How strong is India’s economy?

It isn’t the next China, but it could still transform itself and the world

Narendra Modi, on track for a third term as India's prime minister, has risen from humble beginnings to become the most significant leader since Nehru. His tenure reflects not just his political acumen and the resonance of his Hindu-nationalist ideology, but also his undermining of democratic norms. Yet, many see him as a figure of national prosperity and assertiveness on the global stage. As the world's fastest-growing large economy, India under Modi is not emulating China's manufacturing miracle but is forging a distinct path marked by vast infrastructure projects, a booming services sector, and innovative digital welfare systems. While his policies build on liberal reforms from previous decades, Modi has been crucial in driving through changes and shaping a more streamlined governance model.

However, Modi's leadership also entails a focus on ideological pursuits and an increase in illiberal practices, potentially stifling necessary economic reforms and investments. With a large fraction of India's billion-strong workforce in unstable employment, the challenge is to create more formal jobs through sectors like IT and manufacturing incentives. As Modi faces the future, the imperative is to temper his autocratic impulses and foster an environment that encourages investment and broad-based growth. The test for Modi and for India is whether his government can adapt to foster a knowledge-driven economy and maintain its democratic framework.

Why India isn’t winning the contest with China

A series of setbacks suggest that new policies are needed

The pilot’s tower at Colombo port, in Sri Lanka’s capital, provides a telling snapshot of India’s struggle with China in South Asia. To the east lie the berths where Indian and Chinese warships often dock, a port official explains. Southwards sits the Chinese-operated container terminal that was an early part of China’s Belt and Road plan. Next door, to the west, is where India’s Adani Group is building another terminal which, in 2023, won $553m of American government funding.

When that deal was unveiled, it was hailed as a showcase of cooperation to counter Chinese influence, which had been spreading in the region through trade, arms sales and infrastructure projects. India was pushing back in other ways too, granting neighbours relief from COVID-19 and from debt problems linked to Chinese loans. “India is no longer losing—and may even be winning—its strategic competition with China,” wrote the Rand Corporation, a think-tank, in 2023.

Yet as Narendra Modi, India’s prime minister, prepares to visit Washington this month, his regional scorecard looks patchy at best. In the last 18 months, India-friendly leaders have been ousted in the Maldives, Nepal, Bangladesh and Sri Lanka. Bangladesh, especially, is tilting towards China. And several regional Adani projects are mired in controversy following those upheavals and American bribery allegations against its chairman, Gautam Adani (who denies wrongdoing). On December 11th, the firm said it would no longer use America’s loan for the Colombo port.

The to-and-fro is partly because regional leaders are playing Asia’s giants against each other. But it also stems from poor diplomacy. That raises tough questions for India, whose geographical and cultural links give it a natural edge. Moreover, Mr Modi adopted a “neighbourhood first” policy in 2014. Within India’s security and diplomatic elite, some fear a lack of vision and cohesion is thwarting potential gains in a period of relative Chinese weakness. It is a worry, too, for America and other governments banking on India to help constrain China. Many Western officials fear that India’s regional diplomacy often backfires or conflicts with their own. Some say it mirrors China’s behaviour by backing despots, promoting opaque business deals and stirring chauvinistic nationalism at home. Donald Trump’s return to the White House adds new challenges, too.

Take Bangladesh, the biggest regional “swing state”. (Pakistan has long been in China’s camp.) India was a staunch supporter of Sheikh Hasina, Bangladesh’s prime minister from 2009 to 2024, and turned a blind eye to her increasingly autocratic rule. Indian officials even lobbied America to tone down criticism of her record, warning that Bangladesh could be overwhelmed by Islamist extremists.

For a while, India’s approach worked. Trade, infrastructure and security ties flourished. Bangladesh expanded links with China, but deferred to India on security. Then, in August 2024, India’s gamble backfired. Sheikh Hasina was deposed by student-led protests and fled to India. Anti-Indian sentiment is now widespread in Bangladesh; many Indians are outraged by reports of attacks on Bangladesh’s Hindus. China, meanwhile, is exploiting any strategic openings despite scaling back its Belt and Road infrastructure push, and despite resolving a four-year border standoff with India in October. China has already pledged $2bn in financial aid for Bangladesh and is discussing $5bn more, says Touhid Hossain, Bangladesh’s interim foreign minister. Visiting Beijing in January, he requested more and China extended the term of some loans. Both sides also committed to infrastructure projects and discussed a Chinese proposal to develop Mongla port (Bangladesh’s second-biggest). India bid for that under Sheikh Hasina as part of efforts to match the network of Chinese-controlled Indian Ocean ports. This was not just an Indian intelligence failure: it exposed an outdated approach to the region. For decades, India has largely backed whoever is in power so long as they furthered its security interests. Mr Modi built on that but relied more on economic muscle, using generous aid (including $4bn for Sri Lanka after its debt default in 2022) but also stiffer penalties such as an unofficial blockade of Nepal in 2015. Indian officials say the approach is working. They cite their outreach to Sri Lanka’s new president, whose first foreign trip was to India, despite his party’s historic links to China. They also persuaded the Maldives’ new leader to reverse the “anti-India” stance of his election campaign. As for Bangladesh, they do little to quell unfounded Indian media chatter that America engineered Sheikh Hasina’s downfall.

In recent weeks, however, senior Indian diplomatic and security figures have called for a rethink. They say India has been too heavy-handed and, like China, failed to nurture links to opposition parties and civil society or promote a common sense of values and identity. Some connect those to Mr Modi’s hostility to political opponents and non-governmental organisations; his Hindu nationalism often backfires too (especially in Muslim-majority Bangladesh). “The world has changed very fast,” says Shivshankar Menon, a former foreign secretary. “But we’re still doing what worked earlier and expecting the same result.” India, he says, should concentrate on economic integration and stop seeking reciprocity from weaker neighbours. Others want greater focus on the region’s young people, getting more to study in India. Shyam Saran, another former foreign secretary, says India needs more diplomats dealing with the region and more involvement by local governments in border areas. Indian diplomats have been nimbler with Sri Lanka. But its president, Anura Kumara Dissanayake, is still hedging. Visiting China in January, he agreed to fast-track a $3.7bn Chinese plan for an oil refinery alongside a Chinese-owned port in southern Sri Lanka that India considers a potential military threat. He has lifted a moratorium on visits by foreign research ships that was imposed after India protested about such visits by Chinese vessels.

He also adopted China’s preferred wording, referring to Tibet as “Xizang” (its Mandarin name) and backing “all” China’s efforts to achieve unification with Taiwan. Nepal’s prime minister, K.P. Sharma Oli, used similar wording when he visited China in December and agreed to deepen economic ties. Ranjit Rae, a former Indian ambassador to Nepal, faults India for neither building cross-party ties nor inviting Mr Oli to visit after his appointment in July.

Another worry for India is its reliance on Adani (whose chairman is close to Mr Modi) in competing for infrastructure projects. In 2017 Adani signed a 25-year deal to supply electricity to Bangladesh. In Sri Lanka, it won the Colombo port contract and a wind-power deal, both without open tenders. In Nepal, it has lobbied to build one airport and operate three. Bangladesh now wants to renegotiate the power deal, alleging it involves inflated prices (Adani has said the company has upheld all its contractual obligations). Sri Lanka is reviewing the wind deal on similar grounds.

