India: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diversified growth drivers
- High levels of savings and investment
- Efficient private sector in services
- Moderate level of external debt and comfortable foreign exchange 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 is Expected to Rebound
Real GDP is expected to grow quicker in 2018, supported by strong performance in the services sector, after a slight slowdown at the end of FY 2016/17 due to the demonetization decision of Modi’s administration in November 2016 (withdrawal of the 500 and 1000 rupee notes). Household consumption was negatively affected by this measure, and its impact on the informal sector, although difficult to quantify, has been significant. However, improved financial integration of the poorest households should support demand in the long term. Inflation reached a record low on June 2017, and remains below the central bank’s target of 4%. A combination of lower commodity prices and a dip in key agricultural products contributed to this decline, enabling the central bank to lower rates in July. However, it is expected that inflation will increase in 2018, as the federal VAT system (Goods and Services Tax, GST), which was implemented on July, exerts upside pressure on prices.
The private sector should continue to benefit from the impact the Modi government’s reforms, aimed at boosting India’s manufacturing sector, attracting FDI, and reducing constraints burdening the economy. India jumped 30 spots to 100 in this year’s “Ease of Doing Business” ranking by the World Bank. However, non-performing loans in the banking system have impacted the monetary policy transmission mechanism by keeping borrowing costs high. This has hindered domestic companies’ willingness to borrow money and invest. Reforms aimed at cleaning up the banking system have been put in place, but these take time and could impact the supply of credit, despite the Reserve Bank of India’s loose stance. Higher government expenditures in infrastructure (transport infrastructure and utilities) should offset this weakness.
Willingness to Improve Public Finances
Fiscal deficit and public debt levels remain high, but the country has initiated plans to reduce them. The most notable of these initiatives is the introduction of the GST, which aims to boost fiscal revenues and make the economy more competitive in the long term, despite some disruption in the short term (higher prices). Fiscal consolidation efforts are facilitated by low energy prices, which remain subdued in line with global oil prices (India is a net importer). In addition, measures to demonetize a portion of outstanding bank notes should improve budget revenue by reducing the weight of the informal economy.
The current account deficit is expected to increase slightly. The increase in imports is partly due to the rising demand for gold after demonetization. Deficits in the trade balance and income balance are likely to worsen, and the services surplus should also reduce.
The rupee is expected to remain relatively stable in 2018, but like other emerging currencies, it remains vulnerable to a rise in global risk aversion and a faster-than-expected rate of monetary policy tightening in the United States. Foreign exchange reserves are set to remain at comfortable levels (nearly ten months of imports in 2017), and FDI and portfolio investments are on an upward trend.
Narendra Modi Supported by Regional Elections
Narendra Modi’s party, the BJP (Bharatiya Janata Party), won the regional elections in March 2017, gaining 312 out of the 403 seats in the lower house in Uttar Pradesh. This is the most populated state and so is often considered a “popularity barometer” for the government. The victory helps to further strengthen Modi’s position, two years ahead of the next national elections. Demonetization seems to have weighed on household consumption, but was eventually perceived as a commitment to his campaign proposal to combat inequality and root out corruption. However, as the Congress Party continues to dominate the Upper House, the reforms long-awaited by the business community are delayed.
Kashmir remains a source of tensions between India, Pakistan and the separatists of the region. Diplomatic talks were suspended after an attack on an Indian base in Punjab on January 2016, and relations between the two countries have deteriorated in recent months. New tensions have emerged after the Indian army shot the leader of the main insurgent movement, Sabzar Ahled Bhat, in Kashmir on May 2017. However, an escalation of violence is unlikely as Pakistan and India both have an interest in maintaining the status quo.