Economic Outlook: India's untapped potential

Despite the brighter picture painted by the rebasing of GDP data, India’s economic recovery looks uneven. Real GDP grew +7.5% year-on-year in the fourth quarter, but domestic demand remains weak. Both investment and private consumption are struggling to grow, and the manufacturing sector is muted.

On the plus side, a number of forward-looking indicators, including the purchasing managers’ index, suggest an improved outlook. Softening inflation, easing commodity prices and input costs, ample liquidity in the financial system, and rising business and consumer confidence should enable demand to pick up.

Meanwhile, the monetary easing initiated by the central bank in January 2015, with additional rate cuts expected throughout 2015, should stimulate credit growth and boost domestic demand. The timing and extent of further monetary easing will depend on fiscal and external developments, and remain conditional on favourable inflation.

IHS Global Insight expects the central bank to deliver as much as 125 basis points (1.25 percentage points) in additional rate cuts in 2015. Coupled with the government’s efforts to revive investment, this should help India’s economy to grow +7.4% in the fiscal year (FY) ending March 2015, further accelerating to +7.9% in 2015/16.

The resounding victory the Bharatiya Janata Party (BJP) in the 2014 Parliamentary elections, and the formation of the first non-coalition government in 30 years, have put Prime Minister Narenda Modi in a strong position to transform the economic landscape.

Second budget

The second BJP budget—presented in late February—outlines a clearer path for reforms. However, the approach remains gradual and measured, rather than immediate and fast paced, and structural reforms in the private sector will continue to outpace those in the public sector.

India’s plentiful, undeveloped natural resources offer untapped potential, while the skilled, educated labour force boosts prospects for both the private and public sectors. The dynamic, successful overseas Indian community also sparks domestic entrepreneurial activity, both directly and indirectly. Rapid urbanisation will also act as an important force of change in the long term.

However, the government’s optimistic economic growth target of upwards of +10% a year still remains out of reach. Such rapid growth would require a substantial increase in public and private investment.

In order to bring the economy back on track and fully realise this potential, India will have to speed up investment, liberalise its rigid labour market, eliminate wasteful subsidies, and diversify from IT-enabled services into value-added manufacturing and financial services.

Net foreign investment inflows are seen picking up on improving post-election business sentiment. Strong post-election momentum has turned into a sharp rise in foreign direct investment (FDI) inflows to India, up by a factor of five to US$ 39.9 billion during the first half of fiscal year 2014–15

India will also benefit from lower world oil prices since it is a significant oil importer. The impact of lower oil prices could provide a 0.5% to 0.8% stimulus to Indian GDP growth in 2016.

The most recent BJP budget introduced an array of reforms focusing on tax rationalisation and infrastructure investment. It includes an ambitious plan to upgrade India’s poor infrastructure, with nearly US$ 11 billion to be spent in FY2015/16 alone on roads, railways, ports and other projects. In a separately announced railway budget, annual spending was increased 52% from prior spending and envisaged a total investment of nearly
US$ 137 billion in India’s outdated rail network over the next five years.

In the energy sector, the budget proposed an expedited commissioning of five ultra-mega power generation projects of 4 GW each and electrification of 20,000 villages by 2020. In housing and urban development, the budget stuck the existing “Housing for all” programme to build 20 million house in rural areas and 40 million houses in urban India by 2022.

This would be financed in part with a National Investment and Infrastructure Fund with annual inflow of INR 200 billion (US$ 3.1 billion). In addition, the government has introduced tax-free infrastructure bonds for projects in the rail, road and irrigation sectors, and encouraged government-run ports to develop under the Companies Act, which should help attract investors.

Construction outlook

Since the Indian business community routinely cites infrastructure as the single biggest hindrance to doing business, ahead of corruption and cumbersome bureaucracy, this budget is a critical step toward advancing Indian competitiveness, as well as representing a boon to construction companies. The construction outlook reflects the current realities in India, while building on the expectation for reform.

The forecast for the residential sector is strong compared to some markets, but weak compared to total Indian construction. Urbanisation, government spending, population growth and an emerging middle class contribute to growth, but investment is targeted elsewhere.

Office construction has been strong for the past five years, driven by India’s IT industry. Demand from this sector will wane over the forecast, but anticipated growth in financial and business services will drive continued growth. The forecast for growth in industrial structures does hinge upon market reforms to boost India’s manufacturing industries and export competitiveness. Reforms have already been partially implemented for some commercial categories, notably retail trade. While commercial growth features the strongest turnaround over the forecast, this is among the safest projections of any structure type.

Infrastructure has been the second strongest performing segment over the past five years, and it will be the strongest over the forecast. The Modi government understands that this is critical to growth and has created the incentives and proposed the spending to meet the need.

Similar logic holds for institutional spending. For India to realise its potential, the education system requires significant investment, and the BJP has also begun to address this need. New investment in rural communities will also offer improved access to health care.

India’s outlook is much improved from a year ago. Low inflation and falling oil prices allow for interest rate cuts, while government policy is increasingly pro-investment and infrastructure spending has become aggressive. The challenge for India is to capitalise on this opportunity and return to being a high growth economy.