Underlying all these problems is a more fundamental one. Mr Modi promotes India as an emerging world power and a champion of the global south. Yet officials across the region say it is still unclear what India stands for in its own backyard. Until it defines that, sceptical neighbours will continue to hedge their bets. And China will reap the rewards. ■

The India Express - For its next phase of growth, India needs a new reform agenda

With the right changes, it can become an engine of global growth

Historians reckon that the two Asian giants have had roughly equal economies for much of their history. Only since the 1990s, when China began its daring, deep-seated economic reforms, has it raced ahead. Its nominal gdp is now five times India’s. The dragon has slowed its pace, but even so, it is still adding the equivalent of a quarter of India’s economy every year. If India were to sustain its gdp growth per person of 7%—about its average for the past two decades—to 2030, it would barely have got to where China is today. And even that may prove ambitious. Now, with alarming speed, India has gone from being the world’s fastest-growing large economy to something more like a rumbling Indian railway train. Believing its own boosterism, the government failed to see the signs. Businesses are watching to see what will follow. There are rumours of a sweeping privatisation drive. But it is unclear whether Mr Modi’s reforming side can override his conservatism, which reflexively favours an interventionist state, protectionist trade policies and the opinions of Hindutva trade unions, small business lobbies and ideologues.

Some progress

These tensions played out during Mr Modi’s first term, which saw the introduction of some welcome reforms. A long-overdue bankruptcy law theoretically reduced the time to settle a business failure from around four years to nine months. The gst did, for all its paperwork, abolish absurd interstate duties and so sped up internal commerce. Fiscal discipline kept inflation modest. Infrastructure—and in particular power supplies—improved substantially. Over the past decade 30m more Indians every year have been connected to the electric grid, which now reaches 90% of all homes. India climbed a stunning 65 places up the World Bank’s Ease of Doing Business Index and pulled in record hauls of foreign investment, totalling more than $35bn in each of the past three years.

Yet the government shied away repeatedly from risking its political capital on deeper structural reforms. Labour laws that make hiring and firing too expensive remained a block to growth, as did laws making it hard for companies to acquire land. Such blockages continue to hamstring efforts to expand India’s manufacturing base, Chinese-style, to create plentiful low-paid factory jobs for rural migrants. Instead of supporting small business, the government experimented with shock demonetisation, fancy new taxes and heavier enforcement. Rather than promoting trade, it scrapped existing bilateral deals, raised tariffs and sparred with the wto. Disappointing his own business constituency, Mr Modi dodged calls to privatise some banks, industries and utilities, instead forcing healthy state-owned firms to swallow sick ones.

Though foreign direct investment stayed strong in Mr Modi’s first term, all but a trickle of the new money poured into services and a few big acquisitions, rather than job- or export-generating industry. All the while, talk of Indian growth obscured such facts as declining farmgate prices, stagnant urban wages, flat exports, rising household debt, a long-term decline in savings and investment rates, and flat or falling consumer spending. since the country’s statistics agency changed its methodology in 2011, there had been growing divergences between calculations of gdp and a range of other indicators. The doubters, who include Arvind Subramanian, the government’s chief economic adviser from 2014 to 2018, do not suggest foul play but rather poor methodology, compounded by the difficulty of measuring an “informal” sector that makes up 45% of the economy and accounts for 75% of employment. If the critics are right, growth since 2011 may have been overstated by 2-2.5% a year. Indeed, the strongest proof that growth was overstated may be that India appears to have driven off course. The current slump can largely be ascribed to policies followed in the mistaken belief that India was hurtling along at 7-8% annual growth, when the reality was more like 5-6%.

Since the slowdown has taken hold, Ms Sitharaman has scrapped the most onerous of new taxes and compliance rules. She also announced the government would support nbfcs, and top up a range of schemes meant to ease access to export credits and housing loans. Amid a series of rate cuts by the rbi, the government also imposed a slew of mergers between state-owned banks that will, in theory, improve their books and make them keener to lend. The sudden move to slash company taxes came with a further sweetener, a two-year window for new industrial investments to attract a rate of just 17%. Businesses have broadly welcomed all these moves, as well as having their tax cut by a third, but concerns persist. Though the supply-side tinkering helps, it does not indicate personal attention from Mr Modi, let alone the kind of policy shift many feel is needed to kick-start growth. “The lack of economic vision baffles me,” says a conservative think-tank scholar who now regrets voting for Mr Modi. “They get this monster electoral verdict, and then do nothing?

Turning ten stodgy state banks into four bigger ones, for instance, may indeed strengthen the financial sector in the long term. More immediately, though, it ties up the institutions just when the economy needs them. The government promises to buy itself more cars, and to lower interest rates on housing for public servants, but neglects stronger demand-side prods such as rural public works. Ms Sitharaman talks of tweaking export credits and speeding tax reimbursements for exporters, when letting the overvalued rupee drop would boost exports even more. She has chastised tax officers for being overly aggressive, but aside from the cut in corporate rates that simply brings India closer to world averages, has proposed no other bold tax relief. This is badly needed. India has some of the world’s most convoluted taxes, and enforces them with gusto. GST paperwork is tricky. Rates for some goods are ruinously high. Cement and cars are taxed at 28% (plus hefty further taxes for cars), which is odd if you wish to save manufacturing jobs or spur housing investment. Some personal stories are hair-raising. One luxury-goods executive complains that inspectors invaded his home at gunpoint in the middle of the night and held him and his wife hostage for two days, threatening jail for not co-operating as they poked through his cupboards. They found nothing, but left the businessman shaken. He has decided to leave the country.

Can’t rely on unicorns

Despite the gouging, the government is faced with a chronic deficit. It pretends this is a mere 3.4%, but after allowing for hidden off-budget liabilities and state debts, overall government borrowing is closer to 9%. August brought a reprieve, with a hefty and controversial dividend payment from the central bank to shore up revenue. But those off-budget fudges, demands from states and shrinking tax receipts will soon start to squeeze the exchequer. The gloom is not universal. The $180bn it sector, centred on boomtowns like Bengaluru (formerly Bangalore) and Hyderabad, continues to prosper. nasscom, an industry body, counted 7,200 start-ups in 2018, of which eight became “unicorns”, valued at over $1bn. Tata Consulting Services passed another milestone for Indian it firms, reaching a market capital of $100bn. The sector cannot pull the rest of India along, however, and has its own limits. nasscom predicts that automation is likely to shrink the number of it jobs—currently more than 4m—by some 14% in the next five years. Population growth, rising productivity and growing aspirations can probably propel a big, diversified economy at a steady 5%. Barring a global crisis, even without ambitious new policies, India may be able to climb out of the current doldrums. Returning to the trajectory of 7-8% growth would take a little longer. With luck, in a few years’ time, the present slump may be regarded as a useful catalysing moment, like the economic crisis of 1991 that sparked India’s initial market reforms. But bringing back the brash, risk-taking ebullience of the mid-2000s will not be easy. Many believed Mr Modi when he promised achhe din—good times—in 2014. Starting his second term with a deep slump, he has no one to blame but himself. Worse, say critics, he has no one to turn to. Ms Sitharaman is tough and straight, but her team does not inspire confidence. “We always had bad institutions, but a few really talented people—ninjas who could go in and make things work,” says a former finance-ministry mandarin. “Now it’s a Trumpian wasteland.”

20 - Twenty Four

The consecration of the Ram temple in Ayodhya, a city in Uttar Pradesh, in January was a matter of supreme importance to Narendra Modi, India’s prime minister; attendance was thus de rigueur for those seeking his approval. The attendant courtiers included not just politicians, officials and foreign dignitaries but also India’s biggest corporate bosses. Uttar Pradesh is not their normal stamping ground, and Ayodhya has not until recently been much of a destination for tycoons. Now it has 115 hotels under construction, and some of those January visitors may soon be finding reasons to return.

