Post-Covid recovery amid headwinds

The Indian economy is a good performer among emerging economies, with +6.5% growth on average over 2000-2019 and +6.9% over 2010-2019 (roughly in line with emerging Asia). However, the Covid-19 crisis hit India badly, and the economy was already in a vulnerable state at the end of 2019. The resulting contraction in GDP was among the deepest in the Asia-Pacific region. A partial recovery was thereafter delayed by a renewed outbreak of Covid-19 (the Delta variant). India had been lagging the global and regional economic recovery due to the difficult management of the pandemic domestically, the country's comparatively smaller exposure to exports and more limited room for domestic policy support. However, 2022 has kicked off a solid recovery as sanitary restrictions have been removed and a catch-up in private domestic demand along with elevated public spending is supporting growth – we expect GDP to expand by +7.2% in FY2022-2023. A slowdown going into 2023 is likely, in a context of inflationary pressures and slowing external demand. We expect GDP to grow by +6.1% in FY2023-2024.

Despite the relatively limited room for maneuvering, policy measures had been put in place to dampen the negative impact of the Covid-19 crisis. The fiscal deficit has declined slightly since the height of the pandemic but public spending will remain elevated ahead of the general election in 2024, supporting energy, transport and infrastructure, as well as lower taxes on fuel, higher fertilizer subsidies and other measures for households. On the monetary side, after strong monetary easing through 2020-2021, the Reserve Bank of India (RBI) started raising its policy rate since May 2022. As of October 2022, an accumulative 190bps of hikes have been put in place to contain inflationary and currency-depreciation pressures. We expect 75bps worth of further rate hikes in the coming few quarters, bringing the policy rate to 6.65%.

India’s business environment is close to the median in our assessment of 185 economies, with significant change over the past few years. The Heritage Foundation’s ‘Index of Economic Freedom’ survey 2021 assigns India rank 123 out of 184 economies (unchanged from the 2016 survey), reflecting good scores with regards to the tax burden, government spending and business freedom, though weaknesses remain in particular with regards to fiscal health, investment freedom, financial freedom and labor freedom. Meanwhile, the World Bank Institute’s annual ‘Worldwide Governance Indicators’ survey indicates that the regulatory quality and measures to combat corruption have improved since 2016 (from low scores). Our proprietary ‘Environmental Sustainability Index’ puts India at rank 174 out of 210 economies, reflecting strengths in energy use per GDP and CO2 emissions per GDP, but weaknesses in terms of climate change vulnerability, renewable electricity output and recycling rate.

The ruling Bharatiya Janata Party (BJP) is likely to stay in power until the end of its term in 2024. Narendra Modi, prime minister since 2014, should remain the dominant figure in the government. Given the lack of an effective political opposition, the stability of this government is unlikely to be rattled in the coming few years. We would watch out for the BJP intensifying its Hindu nationalist agenda in 2023 ahead of the general election, potentially generating communal clashes.