India’s long-term potential

Executive summary

India is about to undergo a general election. Its outcome could determine if reformist Prime Minister, Narendra Modi, is able to retain his dominant grip on power. If he can, economic growth is likely to benefit from improvements to bankruptcy laws, openness to international trade, a healthy demographic profile, urbanisation and the much-needed growth of its manufacturing sector.

If Mr. Modi is unable to retain power, his legacy of reform has brought sufficient success to suggest that opposition politicians will have to succumb to the reality that India must move away from the isolationist socialism that has prevented this sleeping giant from finally waking up and taking on the world.

Don’t be fooled

At first glance, India’s economy is unremarkable for the seventh-largest country in the world by landmass and one that harbours around 1.2 billion people. The country’s economy has finally surpassed that of Russia largely thanks to the latter’s over-dependence on oil exports while just about catching up with the UK, a country one thirteenth its size with one twentieth of the population.

But don’t be fooled. The broad and near-unanimous consensus is that India is set to mimic China’s economic rise. The most recent long-term outlook from the International Monetary Fund (IMF) confirms the general outlook that India’s economic growth rate will continue to outstrip that of China in 2019, albeit from a lower base.

Looking further ahead, various independent reports project that the Indian economy will overtake that of the US in the coming decades. For example, in its 2017 report entitled, “The World in 2050”, professional services firm PwC predicts that India’s overall economy will be second only to China (1).

1 Source: The World in 2050, PwC


Before we consider how this might come about, we must first look at why this potential has yet to be realised.

The Indian giant has been asleep for so long due to a sustained policy of socialism which was, in part, a reaction to having been under the oppressive yolk of British rule for many years. In seeking to establish a society of equality, government after government locked out economic growth through trade restrictions and anti-business regulations.

This only began to change in any significant way during the 1990s when the Indian economy was in such dire circumstances that there began to be a reluctant general acceptance that economic reform was needed. Even so, progress since then has been stilted with different political parties and ideologies coming and going.

The incumbent Prime Minister, Narendra Modi, has finally taken business reform to a new level. His ambitious “Make in India” programme has encountered a number of challenges, but has succeeded in one crucial aspect: there is now a general understanding and acceptance that business reform and economic development are needed in India.

Indian development

Modi faced an economy with too much state involvement, some over-powerful monopolies, rising inflation, barriers to trade, and low rates of savings and investments. The governments since 1991 have begun to chip away at these problems, but the momentum has increased under Modi since 2014. This has helped the Indian economy to rise from around $2.0 trillion in 2014 to nearly $2.7 trillion in 2018, putting it on par with that of the UK for the first time since the 1960s.

The nature of India’s economic growth has been unconventional. Most economies go through the five stages of development outlined by US economist Walt Whitman Rostow in 1960, as shown below.

Unlike the UK, India tried to skip stage three by focusing development on its IT-led services industry. It had a substantial degree of success and this has led to the services sector accounting for more than half of the entire Indian economy. But continued growth was dependent on a supply of educational and physical infrastructure that is not yet in place. Aware of this, Prime Minister Modi coined his “Make in India” campaign which aims to lead India through the process of industrialisation.

Walt Whitman Rowtow’s stages of economic development:

  1. Traditional society: subsistence agriculture, low-level of technology, labour-intensive
  2. Pre-conditions to take-off- regional trade, the development of manufacturing
  3. Take-off: the beginning of industrialisation
  4. Drive to maturity: rising living standards, economic diversification, strong use of technology
  5. High mass consumption: mass production and consumerism

Keep in mind that the UK completed stage 3 at the beginning of the 19th century. India has yet to begin that stage in earnest and yet it is already overtaking the UK.

Make in India

This campaign is designed to push India through stage three of Rostow’s economic model. Modi’s reforms are building on efforts since the early 1990s to make India more open to trade and inward investment, increase the ease of doing business in India and enhance human capital i.e. invest in the education and development of the broader population.

One of the key goals that these improvements are intended to achieve is an increase in the proportion of the Indian economy accounted for by manufacturing to 25% by 2025 with the creation of around 100 million jobs.

This target seems unrealistic. Manufacturing’s contribution is running at around 15% of India’s overall economy having fallen from around 18.5% in the mid-1990s (2). However, that is largely due to the huge growth in the country’s services sector.

2 Source: Manufacturing World Bank data, accessed 22 March 2019

Driving growth

But there are success stories. India’s automobile industry is in rude health. It has grown from annual production of around half a million vehicles in the year 2000, to around four million in 2018. That has taken it past the production levels in both South Korea and the US. German production has been between five-and six-million throughout this period, so India looks set to overtake that before too long as well.

This growth is delivering on India’s Automotive Mission Plan which aims to push the automotive sector to account for 40% of manufacturing as well as 12% of total gross domestic product by the year 2026.

Short-term pain long-term gain

The overall manufacturing sector has been growing of late, but not as fast as it might have. Modi’s other reforms, while well intentioned and likely to be beneficial in the long-run, have not helped.

