31 May 2022

In my March 2019 blog entitled “India: Long Growth Runway Still Lies Ahead”, I suggested India may enjoy faster economic growth than all other large economies during the next decade, including China. The following Chart indicates the IMF now shares this appraisal, as India’s long-term potential GDP exceeds all other countries (except Vietnam). Likewise, during the past three years, the Indian equity market has outperformed both Global and Emerging Market indices.

However, such optimism is not without risks and setbacks. Indeed, India has suffered greatly during the Covid pandemic: experiencing the third highest number of cases. Consequently, last year’s 6.6% GDP decline exceeded the downturn in the USA, Europe, and most of Asia — including China’s 2.2% growth. Covid (and other health issues) continue to pose risks to India’s near-term economy recovery and long-term growth story.

Additional uncertainties have arisen more recently. The rise in China’s economic and military power poses both opportunities and serious security risks. Likewise, relations with Russia, India’s historical geo-political partner, have been complicated by the deepening Sino-Russian friendship. Meanwhile, while the USA shares India’s concerns about China’s rising regional prominence, the Biden Adminsitration is vexed by India’s unwillingness to publicly oppose Russia’s invasion of Ukraine. Furthermore, India’s recent heat wave illustrates the profound economic risks climate change poses. India confronts an urgent need to comprehensively alter its energy system, and Russia, China, and the USA (Europe too) could all play important roles.

Therefore, in addition to the need for widespread domestic reforms, how India juggles Great Power geo-politics and its energy transition will play a vital role in determing whether India achieves its long-term potential.

Rising China: Juggling Relations With China, Russia, and USA

India is no stranger to managing Great Power politics. During the Cold War, as the leader of the Non-Aligned movement, India aimed to pursue a neutral, independent stance in the Russia-US confrontation. In practice, however, India relied on Russian political/military support during frequently tense relations with China, including periodic border clashes. In addition, Russian ties were invaluable as China (and the USA) pursued relations with Pakistan. Indeed, the vast majority of Indian arms imports came from Russia (Chart above).

However, Eurasia’s geopolitical tectonic plates are shifting. China’s rise poses both risks and opportunities. India, for example, seeks to expand further the sharp rise in India-China bilateral trade (Chart below). At the same time, however, Chinese President Xi aims to address unresolved territorial claims, including those with India (although Taiwan and the South China Sea are greater priorities). As Sino-Russian ties deepen, however, India may conclude Russian support is now less reliable.

Historically, US-Indian relations have been inconsistent: hampered by India’s ties with Russia and America’s with Pakistan. Regardless, the USA is India’s largest trading partner, and its market share is rising (Chart above). Moreover, their shared concern about China’s increasing regional dominance has led to the establishment of the Quadrilateral Security Dialogue (along with Japan and Australia). Nevertheless, India’s unwillingness to condemn Russia’s invasion of Ukraine, and the deployment of Russian S-400 missile systems, threaten ties with the USA, and could potentially lead to sanctions.

To be sure, India will try to continue its complex juggling act. What are some implications? First of all, India will expand its domestic defense industry to reduce its reliance on Russian imports (perhaps Russia’s performance in Ukraine provides another incentive). Meanwhile, India will diversify the sources of its military purchases (Chart above). Indeed, France is already benefiting, and opportunities exist for US and European producers.

Despite its military ties, Russia’s bilateral trade links are trivial: India’s 25th largest trading partner (Chart above). Russia has little to offer beyond energy products. But, even though India relies heavily on foreign energy suppliers, Russia represents only 1%, 2%, and 4% of Indian oil, natural gas, and coal imports respectively (to be sure, however, India is exploiting the deep price discounts Russia is now offering).

Despite strengthening Sino-Russian ties and potential border issues, India aims to expand commercial ties with China. However, reflecting concerns of Chinese regional ambitions and historic suspicions, India will further diversify its trading links with other Asian countries, as well as Europe and the USA. The next section will show that climate technology will be a useful area of collaberation. Most importantly, ongoing domestic reforms should aim to expand opportunites for Indian producers locally.

Climate Change: A Glimpse of the Future?

In March, India endured the most severe heatwave in over 100 years, with temperatures often reaching 50C. Is this a glimpse of the future? In my climate model (see my blog “Climate Change: Who’s Preparing, Who’s Not”), India ranks 81 (out of 90 countries) in terms of preparedness for climate change. Similarly, India rates 121st (of 182) in Notre Dame’s comprehensive GAIN index. Indeed, India is the world’s third largest CO2 producer, and emissions are growing 6X faster than the global average (Chart above). At the recent COP26 summit, India established an unambitious goal of net carbon-neutrality by 2070. The highly-regarded Climate Action Tracker scores India’s policies and goals as “highly insufficient” to contribute to the Paris Agreement’s 1.5C target.

