India’s economy hasn’t reached a high growth phase yet

By Mihir Sharma

As India prepares for elections this spring, confidence about the country’s prospects seems ubiquitous. The country has just finalized a new trade agreement; it’s with a small trading bloc composed of Norway, Switzerland, Liechtenstein and Iceland, but the headline number for new foreign investment it commits to bringing in, $100 billion, is nevertheless eye-catching. The stock markets are at record highs, and most expect them to rise even higher.

This year, Indian debt will begin to be included in global bond indexes, starting with JPMorgan Chase & Co.’s products in June, followed by the Bloomberg Emerging Market Local Currency Government Index from January 2025. (Disclaimer: Bloomberg LP, the parent company of Bloomberg News, offers index products for various asset classes through Bloomberg Index Services Ltd.) And, when last quarter’s growth numbers were announced in the past fortnight, analysts were startled to see that the Indian economy had apparently grown at an annualized rate of 8.4 per cent.

There are certainly solid grounds for optimism. India’s macroeconomic stability is impressive compared to many of its peers. Pandemic spending wasn’t excessive. The fiscal deficit has been steadily shrinking as a proportion of gross domestic product. The rupee has been remarkably stable. And “core” inflation, which excludes food and fuel prices, has eased to 3.3 per cent year-on-year, according to data released this week.

Some of this stability is hard-won, born of tough choices that the government in New Delhi has made. Fuel taxes are kept high to feed government revenue, for example, and an inflation target has been institutionalized for the country’s central bank.

Yet, even if some investors and sell-side analysts are touting India as “the best structural growth opportunity in emerging markets, if not the world,” it is worth looking beyond the hype to the real reasons for some of these surging indicators, to judge whether India’s growth is assured in coming years.

Consider the Indian equity markets. There are excellent, long-term reasons why they have been on an upward trend. But it is always unwise to deduce the real health of an economy from the level of its headline stock index. It sometimes says more about the choices available to capital than anything else.

That’s certainly the case in India. We are in the middle of a years-long shift to the greater financialization of savings. As Indian households gain easier access to formal finance, they will put less of their wealth into gold or real estate and more into financial assets, whether bank deposits or stocks. Even when foreigners sell Indian equities — as they did heavily at the beginning of this year — the domestic appetite for shares seems inexhaustible, driven by this bedrock change in household preferences.

Equities are also island of calm, competence and transparency in the Indian economy. The securities regulator is largely independent and efficient; minority shareholders’ rights are legally protected better than in many advanced economies; and you can find large companies in most sectors with trustworthy balance sheets and professional management. Money, including global finance, piles into Indian stocks partly because it so much easier than taking a punt on, say, building a factory.

But it’s only when more and more investors want to create real factories rather than juice up financial assets that India’s economy will really take off. This is part of the reason that, when judged against earnings, Indian shares are among the most expensive in the world. The macro figures underline the basic problem: Although corporate earnings have increased from a multi-decade low a few years ago, profits as a percentage of GDP are still about three percentage points lower than they were in the boom years of the 2000s.

Growth, meanwhile, was higher than expected partly because it’s only now that the post-pandemic recovery is really kicking in — and partly because government subsidies declined sharply. Thanks to how national accounts are calculated, that meant while actual value added seems to have slowed a little, the GDP numbers jumped up.

That’s a symptom of one underlying problem: It is still government actions that are pushing growth up or down, rather than the choices made by India’s private sector. Private investment in India has simply never recovered to the levels it reached during India’s 2000s growth spurt. While big public infrastructure rollouts have soaked up Indians’ savings, the private spending they were supposed to “crowd in” hasn’t yet materialized.

A decent platform has been built for the Indian economy to achieve liftoff. But the India hype, in contrast, doesn’t have firm foundations. The next government still has a lot to do if the Indian economy is to enter a real high-growth phase. Watch corporate earnings and private investment over the next few years to see if it’s going to happen.