It seems altogether fitting that on the occasion of Diwali – the Hindu “festival of lights” – India should emerge as the brightest star in the BRIC firmament, threatening to eclipse perpetual economic luminary China. While the planet’s largest democracy has long toiled in the shadow of the world’s second-largest economy, India is finally stepping into the limelight thanks to the election of a pro-business government in mid-2014, even as growth slows perceptibly in China. Will Diwali of 2014 usher in a new age of prosperity for the Indian economy?
A brief economic history of India: 1947 – 1991
India’s economic history since it attained independence can be divided into two distinct phases – the 45-year period to 1991 when it was largely a closed economy, and the period after 1991 when economic reforms led to revitalization and rapid growth.
India faced a host of daunting challenges when it became an independent sovereign nation in 1947, ranging from religious riots and war to rampant poverty, low literacy and a shattered economy. These issues shaped its economic policies – which were somewhat socialist in nature and designed to encourage self-reliance while lessening the country’s dependence on imports – for the next 40 years. However, the government’s iron grip on nearly every aspect of the economy only succeeded in creating a pervasive industrial licensing system, disparagingly referred to as the “License Raj,” that served to breed bureaucracy and foster corruption.
Despite these obstacles, the Indian economy managed to amble along at a 3%-4% growth pace until the 1980s. In fact, economic growth increased in every decade from the 1950s onward, except for the struggling ‘70s, when the economy was hampered by oil shocks and near double-digit inflation. The Indian economy continued to remain closed to foreign investment throughout this period, its insularity highlighted by the exit of multinationals like Coca-Cola and IBM from the country in 1977. This exodus was precipitated by the stringent provisions of the Foreign Exchange Regulation Act, and tough demands made by the new Indian government, such as its insistence that Coca-Cola partner with an Indian company and share its secret formula. (Related: An Introduction to the Indian Stock Market.)
The post-1991 period
Although India had made some perfunctory attempts to open up its insular economy in the late 1980s, these efforts attained the utmost urgency from 1990 onwards, as a balance of payments crisis took the country to the brink of bankruptcy. The collapse of the Soviet Union eliminated a major supplier of cheap oil to India, and as oil prices skyrocketed due to the Gulf War, India’s foreign exchange reserves were depleted to less than $1 billion by mid-1991, only enough to cover two weeks of imports.
With the country in the grip of an economic crisis and still reeling from the assassination of former Prime Minister Rajiv Gandhi, an unexpected free-market champion emerged during this dark hour in the form of Manmohan Singh, a well-regarded economist who became India’s new finance minister in June 1991. Singh immediately launched an ambitious slate of economic reforms based on three pillars – devaluation of the rupee, slashing of import tariffs, and decontrol of gold imports (to eliminate the “hawala” or currency black market). Singh also liberalized the industrial licensing policy and relaxed the rules for foreign direct and portfolio investments.
The measures paid off very handsomely, as the Indian economy was transformed into an IT and knowledge-based powerhouse with one of the fastest growth rates of the major global economies. From 1991 to 2011, India’s GDP quadrupled, while its forex reserves soared more than 50-fold to over $300 billion, and exports surged 14-fold to $250 billion. The benchmark BSE Sensex index rose almost 15-fold in the 20-year period from June 1991 to June 2011.
Rapid economic growth also led to the emergence of a huge middle class population that had an insatiable demand for consumer goods. An example of this runaway demand can be seen in the explosive growth of the phone industry in India. India previously had an antiquated phone system that resulted in a landline waiting list that was measured in years. The overhaul of the telecom sector and the introduction of cellular phones in the 1990s dramatically changed the phone industry. The number of phone subscribers soared from 0.5 million in 1991 to 960 million by May 2012, the overwhelming majority of which were cellphone users; this was not just an urban revolution but a rural one as well, with rural users making up 35% of the subscriber base. As a result, the number of phones per 100 people in India increased in leaps and bounds, from just 0.02 in 1950 to almost 3 in 1990, and over 79 in 2012.
The second wave
Despite these tremendous achievements, the Indian economy was bogged down in recent years by various factors. These included inadequate infrastructure, a deteriorating financial position characterized by rising fiscal and current account deficits, and most importantly, fractious coalition governments that made it difficult to achieve consensus and push through the tough reforms needed to take the economy to the next level.
