Economy, English Amid GDP growth, can Modi change India’s economic trajectory?

Economy, English

Amid GDP growth, can Modi change India’s economic trajectory?

With plans to liberalise the economy by increasing foreign investment and ensuring banking transparency, Prime Minister Narendra Modi plans to turn India into a developed nation

From London

India’s economic policy over the last two decades has been characterised by protectionism and subsidies, which determined its economic growth based on the services sector rather than manufacturing. This scenario is about to change with Prime Minister Narendra Modi’s market oriented economic reforms, which aim to renew the market’s confidence by increasing foreign direct investments into the country. According to the IMF’s World Economic Outlook for 2015, growth in India will reach 6.4 per cent – representing a welcoming improvement from the 5.6 per cent growth in the previous year. But will the opening of markets trigger India’s economic development?

Considering the macroeconomic factors surrounding India’s economy in 2015, the answer is yes. The timing for the structural reforms is ideal: GDP growth is bringing down inflation – which the Reserve Bank of India (RBI) has targeted to be 6 per cent by January 2016 – planning to maintain a decreasing trend in the long run. If inflation goes down prices will relatively increase less, which means that the government is “meeting its budget goals” of reducing living costs. In order to boost its growth pace, the RBI has lowered interest rates earlier than expected, reducing the lending repo rate from 8 to 7.75 per cent for the first time in nearly two years. This movement can stimulate companies and entrepreneurs to increase investments in the country since they tend to have “extra” money and can obtain cheaper loans. On Twitter, Nirmala Sitharaman, the Minister of State, Commerce and Industry, argued that the central bank’s early move on monetary policy will be “highly encouraging for industry and economy”.

India will also benefit from the current falling of oil prices. Market analysts predict that some industries – like automobile, plastic and chemicals – will profit the most from this trend on the short run and will directly impact the country’s accounts by reducing current deficit to approximately 0.5 per cent of GDP and consequently, the fiscal deficit to roughly 0.1 per cent of GDP, due to diminished expenses on oil imports. Therefore, the fall of oil prices will help India increase its reserves of foreign exchange.

But in the long run, the country must be very careful with this trend because if prices continue to fall, the world economy is most likely to slow down and India will feel the collateral effect by witnessing a decrease in demand for its exports. However, one can also argue that cheaper oil prices might have the opposite effect on highly industrialised economies, leading to lower costs of business, stronger growth and more investments on those countries, even though these fall indicates a slow down in the economies of China and Japan, for instance.

The macroeconomic scenario indeed provides confidence to India push forward its structural reforms. Prime Minister Modi’s intentions are clear: he believes it is the moment to lift hundreds of millions of Indians out of poverty by promoting manufacturing and attracting foreign investment to expand the country’s infrastructure. To provide an example of those intended changes, India at the moment allows insurance companies to partner with foreign investors whose maximum participation is capped at 26 per cent. If the reforms pass, the participation allowed for foreign investors in the insurance sector will rise to up to 49 per cent. This capital influx into the country will increase India’s state fiscal capacity that will be re-invested to expand the railways, roads, energy system and digital networks.

Following the increase of foreign direct investment, Modi’s agenda also includes giving more independence to the country’s financial institutions, which according to the Financial Times have a “heritage of lazy banking”, meaning that they act as risk-averse lenders. This means that New Delhi is improving its governance standards by no longer having an interventionist policy, triggering a greater competition on the financial system and less rent-seeking or political favouritism.

Despite the proposed structural changes to liberalise the economy and put India on the path to become a developed nation, the country’s GDP growth is still reliant on the services sector that represented 57 per cent of the Indian economy in 2013, according to the World Bank. Manufacturing represents only 15 per cent of the economy and according to Jayant Sinha, Minister of State for Finance, to have a balanced economy, manufacturing must represent up to 30 per cent of GDP. In order to achieve industrial growth, he adds that India must increase the domestic demand by specialising in segments where it has competitive advantage, such as solar panels, home systems and small cars manufacturing. Therefore, India must ensure a sectorial transition from services to manufacturing to fully sustain the structural changes proposed by Modi and become a developed nation.

The growth of manufacturing also increases competitiveness, bringing more jobs and opportunities to the rising population of the country. Those profits must be reinvested into the economy and technology should be constantly updated for India to be competitive with developed nations and, therefore, increase not only its GDP, but also the living conditions of its citizens just like Modi intends to. The Prime Minister’s structural reforms may bring hope and will indeed generate economic growth. But this is just the first step towards the road of turning India into a developed nation. The announced measures will increase the state’s capacity, but public investment must decrease and the government must keep a coherent and predictable monetary policy that will bring security and confidence to foreign investors in the long run.