India: Risk Assessment

Country Rating¹

Rating: A3

Business Climate Rating¹

Rating: A4

Risk Assessment²

After strong GDP growth in 2010/2011, a slight slowdown likely in 2011/2012
The Indian economy rebounded in 2010/11 thanks to the recovery of domestic demand supported by economic policies that have remained accommodating, interest rate hikes notwithstanding, with 7.8% GDP growth recorded in the first quarter. Investment benefited from vast infrastructure projects while consumption was driven by the rise of wages associated with the good performance achieved in a farm sector on which 70% of the population depends. On the supply side, the secondary and tertiary sectors proved very dynamic with private Indian companies enjoying comparative advantages in services (information technology, outsourcing) and industry (capital goods, retail sales, pharmaceuticals, automotives, electronics, home appliances).
Inflation has increased meanwhile due to the persistence of negative real interest rates, the rise of raw material prices, and the reductions in price subsidies for oil, diesel, kerosene; and gas. The rise of food prices is transmitted to the core inflation rate (exclusive of energy and food prices) via wage growth, which ultimately leads to increases in the final prices. The high inflation, in conjunction with the widening of the current account deficit reflects the evident overheating of the Indian economy. The rapid growth of domestic demand cannot be met by domestic supply alone, and the economy has been growing above potential: India's shortcomings in terms of education and infrastructure constitute major economic bottlenecks.
In 2011/12, the Central Bank is expected to continue to raise interest rates, which could slow the economy. Growth will nonetheless remain at satisfactory levels thanks to India's solid fundamentals notably including a large domestic market, high savings and investment rates, favourable demographics, balanced growth jointly underpinned by investment, exports, and the rapid development of middleclass consumption. Inflation, meanwhile, will remain high: the interest rate hikes will attract an influx of speculative capital with the expansion of credit accelerating and prices rising in consequence.

Public-sector finances continue to limit infrastructure development
In 2010/11, the fiscal deficit declined slightly with the gradual withdrawal of the stimulus plan. Although this trend will likely continue in 2011/12, the deficit will nonetheless remain substantial, adding to an already high public debt. Furthermore, the heavy debt service is expected to continue to penalize public sector capital investments, particularly in infrastructure, which are crucial to further acceleration in economic growth.
Conversely, India's external financial position remains solid. The current account deficit will likely widen slightly with the recovery of imports, driven by strong domestic demand, proceeding at faster pace than that of exports. Financing needs will nonetheless be largely covered by FDI.
Foreign debt ratios will thus remain moderate. Meanwhile, the massive influx of volatile capital in 2010/11 drove up the Indian rupee and poses challenges for monetary policy. Capital controls could be instituted in 2011/12. And foreign exchange reserves are expected to remain high providing the country with good capacity to cope with sudden capital flight.

Persistent shortcomings in the business environment
The economy continues to suffer from governance shortcomings especially as regards corruption. Several scandals came to light late 2010 and early 2011, particularly in the organisation of the Commonwealth Games and the granting of mobile telephony licences.

Strengths

• Diversified growth engines
• Solid fundamentals: high savings and investment rates
• Good private sector performance in industry and services
• Moderate foreign debt and large foreign currency reserves

Weaknesses

• Lack of infrastructure and weak education system
• Rise of wages for skilled labor susceptible of eroding the competitive advantage
• Increase of private corporate debt
• Fragile public finances
• Persistent uncertainty over the Kashmir question