Like other developing countries, however, India’s CO2 emissions are low on a per capita basis (Chart above). Inevitably, Indian emissions will continue to rise, as the nation pursues its economic development and poverty reduction objectives. Therefore, in order to minimize both the global and domestic economic and climatic consequences of India’s development, comprehensive structural changes will be required in India.

Most importantly, India’s energy consumption mix must change radically. In particular, India must reduce its heavy reliance on coal: 2X the Asian average and 5X Europe and the USA (Chart above). Unfortunately, India plans to increase its coal capacity 30% by 2030 — the world’s largest coal pipeline. Coal consumption and imports have risen 5% annually in the past decade.

Similarly, oil demand will remain robust — up 5% per year in the recent decade — as industrialisation and motor vehicle ownership ramps up. Expanded production of electric vehicles is a key goal, but will require large-scale expansion of EV infrastructure. As imports account for 85% of oil consumption, securing energy supplies is a priority. Roughly 70% is supplied by Middle East countries. US market share is only 5%: an area of possible collaberation. Undoubtedly, Russia (only 1% market share) will attempt to divert petroleum exports from Europe to India.

Natural gas accounts for only 8% of Indian energy consumption. Increased NG usage is a goal, but domestic production (which accounts for 40% the total) has been declining in the past decade. And, while NG consumption has expanded 2% pa in recent years, this pales in comparison to China’s 13% yearly growth. Likewise, India’s LNG imports are up 10% annually lately, but China’s purchases have risen 30% per year. Huge investment in LNG infrastructure is needed to increase usage. Again, Middle East/West African suppliers dominate, but the USA could boost its 10% share (Russia 2%).

Fortunately, India is successfully expanding its consumption of renewables. Indeed, usage of solar and wind are rising 90% and 15% per year respectively in the past decade. The government targets an additional 150% growth in this sector by 2030. As the world’s largest solar player, China may benefit. Likewise, nuclear energy production is growing at a double-digit pace.

Meanwhile, the government aims to improve energy efficiency by 30%. This may prove difficult. The Chart above suggests Indian efficiency is not too bad. But, agricultural and service sectors, which use less energy than the industrial sector, account for much of Indian GDP compared to other Asian countries. Therefore, as India industrialises, energy usage per unit of GDP may actually rise. As European firms are comparatively energy efficient, this is a potential area of collaberation.

Agriculture: Big Changes Ahead

Climate change poses particulary serious risks to countries with large rural populations, with the potential to worsen income inequality. In India, the agricultural sector is a huge source of its green house gas emissions. Indeed, the rural area accounts for 21% of India’s overall emissions compared to 6% in China and the USA. In addition, the scale of India’s impoverished farming community, which is especially vulnerable to climatic volatility, is a major source of the country’s climate vulnerability (Chart above).

As this year’s heatwave illustrates, disruptions in India’s agricultural output can have implications for supplies (and prices) in both domestic and global food markets. Indeed, India ranks #1 or #2 in the world in the production of rice, milk, wheat, cotton, sugar, as well as numerous spices, vegetables, and pulses.

Indian agricultural productivity is low. As India industrialises, therefore, the rural sector will be a huge source of labour supply. In coming decades, perhaps India’s biggest economic development challenge will be to create enough jobs to absorb both rural sector migrants and women entering the labour force. The Chart above illustrates India’s huge gap between male and female employment rates. To prevent a rise in unemployment, India may need to create over 100 million new jobs in coming decades. By comparison, China added roughly 80 million during the past 25 years.

Covid: Health and Economic Risks Not Over

Fortunately, the Covid situation in India is much improved. However, as India has one of the lower vaccination rates in Asia, the emergence of new variants could pose near-term growth risks (Chart above). Over the medium term, India’s low level of healthcare spending will need to increase to mitigate future health risks, including those emanating from climate change (Chart below).

Strategic Considerations

• Despite numerous challenges, I still expect Indian GDP growth to outpace China and other EM economies.
• Climate change will pose serious challenges and risks. Despite greater usage of renewables, Indian economic development will remain reliant upon fossil fuels, and emissions will grow meaningfully. Rising temperatures could be a potent economic headwind, and lead to even greater income inequality.
• India will continue to juggle Great Power politics. In the near term, purchases of Russian energy are likely to increase, but US LNG and oil exports to India should rise also. India will diversify its arms imports (benefiting US and European producers), and boost domestic defense production.
• Bilateral trade with China will grow, but other Asian countries may be the biggest beneficiaries. US and European technology firms (China too) should benefit as India copes with climate change.
• To combat accelerating inflation, Indian interest rates may rise towards 6.5% (from 4.4%) in the next year.
• The Indian Rupee will depreciate enough to offset the inflation differential with the USA in order to maintain industrial sector competitiveness in the next few years.
• India’s greatest challenge will be to create sufficient jobs to absorb new entrants to the labour force.