The star duo – one a famous investment strategist, the other a Nobel Prize winning economist – highlight three critical risks facing the Indian economy, risks which we believe are poorly appreciated in the broader investment fraternity.
Firstly, India’s economic muscle in IT Services and its massive diaspora remitting money back home brings $350bn+ of annual inflows into the country, something that no developing country has ever seen before. This allied to foreign investor inflows creates a very real risk of an overvalued currency. If India is to thrive with an overvalued currency, the Indian economy will need to become far more efficient: “On the domestic front, India is on the cusp of an even greater inflow of FDI and portfolio investors. Such capital has many benefits, of course, including job creation, technology transfer, and greater access to cheaper funding.
But as other countries’ experience shows, large inflows require rapid adaptation of policies and policymakers’ mindsets, as well as measures to overcome internal resistance from domestic incumbents. Otherwise, the benefits will be more than offset by the serious threat of macroeconomic instability, severe resource misallocation, excessive risk taking, and corruption.”
Secondly, environmental issues are already becoming an increasingly prominent challenge for those of us who live in India (eg. smog in the winter, water scarcity in the summer, floods during the monsoons, etc). The authors warn that the sort of economic growth India seems destined for will make these environmental issues even more acute: “Carbon dioxide emissions, another dimension of global impact, paint a similar picture. India ranks behind only China and the United States in terms of overall CO2 emissions. But this, again, is a function of its large population; its per capita emissions are still quite low, at 1.89 metric tons, well below the global average of 4.66 metric tons.
Moreover, India already has plans to reduce its emissions. The chart below, from a 2022 McKinsey Sustainability report, depicts alternate decarbonization pathways that it could take. The “line of sight” (LoS) scenario (the royal blue line) reflects the anticipated adoption of existing technologies, policies, and commitments that have already been implemented or announced, whereas the accelerated scenario captures further-reaching measures such as carbon pricing and carbon capture, utilization, and storage (CCUS).
But even the LoS scenario seems very aggressive to us. With overall CO2 emissions peaking in the mid-2030’s, and with 7% annual growth in the interim, it will be achieved only if the carbon intensity of the economy declines at an equally rapid pace. But over the past decade, McKinsey notes, India’s carbon intensity declined at a rate of 1.3% per year. If India manages to stay on the LoS path, its per capita CO2 emissions would peak at 2.71 metric tons – something that has never been done before.”
And, thirdly, the authors contend that if India is to avoid becoming an international outcast like China then deep & early engagement with the global powers is a must: “With India expected to remain the world’s fastest-growing major economy, policymakers face the increasingly complex challenge of balancing external and internal interests, while still maintaining the country’s growth and development trajectory….
Recent history shows that the necessary internal course corrections, as well as the ability to shape international perceptions, can come late or be insufficient. As a result, a country’s (or a company’s) secular transformation can end up being more complicated than it needs to be.
This is not just about India playing defense to manage the growing international expectations that come with increased regional and global influence. It is also about playing offense. The Indian economy is reaching the point where maintaining reliable access to international markets is not just valuable but also important as a development priority.
One of India’s major challenges is to avoid the error that both China and Big Tech made when they failed to recognize their newly acquired global influence and adapt accordingly. In China’s case, policymakers remained too narrowly focused on their domestic development agenda as the country was becoming more systemically important. By the time China woke up to the external realities associated with a growing global footprint, it was already getting serious pushback from other countries. These responses piled up and ultimately created major complications – including by exacerbating domestic challenges – which could now derail, or at least hamper, China’s impressive development journey.”
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