India's Sliding Doors Moment - Part 1

The future may hold economic and political success... or failure.

Perhaps a legacy of the past twenty-five years—when its WTO membership marked the start of a profound global economic transformation—China remains a favourite in the news. Once heralded as a global opportunity, there is little doubt that China is now viewed as a significant stability risk within the Western community.

While it is evident that we should keep our eyes on China, I argue in this series of two papers that India warrants considerably more attention than it currently receives. India’s vast economic and political opportunities to the Western world are well researched and reported. But I read much less about the risks that Indian stellar growth and aggressive economic strategy could pose to world stability in adverse but plausible scenarios.

Let’s begin with the economy (political risks and opportunities will be addressed in “India’s Sliding Doors Moment - Part 2”, so stay tuned!)

India has just become the most populous country in the world and has been showcasing impressive economic growth rates recently. For this trend to be sustained over the coming decades, India’s approach is to enhance the manufacturing component of its overall economic activity substantially. 

The Re-manufacturing strategy

The current administration has approached this challenge far more effectively than earlier governments.

As a developing economy, India boasts a massive service sector and very little manufacturing, especially considering its economic development stage (see the chart below comparing India’s manufacturing value added to countries with similar income per capita). Historically, the advancement of manufacturing has been hindered by inadequate or unreliable infrastructure (energy, logistics, etc.). 

This situation created a dependence on imports of manufacturing goods (mostly from China) and sub-par productivity gains, as those are normally supported by high-end manufacturing activity (see chart below).

The current administration has approached this challenge far more effectively than earlier governments. The past failure of various industrial strategies stemmed from the same fundamental issue: although subsidies were allocated to generate new economic activity, the latter struggled to flourish due to inadequate infrastructure.  In contrast, the current Prime Minister has decided to address the issue by targeting its root cause (unreliable infrastructure), thereby fostering the growth of industrial activity on a much more stable foundation.

Central to this strategy is the PM Gati Shakti scheme (PMGSS). Launched in 2021, this extensive initiative focuses on developing logistics infrastructure—especially multi-modal connectivity. If it proves successful, manufacturing companies will be able to prosper with access to far more dependable infrastructure to meet their requirements. 

Projected to cost USD 1.2 trillion by 2025, the initial three years of the initiative have been regarded as a success, funded through deficit spending and foreign direct investment inflows. India has also initiated discussions to implement the scheme internationally—essentially its answer to China's One Belt One Road.

With the plan’s continued success, the government anticipates a significant increase in the manufacturing sector's contribution to total value added, currently at very low levels. This would enhance labour productivity and introduce a new growth mechanism, making the present GDP rise more resilient over an extended period and accelerating the real convergence of the Indian economy.

Revamping the Indian manufacturing sector presents a distinct opportunity for Indian involvement in the supply chains of global corporations. These companies are actively seeking to de-risk their supply chain, which essentialy means limiting their exposure to China. Preferred alternative locations—such as Vietnam or Bangladesh—are either oversaturated or politically unstable. With its large workforce and consumer market, low operating expenses, English proficiency, and strong emphasis on STEM education, India could emerge as an increasingly viable alternative to China for the supply chains of global corporations.

In an alternative scenario, opportunities mutate into risks

If the economic opportunities for India are very clear, some risks to its strategy might frustrate growth and trigger economic volatility.

Firstly, India is not alone in pursuing industrialisation; advanced Western economies are also doing so. The intricacies of the geopolitical landscape are prompting a surge of industrial policies aimed at reducing external reliance, particularly concerning strategic goods. Whereas China reaped substantial benefits from the commitment of advanced economies to delocalise significant portions of their manufacturing from 2000 to 2015, India will now face competition from countries eager for manufacturing growth. This competition will be particularly pronounced in higher-value-added production of advanced goods. As such, there is the risk that India’s extensive initiatives in re-manufacturing will primarily yield an increase in low-end production, which is less profitable and generates lower productivity.

Second, the continued success of the PM Gati Shakti plan is heavily reliant on India’s ability to attract foreign investment, particularly as the initiative approaches its most sensitive phase after the easily attainable gains have been secured. The government aims at reducing fiscal deficit that had surged with COVID and the initial two years of PMGSS. Continued progress hinges on private investment, especially FDIs, as global companies reap the benefits from the initial achievements of PMGSS. 

Recently, FDI inflows have accelerated, yet over 60% originated from the United States. A potential new Trump administration could probably result in a decline in US investment abroad— the Republican candidate's 'MAGA' agenda may encourage corporations to invest domestically. Note how even during the first Trump administration (2016-2020), US FDIs to India had decreased (see chart below).

Finally, India's appeal as a manufacturing centre relies heavily on a consistent and dependable supply of energy and electricity.  The country imports almost 85% of the oil it needs (second largest oil importer). In 2021, before the Russian invasion of Ukraine in 2022, only 2% (approximately 80K barrels per day) came from Russia. By May 2024, Russia represented 41% of India's oil imports (almost 2.4 million barrels per day). While India has generally framed its newfound reliance on Russian oil as ‘opportunistic’ (due to the significant oil price discount obtained – approximately 8% according to some sources), the reality is that reverting to its previous suppliers would significantly raise oil import costs for India, particularly as tensions in the Middle East are causing disturbances in oil markets. More on this in the next section of this study (politics). 

In summary, the Indian economy is transforming into something different. According to its leaders' vision, India would become a manufacturing hub, gradually incorporating Western supply chains migrating away from China. This would bolster India's ability to sustain its economic growth at current rates and accelerate real convergence. However, in an alternative scenario—where Western nations aggressively pursue re-manufacturing strategies, a new Trump administration emerges, and geopolitical tensions escalate—the risk of collapse for the government initiatives increases significantly, and India could fail to establish a sustainable and resilient trajectory for the world’s most populous nation.