Washington, D.C., June 26, 2014 - India is back in business. The electorate delivered a stunning verdict by giving the Bharatiya Janata Party (BJP) a single-party parliamentary majority for the first time in 30 years. Prime Minister Narendra Modi's cabinet and initial steps to improve governance have been well received. The market bets in the run up to the national elections paid off handsomely and expectations have been high for a strong and action-oriented administration to move forward on economic reforms to lift growth and lower inflation.
The Institute of International Finance's (IIF's) report on Capital Flows to Emerging Markets, released last month, projects that net private capital inflows to India will be further bolstered by improved investor confidence. A supportive global environment and stepped-up efforts to advance structural reforms will help underpin capital inflows of around $85 billion this fiscal year and next, up from around $75 billion in 2013/14. These will easily finance a moderate import-led widening of the current account deficit after the sharp correction last year. Imports are set to rise with a gradual relaxation of restrictions on gold imports and stronger growth.
Given the improved prospects for reforms, real gross domestic product (GDP) growth should increase from 4.7% in 2013-14 to around 6% in 2014-15 and 7% in 2015-16. A key ingredient will be a revival in investment along with greater private capital inflows and stronger exports. The main downside risks relate to the possibility of a drought this year and the need to bring state governments on board for aggressive reform implementation.
In contrast to India, China faces divergent fortunes. In the wake of the global financial crisis, China embarked on a massive stimulus to shore up growth, but which also led to an over-extended property sector, sharp expansion in shadow banking, over-capacity in many industries and surge in local government debt. Having to deal with the legacy issues along with President Xi Jinping's stepped up anti-corruption campaign means that growth in China is set to fall to around 7.3% this year and 7% next year.
While a housing crunch could precipitate market turbulence and a sharper slowdown, a combination of a mini-stimulus and firmer external demand should help achieve a soft landing in China. In the medium term, policymakers are seeking a new normal annual growth path of 6-7%. To achieve this, rebalancing towards more consumption-led expansion is to be supported by productivity-enhancing and market-based reforms in line with the Third Plenum blueprint.
The mantra of the new Chinese leadership is sustainable growth over the next decade, accompanied by a needed improvement in lagging wages and employment conditions to address dissatisfaction and easing of curbs on rural-urban movement of people. With environmental concerns reaching a tipping point, the leadership is also conscious of the necessity for tackling air and water pollution, which is another headwind for the economy to navigate. Meanwhile, fewer entrants to the labour force mean that growth could be half the rate during 2002-2007.
While the prospects for India relative to China are turning more sanguine, there is a lot of catching up to do. China's per capita GDP is $7,000, as against $1,500 for India. China's exports were $2.2 trillion in 2013, but only $320 billion for India. China attracted inward foreign direct investment (FDI) of $250 billion in 2013, compared with $30 billion for India. Tripling annual FDI through investor-friendly policies should be an important near-term objective for India.
As such, India has a long way to go and many challenges to overcome. But, hopes are rising. A capable pro-reform administration is in place. The global backdrop is benign and there should be sustained appetite for emerging market assets given growth and yield/valuation differentials, assuming no major surprises in the path of Fed exit.
Geopolitics may also help. Tensions in the East and South China Seas will prompt diversification from China.
There are opportunities for inducing Japanese companies to invest more in India, facilitated by a push to develop industrial corridors and clusters. Chinese firms are looking to expand overseas, and their infrastructure-building acumen, such as in railways, could be tapped. Equally, India is vital in the Asia strategy of the US, bolstered by the large Indian diaspora.
Reviving stalled investment projects will be important as will be the budget for 2014-15, and efforts to tackle bureaucratic impediments. If a goods and services tax (GST) can be put in place by early 2015, it would signal that the game plan of securing state-level support for reforms is working.
While there is plenty of upside for the economy, it will also be necessary to ensure that potential tensions from mining contracts, land acquisition and labour market reforms are properly managed with policies to ensure that all sections of society benefit. In conclusion, Prime Minister Narendra Modi's mandate is a game changer, and domestic as well as global conditions appear propitious for him to be able to deliver on the electorate's rising expectations.