deficit is fully financed by investment inflows and is expected to rise gradually in the coming years, driven in particular by the surge in imports of capital goods resulting from the forecast increase in FDI. Foreign trade and investments – in this attractive destination in terms of global supply chain diversification – are an important component of the government’s strategy to boost future economic activity, which is why the government will remain active in seeking new free trade and investment agreements at a bilateral level, such as with the EU, for example. Meanwhile, robust exports and investment inflows are having a positive impact on India’s liquidity. Last year, foreign exchange reserves covered more than seven months of imports, a comfortable level that explains the persistently strong short-term political risk rating of 2/7. The situation is also sound when it comes to external debt: according to the World Bank, the external debt stock and service in 2023 amounted to less than 20% of GDP and 10% of current account receipts respectively. These aspects should stay contained in the medium-to-long term, and these macroeconomic strengths are expected to contribute to keeping India’s MLT political risk at a stable and good rating of 3/7.

Structural weaknesses make the future more challenging

Public finances are a chronic concern, with permanently wide fiscal deficits (above an average of 8% of GDP in FY14-FY23, and expected to stay over 7% in the coming years) keeping government debt at high levels. The latter is expected to come in at 83.4% of GDP – or 390% of public revenues – in FY24, a 20-year high, and projected to decrease only slightly in the MLT. That said, public debt is primarily domestic, which mitigates risks. The fact that interest payments continue to consume around a quarter of government revenue is a constraint on government spending, but since coming to power in 2014, PM Modi has greatly expanded existing social benefits to a higher number of people, successfully increasing the use of technology to make electronic payment transfers. His large-scale welfare programmes have been a popular pillar of his rule. However, though cash transfers play a role amid large income inequalities and high poverty, their significance and new permanence have increased beneficiaries’ dependence and raised the fiscal burden amid weak public finances. Moreover, they do not tackle structural issues, especially insufficient public investments in health and education and the lack of jobs – youth unemployment is particularly high – that both affect India’s demographic dividend, consumption and GDP growth.

Other risks cloud the outlook, from heightened communal tensions under Modi’s Hindu-centric rule to climate change. Indeed, intensifying natural disasters and water issues have become salient risks in the world’s most populous country, where agriculture is the dominant source of revenue and employment for the largest share of the population.

Political stability under Modi’s long leadership

India benefits from political stability and policy continuity. Last spring, PM Modi and his BJP party won again in the general elections, allowing him a third consecutive five-year term as Prime Minister. However, while this highlighted his enduring popularity, his success was moderate and he lost ground to the large “INDIA” opposition coalition. The loss of the majority in Parliament compelled his NDA government alliance to enter a coalition with two minor allies, but this new vulnerability compared to the past 10 years is unlikely to affect policy-making too much. Looking ahead, the combination of an unstable INDIA coalition and the BJP’s strong political machine might allow the ruling party to keep power beyond the career of the 74-year-old Modi.

A Global South leader and adroit foreign policy in an unstable new world order

In a shifting global order, the Indian democracy aims to position itself as a leader of the Global South in competition with China, while ensuring continuity with its historic non-alignment stance by cleverly playing the independent card. Therefore, India is expected to continue successfully navigating across geo-economic blocs, on the one hand by cultivating good relations with the West, offering economic and security benefits in its natural opposition to China’s regional and global ambitions, and on the other hand by strengthening its role as the defender of developing and emerging countries’ rights and interests. It will look to achieve this via global climate talks and BRICS, and expanding trade with sanctioned Russia, for example, which has quickly become its most important oil supplier, from supplying almost nothing prior to the war in Ukraine. Regarding its key bilateral relations with Pakistan and China, they have stabilised with the former and warmed up with the latter, demonstrated by the easing of tensions since last October when India and China agreed to have military patrols along their disputed Himalayan border. However, this positive thaw could be temporary as China’s regional assertiveness will intensify in the future and the two countries share a diverging approach to global order. As for the USA, strong ties between Indian and US leaders should allow their bilateral cooperation to grow further. However, given US President Trump’s insistence on trade surpluses to impose higher import tariffs, India may have to commit to increasing military purchases from the USA and lowering import tariffs on certain US products.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com