Uttar Pradesh, known as up, is India’s most populous state and also one of its poorest. With 240m people, it would be the world’s sixth-largest country. Its nominal GDP per person is $1,000, less than half the national average; on that basis it would rank around 174th in the world, alongside Tajikistan and Togo.

But over the past five years it has been growing at an annual rate of 5.3%—a percentage point faster than the national average—and, since 2021, at 9.2%. The state government’s investment, as a percentage of output, is the highest in India, at 6.6%, says hdfc Bank. New roads crisscross the state. up’s chief minister, Yogi Adityanath, a keen follower of Mr Modi, is clearing red tape and cracking down on crime to attract business. One vivid example: the liquor trade, long a source of financing for criminals, is becoming part of the formal economy, as shown by rising tax receipts.

Talk of India’s economic prospects often focus on Bangalore, the tech hub, or Mumbai, the financial center. But Mr. Modi’s ambition of viksit Bharat, or developed-country status, by 2047 (in the form of a GDP per head of $14,000) needs a broader perspective. It is one in which all the 28 states are capable of competing against each other economically, giving business leaders opportunities beyond the prosperous south.

There are signs that this is happening. In February Tata Electronics said it would invest $3bn in a chip plant in Assam, creating 27,000 jobs in the remote state. In May, what will be India’s biggest vaccine plant will open in Odisha, a middling state on the rise. But the needed change is only just getting under way.

The almost 7% solution

The idea that Mr. Modi is a strong economic manager is one reason Indians, who go to the polls this month and in May, are likely to give him a third ﬁve-year term in office. GDP grew at a blistering 8.4% in the year to the fourth quarter of 2023 (though the underlying trend is closer to 6.5% because of quirks in how India measures GDP). But overall growth during Mr. Modi’s tenure has not been remarkable by the country’s standards since it embarked on a path of liberalization in the early 1990s. That was when India’s elites decided that the highly regulated socialist system (the “license raj”) of the decades following independence needed wholesale reform, a process which has played out with remarkable continuity, despite changing political tides. Over three decades of reform, growth has averaged 6.4% a year. Though it has averaged 5.6% during the decade of Mr. Modi’s rule, that has been in line with a broader slowdown in global growth.

Since 2021 India has been the world’s fastest-growing large economy

Yet robust growth since the pandemic and a strong outlook ahead has pleased voters and impressed outside observers, not least because it is measured against a world where growth remains sluggish. Since 2021 India has been the world’s fastest-growing large economy, and 6.5% growth would be more than twice the global average. If that average stays around 3%, India would account for 15% or more of the total this decade. But compared with other countries in the recent past, the rate might seem disappointing. East Asian countries grew at rates above 10% in their heyday. China and India had similar incomes per person in the 1980s. China is now five times richer.

Few in India believe the country can achieve double-digit growth. The East Asian countries benefited from huge inflows of foreign investment and the exports of a job-rich low-skill manufacturing sector. That helped them deepen their links to global value chains at a time of rampant globalisation. India’s rise began later and followed a different path. That is hardly a surprise; in its size, religious and linguistic variety, it is unique. Governmental responsibilities are divided between the centre and the states in ways that make rapid reform tricky.

India’s path has, therefore, been singular: its exports have been led not by manufacturing but by a productive yet job-poor it and services sector, and its companies are led by a handful of sprawling conglomerates along with a long tail of small informal businesses. Sustaining growth rates of 6% or more would be consequential. Goldman Sachs, a bank, expects India to become the world’s third-largest national economy this decade. Bump growth rates up just half a percentage point, cross your fingers and extrapolate wildly and it could even reach the number-one spot by 2070 (see chart 1), though it would still only be half as rich as China and a quarter as rich as America per person (see chart 2).

To achieve that growth, and have a fighting chance of boosting it, the future must look different. Because of the country’s remarkable diversity, there is no simple national nostrum. It will need everything from increasing competitiveness in labor-intensive sectors like textiles to growing prowess in high-tech sectors that blend services and manufacturing. That will require a deeper single market to boost domestic business, more innovation to export at the global frontier, and a stronger state that delivers on basic services to ensure India’s copious young talent is unleashed.

Cleaning up

Mr. Modi’s two terms have seen progress on some of this. The financial sector has been cleaned up and enjoys growing global credibility. The corporate sector has a return on equity above the global average. That reflects a healthier business environment, including a national goods-and-services tax, introduced in 2017, that works across state lines and creates revenues which exceed those of the old state-based system. Public-infrastructure investment is surging (see chart 3); the national road network has grown by 60% over ten years, double the rate of the previous decade.

Digital infrastructure has become even more impressive. Building up the national identity system called Aadhaar, begun by the previous government, has laid the foundation for a payment system that 300m Indians use every month (see chart 4). It has also enabled most households to get a bank account. Welfare payments are now paid electronically and credit is easier to access. The number of new business registrations in India has tripled since 2015.

But there is no avoiding the economy’s shortcomings. The labour market is weak, with a majority of Indians underemployed or out of the labor force altogether. That limits consumption, and exports do not make up the shortfall. Indian education is partly to blame and cities lack the governance needed to accommodate vast shifts of people from rural to urban areas, a potential boon for productivity. Tackling these issues needs a lot more co-operation between central and state governments than financial reform does, and better relations with state governments have not been Mr. Modi’s strong suit. Some, like up’s, are led by politicians of the prime minister’s stamp. Many are not.

Mr Modi’s muscular management style has had some benefits, not least pushing through some big national projects. It has also strayed into bullying and an increasingly authoritarian approach. Yet the country’s basic political structure is still democratic, so consensus-building will be needed. Thirty years of reform have laid a foundation for India to reach scale. To achieve its potential, a new agenda just as ambitious as that of 1991 is needed. In surveying the landscape to ascertain where India is heading, a good place to start is where it has turned weakness into strength: the financial sector. ■

Surprise Winner - India’s financial system has improved dramatically in the past decade

There is much more change to come

In “lombard street”, the City of London’s success was based on taking funds that elsewhere were kept under floorboards, and putting them to use. He might have found what is unfolding in modern India to his liking.

But for those dormant funds to be used, the system first had to be repaired. In 2013, the year before Narendra Modi became prime minister, Morgan Stanley, a bank, had grouped India with other financially troubled countries—Brazil, Indonesia, South Africa and Turkey—into what it called the “fragile five”. India’s weak capital markets were contributing to three big problems: financial and balance-of-payments instability; no way for ordinary people to save; and a high cost of capital for business. There was also high inflation and a growing problem of non-performing loans at state-run banks.

Ten years on, inflation is stable (if a little high) and India is less dependent on capital flows from abroad. It has large foreign-exchange reserves, strong domestic savings, and adequate exchange-rate management. More change is needed. But reforms have moved it to a position of comparative strength. Indian finance, and thus India itself, is becoming more credible.

In 2010 state-run banks, then the largest component of the financial system, were rotten and threatened to drag down the rest. But in 2013, the previous government brought in a professor from the University of Chicago, Raghuram Rajan, to run the Reserve Bank of India (rbi). He initiated an “asset quality review” that put an official stamp on the country’s “twin-balance-sheet problem”, the holes on both bank and corporate balance sheets. In 2016 a new bankruptcy code was introduced. Bad loans worth $106bn were written off, and there was an injection of government money, forced financial consolidation and new rules.

Between 2017 and 2019, the government merged 27 government-run banks into 12. Rules were changed to allow dbs, a Singaporean bank, to acquire Lakshmi Vilas bank in 2020, allowing an outsider to have a large branch network for the first time. The tighter reporting regime brought revelations which led to the failure of five major Indian financial institutions.