However, the landslide victory of the Bharatiya Janata Party (BJP) in India’s general elections in May 2014 handed the party and its pro-business leader, Prime Minister Narendra Modi, an unequivocal mandate. Investors were confident that Modi would be able to replicate the success he enjoyed as chief minister of the western Indian state of Gujarat, where annual growth from 2003 to 2012 averaged 10.3% with Modi at the helm, a faster pace than India’s 7.9% GDP growth rate over the same period. There was also unprecedented optimism that Modi would be able to expedite decisions on critical projects worth almost a quarter-trillion dollars that had been stalled by infighting between the previous government and its coalition partners.
The second wave of landmark reforms may not be as dramatic as the first wave that commenced in 1991, but they will have far-reaching effects on the Indian economy just the same. Proposed measures include infrastructure development, implementation of a goods-and-services (GST) tax that could contribute to a percentage point increase in annual GDP growth, and opening up more areas of the economy to foreign investment. Another priority would be reducing the burgeoning subsidy bill that had grown fivefold over the past decade to 2.6 trillion rupees annually.
Long-term growth drivers for India
- “Demographic dividend”: Half of India’s 1.2-billion population is under the age of 25. By 2020, India will have the world’s youngest population, with a median age of 29 years, compared with a median age of 37 in China. This demographic dividend could potentially give India the biggest labor force and make it the largest consumer market in the world.
- Growing middle class: India’s middle class of 250 million already represents one of the biggest consumer markets in the world. This educated, tech-savvy and relatively affluent group is expected to continue its rapid growth in the years ahead.
- Low penetration of goods and services: Despite the economy’s progress over the past quarter-century, the Indian market still has a relatively low penetration of goods and services, which translates into massive untapped potential. For example, in 2009, there were only 11 passenger cars per 1,000 people in India, compared with 34 in China, 179 in Brazil, 233 in Russia, and 440 in the U.S.
- A functioning democracy: One of India’s greatest strengths is that it is a vibrant and functioning – albeit a trifle chaotic – democracy, where the electorate regularly exercises its constitutional right to kick out non-performing governments. India’s army, one of the world’s largest, is also staunchly apolitical and has consistently remained aloof from political shenanigans.
- Established companies and institutions: India has a thriving business sector with dynamic SMEs and large companies that are increasingly expanding overseas, educational institutions that are among the world’s best, and competent financial organizations. India’s central bank, the Reserve Bank of India (RBI), is currently headed by Raghuram Rajan, who was formerly chief economist at the IMF.
The long-term outlook for the Indian economy is getting brighter just as that of its BRIC counterparts is getting murkier.
The IMF projected in its October 2014 World Economic Outlook report that the Indian economy would accelerate from a 5.6% pace in 2014 to 6.4% in 2015 (see Table), propelled by rising exports and investment. In contrast, China’s growth is projected to moderate to a more sustainable pace, from 7.4% in 2014 to 7.1% in 2015, as decelerating credit growth slows investment and real estate activity continues to ease. While China continues to grow at a faster pace than India, the performance differential is shrinking, and for the first time in years, the growth trajectories are moving in opposite directions.
The outlook for Brazil and Russia is much less positive. The Brazilian economy contracted in the first half of 2014, and is forecast to grow only 0.3% in 2014, hindered by political uncertainty, low business confidence and tighter financial conditions. The IMF forecasts growth to rebound modestly to 1.4% in 2015. Russia is forecast to post the slowest growth of the BRIC nations in 2014 and 2015, as economic sanctions in the wake of the Ukraine conflict take their toll on the economy.
The Bottom Line
The IMF forecasts that India will become a $2-trillion economy in 2014 – the tenth biggest in the world – and will cross the $3-trillion threshold in 2019, which would make it the world’s seventh biggest economy. But while the long-term outlook is very positive, the 26% increase so far in 2014 in the BSE Sensex index – which reached a record level of 27,354 in September 2014 – has made valuations among the most expensive in the emerging market space. Nevertheless, for investors who are comfortable with the risks inherent in emerging markets, India represents an alluring investment choice on a pullback, which could well occur if Modi is unable to proceed with reforms as rapidly as investors expect.
Disclosure: The author did not own shares of any securities mentioned at the time of publication.