India: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diversified growth drivers
- Large workforce (over 50% of the population under 25) with good command of English
- Efficient private sector, especially services
- Positive contribution from expatriates’ remittances, jewelery, garments, vehicles and medication exports, as well as tourism revenues to current account
- Moderate level of external debt and adequate FX reserves
- Lack of infrastructure and shortcomings in the education system
- Bureaucratic red tape and persistent political tensions
- Net importer of energy resources
- Rising level of private firm indebtedness
- Weak public finances
- Persistent uncertainties over the Kashmir issue
Growth will remain subdued
The economy will continue to face headwinds in 2020. Slower domestic consumption (60% of GDP) is still recovering from the residual impact of demonetisation (withdrawal of the 500 and 1,000 rupee notes) and the introduction of a harmonized goods and services tax (GST), as their impact on the informal sector remains significant three years later. Meanwhile, tighter credit conditions are limiting private investment, key to unlocking the country’s growth potential. Non-performing assets (NPAs) in the banking system have declined, but they remain high (9.1% in 2019). This has made banks more cautious about extending credit, fearing their situation may get aggravated. The banking sector is also recovering from a series of corruption scandals in 2018 and 2019. Weaker investment growth has translated into fewer jobs, with unemployment levels reaching a record high of 8.45% in October 2019. The unemployment rate will likely fall slightly, but labour participation rates remain subdued at around 43%, which does not bode well for domestic consumption going forwards.
Inflation remains subdued, thanks to weaker energy and food prices. It appears that the Consumer Price Index (CPI) will remain below the Reserve Bank of India’s (RBI) target of 4.5% YOY in FY20. Some upside risks are possible in case of abnormal monsoon rains that disrupt supply. However, CPI below target allowed the RBI to cut interest rates by a cumulative of 135 basis points in 2019. This should have proven supportive of growth and employment under normal conditions, but there have been transmission problems owing to the issue of high NPAs. RBI will likely implement an additional 1-2 additional rate cuts in 2020, albeit with limited impact on activity. In this context, the onus will fall on fiscal policy stimulus. The government will also focus on structural reforms to boost foreign direct investment (FDI) and domestic liquidity. India overhauled its corporate tax system in August 2019, and is now on a par with other regional peers such as China, with even larger fiscal incentives for high-tech manufacturers that move to India within the next two years. Additionally, the Ministry of Finance launched a mega-merger of 21 state banks into 4 bigger entities, which will aid with issues related to bad debt.
Public finances to struggle amid headwinds
Finance Minister Nirmala Sitharaman unveiled an ambitious budget for 2020. In addition to corporate tax cuts, she proposed to expand a pension scheme to cover an additional 30 million people and measures to boost agricultural incomes (the agricultural sector employs 80% of the population). This means India will likely overshoot the fiscal deficit target to 3.3% of GDP in FY20. This is especially the case as revenues from the GST have been disappointing, both in terms of weaker domestic consumption but also due to problems with collection. India has also planned increases of import duties, higher taxes for high-income brackets and its first foreign currency offshore bond issuance. These should help to cushion downside pressures, but public finances will worsen before they can improve.
The current account (CA) deficit will likely widen further. Exports will continue to remain subdued, while imports are set to increase thanks to stimulus measures to boost domestic demand. Oil prices are set remain range-bound at around USD 60 per barrel in 2020.However, a potential shock could exacerbate pressures on the current account, as this remains India’s largest import. Rising demand for gold after demonetisation will also continue to play a role in driving imports. The rupee is therefore likely to remain subject to depreciatory pressures in 2020. Foreign exchange reserves remain at comfortable levels (nearly ten months of imports), and FDI and foreign portfolio investments are on an upward trend, and should accelerate in the coming years, thanks to recent structural reforms.
Modi’s BJP party keeps its majority, but support may dwindle
The alliance formed around Prime Minister Narendra Modi’s Bharatiya Janata Party (BJP) secured a landslide victory in the Parliamentary elections of May 2019 (349 out of 542 seats). Modi won his second election by focusing on job creation and investments in infrastructure, while tackling corruption and fostering the ideology of Hindu nationalism. Given the slow progress on the economic front, BJP could ramp up the nationalist agenda, something that would not sit well with foreign investors, who are keen on secular policies. India needs to attract FDI to plug its infrastructure gap, finance the current account deficit and boost potential growth. Tensions with Pakistan over Kashmir intensified, after Modi stripped the region of its semi-autonomous status in August 2019.