India has experienced strong levels of growth in the post-pandemic period — in fact, since 2022 it has remained the fastest growing major economy. Its arrival as a dominant economic force has been expected for a while, and there are reasons to believe that it might now start consistently delivering on that promise. Its economic stability has improved in recent years, and this — as well as its strength in the services sector — seems to provide the right environment for it to unlock its growth potential. But the threat of a labour market mismatch could threaten to delay India’s economic charge once again.
In the last ten years, India’s inflationary environment has not only settled down to a lower average value that at the start of the last decade but also become visibly less volatile. This change coincided with a series of deliberate monetary policy reforms from the Reserve Bank of India, including pursuing a flexible inflation-targeting regime, setting their CPI inflation target at 4%. The more stable inflationary environment has contributed to increased levels of consumer and investor confidence, leading to a rapid increase in foreign direct investment into the country.
Refresh this chart in your browser | Edit the chart in Datastream
Refresh this chart in your browser | Edit the chart in Datastream
Other signs of strength in the Indian economy are in the performance of its services exports. In contrast to many other countries at a similar stage of development, it is in the services sector rather than manufacturing in which it holds a comparative advantage. This suggests that India’s growth pathway may be a services-led one as opposed to the traditional manufacturing-led one. In fact, India’s services exports have more or less balanced out any goods trade deficits, meaning that India only runs a small current account deficit. Although running a current account deficit is not necessarily a bad thing for an emerging economy, a more balanced current account does limit exposure to external shocks, which creates a more stable macroeconomic environment.
Refresh this chart in your browser | Edit the chart in Datastream
Want more charts and analysis? Access a pre-built library of charts built by Fathom Consulting via Datastream Chartbook in LSEG Workspace.
Refresh this chart in your browser | Edit the chart in Datastream
A growing body of academic literature suggests that India’s strength in services can indeed be the driver it needs to propel its economy to the next level. One big allure of the services-led approach as opposed to the manufacturing-led approach is that the domestic value added of services exports tends to be a lot higher. The benefits of this are clear: not only does a higher return from production accrue to domestic factors, but it also means that its supply chains are less reliant on imports — an increasingly important consideration in today’s geopolitical environment. Of course, it should be noted that imports are not a bad thing per se, since they allow you to benefit from the efficiency gains from specialisation. But a high concentration in the source of those imports might be problematic, to the extent that it leaves supply chains vulnerable — in essence, with a low import dependency India is effectively favouring reduced vulnerability over increased gains from trade.
A services-led approach does come with its challenges, however, particularly in job creation. India’s services sector can create high-skilled job opportunities in sub-sectors such as IT; but a large proportion of India’s working-age population are comprised of unskilled workers. In fact, it is reported that around 75% of India’s population between the ages of 25 and 64 have an educational attainment below ‘upper secondary’. Although upskilling the population is a long-term goal of the Indian government, one way of addressing this skills mismatch in the interim is by investing in the manufacturing sector, which can create many unskilled and semi-skilled jobs.
The current geopolitical climate presents an opportunity for India in this regard, as it can use its promising and relatively stable macroeconomic environment to present itself as an attractive alternative for foreign companies looking to de-risk their supply chains way from China. We are seeing examples of this already, as several US electronics companies have invested in manufacturing capacity in India in place of China, as illustrated by the opposing trends of US FDI in the two countries over the last few years.
Refresh this chart in your browser | Edit the chart in Datastream
India has created a solid foundation for growth, and its economic stability and strength in the services sector can prove to be important drivers for sustained growth in the years to come. Ultimately however it will need to balance its growth to ensure that sufficient job opportunities follow.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
______________________________________________________________________________________
LSEG Datastream
Financial time series database which allows you to identify and examine trends, generate and test ideas and develop viewpoints on the market.
LSEG offers the world’s most comprehensive historical database for numerical macroeconomic and cross-asset financial data which started in the 1950s and has grown into an indispensable resource for financial professionals. Find out more.
