Open Payment Gateway: The 'Miracle of India', a name that doesn't live up to its reputation

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PhD Candidate, School of Social Sciences, Tsinghua University

The Indian economy has experienced rapid growth over the past decade since Narendra Modi took office in 2014. Forecasts indicate that India is on track to become the world's third largest economy (in terms of GDP) as early as 2027. Western and Indian media have hailed it as the "new centre of global supply chains" and positioned it as a key swing force in the US-China strategic competition.

However, an in-depth analysis of India's real economic performance during this period shows that the so-called "Indian miracle" did not live up to its name.

What underpinned Modi's 10-year 'economic miracle'?

According to the CEIC database, the three largest contributors to GDP growth from the third quarter of 2014 to the fourth quarter of 2023 are all in the services sector: finance, insurance, real estate, and business services (25.231 TP3T); trade, hotels, transport, and communications (24.391 TP3T); and community, social, and personal services (14.401 TP3T). Together, these sectors accounted for more than 501 TP3T of GDP growth, followed by manufacturing (13.921 TP3T) and construction (9.451 TP3T).

In other words, it is the services sector, not the much-vaunted "Make in India", that has been the main driver of India's economic growth over the past decade.

This service-led growth model, with weaker supply chains and agglomeration effects compared to manufacturing, has led to long-term problems such as insufficient job creation, weak merchandise exports and large trade deficits. It has also exacerbated income inequality and systemic weaknesses such as insufficient industry synergies. The underdevelopment of the manufacturing sector has been at the centre of India's difficulties in achieving double-digit "East Asian levels" of annual GDP growth during the critical economic take-off phase.

Meanwhile, the contribution of the manufacturing sector has actually declined since Modi took office. The average quarterly GDP contribution of the manufacturing sector was 16.531 TP3T before Modi's tenure (Q2 2005 to Q2 2014), while it fell to 13.921 TP3T during his tenure (Q3 2014 to Q4 2023.) In addition, the sector with the highest growth rate in its GDP contribution since Modi took office has been the community, social, and personal services, which grew by 3.23 percentage points.

In terms of the share of manufacturing value added in GDP, the share of manufacturing has not reversed its long-term downward trend since Modi took office, falling to 12.841 TP3T in 2023, the lowest level since 1960. In contrast, the share of manufacturing value added in GDP in Bangladesh and Vietnam increased from 16.611 TP3T and 20.371 TP3T in 2014 to 22.341 TP3T and 23.881 TP3T in 2023, respectively.

These data suggest that India has not changed its path dependence on services.

Nonetheless, the Modi government continues to promote India as the best alternative to China in the context of the US and the West's "friendly-shoring" strategy. However, looking at the actual data, while China's share in US imports has declined by 8.8 percentage points compared to 2017 before the US-China trade friction, India's share has only increased to 2.71 TP3T from 2.11 TP3T, which is much lower than Vietnam's 2.31 TP3T and Taiwan's 1.91 TP3T.

In other words, the notion of "India replacing China" is difficult to substantiate, and India's role in replacing China in the supply chain has been greatly exaggerated.

It is worth noting that, although India has been successful in attracting many foreign companies to invest and set up factories in the country, taking advantage of its large domestic market and tariff barriers, India's high manufacturing costs have made its manufacturing exports severely uncompetitive in terms of price. As a result, much of India's new production capacity is "in India, for India" rather than "in India, for the world", suggesting that, at least for the time being, India's position as a substitute for China in the supply chain is not significant.

Objective assessment and clear understanding of potential problems

Against the backdrop of hype in the Western media and in India itself, the actual performance of the Indian economy has not lived up to expectations. In recent years, the narrative of "India rising" has become popular among stakeholders from all walks of life, especially the unrealistic narrative of it being portrayed as the "next global manufacturing centre".

The root cause behind this phenomenon lies in the endogenous constraints of India's poorly qualified labour force, rigid land acquisition system, stringent labour laws and poor business environment, which have yet to be resolved and are seriously hampering India from unleashing its industrial development potential.