Cliff edge

It looked like India might fall off a financial cliff. In retrospect, an inflection point had been reached. Non-performing loans at state-controlled banks have since declined from 15% in 2018 to 4% of assets.

As the weakest components of the system were strengthened, other aspects that had been seeded decades before came into their own, starting with a handful of new private banks. hdfc Bank, founded in 1994, is now the world’s tenth-most valuable bank by market capitalisation. It returns 16% on equity. JPMorgan, America’s leading bank, returns 12%; European banks, on average, just over half that.

The new healthier system has enabled credit to be available for consumption, housing and industry. The private banks have boosted the number of branches by 60% since 2015 to 163,000 (America has 78,000). This has had a huge effect in villages, as consumer finance has shifted from local lenders charging 10% per week to bank loans at annual rates of 15% or below.

The big push to help poor people open basic bank accounts—520m have been opened since 2014, and they now hold $28bn—has been crucial, helping to transform India’s masses into savers, providers of capital and, possibly, entrepreneurs. Since the accounts are linked to India’s new digital payment and identification system, they are records that can be used to evaluate and grant credit. This may explain a recent increase in lending to small businesses.

Stockmarkets, too, are booming, reflecting the success of Indian business and the expansion of available capital. Ten years ago, capitalisation of India’s stockmarkets was smaller than Spain’s. Now neck and neck with Hong Kong’s, only America’s, China’s and Japan’s surpass them. Based on long-term growth rates, bcg, a consultancy, says India’s will become the second-largest in 2036. The proportion of the population owning shares of some sort has risen from 7% to 20% since 2019. Small monthly payments into mutual funds through “systematic investment plans” have risen sharply. From 2013 to 2023, fund assets under management rose by over 600%. They now account for 9% of equity holdings in the Indian market. Money flowing into the stockmarket is not idle. A record number of firms has gone public already in 2024.

In developed markets, this kind of growth could seem like a bubble, and that may be part of the story. It may also just be catch-up. A study by Deepak Parekh, one of the architects of India’s private financial system, found that fund assets equate to only 17% of gdp, compared with an average of 80% in developed markets. This “under-penetration” is clear in other areas such as consumer credit, totalling 37% of gdp compared with 62% in China and 80% in America.

The Indian financial system is slowly reconfiguring itself to deal with these imbalances. In 2006, 56% of assets were in the banking system. In 2022 the proportion was 48% and bcg predicts that will shrink to 36% by 2030 (see chart). In place of the banks will come components of more mature capital markets: funds, pensions, insurance companies, private equity and more venture capital. Life Insurance Company of India, listed by the government in 2022, was the world’s fourth-largest life insurer in 2023 by market value. A common theme in these expanding sectors is their desire to use capital to foster growth.

Not everything is rosy. A surge of foreign venture capital starting in 2020 has imploded as a result of some big tech startup failures, from a record $42bn in 2021 to $2.5bn in the first quarter of 2024. Commonly published valuations of private firms are being written down; many will crash. But none of this seems to affect the general public or the domestic stockmarket.

The bond market, too, is still in an early stage of development. It has grown and become more free, but it is still run to finance the government and is largely unavailable for all but the largest firms. Even for them, the long-term debt that is best suited for the big capital investments that India needs is often unavailable, and must be obtained overseas, with additional costs. However, a healthier system creates its own opportunities. India has asked all the big global ratings agencies to upgrade its borderline junk status, which has been left unchanged since the mid 2000s.

An upgrade would signal India’s rising stature. It would also help to lower the capital costs which impede investment and growth. The most solvent companies pay 8% or more on bank loans, compared with under 6% in Singapore or America and under 2% in Japan. What is more, a high sovereign rating would provide an underpinning for the issuance of long-term corporate debt.

In September, JPMorgan will be adding India to a government-bond index, in January Bloomberg indicated it will do the same. Foreign portfolio investment hit a record $40bn in the year to March. Money is being put to better use. Bagehot might applaud. ■

Functioning Anarchy - India’s difficult business environment is improving

The changes are allowing Indian firms to become more dynamic

Ramesh muthuramalingam founded Alphacraft, a manufacturing firm, 25 years ago in a small workshop in the southern city of Coimbatore. It now operates out of a 4,500 square-metre (50,000 square-foot) factory, piled with aluminium cast parts. It employs 400 people and will soon open a second facility of similar size. Customers include Indian startups, notably Ola Electric, a fast-growing local scooter manufacturer, and global companies including Britain’s Aston Martin and America’s John Deere.

Foreign firms are newly interested in companies like Alphacraft because of three shifts: a desire to lessen their dependence on China; a belief that Indian production can now meet global standards; and the fact that India itself is a fast growing market that favours local production for its own products.

In the past, the biggest block to growth was not customers, but financing, says Mr Muthuramalingam. For most of the firm’s existence, interest rates over 15% were common, if money was available at all. Over the past year, the rate it pays has fallen to 10%. Availability has improved, though the long-term debt best suited to capital investment remains scarce. The shift to a single goods-and-services tax, electronically filed, has made sales in other states easier.

The growth and diversification of firms like Alphacraft suggest India is becoming more open. A spate of pro-business policies, some of which began under previous governments but have been pursued by the current one, have been crucial for this. That is why most of corporate India backs a third term for Mr Modi.

In 2019 the top 20 companies in India earned 79% of all profits

The reforms also reflect a broader change going on within Indian business. A century ago the American corporate world, after a period of frenetic growth, underwent profound structural change as owners gave way to professional managers, and companies reconfigured themselves in accordance with shareholder demands. Some of that is now happening in India.

Professional eyes

Based on the market value of holdings, what are known in India as “promoters” (that is, those who have a controlling stake in the company, usually the founders or their descendants) still own slightly more than half of the value of companies trading on the Indian exchange. A study by the National Stock Exchange has found that control of companies by promoters declined between 2009 and 2019; though that trend has since levelled off, other evidence suggests that non-promoter management is increasingly valued. A survey by ema Partners, an executive-search firm, on million-dollar compensation packages showed the number of outsiders who have reported salaries which put them in that bracket has risen from 61 in 2016 to 119 in 2023.

The difficulties of doing business in India and the lack of broadly available finance are two reasons why large conglomerates have dominated the economy—they have been able both to obtain finance and handle a prickly state. But there are hints of change. A study by Marcellus, a money-management firm, concluded that in 2019 the top 20 companies in India earned 79% of all profits. The figure fell to just 38% in the fiscal year ending in March 2023. The share of the bse500’s market capitalisation held by the top 10 firms has fallen from 33% to 26% in the same period. The shift is being driven by the expanding breadth of successful companies. The number of listed firms valued at more than $1bn has increased 20-fold since 2000.

That said, the big conglomerates are still influential. Reliance Industries dominates telecoms and refining, and is expanding into entertainment. The Adani Group is the largest manager of airports and seaports and the second-largest producer of cement and power. Though broader corporate concentration may be weakening, these firms have seen continually increasing market shares. The recent data could turn out to be a post-covid blip. Tata Sons is, through subsidiaries, the biggest of all, owning the largest it consultancy and interests in cars, hotels and steel. The Bajaj Group owns the largest non-banking finance company and builds appliances, motorcycles and rickshaws.

State-controlled firms also continue to play a big role. The collective valuation of those listed on India’s stock exchanges is $804bn. Hindustan Aeronautics (defence), pfc (financing of energy projects) and the State Bank of India all dominate their sectors. A handful of foreign-controlled firms remain important, including Hindustan Unilever and Nestlé in consumer products, Maruti Suzuki and Honda in vehicles, and Google and Amazon in tech. And some global supply chains have shifted as India has become the “+1” in an increasing number of China+1 strategies.

