Decreased Indian Economic Growth Rates: A Cause for Concern?

Recent Indian economic growth figures have been a cause of concern for some observers. In the fourth quarter of the latest fiscal year GDP growth rates shrank to 6.1 percent, which allowed China to once again pass India as the world’s fastest-growing economy. Some experts attributed lower growth to Prime Minister Narendra Modi’s demonetization campaign, which when announced in November 2016 took the 500 rupee and 1,000 rupee banknotes out of circulation. This sudden move to remove 86 percent of all cash from the Indian economy was initiated to fight corruption, but it still caused panic for many Indian citizens, as the Indian economy is highly dependent on cash transactions. Even so, while the Q4 rates were lower than anticipated, growth rates for the 2016-2017 fiscal year still finished at 7.1 percent - approximately the same level predicted by many economists.

Despite reasons for skepticism, some larger policies implemented by PM Modi since he came to power in 2014 allow for optimistic prognostications about India’s economic growth. The effective rollout of the new Goods and Services Tax (GST), which will be implemented July 1, would go a long way towards instilling confidence in the Indian economy. This initiative will simplify the Indian tax code by placing a single tax on supplying goods and services, where participants will only be taxed according to the value added to the product by contributors to the previous stage of the supply chain. When combined with a favorable monsoon season that will aid agricultural production and potential interest rate cuts, the GST will hopefully help India experience greater economic growth.

Another way PM Modi’s government has attempted to spur economic growth rates in the past three years is through significantly increasing foreign direct investment (FDI). In addition to rising growth rates, FDI is also essential to the Indian government’s Make In India program, which seeks to build India’s manufacturing sector and make it more attractive to outside investors. In the 2013-2014 fiscal year before Modi took power, India received $24.3 billion US dollars in FDI. However, in the 2016-2017 fiscal year, FDI reached $43.5 billion US dollars, almost double what it was three years earlier.

Specifically, the services sector of the Indian economy generated the highest levels of FDI, attracting $8.69 billion dollars (almost 20 percent of total FDI) in the 2016-2017 fiscal year. Attracting foreign businesses in this sector was one of the most important economic goals for Modi’s government, and thus far it has received commitments from Marriott, Ford, Holitech Technology and Pepsi, among others, to invest in the Indian economy. These commitments have happened at the same time as increases in gross capital formation in the services industry, which grew from 1,868,271 crore rupees in 2013-2014 to 2,285,687 crore rupees in 2015-2016. In the first year after Modi took office, there was also a 63.7 percent increase in gross capital formation in financial services, as well as a 22.9 percent increase in real estate. This further demonstrated Modi’s commitment to making India more hospitable to business transactions.

Although the 2016 UNCTAD World Investment Report placed India as the country with the tenth largest FDI inflow in 2014 and 2015, in order to sustain increased levels of foreign direct investment, the Indian government must make it easier for international investors to do business in the country. Despite increases in FDI, from 2015 to 2017 India only improved its score in the World Bank’s Ease of Doing Business index by four places: from 134 to 130 out of 189 countries. Therefore, while the Indian government has tried to make it easier to start businesses and engage in international trade, enforce contracts and strengthen intellectual property rights, it needs to provide investors with further assurances to give them a greater sense of security while doing business in India.

After a disappointing economic performance in Q4 of the last fiscal year, there are some signs that the Indian economy will bounce back in the new fiscal year. In its most recent World Economic Outlook, the IMF projected that the Indian GDP growth rate will increase to 7.7 percent by the 2018 fiscal year. Similarly, the World Bank also posted optimistic projections for India, predicting 7.5 percent GDP growth for India by the 2018 fiscal year. Although it conceded that demonetization had short-term negative consequences, the World Bank argued that India’s “economic fundamentals remain strong”, and that in the long-term demonetization will help reduce corruption, increase tax collection and lead to higher levels of economic inclusion.

While the statistics from the most recent quarter are concerning, the Indian economy has experienced GDP growth around 7 percent or higher in each year since PM Modi came to power, consistently placing it as one of the world’s fastest-growing economies. Importantly, promising projections by the IMF and World Bank for the Indian economy are contingent on improved GDP growth rates in the first quarter of the new fiscal year; if the economy bounces back, it is likely that demonetization was a temporary setback. However, if there is no rebound, it might signify that PM Modi’s demonetization campaign simply concealed greater deficiencies in the Indian economy. Therefore, we must wait until the first quarter returns of this fiscal year before declaring India’s recent economic issues an aberration, rather than an indication of larger systematic issues in the Indian economy