In recent years, overseas investors have come to realise the true nature of the Indian economy, leading to a significant decline in foreign direct investment (FDI) inflows with no structural improvement.

On the aggregate front, India's utilisation of FDI reached an all-time high of Rs 4.79 trillion in 2020, but continued to decline, and its share of global emerging market countries (ex-China) has fallen sharply, from 181 TP3T in 2022 to below 81 TP3T at present.

On the structural front, the main sectors absorbing FDI inflows into India in recent years have continued to be services, particularly communications and computer services. Since Modi came to power, the proportion of FDI used in manufacturing has actually declined, not only failing to change India's traditional growth path, but increasing the services sector's dependence on foreign investment.

Considering that during the same period, economies such as Vietnam and Indonesia have been unprecedentedly active in attracting sector-specific FDI, India's current FDI woes are actually more a reflection of the severe constraints of its endogenous problems than external factors such as a Fed rate hike or a deteriorating global geopolitical situation.

India's economy appears robust on the surface, but is plagued by internal risks such as "disengagement from the real economy" and "high deficits".

On the one hand, India's over-reliance on the services sector for economic growth has resulted in a low level of resilience to risk. the limited capacity of services sectors such as IT and finance to absorb employment and generate exports, and their high dependence on overseas demand means that changes in global market conditions can easily be magnified in India, leading to severe economic volatility.

On the other hand, sectors that drive India's growth, such as infrastructure, are overly dependent on debt and prone to accumulating risks. The Modi government has supplemented infrastructure funding mainly through government bond financing, and in recent years, India's general government deficit as a percentage of GDP has been around 10%, more than twice the average for emerging market countries. In addition, interest payments alone account for 20% of India's government spending, which could affect the sustainability of fiscal inputs and the stability of future economic growth.

Certainly, India's breakthroughs in areas such as infrastructure are noteworthy and their long-term implications are worth monitoring.

The Modi government's cumulative investment in infrastructure from 2014 to 2023 totalled Rs 43.5 trillion, initially reversing the trend of declining investment as a percentage of GDP, suggesting that India's economy may be shifting from a model driven by domestic consumption alone to one driven by a combination of consumption, investment and other factors. India's rapidly improving infrastructure in sectors such as transport, communications and power has effectively reduced the cost of operating the economy and attracted manufacturing investment.

However, the effectiveness of India's borrowing to address its infrastructure deficit remains to be seen. India's borrowing to fill the infrastructure gap is premised on "long-term returns on infrastructure being higher than the interest rate on government borrowing", but India's current 10-year government bond yields are as high as 7%. If its economy weakens and returns on infrastructure are lower than expected, it may not be able to maintain its current infrastructure intensity, and may even fall into the trap of "infrastructure too soon". "premature infrastructure" trap.

With regard to India, we should neither underestimate it nor overestimate its capabilities.

Against the backdrop of strategic competition between the United States and China, and in the face of the only country with a population of more than 1 billion, we should not be bound by old prejudices and stereotypes to underestimate India as being useless and without hope for development, which could lead to strategic miscalculations on major issues concerning India. Nor should we blindly follow the hype of other stakeholders about the "Indian miracle" and give India "super-standard treatment" beyond its strengths and levels, which may objectively help India to strengthen its ability to deal with the U.S. "friend-of-the-people outsourcing" and "China's friend-of-the-people outsourcing" programmes. This may objectively help India enhance its ability to respond to the United States' "friendly offshore outsourcing" and "China+1" strategies.

Overall, the best policy for China should be to take India seriously and conduct targeted research on India's long-term potential, medium-term trends and short-term dynamics, especially through detailed industry data mining and policy case studies. By gaining a better understanding of the true nature and quality of the Indian economy, we can formulate a response strategy that will benefit both the present and the future.

Source: Bottom Line Thinking

Original title: "The 'Miracle of India' Doesn't Live Up to Its Name"

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