India's Economic Comeback

After a prolonged period of relatively sluggish growth, the Indian economy surprised many analysts by growing at a stronger-than-forecast rate in the second quarter of this year. This positive surprise has raised hopes that India could be on the verge of returning to the higher levels of growth that were achieved in previous years. With a potentially huge domestic market and with a pro-business government, India has the ability to achieved sustained economic growth rates well above current levels. However, many of the same obstacles that have hindered growth in recent years are likely to remain in place unless massive reforms are undertaken.

In the second quarter of this year, India’s economy expanded by 5.7% on a year-on-year basis, the highest rate of growth in India since late 2011. This was well above the forecasted rate of growth in the second quarter and has helped boost sagging confidence in the Indian economy. Nevertheless, this level of growth is far from the double-digit economic growth rates that were achieved in India in the early part of this decade, when many economists were predicting that India was on the verge of achieving sustained high rates of growth along the lines of those seen in China. Moreover, a closer look at the economic data from the second quarter shows that much of this surge in growth in India was the result of a jump in government spending during that period, something that is not sustainable over the longer-term.

Unfortunately, many of the same factors that have troubled the Indian economy so much in recent years remain firmly in place. For example, India’s vast consumer market remains depressed as consumer spending levels remain well below what had been expected just a few years ago. Meanwhile, business investment levels in India remain well below those of other Asian emerging markets. As for India’s desperately poor infrastructure, too little has been done to improve this key hindrance to economic growth in India and, as a result, India’s overall economic competitiveness has fallen further behind those emerging markets that have invested heavily in their infrastructure in recent years.

For India’s new government and its business-minded Prime Minister Narendra Modi, the positive news from the second quarter will be viewed as a sign that its economic policies are going to restore higher levels of growth for the Indian economy. However, the Indian government will need to enact major reforms in order to ensure that India achieves sustainable high rates of economic growth, and enacting such reforms is likely to prove to be very difficult given the nature of Indian politics. As a result, reforms in India are likely to remain very uneven and this is going to lead to a greater disparity between those regions that enact reforms and attract investment (such as Prime Minister Modi’s state of Gujarat) and those states that continue to shun reforms. In turn, such growing disparities in terms of economic performance will exacerbate the political and social divisions already in place in India, hurting India’s chances of attracting the levels of investment that China did as it was embarking on three decades of rapid economic expansion.