EFG AM’s Sam Jochim: India is a light in dimming global economy

This is expected to trigger huge inflows of foreign investment, further buoying India’s prospects and providing a bright spot for investors against an otherwise gloomy global growth outlook.

GDP growth is projected to be around 6% per annum for the next five years and despite the recent surge, inflation has returned to its target range, opening the door for rate cuts in 2024.

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That said, average living standards in India are disappointingly low, and additional structural problems such as an inefficient labour market persist despite prime minister Narendra Modi’s vision for a ‘self-reliant India’.

In terms of reforms, his focus has been on deregulation, attracting foreign investment and simplifying processes.

Nevertheless, groundwork is now being laid for India’s future, with the National Education Policy having the potential to mitigate some of these problems.

This will take time and the challenge is not insignificant. Re-election for Modi in 2024 could see a fresh set of reforms introduced.

In any case, India appears to be on the right path, and has the potential for a prosperous future.

Consumer Optimism

Following the pandemic-related contraction in fiscal year 2020-21, India’s GDP rose 9.1% and 7.2% in fiscal years 2021-22 and 2022-23, respectively.

Almost 60% of this growth was accounted for by private consumption, with over a third coming from capital expenditures, around 10% from government spending and trade detracting slightly from growth.

Given the strength of the services sector and the high level of consumer optimism in India, private consumption appears well placed to drive growth again in fiscal year 2023-24.

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Furthermore, the Reserve Bank of India (RBI) said banks and private companies have healthy balance sheets, while supply chain normalisation, business optimism and robust government capital expenditures are additional factors supportive of a renewal of the capex cycle.

A further tailwind to growth comes from the government’s Production-Linked Incentives (PLI) scheme which was introduced in 2020.

This scheme proposes financial incentives over five years to boost domestic manufacturing across 14 key sectors.

Since the PLI’s introduction, fixed capital formation in India accelerated beyond its 2011-2018 trend implied level.

Further acceleration is possible in 2024 as protectionist policies, such as import restrictions, encourage domestic production.

However, while protectionist policies can raise demand for domestic products in the short run, in the longer run they are more likely to reduce aggregate demand due to market inefficiencies which increase costs for consumers. The result could be a slower pace of GDP growth.

Monetary Policy

Turning to monetary policy, India adopted a flexible inflation targeting framework in 2016, formalising price stability as the primary policy objective.

The RBI targets CPI inflation at 4% with a 2% tolerance band either side of the target. Food accounts for around 46% of the CPI basket in India, making it an important determinant of inflation.

Since food prices are more vulnerable to supply shocks than other goods and services, having a credible inflation target to anchor both inflation and inflation expectations is important.

Without such a target, long-run inflation expectations can drift due to supply shocks, on which monetary policy has little impact.

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If long-run inflation expectations are stable, supply shocks are less likely to lead to second-round effects and more likely to manifest themselves as one-off changes to the rate of inflation, for example, they become transitory.

Conditions were in place for interest rate cuts before the end of 2023.

However, in July inflation increased once more above the RBI’s target range. This was driven by an increase in vegetable prices, reflecting the impact of a late start to the monsoon season and uneven rainfall distribution, highlighting the vulnerability of inflation in India to agricultural supply shocks.

The RBI believes price increases peaked in the second quarter of the fiscal year at 6.4% and will fall towards the midpoint of its inflation target over the next year. In the absence of further shocks, interest rate cuts are possible in 2024.

Looking ahead, India’s general election will be held between April and May 2024 and, despite a lack of progress with many important reforms, Modi is likely to retain the premiership for another five years.

His current approval rating is almost 80%. With domestic consumer confidence appearing robust and a likely inflow of foreign capital, India is indeed a bright spot on the global economic map.

Sam Jochim is an economist at EFG Asset Management