These included the clumsy implementation of the new Goods and Services Tax, and the sudden replacement of some key denominations of currency as part of the drive to curtail black-market activities.

Other factors that have provided a stronger base for long-term economic growth in India include the new bankruptcy laws which have helped to remove unsustainable companies, while the excess of government spending is being tackled. Again, these are excellent foundations for longer-term growth, but they cause short-term pain for voters in the form of job losses and lower government hand-outs.

Political uncertainty

This is particularly important as we approach the Indian general elections which will take place across April and May.

Prime Minister Modi’s Bharatiya Janata Party (BJP) has fared poorly in recent regional results and polling measurements. He currently enjoys a fairly free rein in power, enabling him to enact his policies without too much encumbrance. If he retains this mandate then India’s reform is likely to continue apace.

Should his majority be reduced, he would face a potential veto on individual policy proposals. The alternative possibility is that the BJP could lose power entirely. This is because opposition parties have united against the BJP and have begun to eat away at its lead in the polls. But even if the main opposition Congress Party led by the latest in the Ghandi political dynasty were to gain power, the recognition that economic growth is vital would be likely to hold sway in the medium-term regardless of short-term turbulence.

The outcome of the general election will become clear towards the end of May when we can issue a short update to this piece depending on what happens. In the meantime, it is beneficial to consider the challenges and opportunities that face India, and why we believe the Indian economy will flourish over the long term.


Lack of central bank independence

For a man committed to reform, Prime Minister Modi’s pressure on the Reserve Bank of India (RBI, the central bank), has been both incongruous and dangerous. Two credible and respected governors of the RBI have been forced out as a result of Modi’s criticism. Former governors and career economists, Raghuram Rajan and Urjit Patel, were both tackling high inflation with appropriately elevated interest rates. Higher interest rates make borrowing more expensive which reduces spending and incomes. This is politically unpopular, and Modi made clear his dislike of these orthodox and financially prudent policies.

The incumbent governor, Shaktikanta Das, whose background is in administration rather than economics, has overseen a much more dovish approach to monetary policy, including a reduction in interest rates.

While this might help to counter fears of a slowdown in global growth, it undermines the credibility of the IRB. To be effective, a central bank has to be seen to be independent from political pressure. If that is not the case, then investors take less notice of the economic data such as inflation, and pay more attention to what the political leader might prefer.

As the current ballooning of inflation in Turkey demonstrates, politicians meddling with financial management to serve their political careers can be extremely bad for economic health. The seeds of doubt have been sown in India. We believe that a credible and clearly independent governor is the only solution.


Regardless of their background and leaning, the current and subsequent governors will be unable to ignore the unemployment problem that India faces.

The official rate of unemployment is not always seen as entirely reliable. The worry is that it is vulnerable to manipulation for political ends. But even it has been rising over recent years, despite the welcome economic and business reforms.

According to BCA Research, “a leaked government statistical report suggests that unemployment has indeed gone up and labour participation has fallen more than the government is willing to admit”3.

The reality is likely to have a considerable influence on Modi’s plight at the coming general election. This is particularly true of the approximately 40% of the Indian population who still work on the farm. They are also being affected by falling food prices which are eroding their livelihoods. So the short-term risk is political instability and a pull-back on the reformist agenda.

There is a longer-term and more fundamental risk though. As the Indian economy grows, employment rates will need to keep pace. The time lag between economic growth and the positive knock-on effect on employment could spell trouble for progressive reforms at the ballot box.

Another hangover from its muted past comes in the form of government-led protection of industries. For example, the increased levels of production from China, Korea and Japan have led to Indian steelmakers to seek protection in the form of higher duties.

We believe that trade restrictions always have a negative net outcome. For example, other countries will retaliate and, rather than allowing the most efficient producers of steel or software to concentrate on what they’re good at, less able companies or countries are artificially supported or required to fill the gap.

This healthy exposure to competition is something that the Chinese have been slow to adopt for large parts of their economy. The much maligned state-owned enterprises continue to limp along, supported by government subsidy at the behest of a powerful political elite with vested interests.

India must not make the same mistake. The nettle needs to be grasped; those companies must not be artificially supported. Jobs will be lost in the short-term, but investment will be available to efficient companies that can survive and flourish in the open market. The Indian automobile industry sets the right example.


There are other challenges facing India. Since the controversial break-up of the Indian sub-continent in 1948, tensions have simmered and occasionally boiled over between former fellow countrymen. The latest violence on the borders of India and Pakistan have fuelled worries such these two nuclear-armed countries need to talk if economic growth and social welfare are not to be overrun by jingoism and tragedy.

The countries’ respective international sponsors also have a role to play here, and this introduces another element of both risk and opportunity.

China has been increasing its influence across the south Asian region, with a notable preference for Pakistan over India. The former is more in need of China’s support while the latter perceives a potential threat from China’s economic and military ambitions.

It is unsurprising that the International Monetary Fund’s statistics show 8% of Pakistan’s exports currently going to China while the northern neighbour accounts for less than 2% of India’s exports.