But other foreign consumer-product companies, such as Whirlpool, and giant pharmaceutical companies, such as AstraZeneca, as well as cultural icons such as Disney, are reducing their stakes or teaming up with a local partner, having found that India is a tough place to go it alone. Foreign-direct-investment flows into India, which surged in 2020 to 6.2% of the world’s total, have since fallen to a decadal low (1.1% of the world in the third quarter of 2023). This is partly due to higher interest rates, but also because of the tough operating environment for foreign firms.

Formal eyes

Many Indian companies are now doing well. Leverage has been declining since 2015, such that the finance minister recently said India has swung from the weakness of overleveraged banks and firms to the strength of healthy banks and underleveraged firms. Return on equity for listed companies has been improving since 2019 and exceeds the global average. Profits, lockdown excepted, have been rising strongly since March 2018. The economy has been boosted as informal activities like village money-lending and pushcart sales shift to banks and stores.

There have been pockets of disaster. Byju’s, an ed-tech firm that was once India’s highest-valued startup, at $22bn, is now almost insolvent. Paytm, another star of the short-lived venture-capital boom of a few years ago, played a critical role in spreading electronic payments in India. It was valued at $20bn at the time of its ipo in 2021. Its share price has fallen 73% from the post-offering peak, a reflection of how hard it is to turn a valuable service into a profitable business.

But smaller manufacturing firms are growing. States such as Tamil Nadu, home of Alphacraft, are being transformed by them. Along the new roads there, a vast electronics-assembly industry has emerged, led by local firms like Tata and foreign ones like Foxconn and Pegatron. There are new factories for electric vehicles, green-energy products, shoes and clothing. Since 2021, $10bn has been invested in 130 new projects in the state, with another 48 under way.

One important new development is “global capability centres”—tech centres used by the world’s biggest firms. Unlike the outsourced call centres of old, these also provide engineering, semiconductor design and r&d automation, as well as product development. In Tamil Nadu new entrants include ups and Roche Pharma. Some 1,600 others across the country serve firms such as hsbc, Target and Tesco. These centres are, in some ways, like the Chinese factories manufacturing for foreign firms, but more important. They do not just take orders; increasingly they give them, too.

It is now possible to set up a company entirely online

Since their product is data, they are immune from much of the craziness of doing business in India, from bad traffic to obstructive customs procedures. A new study by Wizmatic, a consultancy based in Pune, says they employ 3.2m people, generating $121bn in revenues including $102bn in foreign currency from exports, making them one of the biggest sectors in India.

Stable eyes

The government has become increasingly pro-active in helping all of these changes. It has done much to clean up and stabilise the financial sector. Administrative changes have led to a surge in business creation. A central-government department has been created to remove obstacles to doing business. In 2020 it became possible to set up a company entirely online. In the same year the government introduced “production-linked incentives” (pli) in 14 sectors, which involve direct payments of at least 4% of revenues, to help firms get established and then phase them out once scale has been achieved. In 2019 corporate taxes were reduced from 35% to 25%.

Against this background, India is becoming more innovative. A study by PatentVector, an analytics firm, showed the valuation of Indian patents has more than tripled over the past five years, as the filing process has been simplified. A private space industry has emerged, with more than 200 firms filling the sector. Two are on the verge of launching rockets.

Many problems remain. Ease of doing business has not improved enough. Legal disputes are backlogged—as of December, there were 50m cases pending in the courts. It remains hard to obtain usable land, to initiate redundancies, and to hire on the basis of merit. New projects can still require dozens of permits. Too much still revolves around finding, and buttering up, the person who can get things done.

All this may explain why the government’s capital investment push has yet to “crowd in” the private sector to the degree Mr Modi would like. The Economist’s analysis of firms in the bse500 index of listed firms, using data from Bloomberg, shows that investment as a share of revenues was 6.3% in the financial year to March 2023, down from 7% before covid. Optimists hope that announcements of new projects, which rose to decadal highs in 2022, indicate an impending surge.

There is also policy uncertainty. Taxes and tariffs on imports and exports change frequently. The demonetisation of the two-largest banknotes in 2016 crushed small businesses and startled large ones. Firms worry about political interference, and whether the rule of law is reliable in India. According to data collected by Henley and Partners, a consultancy, India had a net outflow of 14,000 millionaires in 2022 and 2023, the highest after China and just beating Russia.

Much change still needs to happen. But that the government is even being talked about as a growing part of the solution, rather than the biggest part of the problem, makes it clear how far India has come. ■

A tricky trio - India’s leaders must deal with three economic weaknesses

For growth to become more sustainable, it needs to be broader based to tackle Insufficient Demand, Inadequate Workforce Participation and Geographical Inequality in Economic Benefits

When Shashi Tharoor, a stalwart member of parliament for the opposition Congress Party, criticises the current growth model as “trickle-down economics” that doesn’t trickle down, he has a partial point. Estimates of this nature are fuzzy, but from 2000 to 2022, the wealth share of the top 1% of Indians grew from 33% to 41%, making India the second-most unequal major country in the world, after Brazil. In other ways, though, the problem is a lack of trickle up. The economy is not allowing those with low incomes to become a source of growth.

India’s economy has three intertwined deficiencies: its poverty means there is not enough demand; there are not enough people in the workforce; and there is not enough geographical spread in the benefits of growth. The progress that the country has made in reducing the effects of poverty through redistribution goes some way to minimising the pain of these deficiencies; the standard of living is improving (see charts). But if economic growth is to last, these deep-seated deficiencies must be addressed. Start with the lack of demand. Though India’s gdp is $3.7trn, just 60m of its people earn over $10,000 a year. That is less than 5%. Over the past decade consumption per head grew by just 2.5-3% a year.

When domestic demand is insufficient, the obvious answer is to tap into foreign demand through exports. A casual comparison to the rise of China might suggest that, blessed with the largest pool of cheap labour in a single market that the world has ever seen, India should be a manufacturing giant exporting to all and sundry. Part of the reason that it is not is that too much of that cheap labour is unskilled. But there are other factors at play.

Bhuvana Anand of Prosperiti, a Delhi-based think-tank, points out that the Indian reforms of the 1990s were restricted to the national level; regulations on land and labour, which are state matters, went mostly untouched. That is in stark contrast to the reforms which were turning China into an export powerhouse at the same time: there land and labour markets were very flexible. Even today, India has laws that require factories to get state permission to fire workers if they have over 100 employees on the books. One reason the tech sector has so outperformed manufacturing is that it has been far less regulated, says Poonam Gupta of Mr Modi’s Economic Advisory Council.

What is more, as Raghuram Rajan and Rohit Lamba observe in “Breaking the Mould”, a recent book, China’s growth created a world where following in its path is no longer an option. China already serves the world as a workshop, and manufacturing has become more automated. The power China has derived from its growth at a time of rapid globalisation is one of the reasons why the world is now de-globalising, a development that helps India in as much as “China+1” policies may favour it but which is also a big challenge.

Pawan Goenka, a retired businessman who heads a government committee on advanced manufacturing, says that today Indian exporters are at a big cost disadvantage compared with those in China. He breaks the gap down into logistics costs, high factor costs (such as for power), the tariffs other countries put on Indian exports and a lack of scale on the part of the ﬁrms involved—“All of which”, he says, “are being worked on.”

Infrastructure investment can help with logistics, and the government can do something about trade. Having fought shy of trade agreements for some time, Mr Modi’s government is now pursuing a number of them in the hope of cutting tariffs on its exports of agricultural goods, cars and textiles.

On the basis that these and other measures will take time to have their desired effects, the government is also offering subsidies to encourage exporters: a $26bn pot of production-linked incentives (pli) for firms (including foreign ones) in 14 industries. With only $1bn disbursed to date, some have doubts about the government’s commitment to the scheme.

