Three signs India’s economy is regaining steam

Investors are looking for signs that India’s economy is picking up speed again.

After averaging 7% growth per year from 1997 to 2011, India’s economic growth slowed to 4.5% in 2012 and an estimated 4.7% in 2013. A decline in investment, brought on largely by high interest rates, rising inflation, and a lack of government reforms, was largely to blame. Foreign direct investment, for example, dropped by nearly half last year.

But optimism is returning following government reforms that started in late 2012, and business sentiment has improved in the wake of the election of a new Indian prime minister this year. Following the election, 96% of executives in India polled by consulting firm McKinsey expected the economy to improve within six months, up from 67% three months earlier. Executives in other emerging markets are not as upbeat.

A World Bank report projected India’s economy to come out of the doldrums and grow 6.3% in 2015 and 6.6% in 2016.

“The forecast assumes that reforms are undertaken to ease supply-side constraints (particularly in infrastructure and energy), improve productivity, and strengthen the business environment, and that fiscal consolidation continues and a credible monetary policy stance is maintained,” the World Bank report said.

India matters in the world economy. Along with Brazil, Russia, China, and South Africa, it is part of the emerging BRICS countries, and it is the world’s second most populous nation behind China. Its budding consumer class is young, educated, and increasingly urban.

Despite the decline in foreign direct investment, India claimed the second highest share of capital inflow last year in Asia, the region that in 2013 received the most foreign direct investment in the world.

Investments in India are expected to pick up in the next three years, according to the World Bank. A number of stalled projects, particularly in the infrastructure, steel, and energy sectors, are projected to come on line. 

But risks for India’s growth prospects remain: India’s banking sector is stressed; strong El Niño conditions would adversely affect agricultural production, a sector that employs a large share of India’s work force; and political developments in Russia and Ukraine could result in higher energy costs.

The executives polled by McKinsey worried most about inflation. Sixty-nine per cent said inflation is a potential threat to economic growth in India. High commodity prices came in second with 49%.

To assess the chances of non-inflationary economic growth in India, EY policy advisers suggest looking out for three signs:

Tax reforms. An increase in how much is exempt from personal income tax would stimulate consumer demand and increase household savings. Adoption of a goods and services tax would streamline India’s multiple indirect taxes and improve the business climate, remove any cascading effect of taxes, and widen the tax base.

State government spending. An increase in spending by the Indian government and Indian states with large cash surpluses would drive economic growth if it is concentrated on improving roads, the power grid, education, and health. The government could also boost household savings with incentives.

The increase in government spending could be financed by reducing subsidies, an increase in non-tax revenues, and disinvestment.

Private investment. Loosening the money supply by reducing the interest rate would boost private consumption and investment. Corporate net fixed investment has fallen to close to six percentage points of gross domestic product in the past five years.

Inflation in India, which is heavily influenced by sharp seasonal fluctuations in food prices, has dropped to 8%, from 11.2% in November 2013.

Related CGMA Magazine content:

India Remains Top Investment Market Despite Challenges”: In recent years, India has ranked among the top five destinations worldwide for foreign direct investment despite challenges that multinational companies face doing business in the country.

Corruption Remains a Serious Problem in BRICS, Study Finds”: Emerging markets promise rising consumer demand, but many also harbour serious corruption risks. Find out how the BRICS fare on the 2013 Corruption Perceptions Index and get the rankings for other developed and developing nations.

Sabine Vollmer ( is a CGMA Magazine senior editor.