At the same time, India’s military expenditure has been slowly but steadily rising. In 2017 it spent around $64 billion, up from the $19 billion it managed in 1990. Back then, China was spending a similar $21 billion, but that has rocketed to $228 billion in 2017 (4).

So the need to leave isolationism behind is no longer just economically logical, it’s also geopolitical ideological. This might hold a benefit for the long-term future of India.


The US and China are economic and militaristic rivals. The Indian democracy with its vast population, of whom around 125 million speak English, could become the jewel in America’s crown of Asian allies. This will take some time to manifest itself though because the current US administration plans to end the preferential status for India under which $5.6 billion of imports currently enter the US tariff-free. In a letter to Congress on 5 March 2019, President Donald Trump said that the Indian government “has not assured the United States that it will provide equitable and reasonable access to the markets of India”.

However, over the longer term, we believe that the US desire to counter-balance Chinese power in Asia will lead to a favourable relationship with India. This will not be without conditions though. For example, it is likely that the US would want industrial reform, increasingly open access to Indian markets, independence of the central bank and continued respect of the democratic principle.

If we are right about this, then these factors should help to promote the Indian success story.
Domestic assets

There are domestic Indian factors that should further support India’s development. Firstly, its stock market is more stable and open than that of its fellow Asian giant, China. In China, not all stocks can be bought by investors from overseas, whereas stocks listed on India’s Sensex or Nifty 50 indices are open to the global general public. What’s more, the Indian stock market is not subject to what appear to be thinly veiled government-led interventions that drive stocks up or down in China.

Other favourable comparisons can be made. China’s one-child policy helped stem the country’s population explosion, but left it with an imbalanced and ageing population that could impede growth.

By contrast, India has a more balanced demographic profile that lends itself to economic development, especially if the country can navigate its way through the growth and maturity of its manufacturing sector. Now that the huge increase in China’s workforce has been absorbed, wage and production costs there are rising. This is providing an incentive for companies to move production to other, cheaper locations. India fits the bill.

4 Source: Stockholm International Peace Research Institute military expenditure database. Data in constant (2016) US dollars, published in 2018 and accessed from the SIPRI website in March 2019.

While this internationalisation of India should help to boost economic growth, its legacy of economic isolation offers an ironic benefit. India appears less vulnerable to the prevalent slowing of global economic growth.

For example, investment by Indian companies to acquire or maintain fixed assets such as buildings, land and equipment has begun to increase over the past 12 months. By contrast, this capital expenditure in China has been falling steadily since around 2014 (albeit from a higher base) (5).

What’s more, the investment that India needs to maintain this growth looks increasingly likely to be provided domestically. In other words, we expect that India ought to become less dependent on and vulnerable to inward flows of investment from overseas sources.

This is because domestic investment is driven by domestic savings, and the potential growth of India’s saving rates has a number of factors in its favour.

5 Source: “India’s geopolitics: What investors need to know”, BCA Research, 13 February 2019.

Firstly, India’s proportion of the population that is of working age is on an increasing trend. The more workers there are, the more savings are supported (notwithstanding the need for employment rates to keep up with economic development as mentioned earlier in this briefing).

Secondly, the process of urbanisation has a long way to go in India. This ties in with the growth of manufacturing and draws people from a rural subsistence with little disposable income, to a town-based job in which incomes tend to be higher with money available to save.

Thirdly, as India’s manufacturing base increases, it ought to become more attractive to global customers looking for cost-effective production facilities. This helps to drive a positive feedback loop which should help to propel India through subsequent stages of economic development.

Macro growth

As India mimics China’s mass urbanisation, it ought to follow the same pattern of keeping a lid on wage costs for some years.

What’s more, India’s productivity levels have been increasing substantially in recent years.

According to analysis from research firm Alpine Macro, output per worker in India rose from a value of less than $6,000 in 2007 to more than $13,000 in 2015.

The share value per worker has followed a similarly sharp rise from around $15,000 to around $50,000 over the same period.

As these numbers rise, so does competitiveness which leads to more jobs and more exports; another virtuous circle.

Relevance to UK investors

This might seem removed from UK investors, but it isn’t. According to a study by professional services firm Grant Thornton (6), of the top 62 Indian companies in the UK considered within the study, five were considered to be large with annual turnover above £250m, 27 were mid-size with £25m to £250m annual turnover, and 30 were small-medium-sized enterprises with annual turnover between £5m and £25m.

All of those companies were growing steadily at the time of the study and accounted for a total combined turnover of £26bn. What’s more, just the top 12 of them each employed at least 1,000 people with particular strength in the automobile, industrial and technology sectors of the UK economy. So what happens in India matters to UK investors.

6 “India meets Britain 2016”, Grant Thornton, accessed from India Inc Group March 2019.


In summary, the immediate outlook for Indian economic development depends on its political stability. If Modi retains his majority then Indian growth should continue relatively uninterrupted with longer term boosts coming from the development of the manufacturing sector supported by improved relations with the US.

If Modi does not retain his majority or even loses power, then India’s growth might be interrupted, but we still expect it to continue over the longer term. Modi might not be around to see it, but his economic reforms should leave a positive legacy.

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