Churn out those e-widgets

Electronics have emerged as a bright spot. In 2023 came the news that Apple planned to increase its production of iPhones in India, then around 7% of global supply, to 20% by 2026; it is reported to have already reached 14%. Google will soon begin making Pixel phones in India. Apple’s confidence suggests that, with openness to foreign companies, India can compete in high-tech products. But that has yet to change the overall trajectory. India’s share of global manufactured exports is flat. Corporate investment and foreign direct investment have yet to take off.

Not cracking the export market limits the demand for labour, contributing to a sluggish job market: the second deficiency, and one that is being exacerbated by demographics. Over half India’s population is under 25. Every year 10m people join the workforce. That should be a boon for the economy. Unfortunately it is not creating productive jobs at a commensurate rate.

Getting a handle on the true size of the problem is hard, particularly when it comes to women, whose labour-force participation is particularly low. Anantha Nageswaran, the government’s chief economic adviser, noted in a recent column that one should expect women to drop out of market-based work as families shift away from agriculture and incomes increase. Indeed, the Nobel prize in economics in 2023 was awarded partly for work showing that female labour-force participation follows a “u-curve” as countries develop, dropping and then rising again. Yet this phenomenon should apply broadly, and India’s rate seems to be well below that in other countries (see chart). There are many complex factors behind this. But there are also simple ones like restrictive labour laws; in many states, for example, women are not allowed to work night shifts.

What is more, the shift away from agriculture which might drive such a change is hard to see. The share of Indian employment in agriculture remains high at 43%, up from 41% in 2019. Data for 2022-23 suggest that real consumption grew only about 3% a year in rural areas and 2.4% a year in urban areas, on average, since the last survey in 2012.

The third deficiency is variation in performance across regions. Southern cities like Bangalore are as rich as southern Europe. Parts of the north are like sub-Saharan Africa. The government in Delhi is trying hard to help poor regions, much to the annoyance of rich ones which contribute the bulk of tax revenue. Some poor states, like up, are attracting investment. Yet over the past decade, the gap in income per person between the southernmost seven states and the 21 others has grown from 35% to 50%. Five states in the south are home to 66% of it-services exports and 30% of foreign direct investment despite having less than 20% of the population.

Move it, move it

There are signs that interstate competition is spurring investment in some poor states. But large-scale migration is also needed. India has 100m temporary migrants who work in rich areas and send remittances back home. Yet permanent movement, where migrants bring their families, appears too small to compensate for higher birth rates in poor states.

India has found ways to alleviate some of this. The government has given most poor households bank accounts to which it sends welfare payments directly. In the fiscal year to March 2023, it sent $45bn in cash (1.2% of gdp) this way. There are countless other programmes. “We’ve built 40m houses, enough for every person living in Australia; 110m toilets, one for every German; and piped water for 253m citizens, that would cover everyone in Brazil,” says Amitabh Kant, Mr Modi’s sherpa to the g20. Include numerous state-level programmes and you have a system in which part of India grows and compensates the rest. Poverty rates (at a threshold of $2.15 a day in 2017) have fallen from 40% in 2000 to just 13% today. Life expectancy is up, and infant mortality down.

Arvind Subramanian, the government’s chief economic adviser in 2014-18, notes the new welfare set-up involves the “public provision of private goods”. In a healthy market economy, citizens would buy their own cooking gas. Governments would focus on public goods like education; private consumption and exports would fuel growth. In the light of the three deficiencies, the government has stepped in. ■

Stellar solar - Going green could bring huge benefits for India’s economy

But it is also bringing plenty of tensions

Every day 1,000 trucks jostle along a single-lane road to Khavda, near India’s border with Pakistan, to build the Adani Group’s 730 square kilometre solar and wind farm. When completed, the project, with 30 gigawatts (gw) of capacity, could provide 4% of India’s current electricity consumption.

In all, Gautam Adani plans to build 45gw of renewable-energy capacity by 2030. Between them, he and Mukesh Ambani, India’s biggest tycoon, will together invest $150bn over the next decade in renewables. Over the past five years, over 80% of the newly installed generating capacity in India has been in the renewable sector. Narendra Modi, the prime minister, wants to increase renewable capacity to 500gw by 2030.

Impressive stuff; also sorely needed. India’s coal-fired power plants are a major contributor to the atrocious outdoor air quality that killed around 1m Indians in 2019; add this burden to the indoor air pollution which kills around 600,000 and the total effect is calculated to be costing India 1.4% of annual output, according to a study in the Lancet. The power stations also pump out a lot of carbon dioxide: 1.8 gigatonnes in 2022, 12% of all the world’s emissions from coal, and rising. India’s share of the world’s cumulative emissions from fossil fuels and industry is very low: just 3%. But as a country which will be very badly affected by a hotter climate, it has a powerful interest in future emissions being as low as possible, and that will mean cleaning up at home.

Despite all this, India’s emissions continue to rise. Coal-fired power stations have allowed a tripling in the country’s electrical power consumption in the past 20 years. Even if its renewable goals are reached, which would require the pace of the build-out to increase from today’s 15gw a year to almost 60gw a year, the rate at which consumption is growing leads the government to think more will be needed: 80gw of new coal capacity by 2031, according to R.K. Singh, the minister for power.

There are clear incentives for doing more. Solar panels are cheap and getting cheaper, and India is a sun-drenched place, making them even better value than they are elsewhere; what is more, roof-top solar is heavily subsidised. Solar installations which allow businesses to reduce their reliance on the state-owned power-distribution commissions offer the potential for big savings: the “discomms” have long charged industry extra to subsidise agriculture.

There are also barriers to bring down. The government is slashing red tape to get renewable projects connected to transmission systems faster and using reverse auctions to prioritise the most cost-effective ones. If solar power brings with it electric vehicles, there are more big wins. Electric scooters and cars will not just further reduce air pollution and reduce the economy’s exposure to global oil prices, a chronic source of vulnerability. Those manufactured in India, or using Indian batteries (Ola Electric is building a battery gigafactory in Tamil Nadu which it says will be the largest in the world), could also, with the right trade deals in place, offer an exciting export market, offering the world an alternative to those exported from China.

It will not be plain sailing. Among other things, China does not want a rival. Sumant Sinha, the boss of ReNew, a clean-energy firm, says the country is blocking the export of equipment to make solar wafers so as to prevent India gaining a foothold in green supply-chains. Indian diplomats accuse China of “dumping” batteries , electric vehicles and other clean-tech goods on global markets. Green ambitions have put India in the middle of a trade war.

India’s solar power rollout is flagging - Protectionism is choking the supply of solar panels

When olaf scholz meets Narendra Modi in Delhi this weekend, India’s green-energy targets will be at the top of the agenda. In Berlin last May the German chancellor committed €10bn to help India meet its ambitious goal of generating 500gw of power from non-fossil-fuel sources by 2030. India’s prime minister will have some impressive progress to regale Mr Scholz with. Renewable sources now make up 121gw of India’s 411gw of power-generation capacity, up from 113gw when the two men met in Berlin. Yet there is a significant blot on this progress. By the end of 2022, India had installed a total 63gw of solar-power capacity. That represented a 14gw increase over the year, but was far short of the government’s 100gw target. Given the importance of solar to India’s ambitions, this was ominous. Of India’s 500gw goal for 2030, 280gw is expected to come from solar. Most of the shortfall is in panels mounted on rooftops, which the government envisages will account for 40% of total solar generating capacity.

