One country stands out from the gloomy overall tone of the International Monetary Fund’s recent update of its World Economic Outlook. Against the backdrop of tepid 3.2% global growth in 2022, the IMF expects India’s GDP to expand by 7.4%. This is the fastest growth of any large economy except Saudi Arabia, which is the incidental beneficiary of upward pressure on global oil prices. India may be buying Russian crude at a discount, but, as the world’s third largest oil importer, it is still burdened by high oil prices.
One might doubt that India had an exceptionally difficult pandemic, so it now has exceptional scope for bouncing back. But other countries hit hard by COVID-19, such as Mexico, are not doing nearly as well. One might also note that, with India’s still-rapid rate of population growth, per capita incomes are rising more slowly than the aggregate GDP figures. But a population growth rate of 1% doesn’t fundamentally change the story.
India’s annual GDP growth in excess of 7% is in fact the continuation of an ongoing acceleration, from roughly 5.7% in the 1990s, to 6.2% from the turn of the century to the 2008 global financial crisis, and then to 6.9% from the crisis to the eve of the pandemic. The country has benefited from a buoyant tech sector, surprisingly robust agricultural productivity gains, and decent manufacturing growth. With the worst of the pandemic now behind it, the economy is firing on all cylinders.
The question is whether this can last. Unfortunately, there are good reasons to believe that, given current policies, the answer is no.
To maintain its growth momentum, India needs to export more. The country has never been an export powerhouse, to put it mildly. Exports of services help, but the outsourcing of back-office and customer-facing services is now poised to slow, as firms “friend-shore” more of their operations. The current government’s commitment to investing in logistics seems promising, but only time will tell how investment projects pan out. Rupee depreciation can make merchandise exports more competitive and limit consumption of imports. But the Reserve Bank of India, treating exchange rate stability as an important totem, has been reluctant to let the rupee fall.
In the future, Indian exporters will face a less favorable external environment. China’s economy has slowed. The United States may not be able to avoid recession, and Europe is already in one. So it is not clear whence demand for India’s exports will come. Every Asian economy that has successfully expanded its manufacturing sector has scaled up by exporting, but this avenue may no longer be available to India.
The country can of course borrow abroad to finance its current-account deficit and domestic investment. But India continues to underperform as a destination for foreign direct investment, which is deterred by bureaucratic obstacles to doing business. Having discarded suggestions that it issue dollar bonds, the government now seeks to encourage foreign investors to purchase local currency bonds. But this revised strategy is no less risky. Foreign investors in local currency bonds tend to cut and run at the first sign of trouble, since they otherwise will be hit by the double whammy of falling bond prices and a falling exchange rate.
Nor does the government have space to borrow from residents to finance additional spending on the infrastructure, health care, and education needed to sustain long-term economic growth. General government debt is already 90% of GDP. The primary budget deficit, which excludes interest payments, is 3% of GDP. The government pays an average of 8% interest on its debt.
But the authorities are able to keep interest rates at that level, and maintain a veneer of debt sustainability, only by requiring banks and other institutional investors to hold government bonds. This in turn limits the banks’ ability to provide essential investment finance to the private sector. Meanwhile, much of what the government takes in as revenue goes to entitlements and interest payments. Additional capital spending will therefore have to come from the private sector. And private savings are low by international standards.
Most fundamentally, the government seems to have found it hard to implement structural reforms. Having experienced pushback from vested interests, it has basically taken significant reforms of labor and product markets off the table.
Given its favorable demography, democratic polity, and large and diversified economy, India can in principle grow at 7% or higher for years to come. But the only route to such growth that remains open runs through structural reforms that relax all of the aforementioned constraints at a stroke.