Even as the growth of overall capacity has accelerated, rooftop installation has slowed. Just 8gw of India’s solar-power generation is small-scale, and most of it is atop offices and factories, which pay higher rates for grid electricity, as opposed to residences. Three factors discourage Indians from topping their homes with sun-soaking panels. The first is that most Indian cities, whose residents are likeliest to have the requisite cash and technological know-how, already have reliable grid power and many demands on rooftop space. Urban rooftops tend to be crowded with satellite dishes, water-tanks and other paraphernalia, or used as social spaces. Or landlords may build extra rooms on them.

A bigger obstacle is a shortage of suitable financing for small-scale renewable-energy installations. A 5kw solar unit, sufficient to power most homes, costs at least 250,000 rupees, or about $3,000. And yet the average monthly household electricity bill in Mumbai, an expensive city, rarely exceeds 5,000 rupees. Without attractive financing, Indian households have insufficient incentive to go green. And energy companies also have too little incentive to promote rooftop solar. It works on the basis of “net metering”, whereby the value of the electricity a rooftop unit supplies to the grid is deducted from the household bill. And since the households likeliest to install panels are those paying the highest bills, utilities tend to consider this arrangement a net loss. Central and state governments are experimenting with ways to realign the incentives behind rooftop solar. Haryana, a small state next to Delhi, requires new buildings to get a portion of their electricity from it. In Jharkhand, a poor eastern state, the government is considering topping up the central government’s subsidies for rooftop solar to make it free for low-income households. India is developing a bouquet of such policies, says Ashwini Swain of the Centre for Policy Research, a think-tank in Delhi. “If all materialise, we will probably overshoot the target.” If that proves optimistic, it will probably be because of another bottleneck: protectionism.

To boost domestic manufacturing, the government slapped a 40% import tariff on Chinese panels and decreed that panels used in most solar projects be sourced from an “approved list” of Indian panels and panel-makers. Reducing India’s reliance on China in this area seems prudent. And having robust domestic production, says Nandita Sahgal of ThomasLloyd, an investment company with 434mw of solar fields in India, might make it easier “to have the capacity of installation that India is projecting”. Yet, for now, domestic output is not keeping pace with demand. To supply solar projects that have been approved with domestic panels would take seven years, the minister of power, R.K. Singh, said earlier this month. “But we can’t wait seven years.” The government therefore relaxed its procurement rules for two years. That will allow imports of panels from South-East Asian countries with which India has a free-trade agreement. But the tariff on Chinese panels remains. ■

Building for the future - India must make much deeper changes if it is to sustain its growth

Improved human capital and a better relationship between the centre and the states will be crucial

At the start of the 18th century India was one of the world’s two largest economies, with China the other. Part of that came down to sheer population and, in India’s case, being colonised by the country which led the Industrial Revolution put paid to that. When it achieved independence from Britain in 1947, India made up just 3% of the world economy (adjusted for purchasing power). In 1991, when its great liberalisation started, the figure was 1.1% (at market exchange rates). Today it is 3.6%, spread between 18% of the world’s population. If it can keep growing at 6% or more, as it has for the past 30 years, then by the time of the modern country’s 100th birthday, it will represent 10% or more of the world economy. And depending on assumptions about growth elsewhere, it could be back in the top rank by the 2070s.

But 30 more years of such growth is a tall order, and it will need a wider and deeper national consensus than that which drove the past 30 years of liberalisation. It will require a new compact between central government, state government and the cities where growth will be concentrated. And, India being India, it will require flexibility. There is no simple one size fits all for the world’s most populous and diverse country.

Some of this can be achieved by deepening the liberalisation which has been supported by most of India’s elites so far and which can be achieved by central government on its own, electoral politics permitting. An obvious part of this agenda is trade.

For much of his tenure, Mr Modi has been ambivalent about trade deals, reflecting a belief that past deals hurt India. The country “signed ftas with all the wrong countries...for all the wrong reasons,” says an industrialist who advises Mr Modi. The industrialist adds, though, that there is growing recognition that growth requires exports, and exports require deals. The exact contours of the new strategy are unclear but, since 2021, India has done deals with Australia, the uae and, in March, four small European states. Britain could follow. The biggest prizes are the markets of America, the European Union and Asia. Though America is off the table because of its own domestic politics, negotiations with the eu are ongoing.

A side-benefit of liberalisation would be that India could step back from the subsidies it currently offers exporters. A recent analysis by researchers at icrier, a think-tank, suggests the subsidies and tariffs are partly cancelling each other out. Average tariff levels have grown from 13% to 18% in the past decade, driving up the prices of imported goods which exporters need, as India’s domestic suppliers are too meagre to be an adequate substitute. The fact that the government has its feet on both accelerator and brake may explain why the subsidies have not yet borne much fruit.

There is also much the central government can do to boost the tax base. India’s tax-to-gdp ratio is a middling 18% and has barely budged over the past decade. Just 0.3% of Indians pay 76% of income tax, suggesting the base needs to expand. One impact is an 80% debt-to-gdp ratio, the third largest among big emerging economies, which brings with it interest payments which eat up 20% of the annual budget. The introduction of the goods-and-service tax (gst) shows that tax reform is possible and can increase revenues. Further simplifying the tax system would boost compliance and returns.

One of the things more revenue might be used for is r&d. India’s r&d spending is 0.7% of gdp. In China it is 2.4%, in oecd countries, on average 2.7%. Companies are especially lagging in India. Naushad Forbes, a boss in Maharashtra, says that Samsung, a South Korean firm, spends more on r&d than all of India combined. More money would keep top researchers in India. Cutting bureaucracy would, too. International collaboration remains mired in red tape.

There are other ways to improve the government’s budget. Divestment from state-owned entities would cut overall debts as well as opening more of the economy up to competition. An obvious place to cut spending is on agricultural subsidies, which make up nearly 10% of the budget. But these are a political minefield into which the prime minister has made only a few forays, none of them successful.

The centrifugal and the centripetal

One of the things which might help him do so is a new relationship with the states. The division of power between the centre and the states is one of the things which makes India possible—and also one of the things that can make governing it feel impossible. Many of the reforms which seem obvious to outsiders but remain undone are in domains where the Indian constitution divides power between centre and states (as with labour, energy or schooling) or invests it in the states alone (as with land).

Exporting to the global frontier requires innovation

Building consensus is thus a necessity, not just among elites, as has been done with the case for liberalisation since the 1990s, but among groups nationwide whose interests are often only partially aligned. India’s late finance minister, Arun Jaitley, was crucial to the passage of the gst because he helped convince state governments to sacrifice autonomy for the sake of the national market. No one has taken on that role.

The need for more such bridge-builders is great; only by securing active participation between all levels of government will the reforms of tomorrow be achieved. Take the deepening of the internal market, which is vital to providing jobs and new scope for growth. At the national level a new labour code is still restrictive, but it has at least shortened a list of rules. The obstacles are even greater at the state and local levels. Contract enforcement remains weak. One study found that filling judge vacancies in district courts would produce economic gains 30 times the costs. Land-use restrictions and highly indebted state-run energy-distribution companies raise costs for firms.

Or take schooling. Any serious plan to boost Indian growth also requires far deeper human capital beyond the elites. This is true even if you think India should focus on manufacturing. The boss of a global manufacturer that is planning to double its rate of investment in south India this decade, says he faces bigger talent bottlenecks hiring for roles like design and marketing than for factory workers.

India now has near universal enrolment in primary school. But aser, a nationwide survey, suggests that outcomes plateaued in the 2010s and then fell during the pandemic. In 2022 only two-fifths of students leaving primary school in rural India could read a text intended for second-years. Teacher pay is not bad, yet teacher absentee rates are often 20-30%, suggesting poor governance. And teaching is parochial, too. One of the barriers to internal migration is that schools often teach in regional languages, not national ones. Much as central government might like to drive reform, it cannot; the machinery of education operates at a state and local level to which it has no access.

Leaders within the bjp do not deny this. They suggest the fact that states are increasingly competing with each other for investment, as Mr Modi did when he ran Gujarat, is a reason for optimism. Some think the central government should use its control over most tax revenues as a stick and a carrot to incentivise more states to follow national priorities. Still others argue that if only the bjp had control over more states, as it does through leaders like Yogi Adityanath in Uttar Pradesh, and a whacking majority in the centre, the country’s problems would be solved. But there are reasons to think something deeper and subtler is needed.

Softly, softly

Much of what India needs—from making courts efficient to shoring up education—depends on improved capacity, especially at the local level. In 1992 India amended its constitution to shift many functions of government to the local level. But the amendment stayed on paper. As N.K. Singh, the chairman of the 15th Finance Commission observes, “the three F’s—funds, functionaries and functions” did not follow. Just 15% of government employees work at the local level: in China and America the figure is 60%. Local government spending accounts for a paltry 3% of resources, compared with 50% in China.

Local does not necessarily mean small-scale. The problems of “governance mismatch” are acute in big cities, where elected mayors are ceremonial and control sits with state-appointed bureaucrats less responsive to local concerns. Much of India still sees itself as fundamentally agrarian, and so governance often ignores the needs of cities. “The joke is that you become the chief minister of Maharashtra in order to gain control of Bombay,” says an adviser to the government. Since most growth comes from the cities this matters a lot. The increasing need for cities to become centres of innovation, with well-run universities surrounded by entrepreneurs, makes the issue particularly pressing.

Broadly speaking, the quality of Indian government is proportional to the scale on which it is exercised. This makes the idea of delegating power down the chain of governance seem fraught to central and state governments alike. But for a really large country to develop quickly some such restructuring is necessary. Chinese reformers under Deng Xiaoping realised this early on. India has yet to grasp the nettle.

A national conversation is needed to obtain the buy-in of groups that stand to lose from reform. Mr Modi has made progress extending his party’s support among lower-class groups, but there is still a big divide between urban and rural areas and between the centre and the southern states, and Mr Modi has stirred up animosity towards Muslims and other minorities. In 2020 he tried to reform agriculture, but pushed through the changes without consulting anyone, causing massive protests, and ended up backing down. Bolstering city governance has stalled because no one wants to give up power.

India is a diverse democracy, in which no party has ever won more than half the vote, and a federal one made up of 36 diverse states and territories. Leaders cannot bulldoze everything through. That is why building a lasting consensus around reform is essential to sustaining India’s rise, a consensus as enduring as that on liberalisation in the early 1990s but far wider based. If that can be done, not only will 1.4bn people be better served, but the world at large could have a new engine of growth. ■

How India could become an Asian tiger

The world’s most selective bureaucracy is struggling to make it happen

Is india achieving its potential? In the year to the third quarter of 2023, the country grew at a blistering rate of 8.4%. Over the next half-decade it is expected to expand at 6.5% a year, which would make it the world’s fastest-growing big economy. So far, so good. The problem, as critics point out, is that China, Japan and South Korea all expanded at 10% or so a year during their periods of rapid growth. Part of the reason for India’s less impressive figures is a slowdown in globalisation. But a new book by Karthik Muralidharan of the University of California, San Diego, called “Accelerating India’s Development”, argues that the crucial barrier to faster development is a lack of “state capacity”.

Mr Muralidharan describes this concept as the “effectiveness” of government. Throwing money at a state lacking capacity is like adding fuel to a car near a breakdown: it won’t get you very far. Currently, the Indian state succeeds when on “mission mode”, achieving clearly defined goals. In April it should pull off the largest democratic exercise in history, as voters pick a prime minister. At the same time, it struggles with mundane, everyday aspects of governance, such as education and health. Three in five rural children in the fifth year of school cannot read at a second-year level—and in the past five years the failure rate has only worsened.

Part of the issue is the precociousness of Indian democracy. The franchise became universal in 1950, when the country was mostly impoverished. Citizens demanded that the state met their basic needs well before it had the money or capacity to do so. India launched its food-security programme in the 1960s, for instance, when it was a fifteenth as rich per person as America was when it launched its own such programme in the 1930s. This set a pattern: the Indian state does a lot, but little well.

In his 800-page tome, Mr Muralidharan lays out fixes. The book is crammed with details about how the Indian system works and could be improved. Three ideas stand out. They concern how the state should manage people, use technology and improve its federal system. And they hold lessons for other governments.

Since 2002, when Mr Muralidharan was a graduate student, he has been conducting surveys on absentee rates. It turns out that teachers skip school perhaps as often as pupils: they are absent 20-30% of the time. The problem is not pay. In 2017 a study by Rohini Pande of Yale University found that across 33 countries, India offered the second-highest wage premium to public-sector employees. Rather, the problem appears to be governance. School supervisory positions have ultra-high vacancy rates of 20-40%. Mr Muralidharan calculates that filling such roles would be ten times more cost-effective than hiring more teachers.

Such problems reflect a strange approach to civil-service management. About 1m Indians apply each year for about 1,000 slots, making it one of the most selective bureaucracies in history. Yet India has just 16 public employees per 1,000 people, one of the lowest ratios in the world. Indian officials also hop from position to position across various different tiers of government, moving every 15 months on average. As a recent retiree notes, this means that they have far too little time to develop proper expertise in any one area. Therefore problems go unresolved.

Better data would help. It should not take an academic survey to ascertain rates of teacher absenteeism. Official numbers on educational outcomes paint a far rosier picture than those collected by independent organisations. Schools and low-level bureaucrats have incentives to cheat. As such, Mr Muralidharan suggests digital data collection, audits and stiffer accountability.

A running theme throughout the book is the need to pay attention to India’s federal structure. The country has 28 hugely diverse states, 15 of which are big enough to be in the top fifth of the world’s countries by population. Historically, Indian politicians have fallen prey to cycles of corruption in which companies bribe leaders in exchange for favours, with leaders then using the money to fund expensive campaigns that involve, in effect, bribing voters. In some states, this cycle is starting to break down. Campaigns promising to get stuff done are precisely what propelled Narendra Modi, India’s prime minister, to fame when he ran the state of Gujarat.

Progress in the “third tier” of government, which is made up of villages, towns and cities, has been less impressive, however. Deng Xiaoping, China’s leader from 1978 to 1989, introduced reforms that rewarded local officials for their economic performance. India could use something similar, especially if states granted their local authorities more resources and power. Of the 18 similar countries looked at by Mr Muralidharan, India was the least decentralised when it came to fiscal affairs. Just 3% of state spending happens at a local level, compared with 51% in China. In 2000 three Indian states—Bihar, Madhya Pradesh and Uttar Pradesh—were split in two. So was Andhra Pradesh in 2014. All four splits have led to faster economic growth.

Go-faster stripes

There is much else in Mr Muralidharan’s book. But changes to personnel, data and federalism would together represent the beginnings of a reform package that could do wonders for India’s governance, and therefore its growth. Indeed, the sheer variation in performance across India’s cities and states demonstrates the potential benefits. Karnataka, a large and reasonably well-run state, is six times richer per person than Bihar, the country’s poorest state—making India one of the world’s most geographically unequal countries. Internal migration is relatively rare, which means that for incomes to grow faster, poor states will have to get their act together. The changes outlined by Mr Muralidharan will be tough to enact, but not impossible. And if some states make the leap, they may inspire others to follow their example. ■

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